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on Monetary Economics |
| By: | Chun Chang; Zheng Liu; Mark M. Spiegel |
| Abstract: | We examine optimal monetary policy under prevailing Chinese policy – including capital controls and nominal exchange rate targets – in a DSGE model calibrated to Chinese and global data. Under the closed capital account, domestic citizens are prohibited from holding foreign assets. Foreign currency revenues are sold to the central bank, which then sterilizes these purchases by issuing domestic debt. Uncovered interest parity conditions do not hold, so sterilization results in transfers between the private sector and the government. Given a negative shock to relative foreign interest rates, similar to that which occurred during the global financial crisis, sterilization costs increase and optimal policy calls for a reduction in sterilization activity, resulting in an easing of monetary policy and an increase in Chinese inflation. We then compare these dynamics to three alternative liberalizations: A partial opening of the capital account, removing the exchange rate peg, or doing both simultaneously. The regime with liberalized capital accounts and floating exchange rate yields the lowest losses to the central bank under the foreign interest rate shock. However, intermediate reforms do less well. In particular, letting the exchange rate float without opening the capital account results in higher losses following the interest rate shock than the benchmark case of no liberalization. |
| Keywords: | Monetary policy ; Foreign exchange ; China |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2012-13&r=mon |
| By: | Escudé, Guillermo J. |
| Abstract: | This paper builds a DSGE model for a 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 di¤erent 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’ 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: | E58 F41 O24 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:dynare:015&r=mon |
| By: | Paul R. Bergin; Reuven Glick; Jyh-Lin Wu |
| Abstract: | Long half-lives of real exchange rates are often used as evidence against monetary sticky price models. In this study we show how exchange rate regimes alter the long-run dynamics and half-life of the real exchange rate, and we recast the classic defense of such models by Mussa (1986) from an argument based on short-run volatility to one based on long-run dynamics. The first key result is that the extremely persistent real exchange rate found commonly in post Bretton Woods data does not apply to the preceding fixed exchange rate period in our sample, where the half-live was roughly half as large. This result suggests a reinterpretation of Mussa’s original finding, indicating that up to two thirds of the rise in variance of the real exchange rate in the recent floating rate period is actually due to the rise in persistence of the response to shocks, rather than due to a rise in the variance of shocks themselves. This result also suggests a way to resolve the “PPP puzzle,” reconciling real exchange rate persistence with volatility. The second key result explains the rise in persistence over time by identifying underlying shocks using a panel VECM model. Shocks to the nominal exchange rate induce more persistent real exchange rate responses compared to price shocks, and these shocks became more prevalent under a flexible exchange rate regime. |
| Keywords: | Foreign exchange rates ; Monetary policy |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2012-14&r=mon |
| By: | C. Randall Henning (Peterson Institute for International Economics) |
| Abstract: | This paper examines the exchange rate regimes of East Asian countries since the initial shift by China to a controlled appreciation in July 2005, testing econometrically the weights of key currencies in the implicit baskets that appear to be targeted by East Asian monetary authorities. It finds, first, that four of the larger economies of Southeast Asia have formed a loose but effective "renminbi bloc" with China, with two other countries participating tentatively since the global financial crisis. Second, the emergence of the renminbi bloc in terms of the exchange rate has been facilitated by the continued dominance of the US dollar as a trade, investment and reserve currency. Third, exchange rate stabilization is explained by the economic strategies of these countries, which rely heavily on export development and financial repression, and the economic rise of China. Fourth, analysts should specify the exchange rate preferences of these emerging market countries carefully before drawing inferences about Chinese influence within the region. |
| Keywords: | exchange rates, exchange rate regimes, East Asia, Chinese exchange rate policy, renminbi bloc, East Asian regionalism, dollar standard, monetary power |
| JEL: | F31 F33 F36 F4 F5 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:iie:wpaper:wp12-15&r=mon |
