nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒01‒07
forty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary policy without interest rates. Evidence from France’s Golden Age (1948-1973) using a narrative approach. By Eric Monnet
  2. Uncertain potential output: implications for monetary policy in small open economy By Traficante, Guido
  3. How effective is central bank forward guidance? By Clemens J.M. Kool; Daniel L. Thornton
  4. Monetary shocks and stock returns: identification through the impossible trinity By Ali K. Ozdagli; Yifan Yu
  5. Macroprudential Measures, Housing Markets, and Monetary Policy By Rubio, Margarita; Carrasco-Gallego, José A.
  6. Food Prices and Inflation Targeting in Emerging Economies. By Marc Pourroy; Benjamin Carton; Dramane Coulibaly
  7. Capital Flows and the Risk-Taking Channel of Monetary Policy By Valentina Bruno; Hyun Song Shin
  8. Speculative runs on interest rate pegs the frictionless case By Marco Bassetto; Christopher Phelan
  9. The ECB and the interbank market By Domenico Giannone; Michele Lenza; Huw Pill; Lucrezia Reichlin
  10. Why does the Federal Reserve Forecast Inflation Better than Everyone Else? By B. Onur Tas
  11. Financial system reforms and China’s monetary policy framework: A DSGE-based assessment of initiatives and proposals By Funke , Michael; Paetz , Michael
  12. Drifting inflation targets and stagflation By Edward S. Knotek II; Shujaat Khan
  13. Estimating the Policy Rule from Money Market Rates when Target Rate Changes Are Lumpy By Jean-Sébastien Fontaine
  14. House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macroprudential Policy By Gelain, Paolo; Lansing, Kevin J.; Mendicino, Caterina
  15. The effect of commodity price shocks on underlying inflation: the role of central bank credibility By J. Scott Davis
  16. Monetary Policy and Herd Behavior: Leaning Against Bubbles. By Loisel, O.; Pommeret, A.; Portier, T.
  17. Inflation and output in New Keynesian models with a transient interest rate peg By Charles T Carlstrom; Timothy S Fuerst; Matthias Paustian
  18. On the inclusion of the Chinese renminbi in the SDR basket By Agnès Bénassy-Quéré; Damien Capelle
  19. Optimal Monetary and Prudential Policies. By Collard, F.; Dellas, H.; Diba, B.; Loisel, O.
  20. The Bank of England as the World gold market-maker during the Classical gold standard era, 1889-1910 By Stefaano Ugolini
  21. The Federal Reserve's large-scale asset purchase programs: rationale and effects By Stefania D'Amico; William English; David López-Salido; Edward Nelson
  22. Bretton Woods, swap lines, and the Federal Reserve’s return to intervention By Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
  23. Market structure and exchange rate pass-through By Raphael A. Auer; Raphael S. Schoenle
  24. The Low-Frequency Impact of Daily Monetary Policy Shock By Neville Francis
  25. Fiscal policy considerations in the design of monetary policy in Peru By Rossini, Renzo; Quispe, Zenón; Loyola, Jorge
  26. Selection and monetary non-neutrality in time-dependent pricing models By Carlos Carvalho; Felipe Schwartzman
  27. Robustifying optimal monetary policy using simple rules as cross-checks By Pelin Ilbas; Øistein Røisland; Tommy Sveen
  28. Nonlinear liquidity adjustments in the euro area overnight money market By Renaud Beaupain; Alain Durré
  29. A Short-run Schumpeterian Trip to Embryonic African Monetary Zones By Simplice A, Asongu
  30. Core import price inflation in the United States By Janet Koech; Mark A. Wynne
  31. Are there bubbles in the Sterling-dollar Exchange Rate? New evidence from Sequential ADF Tests By Bettendorf, Timo; Chen, Wenjuan
  32. A Simple Interest Rate Model with Unobserved Components: The Role of the Interbank Reference Rate By Muto, Ichiro
  33. Exchange rate pass-through, markups, and inventories By Adam Copeland; James A. Kahn
  34. The empirical implications of the interest-rate lower bound By Christopher Gust; David Lopez-Salido; Matthew E. Smith
  35. Why the transfer of bank supervisory powers back to the Bank of England is a step in the right direction: Revisiting the role of external auditors in bank and financial services supervision By Ojo, Marianne
  36. Optimal Fiscal and Monetary Policy with Occasionally Binding Zero Bound Constraints By Taisuke Nakata
  37. South East Asian Monetary Integration By Gilles de Truchis; Benjamin Keddad;
  38. Modelling Short-run Money Demand for the USA By Marcus Scheiblecker
  39. Money creation and financial instability: An agent-based credit network approach By Lengnick, Matthias; Krug, Sebastian; Wohltmann, Hans-Werner
  40. "ECB Worries/European Woes: The Economic Consequences of Parochial Policy" By Robert J. Barbera; Gerald Holtham

  1. By: Eric Monnet (Paris School of Economics)
    Abstract: Central banking in France from 1948 to 1973 was a paradigmatic example of an unconventional policy relying on quantities rather than on interest rates. Usual SVAR find no effect of policy shocks and support the common view that monetary policy was ineffective over this period. I argue that only a narrative approach is able to account for the peculiarity and complexity of quantitative controls on money and credit. Using archival evidence, I measure monetary policy stance with a dummy variable denoting restrictive episodes. Impulse response functions then show standard patterns; monetary policy shocks have a strong and long lasting effect. These results offer a revisionist account of postwar monetary policy under Bretton Woods and before the Great Inflation. They also suggest that quantities of money and credit can play a greater role than their prices in the adjustment process of the economy.
