nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒07‒14
nineteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Social Trust and Central-Bank Independence By Berggren, Niclas; Daunfeldt, Sven-Olof; Hellström, Jörgen
  2. The Two-tier foreign exchange market and the conduct of monetary policy: The Belgian case during Bretton-Woods era By Alain Durré; Philippe Ledent
  3. How should monetary policy respond to changes in the relative price of oil? considering supply and demand shocks By Michael Plante
  4. The effectiveness of forex interventions in four latin american countries By Carmen Broto
  5. Central bank credibility and the persistence of inflation and inflation expectations By J. Scott Davis
  6. Do real balance effects invalidate the Taylor principle in closed and open economies? By Stephen McKnight; Alexander Mihailov
  7. Forecasting Inflation Risks in Latin America: A Technical Note By Rodrigo Mariscal; Andrew Powell
  8. PCE inflation and core inflation By Julie K. Smith
  9. Inflation Targeting and Fiscal Rules: Do Interactions and Sequence of Adoption Matter? By Jean-Louis Combes; Alexandru Minea; Rene Tapsoba
  11. Do good institutions promote counter-cyclical macroeconomic policies? By César Calderón; Roberto Duncan; Klaus Schmidt-Hebbel
  12. Sovereign risk, European crisis resolution policies and bond yields By Kilponen , Juha; Laakkonen, Helinä; Vilmunen, Jouko
  13. The Signaling Effect of Exchange Rates: pass-through under dispersed information By Waldyr Areosa; Marta Areosa
  14. Does Foreign Exchange Intervention Volume Matter? By Rasmus Fatum; Yohei Yamamoto
  15. What should core inflation exclude? By Alan K. Detmeister
  16. Responding to a shadow banking crisis: the lessons of 1763 By Stephen Quinn; William Roberds
  17. The Euro Experience: A Review of the Euro Crisis, Policy Issues, Issues Going Forward and Policy Implications for Latin America By Carlos Hurtado
  18. The creation of euro area financial safety nets By Michiel Bijlsma; Shahin Vallée
  19. Interest rates and business cycles in emerging economies: The role of financial frictions By Fernández, Andrés; Gulan, Adam

  1. By: Berggren, Niclas (Research Institute of Industrial Economics (IFN)); Daunfeldt, Sven-Olof (HUI Research AB); Hellström, Jörgen (Umeå School of Business and Economics)
    Abstract: Central banks have been made more independent in many countries. A common rationale has been the existence of a credibility (or lack-of-trust) problem for monetary policy. This indicates a possible and until now unexplored link between social trust and central-bank independence. Our empirical findings, based on data from 149 countries, confirm that there is such a link, in the form of a u-shaped relationship. We suggest that two factors help explain this finding: the need for this kind of reform and the ability with which it can be implemented. At low trust levels, the need for central-bank independence is strong enough to dominate the low ability; at high trust levels the ability for reform is high and dominates the low need; at intermediate trust levels there is neither need nor ability strong enough to generate very independent central banks.
    Keywords: Trust; Credibility; Reforms; Monetary Policy; Inflation; Central Bank; Time Inconsistency
    JEL: E52 E58 P48 Z13
    Date: 2012–05–23
  2. By: Alain Durré (IESEG School of Management); Philippe Ledent (Economics School of Louvain, Belgium)
    Abstract: This paper attempts to better understand the monetary policy decisions under the Belgian two-tier foreign exchange market during the Bretton-Woods system. Whereas this type of market organisation aimed at insulating the domestic currency from (speculative) capital flows, it is questioned whether monetary authorities did (or not) really pay attention to the free market when setting the monetary policy interest rate in practice. Using a Taylor-rule type approach, it is shown that the volatility of the spread between the two segments of the foreign exchange market has played a growing role in the interest rate dynamics over time. Moreover, a Markov switching model applied to the data provides evidence of two separate periods towards the collapse of the Bretton-Woods System, during which the monetary policy concerns have gradually changed.
    Keywords: Two-tier market, Taylor rule, Bretton Woods, Markov switching model
    JEL: E42 E58 C32 C24
    Date: 2012–06
  3. By: Michael Plante
    Abstract: This paper examines optimal monetary policy in a New Keynesian model, where the relative price of oil is affected by exogenous supply shocks and a productivity-driven demand shock. When wages are flexible, stabilizing core inflation is optimal and the nominal rate rises (falls) in response to a demand (supply) shock. When both prices and wages are sticky, core inflation falls (rises) in response to the demand (supply) shock. Stabilizing CPI inflation generates small welfare losses only if the demand shock is the main driver of oil prices. Based on a VAR estimated using post-1986 data for the U.S., both shocks have had minimal impacts on core inflation. The federal funds rate rises in response to the demand shock but falls in response to the supply shock, consistent with the predictions of the theoretical model for a policy that stabilizes core inflation.
