nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒11‒11
nineteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Dual liquidity crises under alternative monetary frameworks: a financial accounts perspective By Ulrich Bindseil; Adalbert Winkler
  2. The optimal inflation target in an economy with limited enforcement By Gaetano Antinolfi; Costas Azariadis; James Bullard
  3. Persistent Habits, optimal Monetary Policy Inertia and Interest Rate Smoothing By Corrado, L.; Holly, S.; Raissi, M.
  4. Monetary Policy in Transition – Essays on Monetary Policy Transmission Mechanism in China By Koivu, Tuuli
  5. Debt-Deflation versus the Liquidity Trap : The Dilemma of Nonconventional Monetary Policy. By Gaël Giraud; Antonin Pottier
  6. Macroeconomic effects of Federal Reserve forward guidance By Jeffrey R. Campbell; Charles Evans; Jonas D. M. Fisher; Alejandro Justiniano
  7. Euler equations and money market interest rates: The role of monetary and risk premium shocks By Gareis, Johannes; Mayer, Eric
  8. Monetary policy and fiscal stimulus with the zero lower bound and financial frictions By Rossana MEROLA
  9. Estimating Phillips Curves in turbulent times using the ECB's survey of professional forecasters By Gary Koop; Luca Onorante
  10. Central bank communication on fiscal policy By Julien Allard; Marco Catenaro; Jean-Pierre Vidal; Guido Wolswijk
  11. A global monetary tsunami? On the spillovers of US Quantitative Easing By Fratzscher, Marcel; Lo Duca, Marco; Straub, Roland
  12. Financial Conditions Indices for the Turkish Economy (Turkiye Ekonomisi icin Finansal Kosullar Endeksi) By A. Hakan Kara; Pinar Ozlu; Deren Unalmis
  13. The forward guidance puzzle By Marco Del Negro; Marc Giannoni; Christina Patterson
  14. Exchange Rates as Exchange Rate Common Factors By Nelson Mark
  15. Pegging emerging currencies in the face of dollar swings By Virginie Coudert; Cécile Couharde; Valérie Mignon
  16. Inflation Expectations and Behavior: Do Survey Respondents Act on their Beliefs? By Wilbert van der Klaauw; Wandi Bruine de Bruin; Giorgio Topa; Basit Zafar; Olivier Armantier
  17. Banking, debt and currency crises: early warning indicators for developed countries By Jan Babecký; Tomáš Havránek; Jakub Matějů; Marek Rusnák; Kateřina Šmídková; Bořek Vašíček
  18. The Determinants of Australian Exchange Rate: A Time Series Analysis By Atif, Syed Muhammad; Sauytbekova, Moldir; Macdonald, James
  19. How Fast Are Prices in Japan Falling? By Satoshi Imai; Chihiro Shimizu; Tsutomu Watanabe

  1. By: Ulrich Bindseil (European Central Bank); Adalbert Winkler (Frankfurt School of Finance & Management)
    Abstract: This paper contributes to the literature on liquidity crises and central banks acting as lenders of last resort by capturing the mechanics of dual liquidity crises, i.e. funding crises which encompass both the private and the public sector, within a closed system of financial accounts. We analyze how the elasticity of liquidity provision by a central bank depends on the international monetary regime in which the relevant country operates and on specific central bank policies like collateral policies, monetary financing prohibitions and quantitative borrowing limits imposed on banks. Thus, it provides a firm basis for a comparative analysis of the ability of central banks to absorb shocks. Our main results are as follows: (1) A central bank that operates under a paper standard with a flexible exchange rate and without a monetary financing prohibition and other limits of borrowings placed on the banking sector is most flexible in containing a dual liquidity crisis. (2) Within any international monetary system characterized by some sort of a fixed exchange rate, including the gold standard, the availability of inter-central bank credit determines the elasticity of a crisis country’s central bank in providing liquidity to banks and financial markets. (3) A central bank of a euro area type monetary union has a similar capacity in managing dual liquidity crises as a country central bank operating under a paper standard with a flexible exchange rate as long as the integrity of the monetary union is beyond any doubt. JEL Classification: E50, E58
    Keywords: Liquidity crisis, bank run, sovereign debt crisis, central bank co-operation, gold standard
    Date: 2012–10
  2. By: Gaetano Antinolfi; Costas Azariadis; James Bullard
    Abstract: We formulate the central bank’s problem of selecting an optimal long-run inflation rate as the choice of a distorting tax by a planner who wishes to maximize discounted stationary utility for a heterogeneous population of infinitely-lived households in an economy with constant aggregate income and public information. Households are segmented into cash agents, who store value in currency alone, and credit agents who have access to both currency and loans. The planner’s problem is equivalent to choosing inflation and nominal interest rates consistent with a resource constraint, and with an incentive constraint that ensures credit agents prefer the superior consumption- smoothing power of loans to that of currency. We show that the optimum inflation rate is positive, because inflation reduces the value of the outside option for credit agents and raises their debt limits.
