nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒01‒19
25 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The Effects of Monetary Policy in a Small Open Economy: The Case of Portugal By Ricardo M. Sousa
  2. Runs on Interest Rate Pegs By Christopher Phelan; Marco Bassetto
  3. Leverage, investment, and optimal monetary policy By Filippo Occhino; Andrea Pescatori
  4. Interest Rates Determination and Crisis Puzzle (Empirical Evidence from the European Transition Economies) By Mirdala, Rajmund
  5. Rational Inattention to News: The Perils of Forward Guidance. By Gaballo, G.
  6. Food Prices and Inflation Targeting in Emerging Economies By Marc Pourroy; Benjamin Carton; Dramane Coulibaly
  7. Policy Regimes, Policy Shifts, and U.S. Business Cycles By Woong Yong Park; Jae Won Lee; Saroj Bhattarai
  8. Currency intervention and the global portfolio balance effect: Japanese lessons By Gerlach, Petra; McCauley, Robert N.; Ueda, Kazuo
  9. The industrial impact of monetary shocks during the inflation targeting era in Australia By Vespignani, Joaquin L.
  10. The Impact of the LCR on the Interbank Money Market By Clemens Bonner; Sylvester Eijffinger
  11. Monetary Transmission Mechanism and Time Variation in the Euro Area By Kemal Bagzibagli
  12. The change of the value of the RMB and its influences on China By Wang, Di; Zhou, Ang; Wang, Dong
  13. Money Demand in the euro area, the US and the UK:Assessing the Role of Nonlinearity By Fredj Jawadi; Ricardo M. Sousa
  14. The proposed eco: should West Africa proceed with a common currency? By Chuku, Chuku
  15. Endogenous Monetary Policy Shifts and the Term Structure: Evidence from Japanese Government Bond Yields By Junko Koeda
  16. Modelling Money Demand: Further Evidence from an International Comparison By Fredj Jawadi; Ricardo M. Sousa
  17. Strategic Asset Allocation for Central Bank’s Management of Foreign Reserves: A new approach By Zhang, Zhichao; Chau, Frankie; Xie, Li
  18. Testing the Predictive Power of Mexican Consumers' Inflation Expectations By José Antonio Murillo Garza; Paula Sánchez Romeu
  19. "Expansion of Federal Reserve Authority in the Recent Financial Crisis Raises Questions about Governance" By Bernard Shull
  20. Dealing with Exchange Rate Issues: Reserves or Capital Controls? By Raquel Almeida Ramos
  21. Inflation and Economic Growth By Robert J. Barro
  22. Risk Shocks By Lawrence Christiano; Roberto Motto; Massimo Rostagno
  23. History, Gravity and International Finance By Livia Chițu; Barry Eichengreen; Arnaud J. Mehl
  24. People's Power: The Power of Money By Kees, De KONING
  25. Support for saving the Euro within German industry is deeply split: large exporters want to see the Euro continue, small and family firms do not. By Schuseil, Philine

  1. By: Ricardo M. Sousa (Universidade do Minho - NIPE)
    Abstract: In this paper, I analyze the macroeconomic effects of monetary policy on the Portuguese economy. I show that a positive interest rate shock leads to: (i) a contration of real GDP and a substantial increase of the unemployment rate; (ii) a quick fall in the commodity price and a gradual decrease of the price level; and (iii) a downward correction of the stock price index. It also produces a "short-lived liquidity effect" and helps explaining the negative comovement between bonds and stocks. In addition, I find evidence suggesting the existence of a money demand function characterized by small output and interest rate elasticities. By its turn, the central bank´s policy rule follows closely the dynamics of the money markets. Finally, both the real GDP and the price level in Portugal would have been higher during almost the entire sample period if there were no monetary policy surprises.
    Keywords: monetary policy, Portugal, euro area.
