nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒09‒09
24 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The Exact Theoretical Rational Expectations Monetary Aggregate By William Barnett; Melvin J. Hinich; Piyu Yue
  2. A DSGE model for a SOE with systematic interest and foreign exchange policy in which policymakers exploit the risk premium for stabilization purposes By Escudé, Guillermo J.
  3. Central Banking for Financial Stability: Some Lessons from the Recent Instability in the United States and Euro Area By Wall, Larry D.
  4. The US monetary performance prior to the 2008 crisis By Li, Kui-Wai
  5. Two Crises, Two Ideas and One Question By David Laidler
  6. Is Openness Inflationary? Policy Commitment and Imperfect Competition By Richard W. Evans
  7. Money Velocity with Interest Rate Stochastic Volatility and Exact Aggregation By William Barnett; Haiyang Xu
  8. Imperfect Credibility and Robust Monetary Policy By Richard Dennis
  9. Heterogeneous distribution of money supply across the euro area By Jitka Pomenkova; Svatopluk Kapounek
  10. Exchange rate pass-through and inflation dynamics in Tunisia: A Markov-Switching approach By Khemiri, Rim; Ali, Mohamed Sami Ben
  11. A model of the euro-area yield curve with discrete policy rates. By Renne, J-P.
  12. Capital Adequacy and the Bank Lending Channel: Macroeconomic Implications By Shaw, Ming-fu; Chang, Juin-jen; Chen, Hung-Ju
  13. RMB Undervaluation and Appreciation By Zhibai, Zhang
  14. Three Essays on Robustness and Asymmetries in Central Bank Forecasting By Taro Ikeda
  15. Monetary policy and endogenous market structure in a schumpeterian economy By Angus C. , Chu; Lei, Ji
  16. Forecasting Inflation with a Simple and Accurate Benchmark: a Cross-Country Analysis By Pablo Pincheira; Carlos A. Medel
  17. The Evolution of Inflation Expectations in Mexico By Santiago García-Verdú
  18. The CAPM-Extended Divisia Monetary Aggregate with Exact Tracking under Risk By William Barnett; Yi Liu
  19. The Financial Market Impact of UK Quantitative Easing By Francis Breedon; Jagjit S. Chadha; Alex Water
  20. The endogenous money hypothesis and securitization: the Euro area case (1999-2010). By M. Lopreite
  21. Latin American Exchange Rate Dependencies: A Regular Vine Copula Approach By Rubén Albeiro Loaiza Maya; Luis Fernando Melo Velandia
  22. Which Financial Frictions? Parsing the Evidence from the Financial Crisis of 2007-9 By Tobias Adrian; Paolo Colla; Hyun Song Shin
  23. Central Banking for Financial Stability in Asia By Kawai, Masahiro; Morgan, Peter J.
  24. Bank Leverage Shocks and the Macroeconomy: a New Look in a Data-Rich Environment By Jean-Stéphane Mésonnier; Dalibor Stevanovic

  1. By: William Barnett (Department of Economics, The University of Kansas); Melvin J. Hinich (University of Texas at Austin); Piyu Yue (IC2 Institute at the University of Texas at Austin)
    Abstract: In aggregation theory, index numbers are judged relative to their ability to track the exact aggregator functions nested within the economy’s structure. Within the monetary sector, Barnett, Liu, and Jensen (1997) compared two statistical index numbers: the Divisia monetary aggregate and the simple sum monetary aggregate. They produced those comparisons using simulated data. In this paper, we again compare those two statistical index numbers with the exact rational expectations monetary aggregate, but we use actual data. Since we are not using simulated data, we estimate the parameters of the Euler equations and thereby of the nested monetary aggregator function using generalized method of moments. We explore the tracking errors of the two index numbers relative to the estimated exact aggregate. We investigate the circumstances under which risk aversion increases tracking error. We also use polyspectral methods to test for the existence of remaining nonlinear structure in the residual tracking errors.