    Keywords: Inflation targeting ; Deflation (Finance) ; Monetary policy
    Date: 2012
  3. By: Corrado, L.; Holly, S.; Raissi, M.
    Abstract: Dynamic stochastic general equilibrium models featuring imperfect competition and nominal rigidities have become central for the analysis of the monetary transmission mechanism and for understanding the conduct of monetary policy. However, it is agreed that the benchmark model fails to generate the persistence of output and inflation that is observed in the data. Moreover, it cannot provide a theoretically well-grounded justification for the interest rate smoothing behaviour of monetary authorities. This paper attempts to overcome these deficiencies by embedding a multiplicative habit specification in a New Keynesian model. We show that this particular form of habit formation can explain why monetary authorities smooth interest rates.
    Keywords: Multiplicative habits, interest rate inertia, optimal monetary policy.
    JEL: D12 E52 E43
    Date: 2012–10–29
  4. By: Koivu, Tuuli (Bank of Finland Research)
    Abstract: China’s economic development has been exceptionally robust since the end of the 1970s, and the country has already emerged as the second biggest economy in the world. In this study, we seek to illuminate the role of the monetary policy in this successful economic performance and as a part of the extensive economic reforms of the last two decades. The five empirical essays seek to discover which monetary policy tools are the most used and most effective for guiding China’s economic development. In addition, we explore which monetary policy transmission channels are functioning and to what extent monetary policy impacts inflation and real economic developments in China. The results indicate that the conduct of monetary policy in China differs substantially from what is typical for an advanced market economy, where an independent central bank often aims to hit an inflation target by simply controlling the target interest rate. First, China’s monetary policy toolkit is highly diverse. Besides a collection of administrated interest rates, it contains quantitative policy tools and direct guidelines. Second, China’s central bank is not independent in its decision-making. For these reasons, it is exceptionally challenging to measure the monetary policy stance or to distinguish monetary policy from other macroeconomic policies in China’s case. This has been taken into account in this study by using a variety of monetary-policy indicators. Our results suggest that China’s monetary-policy implementation and its transmission to the real economy still rely heavily on quantitative policy tools and direct guidelines; interest rates play a much smaller role, in terms of both usage and effectiveness. Overall, our findings suggest that the direct link between monetary policy and real economic performance is weak in China. On the other hand, this study clearly shows that monetary policy has played a key role in price developments, which tells us that monetary policy has been an important factor in China’s economic success.
