nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒01‒12
fourteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Dual liquidity crises under alternative monetary frameworks By Winkler, Adalbert; Bindseil, Ulrich
  2. Monetary Policy Trade-Offs in a Portfolio Model with Endogenous Asset Supply By Schüder, Stefan
  3. On the (IR) Relevance of Monetary Aggregate Targeting in Pakistan: An Eclectic View By Haider, Adnan; Jan, Asad; Hyder, Kalim
  4. Quo vadis Eurozone? A reappraisal of the real exchange rate criterion By Kolev, Galina
  5. Monetary and Fiscal Policy in a Monetary Union under the Zero Lower Bound constraint By Flotho, Stefanie
  6. Implications of Excess Liquidity in Fiji’s Banking System: An Empirical Study By Jayaraman, T.K.; Choong, Chee-Keong
  7. Taylor rule cross-checking and selective monetary policy adjustment By Roth, Markus; Bursian, Dirk
  8. Atypical Behavior of Money and Credit: Evidence From Conditional Forecasts By Afanasyeva, Elena
  9. Rational Expectations Models with Anticipated Shocks and Optimal Policy By Winkler, Roland; Wohltmann, Hans-Werner
  10. Explaining Irish Inflation During the Financial Crisis By Bermingham, Colin; Coates, Dermot; Larkin, John; O'Brien, Derry; O'Reilly, Gerard
  11. Removing bank subsidies leads inexorably to full reserve banking By Musgrave, Ralph S.
  12. Review of Theories of Financial Crises By Itay Goldstein; Assaf Razin
  13. Labour Market Frictions, Monetary Policy, and Durable Goods By Di Pace, Federico; Hertweck, Matthias S.
  14. Liquidity Crises, Banking, and the Great Recession By Radde, Sören

  1. By: Winkler, Adalbert; Bindseil, Ulrich
    Abstract: In a dual liquidity crisis, both the government and the banking sector are under severe funding stress. By nature, dual crises have the potential of being particularly disruptive and damaging. Thus, understanding their mechanics, how they unfold and how they can be addressed under various monetary and international financial regimes, is crucial. We capture the logic of a dual crisis through a new, rigorous approach. A closed system of financial accounts allows for a systematic comparative review of underlying liquidity shocks as well as built-in liquidity buffers, including their limits beyond which a credit crunch materializes. Based on this we are able to (i) make precise the otherwise vague interpretations of liquidity flows and policy options; (ii) compare capacities to absorb shocks under alternative international financial systems; (iii) explain how various constraints interact; (iv) draw lessons for achieving higher resilience against self-fulfilling confidence crises. Most importantly, we analyze the role of a number of potential constraints to an elastic central bank liquidity provision, namely the availability of central bank eligible assets, limits deliberately imposed on the central bank`s ability to lend to or purchase assets of banks and governments (including monetary financing prohibitions), and limits in a fixed exchange rate regime relating to the gold or foreign currency reserves of the central bank. --
    JEL: E50 E58 E42
    Date: 2012
  2. By: Schüder, Stefan
    Abstract: This paper develops an open economy portfolio balance model with endogenous asset supply. Domestic producers choose an optimal capital structure and finance capital goods through credit, bonds and equity assets. Private households hold a portfolio of domestic and foreign assets, shift balances depending on risk-return considerations, and maximise real consumption in accordance with the law of one price. Within this general equilibrium model, it will be shown that central bank interventions may promote an inefficient international allocation of real capital. The application of expansive monetary interventions throughout the course of economic crises maintains the domestic stock of real capital at the cost of inflation, currency devaluation, distortions of interest rates and asset prices, and risk clusters on the central bank s balance sheet. Exchange rate stabilising interventions have the result that the central bank can also stabilise the domestic stock of real capital. However, such interventions produce either risk clusters on the central bank s balance sheet or changes in the domestic price level. --
    JEL: E10 E44 E52
    Date: 2012
  3. By: Haider, Adnan; Jan, Asad; Hyder, Kalim
    Abstract: This study investigates and searches for a stable money demand function for Pakistan’s economy, where monetary aggregate is considered as the nominal anchor. The stability of the money demand has been the focus of numerous debates due to evolving financial innovations and regulations. Earlier studies in Pakistan on the subject provide conflicting explanations due to inadequate specification and imprecise estimation of money demand. However, this study finds that money demand in Pakistan is stable, if specified properly. Therefore, for developing countries, like Pakistan, targeting of monetary aggregates or responding to deviations from the desirable path is important for effective implementation and communication of monetary policy stance and it should remain, if not primary, an auxiliary target in the monetary policy framework.