    Keywords: Price levels ; Economic development
    Date: 2012
  4. By: Carmen Broto (Banco de España)
    Abstract: Many central banks actively intervene in the foreign exchange (forex) market, although there is no consensus on its impact on the exchange rate level and volatility. We analyze the effects of daily forex interventions in four Latin American countries with inflation targets — namely, Chile, Colombia, Mexico and Peru — by fi tting GARCH-type models. These countries represent a broad span of intervention strategies in terms of size and frequency, ranging from pure discretionality to intervention rules. We also provide new evidence on the presence of asymmetries, which arise if foreign currency purchases and sales have different effects on the exchange rate. We find that first interventions, either isolated or initial in a rule, reduce exchange rate volatility, although their size plays a minor role. Our results support the signaling effect of interventions under inflation targeting regimes
    Keywords: Exchange rate volatility; Foreign exchange interventions; GARCH
    JEL: F31 G15 C54
    Date: 2012–07
  5. By: J. Scott Davis
    Abstract: This paper introduces a model where agents are unsure about the central bank's inflation target. They believe that the central bank's inflation target could lie between two extremes, and their beliefs vary depending on the central bank's stock of credibility. They form the expectations used in price and wage setting using this perceived inflation target, and they use past observations of inflation to update their beliefs about the credibility of the central bank. Thus a series of high inflation observations can lead them to believe (incorrectly) that the central bank has adopted a high target. High inflation expectations are incorporated into price and wage setting decisions, and a transitory shock to inflation can become very persistent. The model with endogenous credibility can match the volatility and persistence of both inflation and measures of long-term inflation expectations that we see in the data. The model is then calibrated to match the observed levels of Federal Reserve credibility in the 1980s and the 2000s. By simply changing the level of credibility, holding all else fixed, the model can explain nearly all of the observed changes in the volatility and persistence of inflation and inflation expectations in the U.S. from the 1980s to today.
    Keywords: Price levels
    Date: 2012
  6. By: Stephen McKnight (El Colegio de México); Alexander Mihailov (University of Reading)
    Abstract: This paper examines the implications for equilibrium determinacy of forward-looking monetary policy rules in a Neo-Wicksellian model that incorporates real balance effects. We show that in closed economies the presence of small, empirically plausible real balance effects significantly restricts the ability of the Taylor principle to prevent indeterminacy of the rational expectations equilibrium. This problem is further exac- erbated in open economies, particulary if the monetary policy rule reacts to consumer- price, rather than domestic-price, inflation. These findings still hold even when output and the real exchange rate are introduced into the policy rule, thereby suggesting that the widespread neglect of real balance effects in the literature is ill-advised.
    Keywords: equilibrium determinacy; real balance effects; trade openness; forward- looking inflation targeting; taylor principle
    JEL: E41 E52 F41
    Date: 2012–05
  7. By: Rodrigo Mariscal; Andrew Powell
    Abstract: There are many sources of inflation forecasts for Latin America. The International Monetary Fund, Latin Focus, the Economist Intelligence Unit and other consulting companies all offer inflation forecasts. However, these sources do not provide any probability measures regarding the risk of inflation. In some cases, Central Banks offer forecast and probability analyses but typically their models are not fully transparent. This technical note attempts to develop a relatively homogeneous set of methodologies and employs them to estimate inflation forecasts, probability distributions for those forecasts and hence probability measures of high inflation. The methodologies are based on both parametric and non-parametric estimation. Results are given for five countries in the region that have inflation targeting regimes.
    JEL: C53 E37
    Date: 2012–06
  8. By: Julie K. Smith
    Abstract: This paper investigates the forecasting accuracy of the trimmed mean inflation rate of the Personal Consumption Expenditure (PCE) deflator. Earlier works have examined the forecasting ability of limited-influence estimators (trimmed means and the weighted median) of the Consumer Price Index but none have compared the weighted median and trimmed mean of the PCE. Also addressed is the systematic bias that appears due to the differences in the means of inflation measures over the sample. This paper supports earlier results that limited-influence estimators provide better forecasts of future inflation than does the popular measure of core inflation, PCE inflation minus food and energy; therefore, these limited-influence estimators are core inflation.