    Keywords: China; monetary policy; economic growth; inflation; exchange rates
    JEL: E50 P30
    Date: 2012–10–26
  5. By: Gaël Giraud (Centre d'Economie de la Sorbonne - Paris School of Economics); Antonin Pottier (CIRED)
    Abstract: This paper examines quantity-targeting monetary policy in a two-period economy with fiat money, endogenously incomplete markets of financial securities, durable goods and production. Short positions in financial assets and long-term loans are backed by collateral, the value of which depends on monetary policy. The decision to default is endogenous and depends on the relative value of the collateral to the loan. We show that Collateral Monetary Equilibria exist and prove there is also a refinement of the Quantity Theory of Money that turns out to be compatible with the long-run non-neutrality of money. Moreover, only three scenarios are compatible with the equilibrium condition : 1) either the economy enters a liquidity trap in the first period ; 2) or a credible ex-pansionary monetary policy accompanies the orderly functioning of markets at the cost of running an inflationary risk ; 3) else the money injected by the Central Bank increases the leverage of indebted investors, fueling a financial bubble whose bursting leads to debt-deflation in the next period with a non-zero probability. This dilemma of monetary policy highlights the default channel affecting trades and production, and provides a rigorous foundation to Fisher’s debt deflation theory as being distinct from Keynes’ liquidity trap.
    Keywords: Central Bank, liquidity trap, collateral, default, deflation, quantitative easing, debt-deflation.
    JEL: D50 E40 E44 E50 E52 E58 G38 H50
    Date: 2012–10
  6. By: Jeffrey R. Campbell; Charles Evans; Jonas D. M. Fisher; Alejandro Justiniano
    Abstract: A large output gap accompanied by stable inflation close to its target calls for further monetary accommodation, but the zero lower bound on interest rates has robbed the Federal Open Market Committee (FOMC) of the usual tool for its provision. We examine how public statements of FOMC intentions—forward guidance—can substitute for lower rates at the zero bound. We distinguish between Odyssean forward guidance, which publicly commits the FOMC to a future action, and Delphic forward guidance, which merely forecasts macroeconomic performance and likely monetary policy actions. Others have shown how forward guidance that commits the central bank to keeping rates at zero for longer than conditions would otherwise warrant can provide monetary easing, if the public trusts it. ; We empirically characterize the responses of asset prices and private macroeconomic forecasts to FOMC forward guidance, both before and since the recent financial crisis. Our results show that the FOMC has extensive experience successfully telegraphing its intended adjustments to evolving conditions, so communication difficulties do not present an insurmountable barrier to Odyssean forward guidance. Using an estimated dynamic stochastic general equilibrium model, we investigate how pairing such guidance with bright-line rules for launching rate increases can mitigate risks to the Federal Reserve’s price stability mandate.
    Keywords: Macroeconomics - Econometric models ; Monetary policy ; Federal Reserve banks
    Date: 2012
  7. By: Gareis, Johannes; Mayer, Eric
    Abstract: This paper challenges the view that the observed negative correlation between the Federal Funds rate and the interest rate implied by consumption Euler equations is systematically linked to monetary policy. By using a Monte Carlo experiment, we show that stochastic risk premium disturbances have the capability to drive a wedge between the interest rate targeted by the central bank and the implied Euler equation interest rate such that the correlation between actual and implied rates is negative. --
    Keywords: Euler Interest Rate,Monetary Policy,Risk Premium Shocks
    JEL: E10 E43 E44 E52
    Date: 2012
  8. By: Rossana MEROLA (OECD, Economics Department and Université Catholique de Louvain)
    Abstract: Recent developments in many industrialized countries have triggered a debate on whether monetary policy is effective when the nominal interest rate is close to zero. When the nominal interest rate hits its lower bound, the monetary authority is no longer in a position to pursue a policy of monetary easing by lowering nominal interest rates further. In this paper, I assess the implications of the zero lower bound in a DSGE model with financial frictions. The analysis shows that in a framework with financial frictions, when the interest rate is at the lower bound, the initial impact of a negative shock is amplified and the economy is more likely to plunge into a recession. I assess whether different macro policies, such as the management of expectations by the central bank or a counter-cyclical fiscal stimulus, may help recover the economy from the recession. I find that the monetary authority might alleviate the recession by targeting the price-level. Fiscal stimulus represents an alternative solution especially when the zero lower bound constraint becomes binding, as fiscal multipliers may become larger than one. In analyzing discretionary fiscal policy, this paper also focuses on two crucial aspects: the duration of the fiscal stimulus and the presence of implementation lags.