    Keywords: money demand; stability; monetarism
    JEL: E12 C20 E5 E41
    Date: 2012–12–24
  4. By: Kolev, Galina
    Abstract: In 1976 Vaubel suggested using the variation of real exchange rates when evaluating the desirability of a monetary union within a group of currencies (Vaubel 1976). Currency uni cation is less desirable, the more often real exchange rate adjustments are needed. Ten years later, Mussa reconsidered the high correlation between nominal and real exchange rate movements and presumed predominant influence of transitory factors on the development of real exchange rates (Mussa 1986). The implementation of the real exchange rate criterion for the viability of countries to form a monetary union a ords therefore to isolate the real exchange rate variation which is not caused by short-lived shocks to nominal exchange rates. Using the methodology introduced by Blanchard and Quah (1989), the present analysis examines the contribution of temporary and permanent shocks to the variation of real and nominal exchange rates among European countries. Imposing the restriction that temporary shocks should not a ect the real exchange rate in the long run, the analysis indicates that in most of the EU-15 countries the nominal exchange rate exibility has been used as a means to ful ll real exchange rate adjustments before 1999. Based on the results the most viable monetary union should be between Germany, Luxembourg, and France. Futher on, the empirical analysis applies the real exchange rate criterion to the Eastern enlargement of EMU and shows that giving up the nominal exchange rate exibility will be the most painful for Hungary and Poland. --
    JEL: F41 F33 F15
    Date: 2012
  5. By: Flotho, Stefanie
    Abstract: This paper explicitly models strategic interaction between two independent national fiscal authorities and a single central bank in a simple New Keynesian model of a monetary union. Monetary policy is constrained by the zero lower bound on nominal interest rates. Coordination of fiscal policies does not always lead to the best welfare effects. It depends on the nature of the shocks whether governments prefer to coordinate or not coordinate. The size of the government multipliers depend on the combination of the intraunion competitiveness parameters. They get larger in case of implementation lags of fiscal policy. --
    JEL: E52 E61 E63
    Date: 2012
  6. By: Jayaraman, T.K.; Choong, Chee-Keong
    Abstract: The reasons behind the frequent occurrences of excess liquidity, especially in the recent months since 2007, are well known and documented. They include low investor confidence following the military coups and related political uncertainties with their lingering effects for a while. What are unknown and not studied in detail are the long term effects of excess liquidity on various key economic variables. Utilizing the VAR methodology, this paper examines the effects of excess liquidity on loans, lending rate, exchange rate and price level. The findings are that excess liquidity is a major component of forecast variation in loans, exchange rate and lending rate.
    Keywords: Excess liquidity; loans; monetary policy; cointegration test; variance decomposition
    JEL: E43 O11 E42
    Date: 2012–08–01
  7. By: Roth, Markus; Bursian, Dirk
    Abstract: The Taylor rule is a widely used concept in monetary macroeconomics and has been used in various areas either for positive or normative analyses. We examine whether the robustifying nature of Taylor rule cross-checking in the spirit of R island and Sveen (2011) also carries over to the case of parameter uncertainty. We find that adjusting monetary policy based on this kind of cross-checking can on average improve the outcome for the monetary authority in selected specifications. This, however, strongly depends on the functional form and also on the degree of the parameter misspecification as well as the information set of the monetary authority. In those specifications, increasing the relative weight attached to Taylor rule cross-checking results in a trade-off as higher average gains in terms of a reduction of loss are accompanied by higher standard deviations of the relative losses. --
    JEL: E52 E47 E58
    Date: 2012
  8. By: Afanasyeva, Elena
    Abstract: Great Recession 2007-2008 has revived interest to quantity aggregates (money and credit) and their role as indicators of financial instability for monetary and macroprudential policy. However, many of the previous empirical studies inspecting indicator properties used univariate methods and did not explicitly account for endogenous interactions of variables. We use a multivariate approach (Bayesian VAR) to detect periods of atypical behavior in money and credit in the US and in Euro Area. We find that atypical behavior of these variables is associated with periods of financial distress and (or) banking crises in the US. Moreover, we detect an unsustained credit boom prior to the Great Recession in both Euro Area and in the US. There is a link between this boom and the short-term interest rates in both regions: conditioning on the short-term interest rates substantially reduces the degree of atypical expansionary behavior of money and credit in 2003-2007. --
    JEL: E47 E51 E32
    Date: 2012
  9. By: Winkler, Roland; Wohltmann, Hans-Werner
    Abstract: This paper investigates optimal policy in the presence of anticipated (or news) shocks. We determine the optimal unrestricted and restricted policy response in a general rational expectations model and show that, if shocks are news shocks, the optimal unrestricted control rule under commitment contains a forward-looking element. As an example, we lay out a micro-founded hybrid New Keynesian model and show i) that anticipated cost-push shocks entail higher welfare losses than unanticipated shocks of equal size and ii) that the inclusion of forward-looking elements enhances distinctly the performance of simple optimized interest rate rules. --
    JEL: E52 E32 C61
    Date: 2012
  10. By: Bermingham, Colin (Central Bank of Ireland); Coates, Dermot (Central Bank of Ireland); Larkin, John (Central Bank of Ireland); O'Brien, Derry (Central Bank of Ireland); O'Reilly, Gerard (Central Bank of Ireland)
    Abstract: The recent financial crisis resulted in a steep contraction in the domestic economy together with a sharp decline in inflation. The Phillips curve model of inflation argues that inflation should be negatively related to economic performance and this would seem to be a potential explanatory factor in the behaviour of Irish inflation during the financial crisis. However, Ireland is a very open economy and the Phillips curve has been criticised as an inappro- priate model of inflation for Ireland on the basis that inflation is primarily imported from abroad with little role for domestic factors. We formally assess what role domestic economic activity has on inflation in Ireland. We make a number of findings. First, the deflation in Ireland was unusual by domestic historical and international standards. Second, we find the short-run unemployment gap is the most appropriate way to measure slack in the domestic economy. Third, having controlled for international factors, there is a relationship between the domestic economy and inflation. Fourth, the relationship is not stable over time but seems to depend on the state of the business cycle. Fifth, these types of models predict the actual fall in inflation during the financial crisis quite well. We conclude that these results support the idea that inflation is not purely externally determined in Ireland.