    Keywords: Monetary aggregation, index number theory, spectral analysis, nonlinearity
    Date: 2012–09
  2. By: Escudé, Guillermo J.
    Abstract: This paper builds a DSGE model for a small open economy (SOE) in which the central bank systematically intervenes both the domestic currency bond and the FX markets using two policy rules: a Taylor-type rule and a second rule in which the operational target is the rate of nominal currency depreciation. For this, the instruments used by the central bank (bonds and international reserves) must be included in the model, as well as the institutional arrangements that determine the total amount of resources the central bank can use. The corner regimes in which only one of the policy rules is used are particular cases of the model. The model is calibrated and implemented in Dynare for 1) simple policy rules, 2) optimal simple policy rules, and 3) optimal policy under commitment. Numerical losses are obtained for ad-hoc loss functions for different sets of central bank preferences (styles). The results show that the losses are systematically lower when both policy rules are used simultaneously, and much lower for the usual preferences (in which only inflation and/or output stabilization matter). It is shown that this result is basically due to the central bank's enhanced ability, when it uses the two policy rules, to influence capital flows through the effects of its actions on the endogenous risk premium in the (risk-adjusted) interest parity equation. --
    Keywords: DSGE models,small open economy,exchange rate policy,optimal policy
    JEL: D58 F41 O24
    Date: 2012
  3. By: Wall, Larry D. (Asian Development Bank Institute)
    Abstract: Central banks have had an important role in maintaining financial stability through their lender of last resort role. As lender of last resort, the central bank is given enormous power which is normally tempered by a variety of limits. In the most recent crises in both the United States and euro area, the Federal Reserve and European Central Bank (ECB) have come under enormous pressure to take lender of last resort actions that exceed these normal bounds. This paper reviews the experience of these two central banks and draws some implications for future policy.
    Keywords: central banking; financial stability; united states; euro area; federal reserve; european central bank
    JEL: E50 E58 G28
    Date: 2012–09–04
  4. By: Li, Kui-Wai
    Abstract: This article uses a Structural Vector Autoregressive (SVAR) approach to study the different shocks to the monetary performance in the two decades of the US economy prior to the 2008 financial crisis. By using the Federal Fund Rate as a measure of change in the monetary policy, this study shows that interest rate expectation is informative about the future movement of Federal Fund Rate and the anticipated monetary policy should be one of the crucial reasons in causing monetary and financial deterioration in the US economy. This article discusses a possible conjecture of a low interest rate trap when a persistent and prolonged low interest rate regime led to financial instability.
    Keywords: monetary shocks; interest rate; financial crisis
    JEL: C32 O51 E52
    Date: 2012
  5. By: David Laidler (University of Western Ontario)
    Abstract: Specific ideas about the Fisher relation between real and nominal interest rates and more general ideas about the nature of the central bank's duty to support the financial system in times of crisis were important to the Monetarist re-assessment of the causes of the Great Depression and what this event implied about the inherent stability of the market economy. Aspects of the evolution of these ideas since the Depression and the role that they have played in recent debates about the Great Recession are discussed, and some tentative conclusions about the validity of Monetarist ideas are drawn.
    Keywords: Great Depression; Great Recession; Fisher relation; interest rate; monetary policy; central bank; lender of last resort; quantitative easing; money supply; deflation; inflation; monetarism; economic stability
    JEL: B22 E44 E58 E65
    Date: 2012
  6. By: Richard W. Evans (Department of Economics, Brigham Young University)
    Abstract: This paper proposes a channel through which increased openness to international trade can increase a country's long-run incentive to create inflation. The theoretical justifcation for this channel is the well known "beggar thy neighbor" incentive, and its dominance relies on a monetary authority's ability to commit to policy as well as the asymmetric effects of the underlying frictions in the model across domestic and foreign households. Comparing data from the 1973-1987 period and the 1988-2002 period, I Find evidence that the effect of openness on inflation is positive among developed countries whose monetary policy can be approximated by commitment and that the inflationary bias of openness is dampened by the degree of imperfect competition and the inelasticity of labor supply within the country.