| By: | Athanasios Geromichalos; Lucas Herrenbrueck (Department of Economics, University of California Davis) |
| Abstract: | We revisit a traditional topic in monetary economics: the relationship between asset prices and monetary policy. We study a model in which money helps facilitate trade in decentralized markets, as in Lagos andWright (2005), and real assets are traded in an over-the-counter (OTC) market, as in Duffie, Gˆarleanu, and Pedersen (2005). Agents wish to hold liquid portfolios, but liquidity comes at a cost: inflation. The OTC market serves as a secondary asset market, in which agents can rebalance their positions depending on their liquidity needs. Hence, a contribution of our paper is to provide a micro-founded explanation of the assumption that different investors have different valuations for the same asset, which is the key for generating gains from trade in the Duffie et al framework. In equilibrium, assets can be priced higher than their fundamental value because they help agents avoid the inflation tax. |
| Keywords: | monetary-search models, liquidity, asset prices, over-the-counter markets |
| JEL: | E31 E50 E52 G12 |
| Date: | 2012–09–25 |
| URL: | http://d.repec.org/n?u=RePEc:cda:wpaper:12-20&r=mon |
| By: | Yi Wen |
| Abstract: | This paper develops an analytically tractable Bewley model of money featuring capital and financial intermediation. It is shown that when money is a vital form of liquidity to meet uncertain consumption needs, the welfare costs of inflation can be extremely large. With log utility and parameter values that best match both the aggregate money demand curve suggested by Lucas (2000) and the variance of household consumption, agents in our model are willing to reduce consumption by 7% ~ 10% (or more) to avoid 10% annual inflation. In other words, raising the U.S. inflation target from 2% to 3% amounts to roughly a 0:5 percentage reduction in aggregate consumption. The astonishingly large welfare costs of inflation arise because inflation tightens liquidity constraints by destroying the buffer-stock value of money, thus raising the volatility of consumption at the household level. Such an inflation-induced increase in the idiosyncratic consumption-volatility at the micro level cannot be captured by representative- agent models or the Bailey triangle. Although the development of a credit and banking system can reduce the welfare costs of inflation by alleviating liquidity constraints, with realistic credit limits the cost of moderate inflation still remains several times larger than estimations based on the Bailey triangle. Our finding not only provides a justification for adopting a low inflation target by central banks, but also offers a plausible explanation for the robust positive relationship between inflation and social unrest in developing countries where money is the major form of household financial wealth. |
| Keywords: | Liquidity (Economics) ; Welfare |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2012-037&r=mon |
| By: | D'Amico, Stefania; English, William; López-Salido, J David; Nelson, Edward |
| Abstract: | We provide empirical estimates of the effect of large-scale asset purchase (LSAP)-style operations on longer-term U.S. Treasury yields within a framework that nests the alternative theoretical perspectives on LSAPs. As the principal channels through which LSAPs migh tmatter for longer-term interest rates, we concentrate on (i) the scarcity (available local supply) channel associated with the traditional preferred habitat literature, and (ii) the duration channel associated with the general notion of interest rate risk. Wealso clarify LSAPs’ role in the broader context of monetary policy strategy, bringing out the connections between purchases of longer-term assets and historical Federal Reserve policy approaches. Our results indicate that the impact of LSAP-style operations on longer-term interest rates is mainly felt on the nominal term-premium component; moreover, within the nominal term premium, it is the real term premium that experiences the greatest response. The estimates suggest that the scarcity and duration channels have both been of considerable importance for the transmission of purchases to longer-term Treasury yields. Finally, by isolating the degree to which scarcity and duration impinge on term premiums, our estimates indicate the direction in which macroeconomic models should develop in order to encompass the transmission channels associated with LSAPs. |
| Keywords: | CUSIP-level data; history of unconventional monetary policy; large-scale asset purchases; monetary transmission mechanism |
| JEL: | E52 E58 G12 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9145&r=mon |
| By: | Daniel L. Thornton |