    Keywords: monetary policy, credit controls, VAR, narrative approach, liquidity puzzle, Banque de France, Bretton Woods
    JEL: N14 E31 E32 E51 E52 E58
    Date: 2012–12
  2. By: Traficante, Guido
    Abstract: A huge literature analyzes the performance of simple rules in closed-economy models when the policy-maker observes only a noisy measure of the state of the economy. This paper extends the analysis to a small-open economy new keynesian model. Passing from a closed-economy model to an open-economy one, there is another simple policy rule available to the central bank, namely the exchange rate peg. Hence, evaluating the performance of simple rules allows us to assess if the choice of the exchange rate regime depends on the uncertainty about the true state of the economy. Evaluating the conduct of monetary policy in terms of a Taylor rule, this paper shows that not reacting to the exchange rate yields better outcomes in terms of a standard loss function and quantifies for which parameter configuration in terms of the reaction to the exchange rate and the domestic inflation rate, the fixed exchange rate regime is to be preferred. The analysis is done both with complete and with incomplete information.
    Keywords: small open economy; exchange rate regime; monetary policy rules; uncertainty
    JEL: E52 F31
    Date: 2012–12
  3. By: Clemens J.M. Kool; Daniel L. Thornton
    Abstract: This paper investigates the effectiveness of forward guidance for the central banks of four countries: New Zealand, Norway, Sweden, and the United States. We test whether forward guidance improved market participants’ ability to forecast future short-term and long-term rates. We find that forward guidance improved market participants’ ability to forecast short-term rates over relatively short forecast horizons, but only for Norway and Sweden. Importantly, there is no evidence that forward guidance has increased the efficacy of monetary policy for New Zealand, the country with the longest history of forward guidance.
    Keywords: Monetary policy ; Banks and banking, Central
    Date: 2012
  4. By: Ali K. Ozdagli; Yifan Yu
    Abstract: This paper attempts to identify how monetary policy shocks affect stock prices by using Mundell and Fleming's theory of the "Impossible Trinity." According to this theory, it is impossible to simultaneously have a fixed exchange rate, free capital movement (an absence of capital controls), and an independent monetary policy. The authors present evidence that Hong Kong's monetary policy is heavily dependent on the monetary policy of the United States, a stance which is consistent with this theory because the HK dollar has been pegged to the U.S. dollar since 1983 and Hong Kong does not impose any capital controls. As a result, the Federal Reserve's monetary policy actions can be considered as exogeneous shocks to the Hong Kong economy. Recognizing this relationship helps us solve the endogeneity problem inherent in the studies examining the relationship between stock prices and monetary policy shocks. This is the first paper that presents evidence of severe omitted variable bias in the event studies focusing on the relationship between monetary policy and stock returns. The authors also suggest a way to remedy this bias.
    Keywords: Monetary policy ; Monetary policy - Hong Kong ; Stock - Prices
    Date: 2012
  5. By: Rubio, Margarita; Carrasco-Gallego, José A.
    Abstract: The recent financial crisis has raised the discussion among policy makers and researchers on the need of macroprudential policies to avoid systemic risks in financial markets. However, these new measures need to be combined with the traditional ones, namely monetary policy. The aim of this paper is to study how the interaction of macroprudential and monetary policies a¤ect the economy. We take as a baseline a dynamic stochastic general equilibrium (DSGE) model which features a housing market in order to evaluate the performance of a rule on the loan-to-value ratio (LTV) interacting with the traditional monetary policy conducted by central banks. We find that, introducing the macroprudential rule mitigates the effects of booms on the economy by restricting credit. Furthermore, when both policies are active, interest-rate shocks have weaker effects on the economy. From a normative perspective, results show that the combination of monetary policy and the macroprudential rule is unambiguously welfare enhancing, especially when monetary policy does not respond to output and house prices and only to inflation.
    Keywords: macroprudential; monetary policy; collateral constraint; credit
    JEL: E32 E44 E58
    Date: 2012–12
  6. By: Marc Pourroy (Centre d'Economie de la Sorbonne); Benjamin Carton (CEPII); Dramane Coulibaly (EconomiX-CNRS - Université de Paris Ouest)
    Abstract: The two episodes of food price surges in 2007 and 2011 have been particularly challenging for developing and emerging economies' central banks and have raised the question of how monetary authorities should react to such external relative price shocks. We develop a new-keynesian small open-economy model and show that non-food inflation is a good proxy for core inflation in high-income countries, but not for middle-income and low-income countries. Although, in these countries we find that associating non-food inflation and core inflation may be promoting bably-designed policies, and consequently central banks should target headline inflation rather than non-food inflation. This result holds because non-tradable food represents a significant share in total consumption. Indeed, the poorer the country, the higher the share of purely domestic food in consumption and the more detrimental lack of attention to the evolution in food prices.