    Keywords: Optimal monetary policy; Imperfect competition; International monetary policy; Openness
    JEL: E52 E61 F41 F42
    Date: 2012–01
  7. By: William Barnett (Department of Economics, The University of Kansas); Haiyang Xu (Washington University in St.Louis)
    Abstract: The determinants of money velocity are theoretically explored under various assumptions of interest rate uncertainty in a monetary general equilibrium model. Money is introduced by putting monetary services in the utility function. Monetary assets pay interest. When interest rates are uncertain, it is found that the degree of risk aversion in consumers' preferences and the risk in the return rates of the benchmark asset affect both the intercept and slope of the money velocity function, while the risk in return rates of monetary assets only affects the intercept of the money velocity function. The traditional money velocity function would become unstable if covariances change over time between interest rates and consumption growth rate or between interest rates and real money growth rate. We simulate the model developed in this paper and find that the coefficients of the money velocity function are volatile. The Swamy and Tinsley (1980) random coefficient model is then estimated with money velocity data to compare the results with those from model simulation. It is found that the estimated stochastic slope coefficient of the velocity function behaves in a manner that is approximately consistent with the simulation results.
    Date: 2012–09
  8. By: Richard Dennis
    Abstract: This paper studies the behavior of a central bank that seeks to conduct policy optimally while having imperfect credibility and harboring doubts about its model. Taking the Smets-Wouters model as the central bank.s approximating model, the paper's main findings are as follows. First, a central bank's credibility can have large consequences for how policy responds to shocks. Second, central banks that have low credibility can benefit from a desire for robustness because this desire motivates the central bank to follow through on policy announcements that would otherwise not be time-consistent. Third, even relatively small departures from perfect credibility can produce important declines in policy performance. Finally, as a technical contribution, the paper develops a numerical procedure to solve the decision-problem facing an imperfectly credible policymaker that seeks robustness
    JEL: E58 E61 C63
    Date: 2012–08
  9. By: Jitka Pomenkova (Department of National Economy, Faculty of Economics, VÅ B-Technical University of Ostrava); Svatopluk Kapounek (Department of Finance, Faculty of Business and Economics, Mendel university in Brno)
    Abstract: The recent economic crisis is regarded as symmetric shock which negatively affects all Eurozone member countries. Even if the whole euro area is in recession the probability of asymmetric shock arises on the monetary side of the economy. The issue is that money supply is unevenly distributed across the euro area. Different credit money creation increases inflationary pressures not only in long run but also in short-term, especially in house prices. The combination of credit money creation and increases in asset prices contributes to financial instability. The empirical part of the paper is based on the analysis in time-frequency domain. The authors apply wavelet analysis to identify increasing differences of co-movements in money supply between the selected old Eurozone member states and peripheral countries. The authors use the contribution of different member countries to the monetary aggregate M3 as the proxy of money supply distribution across the euro area.
    Keywords: wavelet analysis, financial stability, asset prices, monetary aggregates
    JEL: E51 F36
    Date: 2012–09
  10. By: Khemiri, Rim; Ali, Mohamed Sami Ben
    Abstract: This paper studies the effect of exchange rate pass-through on inflation in Tunisia over the period 2001-2009. The authors' objective is to track inflation regimes for the Tunisian economy and to forecast its determinants. Using a Markov-switching approach, the authors identified two main regimes for inflation in Tunisia over this period: a low and stable inflation regime associated with a low pass-through level, and a high inflation regime associated with a high pass-through level. In order to highlight the mechanisms underlying shifts in inflation regimes, the authors used a time-varying probabilities approach and identified a set of variables to assess their effect on inflation in Tunisia. The results show that the price level decreases in response to an increase in interest rates. Along with this, the empirical results provide strong evidence that industrial production indices have a negative and significant effect in increasing the probability to stay in an inflationary regime and a high pass-through level. In addition, the results show robust supports to suggest that the imports increase the probability to stay in a high inflation regime and a high pass-through level. However, exports increase the probability to stay in a low inflation regime and a low pass-through level. --