    JEL: E37 E52
    Date: 2012
  2. By: Christopher Phelan (University of Minnesota); Marco Bassetto (Federal Reserve Bank of Chicago)
    Abstract: Until the last couple of years, most central banks around the world conducted monetary policy by setting targets for short-term interest rates. Manoeuvering interest rates as a way to achieve low and stable inflation is now regarded as a success story. Yet this was not always the case. As mentioned by Sargent (1983), the German Reichsbank also discounted treasury and commercial bills at fixed nominal interest rates in 1923; but, rather than contributing to stabilizing the value of the mark, the policy added fuel to the hyperinflation by transferring money to the government and to the lucky holders of the discounted commercial bills. In our paper, we study the extent to which setting a short-term interest rate can be used as a way of implementing a unique equilibrium in a monetary economy. We start our analysis in a simple environment where both the central bank and Treasury trade with all agents in the economy in every period. An explicit model of the interaction among the agents in the economy allows us to clearly specify the policies of the central bank and the fiscal authority as a mapping from histories to actions. We then analyze the consequences of an interest-rate rule, where the central bank sets a price at which private agents are free to trade currency for one-period debt. 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, an interest-rate peg leads to multiple deterministic equilibria, one with low inflation and another one with high inflation and high money growth. The second equilibrium involves a run on the central bank's interest rate target, and the shadow interest rate in the private market is different from the central bank target. We then extend the analysis to environments where agents have infrequent access to financial markets, in which an interest rate run might evolve more gradually.
    Date: 2012
  3. By: Filippo Occhino; Andrea Pescatori
    Abstract: We study optimal monetary policy in an economy where firms’ debt overhangs lead to under-investment and under-production. The magnitude of this debt-induced distortion varies over the business cycle, rising significantly during recessions. When debt is contracted in nominal terms, this distortion gives rise to a balance sheet channel for monetary policy. In the presence of real and financial shocks, the monetary authority faces a trade-off between inflation and output gap stabilization. The optimal monetary policy rule prescribes that the anticipated component of inflation should be set equal to a target level, while the unanticipated component should rise in response to adverse shocks, smoothing the debt overhang distortion and the output gap.
    Keywords: Business cycles ; Monetary policy
    Date: 2012
  4. By: Mirdala, Rajmund
    Abstract: Economic theory provides clear suggestions in fixed versus flexible exchange rates dilemma in fighting high inflation pressures. However, relative diversity in exchange rate regimes in the European transition economies revealed uncertain and spurious conclusions about the exchange rate regime choice during last two decades. Moreover, eurozone membership perspective (de jure pegging to euro) realizes uncertain consequences of exchange rate regime switching especially in the group of large floaters. Successful anti-inflationary policy associated with stabilization of inflation expectations in the European transition economies at the end of 1990s significantly increased the role of short-term interest rates in the monetary policy strategies. At the same time, so called qualitative approach to the monetary policy decision-making performed in the low inflation environment, gradually enhanced the role of real interest rates expectations in the process of nominal interest rates determination. However, economic crisis increased uncertainty on the markets and thus worsen expectations of agents. In the paper we analyze sources of nominal interest rates volatility in ten European transition by estimating the structural vector autoregression (SVAR) model. Variance decomposition and impulse-response functions are computed to estimate the relative contribution of inflation expectations and expected real exchange rates to the conditional variability of short-term money market interest rates as well as responses of nominal interest rates to one standard deviation inflation expectations and expected real interest rates shocks. Effects of economic crisis are considered by estimation of two models for every single economy from the group of the European transition economies using data for time periods 2000-2007 and 2000-2011.
    Keywords: interest rates; inflation expectations; expected real interest rates; SVAR; variance decomposition; impulse-response function
    JEL: E43 C32 E31 E52
    Date: 2012–12
  5. By: Gaballo, G.
    Abstract: This paper studies the social value of information about the future when agents are rationally inattentive. In a stylized OLG model of inflation the central bank (CB) can set money supply in response to the current price. The CB has perfect foresight about the future T shocks and releases this information to rationally inattentive agents. At the unique REE, individual and aggregate risks can increase with the release when the monetary conduct is not "tight enough" and agents are "not attentive enough" to the news. In particular, the shorter the T, the more attentive the agents must be to avoid perverse welfare effects, whereas the notion of "tight enough" remains invariant. In this sense, efficient communication requires effective monetary policy.
    Keywords: Information Acquisition, Central Bank Communication, Monetary Policy, Social Value of Information.