    Keywords: Monetary policy, commodities, food prices, DSGE models.
    JEL: E32 E52 O23
    Date: 2012–12
  7. By: Valentina Bruno; Hyun Song Shin
    Abstract: This paper examines the relationship between low interests maintained by advanced economy central banks and credit booms in emerging economies. In a model with crossborder banking, low funding rates increase credit supply, but the initial shock is amplified through the "risk-taking channel" of monetary policy where greater risk-taking interacts with dampened measured risks that are driven by currency appreciation to create a feedback loop. In an empirical investigation using VAR analysis, we find that expectations of lower short-term rates dampen measured risks and stimulate cross-border banking sector capital flows.
    Keywords: Capital flows, exchange rate appreciation, credit booms
    Date: 2012–12
  8. By: Marco Bassetto; Christopher Phelan
    Abstract: In this paper we show that interest rate rules lead to multiple equilibria when the central bank faces a limit to its ability to print money, or when private agents are limited in the amount of bonds that can be pledged to the central bank in exchange for money. Some of the equilibria are familiar and common to the environments where limits to money growth are not considered. However, new equilibria emerge, where money growth and inflation are higher. These equilibria involve a run on the central bank's interest target: households borrow as much as possible from the central bank, and the shadow interest rate in the private market is different from the policy target.
    Date: 2012
  9. By: Domenico Giannone (ECARES – European Center for Advanced Research in Economics and Statistics; CEPR - Centre for Economic Policy Research); Michele Lenza (European Central Bank); Huw Pill (Goldman Sachs); Lucrezia Reichlin (London Business School; CEPR - Centre for Economic Policy Research)
    Abstract: We analyse the impact on the euro area economy of the ECB’s non-standard monetary policy measures by studying the effect of the expansion of intermediation of interbank transactions across the central bank balance sheet. We exploit data drawn from the aggregated Monetary and Financial Institutions (MFI) balance sheet, which allows us to construct a measure of the ‘policy shock’ represented by the ECB’s increasing role as a financial intermediary. We find small but significant effects both on loans and real economic activity. JEL Classification: E5, E58
    Keywords: Non-standard monetary policy measures, interbank market
    Date: 2012–11
  10. By: B. Onur Tas
    Date: 2012–12
  11. By: Funke , Michael (BOFIT); Paetz , Michael (BOFIT)
    Abstract: This paper evaluates various financial system reform initiatives and proposals in China in a DSGE modelling setting. The key reform steps analysed include phasing out benchmark interest rates, deepening the direct finance market, reducing government’s quantity-based intervention on financial institutions. Our counterfactual model simulation results suggest that the reforms will be beneficial only, if Chinese monetary policy continues to rely on quantity-based interventions on financial institutions or tightens the interest rate rule.
    Keywords: DSGE model; financial sector reform; monetary policy; China
    JEL: E42 E52 E58
    Date: 2012–12–11
  12. By: Edward S. Knotek II; Shujaat Khan
    Abstract: The 1970s provided the United States its first experience with the phenomenon of stagflation—simultaneously high inflation and poor economic performance in terms of unemployment and GDP. Economists continue to debate the root causes of stagflation. The conventional view is that sharp increases in the price of oil during the decade were to blame: large increases in oil prices raise inflation, which saps purchasing power from consumers and businesses and thus hurts economic activity. But a number of economists also point to a role for monetary policy in generating stagflation, in particular through “go-stop” monetary policy: because inflation tends to move slowly, a period of accommodative monetary policy followed by a sharp tightening of policy can result in stagflation, as output turns down quickly but inflation remains high from the “go” phase. ; This paper examines the ability of monetary policy to generate stagflation. Using a relatively standard macroeconomic model, it shows that stagflation arises regularly in cases where the monetary authority allows its inflation target to move around. If households and firms face great uncertainty about the monetary authority’s inflation target, this scenario is also conducive to the emergence of stagflation—even if the inflation target actually remains unchanged. Thus, the paper finds that limiting monetary policy uncertainty and drift in the inflation target during normal times through clearly communicated, credible, and fixed inflation targets would essentially eliminate the possibility of stagflation from monetary factors.
    Date: 2012
  13. By: Jean-Sébastien Fontaine
    Abstract: Most central banks effect changes to their target or policy rate in discrete increments (e.g., multiples of 0.25%) following public announcements on scheduled dates. Still, for most applications, researchers rely on the assumption that the policy rate changes linearly with economic conditions and they do not distinguish between dates with and without scheduled announcements. This assumption is not innocuous when estimating the policy rule based on daily frequency. For the 1994-2011 period, and using an otherwise standard term structure model, I find that accounting for discrete changes leads to economically different estimates. Only the model based on discrete changes depicts a picture that is consistent with existing evidence on the monetary policy rule and risk premium. I study the information content of key policy announcements in the period from the end of 2008, where the policy rate reached a lower bound in the US, until the end of 2011.