    Keywords: Pass-through,inflation,Markov switching,economic fundamentals
    JEL: F3 F4 G15
    Date: 2012
  11. By: Renne, J-P.
    Abstract: This paper presents a no-arbitrage model of the yield curve that explicitly incorporates the central-bank policy rate. After having estimated the model using daily euro-area data, I explore the behaviour of risk premia at the short end of the yield curve. These risk premia are neglected by the widely-used practice that consists in backing out market forecasts of future policy-rate moves from money-market forward rates. The results suggest that this practice is valid in terms of sign of the expected target moves, but that it tends to overestimate their size. As an additional contribution, the model is exploited to simulate forward-guidance measures. A credible commitment of the central bank to keep its policy rate unchanged for a given period of time can result in substantial declines in yields. For instance, a central-bank commitment to keep the policy rate at 1% over the next 2 years would imply a decline in the 5-year rate of about 25 basis points.
    Keywords: affine term-structure models; zero lower bound; regime switching; forward policy guidance.
    JEL: E43 E44 E47 E52 G12
    Date: 2012
  12. By: Shaw, Ming-fu; Chang, Juin-jen; Chen, Hung-Ju
    Abstract: This paper develops an analytically tractable dynamic general-equilibrium model with a banking system to examine the macroeconomic implications of capital adequacy requirements. In contrast to the hypothesis of a credit crunch, we find that increasing the strength of bank capital requirements does not necessarily reduce the equilibrium quantity of loans, provided that banks have the option to respond to the capital requirements by accumulating more equity instead of cutting back on lending. Accordingly, we show that there is an inverted-U-shaped relationship between CAR and capital accumulation (and consumption). Furthermore, the optimal capital adequacy ratio for social-welfare maximization is lower than that for capital-accumulation maximization. In accordance with general empirical findings, the capital- accumulation maximizing capital adequacy ratio is procyclical with respect to economic conditions. We also find that monetary policy affects the real macroeconomic activities via the so-called bank lending channel, but the effectiveness of monetary policy is weakened by bank capital requirements.
    Keywords: Banking capital regulation; bank lending channel; the loan-deposit rate
    JEL: E5 O4
    Date: 2012–09–05
  13. By: Zhibai, Zhang
    Abstract: The bilateral real exchange rate between Chinese renminbi (RMB) and the US dollar is studied. The panel data Penn effect model shows that the RMB was overvalued in 1980–1991 but later undervalued in 1992–2010. In 2010, it was undervalued by 36.7%. Econometric analysis and an examination of the appreciation of seventeen currencies belonging to countries and areas under the same economic development stage show that the RMB should appreciate at an annual speed of 3.2%. At this rate, the RMB misalignment in 2010 will be corrected by 2020. In the future, RMB appreciation should be realized totally from the nominal exchange rate, not partly from the nominal exchange rate and partly from the relative price level. This appreciation path satisfies the interests of both China and the US.
    Keywords: Chinese renminbi; Real exchange rate; Penn effect; Undervaluation; Appreciation
    JEL: F31
    Date: 2012–05–27
  14. By: Taro Ikeda (Kurume University, Faculty of Economics)
    Abstract: This paper introduces asymmetric central bank forecasting into the standard New Keynesian model within the context of robust control theory. Asymmetric forecasting expresses policymakersf reservations about economic forecasts, and the degree of their reservations is reflected as an asymmetric preference whose existence warrants laying aside the assumption that policymakersf base decisions primarily on rational expectations. This study concludes that monetary policy becomes more aggressive because of policymakersf reservations about forecasts stemming from asymmetry, and preference for policies robust enough to overcome unanticipated situations. In addition, adopted policies will likely amplify economic fluctuations and significantly reduce social welfare.