    Keywords: Phillips Curve, Financial Crisis, Threshold Model
    JEL: E31 E37
    Date: 2012–12
  11. By: Musgrave, Ralph S.
    Abstract: The recent banking crisis laid bare a long standing and inherent defect in fractional reserve banking: the fact that fractional reserve is unlikely to work for long without taxpayer backing. Changing bank regulations in such a way that banks are never a burden on taxpayers leads inexorably to full reserve banking. Full reserve involves splitting the banking industry into two halves. A safe half where depositors earn no interest, but they do have instant access to their money, and a second half in which depositors do earn a dividend or interest, but instant access is not guaranteed and depositors bear the losses when the investments or loans to which their money is channelled go wrong. Whether the second half counts as “banking” is debatable. Also whether that split is within banks or involves splitting the banking industry into two different types of institution is unimportant. It is virtually impossible for a full reserve bank to fail, thus there is no implicit taxpayer subsidy of such banks. As to the safe half, deposits are not loaned on or invested, thus the relevant money is not put at risk. And as to the “investment” half, if the value of the relevant loans or investments fall, then depositors lose in the same way as investors lose given a stock market set back. And stock market set-backs do not cause the same sort of crises as bank panics. The reduced amount of lending based economic activity and increased amount of non-lending based activity that results from full reserve is an entirely predictable result of removing bank subsidies. Far from reducing GDP, removing subsidies normally increases GDP, and there is no reason to suppose GDP would not rise as a result of removing bank subsidies: i.e. switching to full reserve banking. Section I sets out the argument, and section II deals with some common criticisms of full reserve banking.
    Keywords: Banks; full reserve; fractional reserve; narrow banking; bank subsidies;
    JEL: E5
    Date: 2013–01–03
  12. By: Itay Goldstein; Assaf Razin
    Abstract: In this paper, we review three branches of theoretical literature on financial crises. The first one deals with banking crises originating from coordination failures among bank creditors. The second one deals with frictions in credit and interbank markets due to problems of moral hazard and adverse selection. The third one deals with currency crises. We discuss the evolutions of these branches of the literature and how they have been integrated recently to explain the turmoil in the world economy. We discuss the relation of the models to the empirical evidence and their ability to guide policies to avoid or mitigate future crises.
    JEL: E61 F3 F33 G01 G1
    Date: 2013–01
  13. By: Di Pace, Federico; Hertweck, Matthias S.
    Abstract: The standard two-sector monetary business cycle model suffers from an important deficiency. Since durable good prices are more flexible than non-durable good prices, optimising households build up the stock of durable goods at low cost after a monetary contraction. Consequently, sectoral outputs move in opposite directions. This paper finds that labour market frictions help to understand the so-called sectoral “comovement puzzle”. Our benchmark model with staggered Right-to-Manage wage bargaining closely matches the empirical elasticities of output, employment and hours per worker across sectors. The model with Nash bargaining, in contrast, predicts that firms adjust employment exclusively along the extensive margin. --
    Keywords: durable production,labour market frictions,sectoral comovement,monetary policy
    JEL: E21 E23 E31 E52
    Date: 2012
  14. By: Radde, Sören
    Abstract: This paper presents a dynamic stochastic general equilibrium model which studies the business-cycle implications of financial frictions and liquidity risk at the bank-level. Following Holmstr m and Tirole (1998), demand for liquidity reserves arises from the anticipation of idiosyncratic operating expenses during the execution phase of bank-financed investment projects. Banks react to adverse aggregate shocks by hoarding liquidity while being forced to decrease their leverage. Both effects amplify recessionary dynamics, since they crowd out funds available for investment financing. This mechanism is triggered by a market liquidity squeeze modelled as a shock to the collateral value of banks assets. This novel type of aggregate risk induces a credit crunch scenario which shares key features with the Great Recession such as strong output decline, pro-cyclical leverage and counter-cyclical liquidity hoarding. Unconventional credit policy in the form of a wealth transfer from households to credit constrained banks is shown to mitigate the credit crunch. --
    JEL: E22 E32 E44
    Date: 2012

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