nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒11‒24
fifteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Optimal Monetary Policy in an Open Economy under Asset Market Segmentation By Singh, Rajesh; Lahiri, Amartya; Vegh, Carlos A
  2. Open-economy Inflation Targeting Policies and Forecast Accuracy By Alessandro Flamini
  3. Monetary policy in a model with misspecified, heterogeneous and ever-changing expectations By Alberto Locarno
  4. Monetary policy in a downturn: Are financial crises special? By Morten Bech; Leonardo Gambacorta
  5. A structural model for the housing and credit markets in Italy By Andrea Nobili; Francesco Zollino
  6. Can We Explain Unexpected Fluctuation of Long-Term Real Interest Rate? By Barbora Volna
  7. The liquidity consequences of the euro area sovereign debt crisis By William A Allen; Richhild Moessner
  8. "The Impact of Financial Reform on Federal Reserve Autonomy" By Bernard Shull
  9. Investigating the determinants of inflationary trends in Bangladesh: an ARDL bounds F-Test Approach By Khatun, Fahmida; Ahamad, Mazbahul G.
  10. Currency intervention and the global portfolio balance effect: Japanese lessons By Petra Gerlach-Kristen; Robert N McCauley
  11. Keynesian and Austrian Perspectives on Crisis, Shock Adjustment, Exchange Rate Regime and (Long-Term) Growth By Mathilde Maurel; Gunther Schnabl
  12. Global Imbalances: Should We Use Fundamental Equilibrium Exchange Rates? By Saadaoui, Jamel
  13. The recent trends in long-term bank funding By Andrea Cardillo; Andre Zaghini
  14. Determinants of TARGET2 imbalances By Martina Cecioni; Giuseppe Ferrero
  15. Globalisation effect on inflation in the great moderation era: New evidence from G10 countries By Qin, Duo; He, Xinhua

  1. By: Singh, Rajesh; Lahiri, Amartya; Vegh, Carlos A
    Abstract: This paper studies optimal monetary policy in a small open economy under flexible prices. The paper's key innovation is to analyze this question in the context of environments where only a fraction of agents participate in asset market transactions (i.e., asset markets are segmented).  In this environment, we study three rules: the optimal state contingent monetary policy; the optimal non-state contingent money growth rule; and the optimal non-state contingent devaluation rate rule.  We compare welfare and the volatility of macro aggegates like consumption, exchange rate, and money under the different rules.  One of our key findings is that amongst non-state contingent rules, policies targeting the exchange rate are, in general, welfare dominated by policies which target monetary aggregates.  Crucially, we find that fixed exchange rates are almost never optimal.  On the other hand, under some conditions, a non-state contingent rule like a fixed money rule can even implement the first-best allocation.
    Keywords: Optimal Monetary Policy; Asset Market Segmentation
    JEL: E42 E60 F F30
    Date: 2012–11–13
  2. By: Alessandro Flamini (Department of Economics and Management, University of Pavia)
    Abstract: Forecast accuracy in macroeconomics is based on statistical techniques for extrapolating time series. This paper takes a new theoretical route studying the relation between forecast accuracy of macroeconomic variables and alternative monetary policies. Considering optimal policy with model-parameter uncertainty in a small open-economy, the paper shows that Domestic Inflation Targeting (DIT) leads to more forecast accuracy than Consumer Price index Inflation Targeting (CPIIT). Furthermore, forecast accuracy and policy aggressiveness turn out to be inversely related, and the trade-o¤ is more severe under CPIIT. These results are obtained in a New-Keynesian model measuring forecast accuracy by the volatility of simulated fan-charts.
    Keywords: Multiplicative uncertainty; Markov jump linear quadratic systems; small open-economy; optimal monetary policy; inflation index.