    Keywords: Price levels ; Forecasting
    Date: 2012
  9. By: Jean-Louis Combes (CERDI - Centre d'études et de recherches sur le developpement international - CNRS : UMR6587 - Université d'Auvergne - Clermont-Ferrand I); Alexandru Minea (CERDI - Centre d'études et de recherches sur le developpement international - CNRS : UMR6587 - Université d'Auvergne - Clermont-Ferrand I); Rene Tapsoba (CERDI - Centre d'études et de recherches sur le developpement international - CNRS : UMR6587 - Université d'Auvergne - Clermont-Ferrand I)
    Abstract: This paper analyzes the effects of Inflation Targeting (IT) and Fiscal Rules (FR) on fiscal behaviors and inflation dynamics. Its main novelty is twofold: first, it is the first study which accounts explicitly for the role of the interactions between IT and FR regarding their fiscal and inflationary effects. Second, it questions the optimality of the sequence of adoption of IT and FR. Using a wide panel of 152 developed and developing countries over the period 1990-2009, we find that adopting both IT and FR leads to better fiscal and monetary outcomes than adopting only FR or only IT. In addition, we highlight the dominance of the sequence which consists of introducing first FR before adopting IT with respect to the opposite sequence, regarding their fiscal and inflationary effects.
    Keywords: Inflation Targeting;Fiscal rules;Interactions;Sequence of Adoption
    Date: 2012–07–03
  10. By: Beatrice D. Simo-Kengne (Department of Economics, University of Pretoria); Mehmet Balcilar (Department of Economics, Eastern Mediterranean University, Famagusta, North Cyprus,via Mersin 10, Turkey); Rangan Gupta (Department of Economics, University of Pretoria); Monique Reid (Department of Economics, Stellenbosch University); Goodness C. Aye (Department of Economics, University of Pretoria)
    Abstract: This paper examines asymmetries in the impact of monetary policy on the middle segment of the South African housing market from 1966:M2 to 2011:M12. We use Markov-switching vector autoregressive (MS-VAR) models in which parameters change according to the phase of the housing cycle. The results suggest that monetary policy is not neutral as house price growth decreases substantially with a contractionary monetary policy. We find that the impact of monetary policy is larger in bear regime than in bull regime; indicating the role of information asymmetry in reinforcing the financial constraint of economic agents. As expected, monetary policy reaction to a positive house price shock is found to be stronger in the bull regime. This suggests that central banker reacts more in bull regime in order to prevent potential crisis related to the subsequent bust in house prices bubbles which are more prominent in bull markets. These results substantiate important asymmetries in the dynamics of house prices in relation to monetary policy, vindicating the advantages of generating regime dependent impulse response functions.
    Keywords: Monetary policy, House prices, Regime switching
    JEL: C22 C32 E52 R31
    Date: 2012–07
  11. By: César Calderón; Roberto Duncan; Klaus Schmidt-Hebbel
    Abstract: The literature has argued that developing countries are unable to adopt counter-cyclical monetary and fiscal policies due to financial imperfections and unfavorable politicaleconomy conditions. Using a world sample of 115 industrial and developing countries for 1984-2008, we find that the level of institutional quality plays a key role in countries' ability to implement counter-cyclical macroeconomic policies. The results show that countries with strong (weak) institutions adopt counter- (pro-) cyclical macroeconomic policies, reflected in extended monetary policy and fiscal policy rules. The threshold level of institutional quality at which monetary and fiscal policies are a-cyclical is found to be similar.
    Keywords: Interest rates ; Monetary policy ; Fiscal policy
    Date: 2012
  12. By: Kilponen , Juha (Bank of Finland Research); Laakkonen, Helinä (Bank of Finland Research); Vilmunen, Jouko (Bank of Finland Research)
    Abstract: We study the effects of the ECB monetary policy and the European crisis resolution policies on the 10 year sovereign bond yields of seven European countries. We find that some of the decisions have had significant impact on sovereign bond yields and have succeeded in reducing stress in the financial markets. However, the impact of the same policy decision might have been positive for some countries while negative for others, suggesting that contagion effects may be important. The economically most significant effects on the bond yields have been due to the announcement of ECB's Securities Market Programme.
    Keywords: bond markets; policy effects; liquidity; European sovereign debt crisis; monetary policy
    JEL: E42 F34 G15
    Date: 2012–06–15
  13. By: Waldyr Areosa; Marta Areosa
    Abstract: We examine exchange-rate pass-through (ERPT) to prices in a model of dispersed information in which the nominal exchange rate imperfectly conveys information about the underlying fundamentals. If the information is complete, ERPT is also complete. Under dispersed information, we derive conditions under which our model displays three properties that are consistent with the stylized facts of pass-through. First, ERPT lies between 0 and 1 (incomplete ERPT). Second, ERPT is usually higher for imported goods prices than for consumer prices (exchange rate-consumer price puzzle). Third, there is a link between ERPT and macroeconomic stability.
