nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒10‒20
23 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Exchange rate pass-through, monetary policy, and variability of exchange rates By Konstantin Styrin; Oleg Zamulin
  2. Regional inflation dynamics and inflation targeting in Peru By Winkelried, Diego; Gutierrez, José Enrique
  3. Assets matter: New and old views of monetary policy By Stan du Plessis
  4. The Federal Reserve's balance sheet and overnight interest rates By Jaime Marquez; Ari Morse; Bernd Schlusche
  5. Quantizing Money By Ternyik, Stephen I.
  6. The federal funds rate and the conduction of the international orchestra By Antonio Ribba
  7. “Pass-through in dollarized countries: should Ecuador abandon the U.S. Dollar?” By María Lorena Marí del Cristo; Marta Gómez-Puig
  8. The Effect of Data Revisions on the Basic New Keynesian Model By María-Dolores, Ramón; Londoño, Juan M.; Vázquez Pérez, Jesús
  9. On the (in)effectiveness of fiscal devaluations in a monetary union By Anna Lipinska; Leopold von Thadden
  10. Euro Area: Single Currency - National Money Creation By Stefan Kooths; Björn van Roye
  11. Monetary policy implications of the dependence of long term interest rates on disagreement about macroeconomic forecasts By Eric Dor
  12. A Real Exchange Rate Based Phillips Curve By Konstantin Styrin; Oleg Zamulin
  13. Firms' entry, monetary policy and the international business cycle By Cavallari, Lilia
  14. Time Variation in an Optimal Asymmetric Preference Monetary Policy Model By Cassou, Steven P.; Vázquez Pérez, Jesús
  15. Money supply in top tax system By Varma, Vijaya Krushna Varma
  16. "Delaying the Next Global Meltdown" By Dimitri B. Papadimitriou; L. Randall Wray
  17. Banks’ balance sheets and the macroeconomy in the Bank of Italy Quarterly Model By Claudia Miani; Giulio Nicoletti; Alessandro Notarpietro; Massimiliano Pisani
  18. Risk, uncertainty and monetary policy By Geert Bekaert; Marie Hoerova; Marco Lo Duca
  19. "Euroland's Original Sin" By Dimitri B. Papadimitriou; L. Randall Wray
  20. Global excess liquidity and asset prices in emerging countries: a pvar approach By Sophie Brana; Marie-Louise Djibenou; Stéphanie Prat
  21. Two-sided learning in New Keynesian models: Dynamics, (lack of) convergence and the value of information By Christian Matthes; Francesca Rondina
  22. Who Ran on Repo? By Gary B. Gorton; Andrew Metrick
  23. "The LIBOR Scandal: The Fix Is In--the Bank of England Did It!" By Jan Kregel

  1. By: Konstantin Styrin (New Economic School); Oleg Zamulin (National Research University – Higher School of Economics)
    Abstract: We document that contribution of identified US monetary shock to exchange rate variability differs across currencies and is inversely related to the degree of a country’s US dollar exchange rate pass-through into import prices. We explore this empirical pattern under the assumption that each central bank, when choosing its monetary policy, takes into account in which currency its country’s exports and imports are denominated. The choice of imports invoicing currency will affect both the degree of exchange rate pass-through and the monetary policy response. Different shape of monetary policy reaction function will result in different contribution of monetary shocks to the exchange rate dynamics. We illustrate this mechanism using a simple general equilibrium model.
    Keywords: Exchange rate; pass-through; invoicing currency; monetary policy; monetary shocks; variance decomposition
    JEL: F41 F42
    Date: 2012–05
  2. By: Winkelried, Diego (Banco Central de Reserva del Perú); Gutierrez, José Enrique (Superintendency of Banking, Insurance and Private Pension Funds)
    Abstract: The Central Reserve Bank of Peru (BCRP) has been targeting inflation for more than a decade, using Lima’s inflation as the operational measure. An alternative indicator is countrywide inflation, whose quality and real-time availability have improved substantially lately. Hence, given these two somehow competing measures of inflation, two interesting policy questions arise: what have been the implications for national inflation of targeting Lima’s inflation? Would shifting to a national aggregate significantly affect the workings of monetary policy in Peru? To answer these questions, we estimate an error correction model of regional inflations and investigate how shocks propagate across the country. The model incorporates (i) aggregation restrictions whereby each regional inflation is affected by an aggregate of neighboring regions, and (ii) long-run restrictions that uncover a single common trend in the system. The results indicate that a shock to Lima’s inflation is transmitted fast and strongly elsewhere in the country. This constitutes supporting evidence to the view that by targeting Lima’s inflation, the BCRP has effectively, albeit indirectly, targeted national inflation.