    JEL: E52 E58 F41
    Date: 2012–11
  3. By: Alberto Locarno (Bank of Italy)
    Abstract: The applied literature on adaptive learning has mostly focused on small, linear models, with homogenous expectations. In non-linear models heterogeneous expectations prevail and the process through which agents select (and change) a forecasting model becomes a necessary ingredient of the analysis; moreover, the temporary equilibrium of the learning process approaches an asymptotic limit that may be affected by the communication strategies of the monetary policymaker. The objective of this paper is to assess whether in such a model economy the optimal monetary policy exhibits properties that are similar to those found in the literature for small, linear models. The main results are the following: (1) expectations heterogeneity is an intrinsic feature of the economy: no PLM succeeds in ruling out all the other forecasting models; (2) contrary to previous findings, the monetary policymaker has no incentive to adopt highly inflation-averse policies: too strong a reaction to price shocks increases both inflation and output volatility; (3) partial transparency seems to enhance somewhat welfare (but fully transparent policies do not); (4) a higher degree of transparency calls for stronger inflation aversion.
    Keywords: Bounded rationality, generalised stochastic gradient learning, transparency.
    JEL: E52 E31 D84
    Date: 2012–10
  4. By: Morten Bech; Leonardo Gambacorta
    Abstract: Accommodative monetary policy during the financial crisis was instrumental in preventing a deeper recession. Views differ, however, on how long such measures should be kept in place. At the heart of this debate is the notion that a protracted period of policy accommodation could create distortions. Some would argue that any distortions will be limited in extent and that further monetary stimuli should bolster the recovery. Others fear that prolonged easing may delay much-needed balance sheet adjustments, thus entrenching weak economic performance. Our analysis, based on a sample of 24 developed countries, indicates that monetary policy is less effective in a financial crisis, when impairments in the monetary transmission mechanism may occur. In particular, the results show that the benefits of accommodative monetary policy during a downturn for the subsequent recovery are more elusive when the downturn is associated with a financial crisis. In addition, we find that private sector deleveraging during a downturn helps to induce a stronger recovery. Both results hold even after controlling for the fiscal policy stance, real exchange rate movements and developments in the international environment. That said, the evidence is tentative owing to the restricted size and other limitations of our sample.
    Keywords: monetary policy, financial crisis, recession, deleveraging
    Date: 2012–09
  5. By: Andrea Nobili (Bank of Italy); Francesco Zollino (Bank of Italy)
    Abstract: We estimate a fully-fledged structural system for the housing market in Italy, taking into account the multi-fold link with bank lending to both households and construction firms. The model allows the house supply to vary in the short run and the banking sector to affect the equilibrium in the housing market, through its effect on housing supply and demand. We show that house prices react mostly to standard drivers such as disposable income, expected inflation and demographic pressures. Lending conditions also have a significant impact, especially through their effects on mortgage loans, and consequently on housing demand. Allowing short-run adjustment in house supply implies a weaker response of house prices to a change in the monetary stance or in banks’ deleveraging process. Finally, we find that since the mid-eighties house price developments in Italy have been broadly in line with the fundamentals; during the recent financial crisis, the worsening in credit supply conditions dampened house price dynamics, partly offsetting the positive stimulus provided by the easing of the monetary policy stance.
    Keywords: house prices, credit, system of simultaneous equations
    JEL: E51 E52 G21
    Date: 2012–10
  6. By: Barbora Volna
    Abstract: In this paper, we create a model of unexpected fluctuation of the long-term real interest rate. This model is based on our new version of IS-LM model. The new IS-LM model eliminates two main deficiencies of the original model: assumptions of constant price level and of strictly exogenous money supply. The unexpected fluctuations of the long-term real interest rate can be explained by existence of special type of cycle called relaxation oscillation on money (or financial assets) market. Relaxation oscillations include some short parts looking like "jumps". These "jumps" can be interpreted like unexpected. In other words, we try to explain these "unexpected" fluctuations of long-term real interest rate and show that these fluctuations can be only seemingly unexpected. Last but not least, we show some impacts of the government intervention by fiscal or monetary policy on economics using this models. Then we suggest possible interaction between fiscal and monetary policy.