| Abstract: | In February 2005 Federal Reserve Chairman Alan Greenspan noticed that the 10-year Treasury yields failed to increase despite a 150-basis-point increase in the federal funds rate as a “conundrum.” This paper shows that the connection between the 10-year yield and the federal funds rate was severed in the late 1980s, well in advance of Greenspan’s observation. The paper hypothesize that the change occurred because the Federal Open Market Committee switched from using the federal funds rate as an operating instrument to using it to implement monetary policy and presents evidence from a variety of sources supporting the hypothesis. The analysis has implications for central banks’ interest rate policies. |
| Keywords: | Federal funds rate ; Greenspan, Alan |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2012-036&r=mon |
| By: | Thomas Windberger; Jesus Crespo Cuaresma; Janette Walde |
| Abstract: | Obtaining reliable estimates of the volatility of interest rates and exchange rates is a necessary condition to evaluate issues related to monetary independence and fear of floating. In this paper we use methods which explicitly account for structural breaks in the volatility dynamics in order to assess monetary independence in the Czech Republic, Hungary and Poland. Our results indicate that the explicit modelling of structural breaks in volatility estimates can lead to striking differences concerning the evidence of monetary independence in Central and Eastern Europe. The results based on volatility estimates which account for regime change tend to indicate that the Czech Republic, Hungary and Poland have had a significant degree of monetary independence in the last decade. |
| Keywords: | Fear of floating, monetary independence, structural break, change-point model |
| JEL: | F31 C22 C11 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:inn:wpaper:2012-21&r=mon |
| By: | Hiro Ito (Asian Development Bank Institute (ADBI)); Masahiro Kawai |
| Abstract: | We develop a new set of indexes of exchange rate stability, monetary policy independence, and financial market openness as the metrics for the trilemma hypothesis. In our exploration, we take a different and more nuanced approach than the previous indexes developed by Aizenman, Chinn, and Ito (2008). We show that the new indexes add up to the value two, supporting the trilemma hypothesis. We locate our sample economies’ policy mixes in the famous trilemma triangle—a useful and intuitive way to illustrate the state and evolution of policy mixes. We also examine if the persistent deviation of the sum of the three indexes from the value two indicates an unsustainable policy mix and therefore needs to be corrected by economic disruptions such as economic and financial crises. We obtain several findings. First, such a persistent deviation can occur particularly in emerging economies that later experience an inflation (or potentially a general or a currency) crisis, and dissipates in the postcrisis period. Second, there is no evidence for this type of association between deviations from the trilemma constraint and general, banking, or debt crises. Third, Thailand experienced such a deviation from the trilemma constraint in the period leading to the baht crisis of 1997, but not other East and Southeast Asian economies. This last result suggests that the main cause for the Thai baht crisis was an unsustainable policy mix in the precrisis period, while other affected economies experienced crises mainly due to contagion from Thailand. |
| Keywords: | exchange rate stability, monetary policy independence, financial market openness, the trilemma hypothesis, emerging economies, Southeast Asian, Thailand |
| JEL: | F15 F F31 F36 F41 O24 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:eab:macroe:23331&r=mon |
| By: | William R. White |
| Abstract: | In this paper, an attempt is made to evaluate the desirability of ultra easy monetary policy by weighing up the balance of the desirable short run effects and the undesirable longer run effects—the unintended consequences. The conclusion is that there are limits to what central banks can do. One reason for believing this is that monetary stimulus, operating through traditional ("flow") channels, might now be less effective in stimulating aggregate demand than previously. Further, cumulative ("stock") effects provide negative feedback mechanisms that over time also weaken both supply and demand. It is also the case that ultra easy monetary policies can eventually threaten the health of financial institutions and the functioning of financial markets, threaten the "independence" of central banks, and can encourage imprudent behavior on the part of governments. None of these unintended consequences is desirable. Since monetary policy is not "a free lunch," governments must therefore use much more vigorously the policy levers they still control to support strong, sustainable and balanced growth at the global level. |
| Keywords: | Banks and banking, Central |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:126&r=mon |
| By: | Simplice A , Asongu |