    Keywords: Regional inflation, inflation targeting, relative PPP, error correction model
    JEL: C32 C50 E31 E52 R10
    Date: 2012–10
  3. By: Stan du Plessis (Department of Economics, University of Stellenbosch)
    Abstract: An extraordinary consensus on the goals and conduct of monetary has been undermined by the international financial crisis and the faltering recovery in many economies. There is an evident need to pay closer attention to developments of asset markets and in the financial sector, which has opened a discussion on the appropriate goals for monetary policy. Meanwhile central banks have employed controversial balance sheet operations to restore market stability and encourage economic recovery. This paper argues that both these developments reflect earlier concerns in monetary policy: prior to the modern consensus both balance sheet policies and an emphasis on financial stability were central concerns of monetary authorities and the future of monetary policy is likely to rhyme with its past.
    Keywords: monetary policy, interest rate policy, balance sheet operations, financial stability
    JEL: E51 E52 E58
    Date: 2012
  4. By: Jaime Marquez; Ari Morse; Bernd Schlusche
    Abstract: This paper provides a comprehensive study of the interplay between the Federal Reserve's balance sheet and overnight interest rates. We model both the supply of and the demand for excess reserves, treating assets of the Federal Reserve as policy tools, and estimate the effects of conventional and unconventional monetary policy on overnight funding rates. We find that, in the current environment with quite elevated levels of reserves, the effect of further monetary policy accommodation on overnight interest rates is limited. Further, assuming a path for removing monetary policy accommodation that is consistent with the FOMC's exit principles, we project that the federal funds rate increases to 70 basis points, settling in a corridor bracketed by the discount rate and the interest rate on excess reserves, as excess reserves of depository institutions decline to near zero.
    Date: 2012
  5. By: Ternyik, Stephen I.
    Abstract: The quantization of money guides us with methodical precision to the decisive role of the quantitative reserve requirement as the single cause-effect systemics of cyclical processes in the advanced monetary production economy.This research compiles the foundation and ultimate conclusion of quantum monetary science and points to a more exact formulation of monetary economics.
    Keywords: quantum monetary science; monetary quantum; monetophysics
    JEL: B41
    Date: 2012
  6. By: Antonio Ribba
    Abstract: In the first thirteen years of EMU, monetary policy choices of the European Central Bank (ECB) in setting the short-term interest rate have followed, systematically, monetary policy decisions made by the Federal Reserve System (Fed). For, despite the presence of variable lags with respect to Fed decisions, turning points of European short-term interest rates have been largely anticipated by movements in the federal funds rate. In this paper we show that, in the context of a bivariate cointegrated system, a clear long-run US dominance emerges. Moreover, the structural analysis reveals that a permanent increase in the federal funds rate causes a permanent one-for-one movement in the eonia rate.
    Keywords: Monetary policy, Identification, Structural Cointegrated VARs;
    JEL: C32 E5
    Date: 2012–10
  7. By: María Lorena Marí del Cristo (Faculty of Economics, University of Barcelona); Marta Gómez-Puig (Faculty of Economics, University of Barcelona)
    Abstract: In this article we examine the convenience of dollarization for Ecuador today. As Ecuador is strongly integrated financially and commercially with the United States, the exchange rate pass-through should be zero. However, we sustain that rising rates of imports from trade partners other than the United States and subsequent real effective exchange rate depreciations are causing the pass-through to move away from zero. Here, in the framework of the Vector Error Correction Model, we analyse the impulse response function and variance decomposition of the inflation variable. We show that the developing economy of Ecuador is importing inflation from its main trading partners, most of them emerging countries with appreciated currencies. We argue that if Ecuador recovered both its monetary and exchange rate instruments it would be able to fight against inflation. We believe such an analysis could be extended to other countries with pegged exchange rate regimes.
    Keywords: Pass-through, shocks, dollarized countries, structural VECM JEL classification: E31; F31; F41
    Date: 2012–10
  8. By: María-Dolores, Ramón; Londoño, Juan M.; Vázquez Pérez, Jesús
    Abstract: This paper proposes an extended version of the basic New Keynesian monetary (NKM) model which contemplates revision processes of output and inflation data in order to assess the importance of data revisions on the estimated monetary policy rule parameters and the transmission of policy shocks. Our empirical evidence based on a structural econometric approach suggests that although the initial announcements of output and inflation are not rational forecasts of revised output and inflation data, ignoring the presence of non well-behaved revision processes may not be a serious drawback in the analysis of monetary policy in this framework. However, the transmission of inflation-push shocks is largely affected by considering data revisions. The latter being especially true when the nominal stickiness parameter is estimated taking into account data revision processes.