    Keywords: robust control, asymmetric forecasting, bounded rationality
    JEL: E50 E52 E58
    Date: 2012–08
  15. By: Angus C. , Chu; Lei, Ji
    Abstract: In this study, we develop a monetary Schumpeterian growth model with endogenous market structure (EMS) to explore the effects of monetary policy on the number of firms, …firm size, economic growth and social welfare. EMS leads to richer implications and different results from previous studies in which market structure is exogenous. In the short run, a higher nominal interest rate leads to lower growth rates of innovation, output and consumption and also smaller …rm size due to a reduction in labor supply. In the long run, an increase in the nominal interest rate reduces the equilibrium number of …firms but has no effect on economic growth and fi…rm size because of a scale-invariant property of the model as a result of entry and exit of fi…rms. Although monetary policy has no long-run effect on economic growth, an increase in the nominal interest rate permanently reduces the levels of output, consumption and employment. Taking into account transition dynamics, we …nd that social welfare is decreasing in the nominal interest rate. Given that a zero nominal interest rate maximizes welfare, Friedman rule is optimal in this economy.
    Keywords: monetary policy; economic growth; R&D; endogenous market structure
    JEL: O30 O40 E41
    Date: 2012–08–27
  16. By: Pablo Pincheira; Carlos A. Medel
    Abstract: We explore the ability of several univariate models to predict inflation in a number of countries and at several forecasting horizons. We place special attention on forecasts coming from a family of ten seasonal models that we call the Driftless Extended Seasonal ARIMA (DESARIMA) family. Using out-of-sample Root Mean Squared Prediction Errors (RMSPE) we compare the forecasting accuracy of the DESARIMA models with that of traditional univariate time-series benchmarks available in the literature. Our results show that DESARIMA-based forecasts display lower RMSPE at short horizons for every single country, except one. We obtain mixed results at longer horizons. Roughly speaking, in half of the countries, DESARIMA-based forecasts outperform the benchmarks at long horizons. Remarkably, the forecasting accuracy of our DESARIMA models is surprisingly high in stable inflation countries, for which the RMSPE is barely higher than 100 basis points when the prediction is made 24- and even 36-months ahead.
    Date: 2012–08
  17. By: Santiago García-Verdú
    Abstract: This paper presents an analysis of the expected inflation distribution based on the surveys made to economic analysts in the private sector, by Banco de México. Conceptually, the analysis can be divided into three aspects: level, dispersion, and skewness, of expected inflation. It is anticipated that the behavior of these aspects will be consistent with the process of inflation convergence to its target, in the sense that the expected inflation level and dispersion, and the probability of observing a sizable realization of inflation have been diminishing, as the cited process has taken place. Additionally, first, a model is presented in which agents face a cost when they update their inflation expectation. This model explains some of the facts seen in inflation expectation dispersion. In the model, the decrease in the dispersion is consistent with an increase in the frequency with which the agents update their inflation expectation, as observed in the data. Second, under an event-study framework the respond of upside risks of inflation expectations to the approval of the Income Law is analyzed. The results suggest that once the cited law is approved, on average there is a decrease in such risks.
    Keywords: Inflation, Expectations, Expected Inflation.
    JEL: E31 D84
    Date: 2012–08
  18. By: William Barnett (Department of Economics, The University of Kansas); Yi Liu (Washington University in St.Louis)
    Date: 2012–09
  19. By: Francis Breedon (Queen Mary, University of London); Jagjit S. Chadha (University of Kent and University of Cambridge); Alex Water (University of Kent)
    Abstract: After outlining some of the monetary developments associated with Quantitative Easing (QE), we measure the impact of the UK's initial 2009-10 QE Programme on bonds and other assets. First, we use a macro-finance yield curve both to create a counterfactual path for bond yields and to estimate the impact of QE directly. Second, we analyse the impact of individual QE operations on a range of asset prices. We find that QE significantly lowered government bond yields through the portfolio balance channel - by around 50 or so basis points. We also uncover significant effects of individual operations but limited pass through to other assets.