    Date: 2012–11
  7. By: William A Allen; Richhild Moessner
    Abstract: We examine the liquidity effects of the euro area sovereign debt crisis, including its effects on euro area banks as a group, on intra-euro area financial flows, on the supply of and demand for collateral, and on international liquidity. The lending capacity of the euro area banking system has been much weakened, despite the remarkable growth of the operations of the Eurosystem, including its greatly increased lending, its intermediation between national central banks in surplus and deficit countries and its collateral policy. The euro crisis has also created international liquidity stresses. We find that central bank swap lines have only had limited effectiveness in alleviating the stresses, probably owing to some stigma being attached to their use.
    Keywords: Financial crisis, liquidity, foreign exchange swaps, central bank swap lines
    Date: 2012–11
  8. By: Bernard Shull
    Abstract: The Federal Reserve has been criticized for not preventing the risky behavior of large financial companies prior to the financial crisis of 2008-09, for approving mergers that aggravated the "too big to fail" problem, and for its substantial contribution to bailouts when their risk management failed. The Dodd-Frank Act of 2010, in attempting to diminish financial instability and eliminate too-big-to-fail policies, has established a new regulatory framework and laid out new responsibilities for the Federal Reserve. In doing so, it appears to address criticisms of the central bank by constricting its autonomy. The law, however, has also extended the Federal Reserve's supervisory authority and expanded its capacity to exercise regulatory control over its extended domain. This new authority is in addition to the augmentation of its monetary powers over the past several years. This paper reviews and evaluates both constraints imposed on the Federal Reserve by the Dodd-Frank Act and the expansion of Federal Reserve authority. It finds that the constraints are unlikely to have much impact, but the expansion of authority constitutes a significant increase in power and influence. The paper concludes that the expansion of Federal Reserve authority invites questions about the organizational design and governance of the central bank, and its traditional autonomy.
    Keywords: Financial Crisis; Federal Reserve; Government Policy and Regulation
    JEL: G01 G28
    Date: 2012–11
  9. By: Khatun, Fahmida; Ahamad, Mazbahul G.
    Abstract: Inflation appears to have emerged as a perennial phenomenon in Bangladesh in the recent past. High inflationary trend that began to show up since the second quarter of FY2010 continued throughout FY2011 and FY2012. In this regard, an empirical examination to explore the major sources of inflation is necessary for effective policy suggestions towards curbing inflationary pressure, ensuring price stability and attaining the desired economic growth. This paper investigates major determining factors of inflationary trends in Bangladesh during the period FY1981 to FY2009. An unrestricted error-correction model (UECM) version auto-regressive distributed lag (ARDL) bounds F-test is employed to find out the short run and long run elasticities of the determinants of inflation. Empirical result reveals that domestic rice production affects inflation negatively in the short run to a significant extent. Conversely, domestic petroleum price and broad money (M2) supply have low but positive impact on inflationary trends. This suggests that increased domestic rice production and effective fiscal-monetary integration are the crucial policy options to curb the inflationary pressure in Bangladesh.
    Keywords: Inflation; Bangladesh; ARDL bounds F-test
    JEL: C32 E31
    Date: 2012–03–12
  10. By: Petra Gerlach-Kristen; Robert N McCauley
    Abstract: This paper shows that the Japanese foreign exchange interventions in 2003/04 seem to have lowered long-term interest rates in a wide range of countries, including Japan. It seems that this decline was triggered by the investment of the intervention proceeds in US bonds and that a global portfolio balance effect spread the resulting decline in US yields to other bond markets, thus easing global monetary conditions.
    Keywords: Intervention, portfolio balance effect, Japan
    Date: 2012–10
  11. By: Mathilde Maurel; Gunther Schnabl (Institute for Economic Policy, University of Leipzig)
    Abstract: The 2010 European debt crisis has revived the discussion concerning the optimum adjustment strategy in the face of asymmetric shocks. Whereas Mundell's (1961) seminal theory on optimum currency areas suggests depreciation in the face of crisis, the most recent emergence of competitive depreciations, competitive interest rate cuts or currency wars questions the exchange rate as an adjustment tool to asymmetric economic development. This paper approaches the question from a theoretical perspective by confronting exchange rate based adjustment with crisis adjustment via price and wage cuts. Econometric estimations yield a negative impact of exchange rate flexibility/volatility on growth, which is found to be particularly strong for countries with asymmetric business cycles and during recessions. Based on these findings we support a further enlargement of the European Monetary Union and recommend more exchange rate stability for the rest of the world.