    Keywords: indirect inference, monetary policy rule, NKM model, real-time data, non-rational forecast error
    JEL: C32 E30 E52
    Date: 2012
  9. By: Anna Lipinska; Leopold von Thadden
    Abstract: This paper explores the fiscal devaluation hypothesis in a model of a monetary union characterised by national fiscal policies and supranational monetary policy. We show that a unilateral tax shift towards indirect taxes in one of the countries produces small but non-negligible long run effects on output and consumption within and between the two countries only when international financial markets are perfectly integrated. In contrast to the existing literature, we find that short-run effects are not always amplified by nominal wage rigidities. We document also how short-run effects of the tax shift depend on the choice of the inflation index stabilized by the central bank and on whether the tax shift is anticipated.
    Date: 2012
  10. By: Stefan Kooths; Björn van Roye
    Abstract: The Eurosystem has been pursuing a crisis management policy for more than four years now. This policy aims primarily at maintaining financial stability in the euro area by providing vast liquidity support to commercial banks that are operating in nationally segmented banking systems. As a side effect, the national central banks substitute money market operations for cross-border capital flows. The national central banks are thus increasingly engaging in substantial balance-of-payments financing, and financial risks are being shifted from investors to European taxpayers via the Eurosystem. Symptomatically, this shows up in exploding TARGET2 positions in the national central banks' balance sheets. The longer this process continues, the stronger the centrifugal forces become that ultimately might break up the single currency. Instead of a fiscal union, a euro-area-wide regulatory approach is required. In addition to establishing a uniform scheme for banking regulation, supervision and resolution, we recommend that contingent convertible bonds (CoCos) be introduced to provide a major source of refinancing for the banking industry. Since CoCos cannot be introduced overnight, national and European banking resolution funds would be needed in the short run. These funds would not rescue banks but they would kick in as soon as a bank's equity is depleted in order to wind up failing banks in a systemically prudent way
    Keywords: Balance-of-payments financing, Target2, Eurosystem, Monetary policy, Financial crisis, Euro area, Financing mechanisms
    JEL: E42 E51 E58 F32 F34
    Date: 2012–08
  11. By: Eric Dor (IESEG School of Management (LEM-CNRS))
    Abstract: Recent studies show that disagreement regarding the future evolution of activity, inflation, or long and short interest rates, significantly forecasts holding excess returns. These studies include the papers of Buraschi and Whelan (2012), Barillas and Nimark (2012), Xiong and Yan (2010), Wu (2009) Such results challenge the common view that, under the expectations hypothesis of the term structure, the excess holding return should be unpredictable. The new evidence thus means that the risk premium is time-varying, moving as a function of disagreement. It is useful to discuss the potential implications of such theoretical results and empirical evidence on related monetary policy issues.
    Date: 2012–12
  12. By: Konstantin Styrin (New Economic School); Oleg Zamulin (National Research University – Higher School of Economics)
    Abstract: It has been noted in many papers that primary commodity exporting economies and developing countries frequently respond to movements in the real exchange rate as part of their monetary policies. For many central banks, this variable is the primary indicator of real activity. At the same time, smoothing the real exchange rate fluctuations has certain inflationary costs. In a way, this trade-off between inflation and the real exchange rate is identical to a standard Phillips curve. This paper derives an exact theoretical expression for this “real exchange rate based Phillips curve,” and finds empirical support for its existence in the data for a number of primary commodity exporting economies such as Australia, Canada, New Zealand and others. It turns out that the correct right-hand-side variable in the Phillips curve is not the real exchange rate itself, but rather its deviation from the fundamental value, which is a function of the international price of exported commodities. The empirical counterpart of the fundamental real exchange rate is obtained from a cointegrating equation for the real exchange rate and the countryspecific price index of exported commodities. As is frequently found in other Phillips curve studies, empirical tests point towards the accelerationist specification, which can be rationalized by dominance of adaptive expectations in price-setting behavior.
    Keywords: Real exchange rate; inflation; Phillips curve; commodity currencies
    JEL: E31 E32 F31
    Date: 2012–10
  13. By: Cavallari, Lilia
    Abstract: This paper provides a theory of the international business cycle grounded on firms' entry and sticky prices. It shows that under simple monetary rules pro-cyclical entry and counter-cyclical markups can generate fluctuations in macroeconomic aggregates and trade variables as large as those observed in the data while at the same time providing positive international comovements. Both firms' entry and sticky prices are essential for reproducing the synchronization of the business cycles found in the data.