    Keywords: Optimal monetary policy, financial accelerator, lower bound on nominal interest rates, price-level targeting, fiscal stimulus
    JEL: E31 E44 E52 E58
    Date: 2012–10–30
  9. By: Gary Koop (University of Strathclyde); Luca Onorante (European Central Bank)
    Abstract: This paper uses forecasts from the European Central Bank’s Survey of Professional Forecasters to investigate the relationship between inflation and inflation expectations in the euro area. We use theoretical structures based on the New Keynesian and Neoclassical Phillips curves to inform our empirical work and dynamic model averaging in order to ensure an econometric specification capturing potential changes. We use both regression-based and VAR-based methods. The paper confirms that there have been shifts in the Phillips curve and identifies three sub-periods in the EMU: an initial period of price stability, a few years where inflation was driven mainly by external shocks, and the financial crisis, where the New Keynesian Phillips curve outperforms alternative formulations. This finding underlines the importance of introducing informed judgment in forecasting models and is also important for the conduct of monetary policy, as the crisis entails changes in the effect of expectations on inflation and a resurgence of the “sacrifice ratio”. JEL Classification: E31, C53, C11.
    Keywords: Inflation expectations, survey of professional forecasters, Phillips curve, Bayesian, financial crisis.
    Date: 2012–02
  10. By: Julien Allard; Marco Catenaro (European Central Bank); Jean-Pierre Vidal (European Central Bank); Guido Wolswijk (European Central Bank)
    Abstract: While the established literature on central bank communication has traditionally dealt with communication of monetary policy messages to financial markets and the wider public, central bank communication on fiscal policy has so far received little attention. This paper empirically reviews the intensity of central banks’ fiscal communication by five central banks (the US Federal Reserve, the ECB, the Bank of Japan, the Bank of England and the Swedish Riksbank) over the period 1999-2011. To that end, it develops a fiscal indicator measuring the fiscal-related communication in minutes or introductory statements. Our findings indicate that the ECB communicates intensively on fiscal policies in both positive as well as normative terms. Other central banks more typically refer to fiscal policy when describing foreign developments relevant to domestic macroeconomic developments, when using fiscal policy as input to forecasts, or when referring to the use of government debt instruments in monetary policy operations. The empirical analysis also indicates that the financial crisis has overall increased the intensity of central bank communication on fiscal policy. It identifies the evolution of the government deficit ratio as a driver of the intensity of fiscal communication by central banks in the euro area, the US and Japan, and for Sweden since the start of the crisis. In England the fiscal share in central bank communication is related to developments in government debt as of the start of the crisis. JEL Classification: E58, E61, E63
    Keywords: Central bank communication, fiscal policy, quantification of verbal information
    Date: 2012–09
  11. By: Fratzscher, Marcel; Lo Duca, Marco; Straub, Roland
    Abstract: The paper analyses the global spillovers of the Federal Reserve’s unconventional monetary policy measures since 2007. First, we find that Fed measures in the early phase of the crisis (QE1), but not since 2010 (QE2), were highly effective in lowering sovereign yields and raising equity markets in the US and globally across 65 countries. Yet Fed policies functioned in a pro-cyclical manner for capital flows to EMEs and a counter-cyclical way for the US, triggering a portfolio rebalancing across countries out of emerging markets (EMEs) into US equity and bond funds under QE1, and in the opposite direction under QE2. Second, the impact of Fed operations, such as Treasury and MBS purchases, on portfolio allocations and asset prices dwarfed those of Fed announcements, underlining the importance of the market repair and liquidity functions of Fed policies. Third, we find no evidence that FX or capital account policies helped countries shield themselves from these US policy spillovers, but rather that responses to Fed policies are related to country risk. The results thus illustrate how US monetary policy since 2007 has contributed to portfolio reallocation as well as a re-pricing of risk in global financial markets.