    Date: 2012–06
  14. By: Rasmus Fatum (School of Business, University of Alberta); Yohei Yamamoto (Department of Economics, Hitotsubashi University)
    Abstract: We investigate whether foreign exchange intervention volume matters for the exchange rate effects of intervention. Our investigation employs daily data on Japanese interventions from April 1991 to April 2012 and time-series estimations, non-temporal threshold analysis, as well as binary choice models. We find that intervention volume matters for the effects of intervention, but only to the extent that the exchange rate effect per intervention unit is magnified in a linear sense by the larger intervention amount. This is a policy-relevant finding that also adds to our understanding of how intervention works.
    Keywords: Foreign Exchange Market Intervention; Intervention Volume
    JEL: E52 F31 G14
    Date: 2012–05
  15. By: Alan K. Detmeister
    Abstract: Consumer price inflation excluding food and energy often performs worse than other measures of underlying inflation in out-of-sample tests of predicting future inflation or tracking an ex-post measure of underlying trend inflation. Nonetheless, inflation excluding food and energy remains popular for its simplicity and transparency. Would excluding different items improve performance while maintaining the simplicity and transparency? Unfortunately, probably not. Averaging across a series of tests suggests that knowing what items to exclude before seeing the data is problematic and excluding food and energy is not a bad ex-ante guess. However, ex-post it is not difficult to construct an index which performs considerably better than excluding food and energy.
    Date: 2012
  16. By: Stephen Quinn; William Roberds
    Abstract: In August 1763, northern Europe experienced a financial crisis with numerous parallels to the 2008 Lehman Brothers episode. The 1763 crisis was sparked by the failure of a major provider of acceptance loans, a form of securitized credit resembling modern asset-backed commercial paper. The central bank at the hub of the crisis, the Bank of Amsterdam, responded by broadening the range of acceptable collateral for its repo transactions. Analysis of archival data shows that this emergency source of liquidity helped to contain the effects of the crisis, by preventing the collapse of at least two other major securitizers. While the underlying themes seem to have changed little in 250 years, the modest scope of the 1763 liquidity intervention, together with the lightly regulated nature of the eighteenth century financial landscape, provide some informative contrasts with events of late 2008.
    Date: 2012
  17. By: Carlos Hurtado
    Abstract: This policy brief reviews the experience of the countries under the Euro currency, focusing on those that have been under significant pressure in recent years— Greece, Ireland, Portugal and Spain, referred to as “emerging” economies. At first they experienced stable growth and converged to the most advanced countries, but subsequent adjustment has proven elusive due to macroeconomic conditions, worsening structural deficiencies, and incomplete integration. The conditions for the survival of the Euro zone are complex and still far from fulfillment. While Latin America has recently experienced a similar period of stable growth, there is no room for complacency. The main lesson from Europe’s experience is that Latin America must take advantage of the current context of growth, stability and optimism in order to carry out much-needed reforms that will leave countries adequately prepared to face a downturn in the world economy.
    JEL: E42 E61 E65
    Date: 2012–06
  18. By: Michiel Bijlsma; Shahin Vallée
    Abstract: The financial crisis has exposed the need to devise stronger and broader international and regional safety nets in order to deal with economic and financial shocks and allow for countries to adjust. The euro area has developed several such mechanisms over the last couple of years through a process of trial and error and gradual enhancement and expansion. Their overall architecture remains imperfect and leaves areas of vulnerabilities. This paper provides an overview of the recent financial stability mechanisms and their various shortcomings and tries to brush the outline of a more comprehensive safety net architecture that would coherently address the banking, sovereign and external imbalances crises against both transitory and more permanent shocks. It aims to provide a roadmap for further improvements of the current mechanism and the creation of new devices including a banking resolution mechanism and amore powerfulmechanismto provide financial assistance addressing both the sovereign and external dimensions of the shocks thereby reducing the need for the ECB to fill the current void.
    Date: 2012–07
  19. By: Fernández, Andrés (Research Department, Inter-American Development Bank); Gulan, Adam (Bank of Finland Research)
    Abstract: Countercyclical country interest rates have been shown to be both a distinctive characteristic and an important driving force of business cycles in emerging market economies. In order to account for this, most business cycle models of emerging market economies have relied on ad hoc and exogenous countercyclical interest rate processes. We embed a financial contract à la Bernanke et al. (1999) into a standard small open economy business cycle model that endogenously delivers countercyclical interest rates. We then take the model to the data. For this purpose we build a novel panel dataset for emerging economies that includes financial data, namely sovereign and corporate interest rates as well as leverage. We show that the model accounts well not only for countercyclical interest rates, but also for other stylized facts of emerging economies' business cycles, including the dynamics of leverage.
    Keywords: business cycle models; emerging economies; financial frictions
    JEL: E32 E44 F41
    Date: 2012–06–18

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