    Keywords: firm entry; international business cycle; international comovements; variable markup; Taylor rule; exchange rate regimes
    JEL: E32 E52 F41
    Date: 2012–07
  14. By: Cassou, Steven P.; Vázquez Pérez, Jesús
    Abstract: This paper considers a time varying parameter extension of the Ruge-Murcia (2003, 2004) model to explore whether some of the variation in parameter estimates seen in the literature could arise from this source. A time varying value for the unemployment volatility parameter can be motivated through several means including variation in the slope of the Phillips curve or variation in the preferences of the monetary authority.We show that allowing time variation for the coefficient on the unemployment volatility parameter improves the model fit and it helps to provide an explanation of inflation bias based on asymmetric central banker preferences, which is consistent across subsamples.
    Keywords: asymmetric preferences, time varying parameter, conditional unemployment volatility
    JEL: E61 E31 E52
    Date: 2012
  15. By: Varma, Vijaya Krushna Varma
    Abstract: In the future economic system, as suggested by TOP Tax system, the total money supply (real money and debt money/loan money) to be necessary for circulation in banks should be at the minimum level of 100% and at maximum level 110% of the value of GDP of the country. Out of this total money supply in the economic system, 99.7% of the money will be in dematerialised (non physical) form in the accounts of citizens, Governments and companies. Only small portion of money, equalling just 0.3% of the total money in the economic system, will be in physical form i.e. currency notes or coins. All high valued paper currency notes will be demonetised.
    Keywords: Money supply; monetary system; monetary policy
    JEL: E51 E42 E5 E52
    Date: 2012–01–12
  16. By: Dimitri B. Papadimitriou; L. Randall Wray
    Abstract: It's a mistake to interpret the unfolding disaster in Europe as primarily a "sovereign debt crisis." The underlying problem is not periphery profligacy, but rather the very setup of the European Monetary Union (EMU)—a setup that even now prevents a satisfactory resolution to this crisis. The central weakness of the EMU is that it separates nations from their currencies without providing them with adequate overarching fiscal or monetary policy structures—it's like a United States without a Treasury or a fully functioning Federal Reserve. Without addressing this basic structural weakness, Euroland will continue to stumble toward the cliff—and threaten to pull a tottering US financial system over the edge with it.
    Date: 2012–02
  17. By: Claudia Miani (Banca d'Italia); Giulio Nicoletti (Banca d'Italia); Alessandro Notarpietro (Banca d'Italia); Massimiliano Pisani (Banca d'Italia)
    Abstract: We investigate the relationship between macroeconomic conditions and banks' balance sheets by referring to a modified version of the Bank of Italy Quarterly Model (BIQM), regularly used for forecasting and policy analysis. In particular, we examine how regulatory bank capital and private sector default probabilities affect interest rates on loans and, ultimately, economic activity. To this end, we build an enriched version of the model to include a number of banking variables. The changes introduced in the model result in an amplification of the responses of macroeconomic variables to monetary policy and world demand shocks, although, in normal times, the effect is not large.
    Keywords: bank regulatory capital, loan interest rates, Italian economy.
    JEL: E17 E27 E51 G21
    Date: 2012–09
  18. By: Geert Bekaert (Graduate School of Business, Columbia University); Marie Hoerova (ECB); Marco Lo Duca (ECB)
    Abstract: The VIX, the stock market option-based implied volatility, strongly co-moves with measures of the monetary policy stance. When decomposing the VIX into two components, a proxy for risk aversion and expected stock market volatility (“uncertainty”), we find that a lax monetary policy decreases both risk aversion and uncertainty, with the former effect being stronger. The result holds in a structural vector autoregressive framework, controlling for business cycle movements and using a variety of identification schemes for the vector autoregression in general and monetary policy shocks in particular.
    Keywords: Monetary policy, Option implied volatility, Risk aversion, Uncertainty, Business cycle, Stock market volatility dynamics
    JEL: E44 E52 G12 G20 E32
    Date: 2012–10
  19. By: Dimitri B. Papadimitriou; L. Randall Wray
    Abstract: From the very start, the European Monetary Union (EMU) was set up to fail. The host of problems we are now witnessing, from the solvency crises on the periphery to the bank runs in Spain, Greece, and Italy, were built into the very structure of the EMU and its banking system. Policymakers have admittedly responded to these various emergencies with an uninspiring mix of delaying tactics and self-destructive policy blunders, but the most fundamental mistake of all occurred well before the buildup to the current crisis. What we are witnessing today are the results of a design flaw. When individual nations like Greece or Italy joined the EMU, they essentially adopted a foreign currency—the euro—but retained responsibility for their nation's fiscal policy. This attempted separation of fiscal policy from a sovereign currency is the fatal defect that is tearing the eurozone apart.