    Keywords: capital flows; emerging markets; Federal Reserve; monetary policy; panel data; portfolio choice; quantitative easing; spillovers; United States
    JEL: E52 E58 F32 F34 G11
    Date: 2012–10
  12. By: A. Hakan Kara; Pinar Ozlu; Deren Unalmis
    Abstract: Since the end of 2010, Central Bank of the Republic of Turkey has adopted a new policy strategy which jointly uses liquidity, credit, and interest rate policies. The new framework has increased the need to develop and monitor a broad measure of “financial conditions” index that would complement the monetary policy analysis in assessing whether the overall set of policies are restrictive or accommodative. This note seeks to fill this gap by developing financial conditions indices for Turkey using a range of monetary and financial indicators.
    Date: 2012
  13. By: Marco Del Negro; Marc Giannoni; Christina Patterson
    Abstract: With short-term interest rates at the zero lower bound, forward guidance has become a key tool for central bankers, and yet we know little about its effectiveness. Standard medium-scale DSGE models tend to grossly overestimate the impact of forward guidance on the macroeconomy—a phenomenon we call the “forward guidance puzzle.” We explain why this is the case and describe one approach to addressing this issue.
    Keywords: Banks and banking, Central ; Interest rates ; Federal Open Market Committee ; Stochastic analysis ; Equilibrium (Economics) ; Monetary policy
    Date: 2012
  14. By: Nelson Mark (Department of Economics, University of Notre Dame)
    Abstract: Factor analysis performed on a panel of 23 nominal exchange rates from January 1999 to December 2010 yields three common factors. This paper identifies the euro/dollar, Swiss- franc/dollar and yen/dollar exchange rates as empirical counterparts to these common factors. These empirical factors explain a large proportion of exchange rate variation over time and have significant in-sample and out-of-sample predictive power.
    Keywords: Exchange Rates, Common Factors, Forecasting
    JEL: F31 F37
    Date: 2012–03
  15. By: Virginie Coudert; Cécile Couharde; Valérie Mignon
    Abstract: The aim of this paper is to study ruptures of exchange-rate pegs by focusing on the fluctuations of the anchor currency. We test for the hypothesis that currencies linked to the USD are more likely to loosen their peg when the USD is appreciating, while sticking to it otherwise. To this end, we estimate smooth-transition regression models for a sample of 28 emerging currencies over the 1994-2011 period. Our findings show that while the real effective exchange rates of most of these countries tend to co-move with that of the USD in times of depreciation, this relationship is frequently reversed when the US currency appreciates over a certain threshold. Such nonlinear effects are especially at stake in Asia where growth is export-oriented.
    Keywords: real exchange rates;anchor currency;rupture of pegs;smooth transition regression models
    JEL: F31 F33 C22
    Date: 2012–10
  16. By: Wilbert van der Klaauw (Federal Reserve Bank of New York); Wandi Bruine de Bruin (Carnegie Mellon University); Giorgio Topa (Federal Reserve Bank of New York); Basit Zafar (Federal Reserve Bank of New York); Olivier Armantier (Federal Reserve Bank of New York)
    Abstract: We compare the inflation expectations reported by consumers in a survey with their behavior in a financially incentivized investment experiment designed such that future inflation affects payoffs. The inflation expectations survey is found to be informative in the sense that the beliefs reported by the respondents are correlated with their choices in the experiment. Furthermore, most respondents appear to act on their inflation expectations showing patterns consistent (both in direction and magnitude) with expected utility theory. Respondents whose behavior cannot be rationalized tend to be less educated and to score lower on a numeracy and financial literacy scale. These findings are therefore the first to provide support to the micro-foundations of modern macroeconomic models.