| Abstract: | Purpose – A spectre is hunting embryonic African monetary zones: the EMU crisis. This paper assesses real, monetary and fiscal policy convergence within the proposed WAM and EAM zones. The introduction of common currencies in West and East Africa is facing stiff challenges in the timing of monetary convergence, the imperative of central bankers to apply common modeling and forecasting methods of monetary policy transmission, as well as the requirements of common structural and institutional characteristics among candidate states. Design/methodology/approach – In the analysis: monetary policy targets inflation and financial dynamics of depth, efficiency, activity and size; real sector policy targets economic performance in terms of GDP growth at macro and micro levels; while, fiscal policy targets debt-to-GDP and deficit-to-GDP ratios. A dynamic panel GMM estimation with data from different non-overlapping intervals is employed. The implied rate of convergence and the time required to achieve full (100%) convergence are then computed from the estimations. Findings – Findings suggest overwhelming lack of convergence: (1) initial conditions for financial development are different across countries; (2) fundamental characteristics as common monetary policy initiatives and IMF backed financial reform programs are implemented differently across countries; (3) there is remarkable evidence of cross-country variations in structural characteristics of macroeconomic performance; (4) institutional cross-country differences could also be responsible for the deficiency in convergence within the potential monetary zones; (5) absence of fiscal policy convergence and no potential for eliminating idiosyncratic fiscal shocks due to business cycle incoherence. Practical implications – As a policy implication, heterogeneous structural and institutional characteristics across countries are giving rise to different levels and patterns of financial intermediary development. Thus, member states should work towards harmonizing cross-country differences in structural and institutional characteristics that hamper the effectiveness of convergence in monetary, real and fiscal policies. This could be done by stringently monitoring the implementation of existing common initiatives and/or the adoption of new reforms programs. Originality/value – It is one of the few attempts to investigate the issue of convergence within the proposed WAM and EAM unions. |
| Keywords: | Currency Area; Convergence; Policy Coordination; Africa |
| JEL: | F15 F42 O55 F36 P52 |
| Date: | 2012–09–25 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:41552&r=mon |
| By: | Herings P. Jean-Jacques (METEOR) |
| Abstract: | We present a general equilibrium model of the new neoclassical synthesis that has the same levelof generality as the Arrow-Debreu model. This involves a stochastic multi-period economy with amonetary sector and sticky commodity prices. We formulate the notion of a sticky price equilibriumwhere all agents form rational expectations on prices for commodities and assets, interest rates,and rationing. We present a general result showing that monetary policy imposes no restrictionswhatsoever on nominal equilibrium price levels and that the set of sticky price equilibria has adimension equal to the number of terminal date-events. Stickiness of prices implies that thisindeterminacy is real. |
| Keywords: | monetary economics ; |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:umamet:2012046&r=mon |
| By: | Susanto Basu; Brent Bundick |
| Abstract: | Can increased uncertainty about the future cause a contraction in output and its components? This paper examines the role of uncertainty shocks in a one-sector, representative-agent, dynamic, stochastic general-equilibrium model. When prices are flexible, uncertainty shocks are not capable of producing business-cycle comovements among key macroeconomic variables. With countercyclical markups through sticky prices, however, uncertainty shocks can generate fluctuations that are consistent with business cycles. Monetary policy usually plays a key role in offsetting the negative impact of uncertainty shocks. If the central bank is constrained by the zero lower bound, then monetary policy can no longer perform its usual stabilizing function and higher uncertainty has even more negative effects on the economy. We calibrate the size of uncertainty shocks using fluctuations in the VIX and find that increased uncertainty about the future may indeed have played a significant role in worsening the Great Recession, which is consistent with statements by policymakers, economists, and the financial press. |
| JEL: | E32 E52 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18420&r=mon |
| By: | Issiaka Coulibaly; Blaise Gnimassoun |