    Keywords: Asset Pricing; Financial markets; Interest rates
    JEL: E43 E44 E47 G12 G13
    Date: 2012
  14. By: Gelain, Paolo; Lansing, Kevin J.; Mendicino, Caterina
    Abstract: Progress on the question of whether policymakers should respond directly to financial variables requires a realistic economic model that captures the links between asset prices, credit expansion, and real economic activity. Standard DSGE models with fully-rational expectations have difficulty producing large swings in house prices and household debt that resemble the patterns observed in many developed countries over the past decade. We introduce excess volatility into an otherwise standard DSGE model by allowing a fraction of households to depart from fully-rational expectations. Specifically, we show that the introduction of simple moving-average forecast rules for a subset of households can significantly magnify the volatility and persistence of house prices and household debt relative to otherwise similar model with fully-rational expectations. We evaluate various policy actions that might be used to dampen the resulting excess volatility, including a direct response to house price growth or credit growth in the central bank’s interest rate rule, the imposition of more restrictive loan-to-value ratios, and the use of a modified collateral constraint that takes into account the borrower’s loan-to-income ratio. Of these, we find that a loan-to-income constraint is the most effective tool for dampening overall excess volatility in the model economy. We find that while an interest-rate response to house price growth or credit growth can stabilize some economic variables, it can significantly magnify the volatility of others, particularly inflation.
    Keywords: asset pricing; excess volatility; credit cycles; housing bubbles; monetary policy; macroprudential policy
    JEL: E32 E44 G12 O40
    Date: 2012–12
  15. By: J. Scott Davis
    Abstract: This paper seeks to document and explain the effect of a commodity price shock on underlying core inflation, and how that effect changes both across time and across countries. Impulse responses derived from a structural VAR model show that across many countries there was a break in the response of core inflation to a commodity price shock. In an earlier period, a shock to commodity prices would lead to a large and significant increase in core inflation, but in later periods, the effect was insignificant. ; To explain this, we construct a large-scale DSGE model with both headline and core inflation, and most significantly, a mechanism whereby fluctuations in inflation caused by purely transitory shocks can become incorporated into long-term inflation expectations. Inflation has a trend and a cyclical component. Private agents cannot distinguish between the two, so a cyclical fluctuation in inflation may be confused for a shift in the trend component. Bayesian estimation reveals that there was a change between the earlier and the later periods in the parameter that governs the anchoring of expectations. Impulse responses derived from simulations of the model show that this change in the effect of commodity prices on core inflation is driven by the change in the anchoring of inflation expectations.
    Keywords: Price levels
    Date: 2012
  16. By: Loisel, O.; Pommeret, A.; Portier, T.
    Abstract: We study the role of monetary policy when asset-price bubbles may form due to herd behavior in investment in an asset whose return is uncertain. To that aim, we build a simple general-equilibrium model whose agents are households, entrepreneurs, and a central bank. Entrepreneurs receive private signals about the productivity of the new technology and borrow from households to publicly invest in the old or the new technology. The three main results of the paper are that bubbles (informational cascades) can occur in this general equilibrium setting; that the central bank can detect them even though it has directly access to less information than the investors; and that the central bank can eliminate bubbles by manipulating the interest rate. Indeed, monetary policy, by affecting the investors' cost of resources, can make them invest in the new technology if and only if they receive an encouraging private signal about its productivity. In doing so, it makes their investment decision reveal their private signal, and therefore prevents herd behavior and the asset-price bubble. We also show that such a “leaning against the wind" monetary policy, contingent on the central bank's information set, may be preferable to laisser-faire, in terms of ex ante welfare.
    Keywords: Monetary Policy – Asset Prices – Informational Cascades – Bubbles.
    JEL: E52 E32
    Date: 2012
  17. By: Charles T Carlstrom; Timothy S Fuerst; Matthias Paustian
    Abstract: Recent monetary policy experience suggests a simple diagnostic for models of monetary non-neutrality. Suppose the central bank pegs the nominal interest rate below steady state for a reasonably short period of time. Familiar intuition suggests that this should be modestly inflationary, and a reasonable model should deliver such a prediction. We pursue this simple diagnostic in several variants of the familiar Dynamic New Keynesian (DNK) model. Some variants of the model produce counterintuitive inflation reversals where the effect of the interest rate peg can switch from highly inflationary to highly deflationary for only modest changes in the length of the interest rate peg. Curiously, this unusual behavior does not arise in a sticky information model of the Phillips curve.
    Keywords: Time-series analysis ; Business cycles
    Date: 2012
  18. By: Agnès Bénassy-Quéré (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CEPII - Centre d'Etudes Prospectives et d'Informations Internationales - Centre d'analyse stratégique); Damien Capelle (ENS Cachan - Ecole Normale Supérieure de Cachan - École normale supérieure de Cachan - ENS Cachan)
    Abstract: We study the impact of a broadening of the SDR basket to the Chinese currency on the composition and volatility of the basket. Although, in the past, RMB inclusion would have had negligible impact due to its limited weight, a much more significant impact can be expected in the next decades, and more so if the Chinese currency is pegged to the US dollar. If the objective is to reinforce the attractiveness of the SDR as a unit of account and a store of value through more stability, then a broadening of the SDR to the RMB could be appropriate, provided some flexibility is introduced in the Chinese exchange-rate regime. This issue of flexibility is de facto more important than that of "free usability" to make the SDR more stable, at least in the short and medium run.