    Date: 2012–07
  20. By: Sophie Brana (Larefi - Laboratoire d'analyse et de recherche en économie et finance internationales - Université Montesquieu - Bordeaux IV : EA2954); Marie-Louise Djibenou (Larefi - Laboratoire d'analyse et de recherche en économie et finance internationales - Université Montesquieu - Bordeaux IV : EA2954); Stéphanie Prat (Larefi - Laboratoire d'analyse et de recherche en économie et finance internationales - Université Montesquieu - Bordeaux IV : EA2954)
    Abstract: The overly accommodating monetary policy is often accused of creating surplus liquidity and bubbles on the asset markets. In particular, it could have contributed to strong capital inflows in emerging countries, which may have had a significant impact on financial stability in these countries, affecting domestic financing conditions and creating a risk of upward pressures on asset prices. We focus in this paper on the impact of global excess liquidity on good and asset prices for a set of emerging market countries by estimating a panel VAR model. We define first global liquidity and highlight situations of excess liquidity. We then find that excess liquidity at the global level has spillover effects on output and price level in emerging countries. The impact on real estate and commodity prices in emerging countries is less clear.
    Keywords: Global liquidity, excess liquidity indicators, crises indicators, emerging countries, financial crisis
    Date: 2012–03–01
  21. By: Christian Matthes; Francesca Rondina
    Abstract: This paper investigates the role of learning by private agents and the central bank (two-sided learning) in a New Keynesian framework in which both sides of the economy have asymmetric and imperfect knowledge about the true data generating process. We assume that all agents employ the data that they observe (which may be distinct for different sets of agents) to form beliefs about unknown aspects of the true model of the economy, use their beliefs to decide on actions, and revise these beliefs through a statistical learning algorithm as new information becomes available. We study the short-run dynamics of our model and derive its policy recommendations, particularly with respect to central bank communications. We demonstrate that two-sided learning can generate substantial increases in volatility and persistence, and alter the behavior of the variables in the model in a significant way. Our simulations do not converge to a symmetric rational expectations equilibrium and we highlight one source that invalidates the convergence results of Marcet and Sargent (1989). Finally, we identify a novel aspect of central bank communication in models of learning: communication can be harmful if the central bank's model is substantially mis-specified.
    Keywords: asymmetric information, learning, monetary policy
    JEL: E52
    Date: 2012–09
  22. By: Gary B. Gorton; Andrew Metrick
    Abstract: The sale and repurchase (repo) market played a central role in the recent financial crisis. From the second quarter of 2007 to the first quarter of 2009, net repo financing provided to U.S. banks and broker-dealers fell by about $1.3 trillion – more than half of its pre-crisis total. Significant details of this “run on repo” remain shrouded, however, because many of the providers of repo finance are lightly regulated or unregulated cash pools. In this paper we supplement the best available official data sources with a unique market survey to provide an updated picture of the dynamics of the repo run. We provide evidence that the run was predominantly driven by the flight of foreign financial institutions, domestic and offshore hedge funds, and other unregulated cash pools. Our analysis highlights the danger of relying exclusively on data from regulated institutions, which would miss the most important parts of the run.
    JEL: G01 G23
    Date: 2012–10
  23. By: Jan Kregel
    Abstract: As the results of the various official investigations spread, it becomes more and more apparent that a large majority of financial institutions engaged in fraudulent manipulation of the benchmark London Interbank Offered Rate (LIBOR) to their own advantage, and that bank management and regulators were unable to effectively monitor the activity of institutions because they were too big to manage and too big to regulate. However, instead of drawing the obvious conclusion—that structural changes are needed to reduce banks to a size that can be effectively regulated, as proposed on numerous occasions by the Levy Economics Institute—discussion in the media and political circles has turned to whether the problem was the result of the failure of central bank officials and government regulators to respond to repeated suggestions of manipulation, and to stop the fraudulent behavior. Just as the "hedging" losses at JPMorgan Chase have been characterized as the result of misbehavior on the part of some misguided individual traders, leaving top bank management without culpability, politicians and the media are now questioning whether government officials condoned, or even encouraged, manipulation of the LIBOR rate, virtually ignoring the banks' blatant abuse of principles of good banking practice. Just as in the case of JPMorgan, the only response has been to remove the responsible individuals, rather than questioning the structure and size of the financial institutions that made managing and policing this activity so difficult. Again, the rotten apples have been removed without anyone noticing that it is the barrel that is the cause of the problem. But in the current scandal, the ad hominem culpability has been extended to central bank officials in the UK and the United States.
    Date: 2012–08

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