    Keywords: Shock Adjustment, Exchange Rate Regime, Growth
    Date: 2011–08–22
  12. By: Saadaoui, Jamel
    Abstract: The reduction of global imbalances observed during the climax of crisis is incomplete. In this context, currencies realignments are still proposed to ensure global macroeconomic stability. These realignments are based on equilibrium rates derived from equilibrium exchange rate models. Among these models, we have the fundamental equilibrium exchange rate (FEER) model introduced by Williamson (1994). This approach is often labelled as normative mainly because the return to the equilibrium is not described in the model. If the FEER is not related neither in the short nor in the long to the real exchange rates, we see no clear justification to intervene in foreign exchange markets based on these equilibrium rates. In this case, the FEER is a normative approach and should not be used to reduce global imbalances. This paper provides empirical evidences robust to cross-sectional dependence that the FEER is related to real exchange rate in the long run and thus could be a useful tool to prevent the resurgence of large global imbalances and associated risks.
    Keywords: Global Imbalances; Equilibrium Exchange Rate; International Monetary Cooperation
    JEL: F32 C23 F41 F31
    Date: 2012–11–10
  13. By: Andrea Cardillo (Banca d'Italia); Andre Zaghini (Banca d'Italia)
    Abstract: We assess the long-term funding conditions for banks in the US, the euro area and the UK and, separately, for the group of global systemically important financial institutions (G-SIFIs), over the period 1997-2011. After the outbreak of the subprime crisis there was a considerable reshuffling of the relative weight of banks’ funding sources, also due to non-conventional monetary policy interventions, government support measures and a significant increase in wholesale funding costs. By looking at 6,400 bank bonds we find that both implicit and explicit guarantees by the sovereign have a substantial role in shaping the wholesale cost of bond issuance with significant differences between AAA-rated and lower-rated countries. However, when a bank CDS exists the role of the government is significantly reduced with the market giving more weight to the soundness and creditworthiness of the issuing institution.
    Keywords: long-term funding, bank balance sheet, financial crisis, G-SIFIs
    JEL: G21 G01 G18
    Date: 2012–10
  14. By: Martina Cecioni (Banca d'Italia); Giuseppe Ferrero (Banca d'Italia)
    Abstract: The paper analyzes developments in TARGET2 imbalances within the euro area since 2007, from two perspectives: national central banks’ balance sheets and countries’ balance of payments (BoP). We examine the relationship between TARGET2 balances and the Eurosystem liquidity provision, analyzing how the circulation of the latter has changed during the crisis. We then study BoP developments in Greece, Portugal, Italy and Spain, investigating which of the following explanations accounts for the growing TARGET2 imbalances: (i) current account deficit, (ii) decrease of net inflows of private capital from securities and interbank markets and (iii) run on deposits. The results of our analysis suggest that while the increase in TARGET2 liabilities is related to the current account deficit in Greece, there is no evidence of this in Italy, Spain and Portugal. In all countries the increase is mostly driven by private capital outflows in securities and interbank markets; deposit runs are apparent only in Greece. In Italy, the reduction of capital inflows consisted entirely in a decrease in the interbank market cross-border activity and in portfolio investments by non-residents.
    Keywords: payment system, financial crisis, monetary policy
    JEL: E42 E52
    Date: 2012–09
  15. By: Qin, Duo; He, Xinhua
    Abstract: Dynamic econometric models are carefully built to analyse counterfactually the globalisation effect on inflation for ten countries from G10 during the Great Moderation period. The main findings are (i) the effect is highly heterogeneous from country to country; (ii) increases in trade openness could be either inflationary or deflationary whereas increased imports from low-cost emerging-market economies are mostly deflationary; and (iii) there is almost no direct globalisation impact as far as inflation persistence is concerned while the impact on inflation variability can be positive as well as negative. Overall, globalisation is found to have contributed positively to lowering rather than stabilising inflation during the Great Moderation era. --
    Keywords: inflation dynamics,globalisation
    JEL: C52 E31 E37 F41
    Date: 2012

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