    Keywords: SDR; renminbi; international monetary system; foreign exchange volatility
    Date: 2012–11
  19. By: Collard, F.; Dellas, H.; Diba, B.; Loisel, O.
    Abstract: The recent financial crisis has highlighted the interconnectedness between macroeconomic and financial stability and has raised the question of whether and how to combine the corresponding main policy instruments (interest rate and bank-capital requirements). This paper offers a characterization of the jointly optimal setting of monetary and prudential policies and discusses its implications for the business cycle. The source of financial fragility is the socially excessive risk-taking by banks due to limited liability and deposit insurance. We characterize the conditions under which locally optimal (Ramsey) policy dedicates the prudential instrument to preventing inefficient risk-taking by banks; and the monetary instrument to dealing with the business cycle, with the two instruments co-varying negatively. Our analysis thus identifies circumstances that can validate the prevailing view among central bankers that standard interest-rate policy cannot serve as the first line of defense against financial instability. In addition, we also provide conditions under which the two instruments might optimally co-move positively and countercyclically.
    Keywords: Prudential policy – Capital requirements – Monetary policy – Ramsey-optimal policies.
    JEL: E32 E44 E52
    Date: 2012
  20. By: Stefaano Ugolini (Sciences Po Toulouse and LEREPS – University of Toulouse 1 Capitole.)
    Abstract: This paper studies the microfoundations of the so-called “gold device” policy by analysing a new dataset on the Bank of England’s operations in the gold market at the heyday of the classical gold standard. It explains that “gold devices” must be understood in connection to the Bank’s role as gold market-maker in London and to the position of London as world gold market. Contrary to the literature, the paper shows that “gold devices” were sophisticated monetary policy tools intended to complement – not to substitute – interest rate policy and aimed at smoothing – not at hampering – international adjustment. These findings demonstrate the potential of adopting a microstructural approach to the study of monetary policy, and call for a reassessment of efficiency measurement for the gold standard.
    Keywords: Monetary policy, Gold standard, Gold market, Market
    JEL: E58 G24 L11 L14 N23
    Date: 2012–12–10
  21. By: Stefania D'Amico; William English; David López-Salido; Edward Nelson
    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 might matter 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. We also 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.
    Date: 2012
  22. By: Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
    Abstract: This paper describes the United States’ first line of defense against shortcomings in the Bretton Woods system, which threatened the system’s continuation as early as 1960. The exposition describes the Federal Reserve’s use of swap lines both to provide cover for central banks’ unwanted dollar exposures, thereby forestalling claims on the U.S. gold stock, and to supply dollar liquidity to countries facing temporary balance-of-payments deficits, thereby bolstering confidence in their parities. As suggested by the expansion and growing use of the swap lines, the operations failed to distinguish between temporary and fundamental disequilibrium forces. In substituting temporary for fundamental adjustments, the lines ultimately proved inadequate.
    Keywords: Bretton Woods Agreements Act ; Financial markets ; Monetary policy ; International finance
    Date: 2012
  23. By: Raphael A. Auer; Raphael S. Schoenle
    Abstract: In this paper, we examine the extent to which market structure and the way in which it affects pricing decisions of profit-maximizing firms can explain incomplete exchange rate pass-through. To this purpose, we evaluate how pass-through rates vary across trade partners and sectors depending on the mass and size distribution of firms affected by a particular exchange rate shock. In the first step of our analysis, we decompose bilateral exchange rate movements into broad US Dollar (USD) movements and trade-partner currency (TPC) movements. Using micro data on US import prices, we show that the passthrough rate following USD movements is up to four times as large as the pass-through rate following TPC movements and that the rate of pass-through following TPC movements is increasing in the trade partner's sector-specific market share. In the second step, we draw on the parsimonious model of oligopoly pricing featuring variable markups of Dornbusch (1987) and Atkeson and Burstein (2008) to show how the distribution of firms' market shares and origins within a sector affects the trade-partner specific pass-through rate. Third, we calibrate this model using our exchange rate decomposition and information on the origin of firms and their market shares. We find that the calibrated model can explain a substantial part of the variation in import price changes and pass-through rates across sectors, trade partners, and sector-trade partner pairs.
    Keywords: Price levels
    Date: 2012
  24. By: Neville Francis (University of North Carolina, Chapel Hill)
    Abstract: With rare exception, studies of monetary policy tend to neglect the timing of innovations to monetary policy instruments. Models which take timing seriously are often difficult to compare to standard monetary VARs because each uses different frequencies. We propose using MIDAS regressions that nests both ideas: Accurate (daily) timing of innovations to policy are embedded in a monthly-frequency VAR to determine the macroeconomic effects of high-frequency policy shocks. We find that policy have greatest effects on variables thought of as heavily expectations oriented and that, contrary to some VAR studies, the effects of policy shocks on real variables are small.