    Keywords: Term structure of interest rates, Monetary policy, Quantitative Easing
    JEL: E43 E44 E47 E58
    Date: 2012–08
  20. By: M. Lopreite
    JEL: E12 E51 E52
    Date: 2012
  21. By: Rubén Albeiro Loaiza Maya; Luis Fernando Melo Velandia
    Abstract: This study implements a regular vine copula methodology to evaluate the level of contagion among the exchange rates of six Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico and Peru) from June 2005 to April 2012. We measure contagion in terms of tail dependence coefficients, following Fratzscher’s [1999] definition of contagion as interdependence. Our results indicate that these countries are divided into two blocs. The first bloc consists of Brazil, Colombia, Chile and Mexico, whose exchange rates exhibit the largest dependence coefficients, and the second bloc consists of Argentina and Peru, whose exchange rate dependence coefficients with other Latin American countries are low. We also found that most of the Latin American exchange rate pairs exhibit asymmetric behaviors characterized by non-significant upper tail dependence and significant lower tail dependence. These results imply that there exists contagion in Latin American exchange rates in periods of large appreciations.
    Keywords: Copula, Regular Vine, Exchange Rates, Tail Dependence Coefficients. Classification JEL:C32, C51, E42.
    Date: 2012–08
  22. By: Tobias Adrian; Paolo Colla; Hyun Song Shin
    Abstract: The financial crisis of 2007-9 has sparked keen interest in models of financial frictions and their impact on macro activity. Most models share the feature that borrowers suffer a contraction in the quantity of credit. However, the evidence suggests that although bank lending to firms declines during the crisis, bond financing actually increases to make up much of the gap. This paper reviews both aggregate and micro level data and highlights the shift in the composition of credit between loans and bonds. Motivated by the evidence, we formulate a model of direct and intermediated credit that captures the key stylized facts. In our model, the impact on real activity comes from the spike in risk premiums, rather than contraction in the total quantity of credit.
    JEL: E2 E5 G01 G21
    Date: 2012–08
  23. By: Kawai, Masahiro (Asian Development Bank Institute); Morgan, Peter J. (Asian Development Bank Institute)
    Abstract: A key lesson of the 2007–2009 global financial crisis was the importance of containing systemic financial risk and the need for a “macroprudential” approach to surveillance and regulation that can identify system-wide risks and take appropriate actions to maintain financial stability. By virtue of their overview of the economy and the financial system and their responsibility for payments and settlement systems, there is a broad consensus that central banks should play a key role in monitoring and regulating financial stability. Emerging economies face additional challenges because of their underdeveloped financial systems and vulnerability to volatile international capital flows, especially “sudden stops” or reversals of capital inflows. This paper reviews the recent literature on this topic and identifies relevant lessons for central banks, especially those in Asia’s emerging economies.
    Keywords: central banking; central banks; financial stability; asia; surveillance and regulation; global financial crisis
    JEL: E52 F31 G28
    Date: 2012–08–31
  24. By: Jean-Stéphane Mésonnier; Dalibor Stevanovic
    Abstract: The recent crisis has revealed the potentially dramatic consequences of allowing the build-up of an overstretched leverage of the financial system, and prompted proposals by bank supervisors to significantly tighten bank capital requirements as part of the new Basel 3 regulations. Although these proposals have been fiercely debated ever since, the empirical question of the macroeconomic consequences of shocks to banks’ leverage, be they policy induced or not, remains still largely unsettled. In this paper, we aim to overcome some longstanding identification issues hampering such assessments and propose a new approach based on a data-rich environment at both the micro (bank) level and the macro level, using a combination of bank panel regressions and macroeconomic factor models. We first identify bank leverage shocks at the micro level and aggregate them to an economy-wide measure. We then compute impulse responses of a large array of macroeconomic indicators to our aggregate bank leverage shock, using the new methodology developed by Ng and Stevanovic (2012). We find significant and robust evidence of a contractionary impact of an unexpected shock reducing the leverage of large banks. <P>
    Keywords: bank capital ratios, macroeconomic fluctuations, panel, dynamic factor models,
    JEL: C23 C38 E32 E51 G21 G32
    Date: 2012–09–01

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