| Abstract: | This paper aims to study the optimality of a monetary union in West Africa by using a new methodology based on the analysis of convergence and co-movements between exchange rate misalignments. Two main advantages characterize this original framework. First, it brings together the information related to several optimum currency area criteria— such as price convergence, terms of trade shocks, and trade and fiscal policies—going further than previous studies which are mainly based on only one criterion at a given time. Second, our study detects potential competitiveness differentials which play a key role in the debate on the optimality or not of a monetary union, as evidenced by the recent crisis in the Euro area. Relying on recent panel cointegration techniques and cluster analysis, our results show that the WAEMU area has a core composed by Burkina Faso, Mali, Niger and Senegal which can be joined by Ghana, Sierra Leone and, to a lesser extent, Gambia, and that Ghana and Senegal appear to be the best reference countries for the creation of the whole West Africa monetary union. |
| Keywords: | Exchange rate misalignment, Optimum Currency Area, West African countries |
| JEL: | F31 F33 O1 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2012-37&r=mon |
| By: | Brent Meyer; Guhan Venkatu |
| Abstract: | This paper reinvestigates the performance of trimmed-mean inflation measures some 20 years since their inception, asking whether there is a particular trimmed mean measure that dominates the median CPI. Unlike previous research, we evaluate the performance of symmetric and asymmetric trimmed-means using a well-known equality of prediction test. We fi nd that there is a large swath of trimmed-means that have statistically indistinguishable performance. Also, while the swath of statistically similar trims changes slightly over different sample periods, it always includes the median CPI—an extreme trim that holds conceptual and computational advantages. We conclude with a simple forecasting exercise that highlights the advantage of the median CPI relative to other standard inflation measures. |
| Keywords: | Inflation (Finance) ; Consumer price indexes |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:1217&r=mon |
| By: | Roger E.A. Farmer |
| Abstract: | This paper is about the effectiveness of qualitative easing; a government policy that is designed to mitigate risk through central bank purchases of privately held risky assets and their replacement by government debt, with a return that is guaranteed by the taxpayer. Policies of this kind have recently been carried out by national central banks, backed by implicit guarantees from national treasuries. I construct a general equilibrium model where agents have rational expectations and there is a complete set of financial securities, but where agents are unable to participate in financial markets that open before they are born. I show that a change in the asset composition of the central bank’s balance sheet will change equilibrium asset prices. Further, I prove that a policy in which the central bank stabilizes fluctuations in the stock market is Pareto improving and is costless to implement. |
| JEL: | E0 E5 E52 E62 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18421&r=mon |
| By: | Toni Beutler (Study Center Gerzensee and University of Lausanne) |
| Abstract: | This paper investigates whether commodity convenience yields - the yields that accrue to the holders of physical commodities - can predict the exchange rate of commodity-exporters' currencies. Predictability is a consequence of the fact that i) convenience yields are useful predictors for commodity prices and ii) commodity currencies have a strong relationship with commodity prices. The empirical evidence indicates that there is a significant relationship between aggregate measures of convenience yields and commodity currencies' exchange rate, both in-sample and out-of- sample. A high level of convenience yields strongly predicts a depreciation of the Australian, Canadian and New Zealand dollars exchange rates at horizons of 1 to 24 months. |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:szg:worpap:1203&r=mon |
| By: | Gustavo Abarca; Claudia Ramírez; José Gonzalo Rangel |
| Abstract: | This article examines changes in the exchange rate expectations associated with capital controls and banking regulations in a group of emerging countries that implemented these measures to control the adverse effects of sudden capital flows on their currencies. The evidence suggests that for most countries the effects of this type of policies are limited. Moreover, in some cases they appear to have an opposite effect from the one intended. In particular, for some currencies our results suggest there were changes in the extremes of their exchange rate distributions, which make their tails heavier and signal that the market allocates a greater probability to extreme movements. In the same way, evidence is found that this type of measures increases the levels of currency risk premium. |
| Keywords: | Capital controls, banking regulation, exchange rate expectations, emerging economies, generalized extreme value. |
| JEL: | C14 E44 E58 F31 G15 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:bdm:wpaper:2012-08&r=mon |