    Date: 2012
  25. By: Rossini, Renzo (Central Reserve Bank of Peru); Quispe, Zenón (Central Reserve Bank of Peru); Loyola, Jorge (Central Reserve Bank of Peru)
    Abstract: We evaluate the financial and real linkages between fiscal and monetary policy in Peru, and show that during the recent export commodity price boom, public finances supported the implementation of monetary policy. In particular, the reduction of the net public debt has translated into a greater capability by the Central Bank to sterilize its FOREX interventions. Also, an active policy to enhance the development of the local capital markets, using the issuance of public bonds denominated in local currency as a benchmark, has created the incentive to de-dollarize banking credit. On the other hand, difficulty in fine-tuning public investment around the business cycle in recent years has led to periods of a fiscal stance that does not counteract the real business cycle. This raises the question of the possibility of adopting a structural rule for the public sector balance, based on structural fundamentals.
    Keywords: Central Bank Monetary Policy, Fiscal Policy, Macroeconomic Stabilization
    JEL: E52 E58 E63
    Date: 2012–11
  26. By: Carlos Carvalho; Felipe Schwartzman
    Abstract: Given the frequency of price changes, the real effects of a monetary shock are smaller if adjusting firms are disproportionately likely to be ones with prices set before the shock. This selection effect is important in a large class of sticky-price models with time-dependent price adjustment. We characterize conditions on the distribution of the duration of price spells associated with the real effects of monetary shocks, and provide a very general analytical characterization of the real effects of such shocks. We find that: 1) Selection is stronger and real effects are smaller if the hazard function of price adjustment is more strongly increasing; 2) Selection is weaker and real effects are larger if there is sectoral heterogeneity in price stickiness; 3) Selection is stronger and real effects are smaller if the durations of price spells are less variable. We also show that 4) If monetary shocks affect primarily the level of nominal aggregate demand, the mean and variance of price durations are sufficient statistics for the real effects of such shocks.
    Keywords: Monetary policy ; Inflation (Finance)
    Date: 2012
  27. By: Pelin Ilbas (National Bank of Belgium); Øistein Røisland (Norges Bank (Central Bank of Norway)); Tommy Sveen (BI Norwegian Business School)
    Abstract: There are two main approaches to modelling monetary policy; simple instrument rules and optimal policy. We propose an alternative that combines the two by extending the loss function with a term penalizing deviations from a simple rule. We analyze the properties of the modified loss function by considering three different models for the US economy. The choice of the weight on the simple rule determines the trade-off between optimality and robustness. We show that by placing some weight on a simple Taylor-type rule in the loss function, one can prevent disastrous outcomes if the model is not a correct representation of the underlying economy.
    Keywords: Model uncertainty, optimal control, simple rules
    JEL: E52 E58
    Date: 2012–12–18
  28. By: Renaud Beaupain (IÉSEG School of Management; Lille Economie & Management - LEM-CNRS (U.M.R. 8179)); Alain Durré (European Central Bank; IÉSEG School of Management; Lille Economie & Management - LEM-CNRS (U.M.R. 8179))
    Abstract: The market-oriented approach promoted by the European Central Bank in the design of its refinancing operations creates incentives to credit insitutions to use actively the interbank market to manage their liquidity needs. In this context, we examine the ability of the overnight segment to guarantee the timely provision of unsecured funds to banks to smoothly absorb their liquidity shocks. This paper specifically focuses on the speed of reversion of transaction costs and available depth to their equilibrium levels in this market for overnight unsecured funds from 4 September 2000 to 31 December 2007. The reported evidence points to time-varying liquidity adjustments and identifies liquidity, market activity and the institutional setting of the ECB’s refinancing operations as significant determinants of the observed resiliency regimes. Our analysis also shows how the speed of mean reversion of market liquidity, by affecting the level and the volatility of the overnight market rate, also affects the anchoring of the yield curve in the euro area. JEL Classification: C22, C25, G01, G10, G21, E52
    Keywords: Overnight money market, market microstructure, transaction costs, price impact, mean reversion, financial turmoil
    Date: 2012–12
  29. By: Simplice A, Asongu
    Abstract: With the spectre of the Euro crisis looming substantially large and scaring potential monetary unions, this study is a short-run trip to embryonic African monetary zones to assess the Schumpeterian thesis for positive spillovers of financial services on growth. Causality analysis is performed with seven financial development and three growth indicators in the proposed West African Monetary Zone (WAMZ) and East African Monetary Zone (EAMZ). The journey is promising for the EAMZ and lamentable for the WAMZ. Results of the EAMZ are broadly consistent with the traditional discretionary monetary policy arrangements while those of the WAMZ are in line with the non-traditional strand of regimes in which, policy instruments in the short-run cannot be used to offset adverse shocks to output. Policy implications are discussed.
    Keywords: Finance; Growth; Africa
    JEL: O55 O10 E50 G20
    Date: 2012–12–01
  30. By: Janet Koech; Mark A. Wynne
    Abstract: The cross-section distribution of U.S. import prices exhibits some of the fat-tailed characteristics that are well documented for the cross-section distribution of U.S. consumer prices. This suggests that limited-influence estimators of core import price inflation might outperform headline or traditional measures of core import price inflation. We examine whether limited influence estimators of core import price inflation help forecast overall import price inflation. They do not. However, limited influence estimators of core import price inflation do seem to have some predictive power for headline consumer price inflation in the medium term.