    Date: 2012
  17. By: Jan Babecký (Czech National Bank); Tomáš Havránek (Czech National Bank; Charles University, Institute of Economic Studies); Jakub Matějů (Czech National Bank; Center for Economic Research and Graduate Education - Economics Institue (CERGE-EI)); Marek Rusnák (Czech National Bank; Charles University, Institute of Economic Studies); Kateřina Šmídková (Czech National Bank; Charles University, Institute of Economic Studies); Bořek Vašíček (Czech National Bank)
    Abstract: We construct and explore a new quarterly dataset covering crisis episodes in 40 developed countries over 1970–2010. First, we examine stylized facts of banking, debt, and currency crises. Banking turmoil was most frequent in developed economies. Using panel vector autoregression, we confirm that currency and debt crises are typically preceded by banking crises, but not vice versa. Banking crises are also the most costly in terms of the overall output loss, and output takes about six years to recover. Second, we try to identify early warning indicators of crises specific to developed economies, accounting for model uncertainty by means of Bayesian model averaging. Our results suggest that onsets of banking and currency crises tend to be preceded by booms in economic activity. In particular, we find that growth of domestic private credit, increasing FDI inflows, rising money market rates as well as increasing world GDP and inflation were common leading indicators of banking crises. Currency crisis onsets were typically preceded by rising money market rates, but also by worsening government balances and falling central bank reserves. Early warning indicators of debt crisis are difficult to uncover due to the low occurrence of such episodes in our dataset. Finally, employing a signaling approach we show that using a composite early warning index increases the usefulness of the model when compared to using the best single indicator (domestic private credit). JEL Classification: C33, E44, E58, F47, G01
    Keywords: Early warning indicators, Bayesian model averaging, macro-prudential policies
    Date: 2012–10
  18. By: Atif, Syed Muhammad; Sauytbekova, Moldir; Macdonald, James
    Abstract: The paper analyzes Australian exchange rate and its determinants by providing an insight into the economic and non-economic factors. By drawing a comparison between quarterly and annual data over the period of 1975 to 2012, it is suggested that Australia’s trade components and macroeconomic indicators such as output and liquidity relative to the US, play a significant role in determination of its exchange rates. However, interest rate and inflation appear insignificant in this relationship. The study also emphasizes on the pertinence of unobservable effects such as political events and external shocks in influencing the exchange rate. Engle-Granger Cointegration test exhibits a long run relationship between exchange rate and its determinants, and corroborates the substantial role of macroeconomic indicators in diminishing the uncertainty in foreign exchange market. --
    Keywords: Exchange Rate,Backward Elimination
    JEL: C22 F31
    Date: 2012
  19. By: Satoshi Imai (Statistics Bureau of Japan.); Chihiro Shimizu (Reitaku University and University of British Columbia.); Tsutomu Watanabe (The University of Tokyo)
    Abstract: The consumer price inflation rate in Japan has been below zero since the mid-1990s. However, despite the presence of a substantial output gap, the rate of deflation has been much smaller than that observed in the United States during the Great Depression. Given this, doubts have been raised regarding the accuracy of Japan’s official inflation estimates. Against this background, the purpose of this paper is to investigate to what extent estimates of the inflation rate depend on the methodology adopted. Our specific focus is on how inflation estimates depend on the method of outlet, product, and price sampling employed. For the analysis, we use daily scanner data on prices and quantities for all products sold at about 200 supermarkets over the last ten years. We regard this dataset as the“universeâ€and send out (virtual) price collectors to conduct sampling following more than sixty different sampling rules. We find that the officially released outcome can be reproduced when employing a sampling rule similar to the one adopted by the Statistics Bureau. However, we obtain numbers quite different from the official ones when we employ different rules. The largest rate of deflation we find using a particular rule is about 1 percent per year, which is twice as large as the official number, suggesting the presence of substantial upward-bias in the official inflation rate. Nonetheless, our results show that the rate of deflation over the last decade is still small relative to that in the United States during the Great Depression, indicating that Japan’s deflation is moderate.
    Date: 2012–10

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