    Keywords: Price levels ; Forecasting
    Date: 2012
  31. By: Bettendorf, Timo; Chen, Wenjuan
    Abstract: There has been mixed evidence regarding the existence of rational bubbles in the foreign exchange markets. Standard unit root and cointegration tests are criticized for their low power to detect rational bubbles that periodically collapse. This paper introduces recently developed sequential unit root tests into the analysis of exchange rates bubbles. Our results show that explosiveness in the nominal Sterling-dollar exchange rates is fully explained by the relative prices of traded goods. --
    Keywords: exchange rates,rational bubbles,sequential unit root test
    JEL: C1 F3
    Date: 2012
  32. By: Muto, Ichiro
    Abstract: In this study, we theoretically investigate the potential role of the reference rate in stabilizing or destabilizing an interbank market with an environment where individual banks cannot fully identify the nature of underlying shocks affecting their interbank transactions. We show that a noise-free reference rate based on a sufficient number of sample transactions can help to make the market interest rate less volatile, whereas the stabilizing effects of the reference rate are significantly reduced if the reported interest rates contain some noisy components. Nevertheless, by increasing the number of sample transactions reflected in the reference rate, the adverse effects of the noise can be mitigated (or eliminated) provided the noise is idiosyncratic to individual transactions. However, if the noise is common to multiple transactions, then the adverse effects of the noisy reference rate cannot be reduced simply by increasing the number of sample transactions. This suggests that the noise in the interest rates reported by just a few of large banks can end up making the entire market more volatile, thereby impairing the transmission mechanism of monetary policy.
    Keywords: Interbank Market; Reference Rate; LIBOR; Imperfect Information; Financial Stability; Transmission Mechanism of Monetary Policy
    JEL: E43 G14 E44
    Date: 2012–12–11
  33. By: Adam Copeland; James A. Kahn
    Abstract: A large body of research has established that exporters do not fully adjust their prices across countries in response to exchange rate movements, but instead allow their markups to vary. But while markups are difficult to observe directly, we show in this paper that inventory-sales ratios provide an observable counterpart. We then find evidence that inventory-sales ratios of imported vehicles respond to exchange rate movements to a degree consistent with pass-through on the order of 50 to 75 percent, on the high end of the range found in the literature.
    Keywords: Exports ; Inventories ; Automobile industry and trade - Finance ; Automobiles - Prices ; Foreign exchange rates ; International trade
    Date: 2012
  34. By: Christopher Gust; David Lopez-Salido; Matthew E. Smith
    Abstract: Using Bayesian methods, we estimate a nonlinear DSGE model in which the interest-rate lower bound is occasionally binding. We quantify the size and nature of disturbances that pushed the U.S. economy to the lower bound in late 2008 as well as the contribution of the lower bound constraint to the resulting economic slump. Compared with the hypothetical situation in which monetary policy can act in an unconstrained fashion, our estimates imply that U.S. output was more than 1 percent lower, on average, over the 2009-2011 period. Moreover, around 20 percent of the drop in U.S. GDP during the recession of 2008-2009 was due to the interest-rate lower bound. We show that the estimated model generates lower bound episodes that resemble salient characteristics of the observed U.S. episode, including its expected duration.
    Date: 2012
  35. By: Ojo, Marianne
    Abstract: The need for effective supervision of capital markets is becoming all the more evident in the aftermath of the recent LIBOR and rate rigging scandals. Financial regulators or indeed bank regulators cannot perform such a function effectively without the involvement of auditors in the supervisory process. A challenging task awaits the incoming Bank of England Governor, Mark Carney – particularly given the reduced involvement of auditors in the bank supervisory process since the time of assumption of the Financial Services Authority's bank supervisory functions. However, he (as well as other recent financial reforms) may prove to be the much needed boost required in the bank and indeed, financial supervisory process. This paper is aimed at highlighting why the transfer of bank supervision back to the Bank of England is required if further progress is to be made in the effective regulation and supervision of the financial services sector. It also highlights shortcomings which exist and need to be addressed if the Bank of England is to perform its tasks efficiently as well as regain the momentum and advantages it had acquired before its supervisory powers were transferred to the Financial Services Authority.
    Keywords: monetary policy; supervision; Bank of England; FSA; external auditors; regulation; financial stability; Financial Crisis; Basel Core Principles; audits; capital markets; central banks
    JEL: K2 E0 E5 M4 E3 G01
    Date: 2012–12–23
  36. By: Taisuke Nakata (New York University)
    Abstract: During the Great Recession, the government provided large fiscal stimulus in an economic environment characterized by a high degree of uncertainty on the future course of the economy while the nominal interest rate was constrained at the zero lower bound. While many papers have analyzed the effects of fiscal policy at the zero lower bound, they all do so in a deterministic environment. This paper studies optimal government spending and monetary policy when the nominal interest rate is subject to the zero lower bound constraint in a stochastic environment. In the presence of uncertainty, the government chooses to increase its spending when at the zero lower bound by a substantially larger amount than it would in the deterministic environment. The welfare effect of fiscal policy is nuanced in the stochastic environment if the government cannot commit. Although the access to government spending policy increases welfare in the face of a large deflationary shock, it can decrease welfare during normal times as the government reduces the nominal interest rate less aggressively before reaching the zero lower bound.
    Date: 2012
  37. By: Gilles de Truchis; Benjamin Keddad (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS);
    Abstract: We study the long-run relationship of real exchanges rates (RERs) among the ASEAN-5 countries by testing the theory of Generalized Purchasing Power Parity (G-PPP) from the new perspective of fractional cointegration. The long-run co-movements of the RERs are examined by applying a recent estimator of fractional cointegration that consists of a frequency Whittle approximation of the cointegrating system’s likelihood function. The contribution of the fractional cointegration study is justified by identifying several weak fractional cointegration relationships that signal that deviations of RERs from their long-run equilibrium are highly persistent. These findings contrast with all previous studies that restrict their investigation to the traditional I(1)/I(0) cointegration. Our results support further monetary integration among different sub-groups of the ASEAN-5 countries as they share long-run comovements with each others. However, a full-fledged monetary union embracing all ASEAN-5 members is still limited from the perspective of the G-PPP theory.
    Keywords: Monetary Union, Fractional Cointegration, Generalized purchasing power parity, ASEAN.
    JEL: F31 F33
    Date: 2012–11–05
  38. By: Marcus Scheiblecker (WIFO)
    Abstract: Nowadays, modelling long-term money demand is largely unambiguous. There is a vast amount of empirical evidence concerning a cointegrating relationship between money demand, some kind of interest rate and income. In contrast to this, short-run dynamics are still opaque. In the existing literature, the return to steady state is modelled quite differently. Simple error correction models have failed in some cases to explain short-run dynamics adequately. Partial-adjustment models allow for a smooth return to equilibrium as costs for adjusting real money balances lead to a sticky behaviour of actual money. Other authors model the return to steady state in a non-linear error correction form, instead. All these models consider disequilibria by the gap between money demand and its steady state of only the last period, disregarding disequilibria in periods before. Ignoring deviations from steady state occurred further in the past miss to account for money stockpiling activities of economic agents. I use a model where weights for cumulating are geometrically decreasing the more they are located in the past. According to Koyck (1954) such models possess an ARMA (1,1) representation. The combination of the Koyck-model with the error correction approach leads to an ARMAX model which is shown to be capable in some cases to track money demand short-run dynamics better and more parsimony than partial-adjustment models.
    Date: 2012–12–19
  39. By: Lengnick, Matthias; Krug, Sebastian; Wohltmann, Hans-Werner
    Abstract: The authors pick up the standard textbook approach of money creation and develop a simple agent-based alternative. They show that their model is well suited to explain the endogenous creation of money. Although more general, their model still contains the standard results as a limiting case. The authors also uncover a potential instability that is hidden in the standard approach but easily recognized within a strict individual-based and stock-flow consistent version. They show in detail how individual interactions build up systemic risk and how banking crises are triggered by the maturity mismatch of different cash-flows and spread by the depreciation of non-performing loans (e.g. interbank or government debt). --
    Keywords: financial instability,endogenous money,agent-based macroeconomics,stock-flow consistency,disequilibrium analysis
    JEL: E42 E51 C63 G01
    Date: 2012
  40. By: Robert J. Barbera; Gerald Holtham
    Abstract: Financial market crises with the threat of a subsequent debt-deflation depression have occurred with increasing regularity in the United States from 1980 through the present. Almost reflexively, when confronted with such circumstances, US institutions and the policymakers that run them have responded in a fashion that has consistently thwarted debt-deflation-depression dynamics. It is true that these "remedies," as they succeeded, increasingly contributed to a moral hazard in US and global financial markets that culminated with the crisis that began in 2007. Nonetheless, the straightforward steps taken by established institutions enabled the United States to derail depression dynamics, while European 1930s-style austerity proved as ineffective as it was almost a century ago. Europe's, and specifically Germany's, steadfast refusal to embrace the US recipe has fostered mushrooming economic hardship on the continent. The situation is gruesome, and any serious student of economic history had to have known, given European policy commitments, that it was destined to turn out this way. It is easy to understand why misguided policies drove initial European responses. Economic theory has frowned on Keynes. Economic successes, especially in Germany, offered up the wrong lessons, and enduring angst about inflation was a major distraction. At the outset, the wrong medicine for the wrong disease was to be expected. What is much harder to fathom is why such a poisonous elixir continues to be proffered amid widespread evidence that the patient is dying. Deconstructing cognitive dissonance in other spheres provides an explanation. Not surprisingly, knowing what one wants to happen at home completely informs one’s claims concerning what will be good for one’s neighbors. In such a construct, the last best hope for Europe is ECB President Mario Draghi. He seems to be able to speak German and yet act European.
    Keywords: Austerity; Central Banks; Economic Stability; Euro; European Central Bank; Eurozone; Eurozone Debt Crisis; Financial Crisis; Financial Instability; Financial Markets; Fiscal Policy; Government Policy and Regulation; Hyman Minsky; Sovereign Debt; Stabilization; United States
    JEL: B20 B31 E62 E63 E65 F01 F36 G01 H63
    Date: 2012–12

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