    JEL: E50 E58 E60 D83
    Date: 2013
  6. By: Marc Pourroy (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne); Benjamin Carton (CEPII - Centre d'Etudes Prospectives et d'Informations Internationales - Centre d'analyse stratégique); Dramane Coulibaly (EconomiX - CNRS : UMR7166 - Université Paris X - Paris Ouest Nanterre La Défense)
    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
    Date: 2012–12
  7. By: Woong Yong Park (University of Hong Kong); Jae Won Lee (Rutgers University); Saroj Bhattarai (Penn State University)
    Abstract: Using an estimated DSGE model that features monetary and fiscal policy interactions and allows for equilibrium indeterminacy, we find that a passive monetary and passive fiscal policy regime prevailed in the pre-Volcker period while an active monetary and passive fiscal policy regime prevailed post-Volcker. Since both monetary and fiscal policies were passive pre-Volcker, there was equilibrium indeterminacy that gave rise to self-fulfilling beliefs and resulted in substantially different transmission mechanisms of policy as compared to conventional models: unanticipated increases in interest rates increased inflation and output while unanticipated increases in lump-sum taxes decreased inflation and output. Unanticipated shifts in monetary and fiscal policies however, played no substantial role in explaining the variation of inflation and output at any horizon in either of the time periods. Pre-Volcker, in sharp contrast to post-Volcker, we find that a time-varying inflation target does not explain low-frequency movements in inflation. A combination of shocks account for the dynamics of output, inflation, and government debt, with the relative importance of a particular shock quite different in the two time-periods due to changes in the systematic responses of policy. Finally, in a counterfactual exercise, we show that had the monetary policy regime of the post-Volcker era been in place pre-Volcker, inflation volatility would have been lower by 34% and the rise of inflation in the 1970s would not have occurred.
    Date: 2012
  8. By: Gerlach, Petra; McCauley, Robert N.; Ueda, Kazuo
    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: exchange/investment/US
    Date: 2012–10
  9. By: Vespignani, Joaquin L.
    Abstract: In this article we analyse the industrial impact of monetary shocks since inflation targeting has been introduced in Australia (1990). These impacts are quantified by constructing a structural vector autoregressive (SVAR) model for a small open economy. Our results show that construction and manufacturing industries exhibit a significant reduction in gross value added (GVA) after an unanticipated rise in the official cash rate. However, the finance and insurance industry, and the mining industry,seem to be unaffected by these shocks.
    Keywords: Monetary shocks; Industrial response; Industrial composition and VAR model
    JEL: C32 E58 E50
    Date: 2012–06–01
  10. By: Clemens Bonner; Sylvester Eijffinger
    Abstract: This paper analyzes the impact of a liquidity requirement similar to the Basel 3 Liquidity Coverage Ratio (LCR) on the unsecured interbank money market and therefore on the implementation of monetary policy. Combining two unique datasets of Dutch banks from 2005 to 2011, we show that banks which are just above/below their short-term regulatory liquidity requirement pay and charge higher interest rates for unsecured interbank loans. The effect is larger for maturities longer than the liquidity requirement’s 30 day horizon. Being close to the minimum liquidity requirement induces banks to increase borrowing volumes in general while it only decreases lending volumes for maturities longer than 30 days. These results also hold when controlling for an institution’s riskiness, the solvency of its counterparts, relationship-lending and period-specific effects.
    Keywords: Monetary Policy; Liquidity; Interbank Market; Basel 3
    JEL: G18 G21 E42
    Date: 2012–12
  11. By: Kemal Bagzibagli
    Abstract: This paper examines the monetary transmission mechanism in the euro area for the period of single monetary policy using factor-augmented vector autoregressive (FAVAR) techniques. The contributions of the paper are fourfold. First, a novel dataset consisting of 120 disaggregated macroeconomic time series spanning the period 1999: M1 through 2011: M12 is gathered for the euro area as an aggregate. Second, Bayesian joint estimation technique of FAVARs is applied to the European data. Third, time variation in the transmission mechanism and the impact of the global financial crisis is investigated in the FAVAR context using a rolling windows technique. Fourth, we tried to contribute to the question of whether more data are always better for factor analysis as well as the estimation of structural FAVAR models. We find that there are considerable gains from the implementation of the Bayesian technique such as smoother impulse response functions and statistical significance of the estimates. According to our rolling estimations, consumer prices and monetary aggregates display the most time variant responses to the monetary policy shocks. The pre-screening technique considered, elimination of almost half of the dataset seems to do no worse, and in some cases, better in a structural context.
    Keywords: Monetary Policy Shocks, FAVAR, Bayesian Methods, Rolling Windows, Euro Area
    JEL: C11 C32 C33 E5
    Date: 2012–11
  12. By: Wang, Di; Zhou, Ang; Wang, Dong
    Abstract: The issue of the change of the value of the Chinese currency has been focused by the world for several years. Its influences on not only China but also the rest of the world could not be neglected. Briefly historical background of the change of the Chinese currency as well as the influences it caused will be discussed in this essay by using the Mundell-Fleming Model as the basic concept to research and explain the particular situation in China. The result is that China should do the steady appreciation in terms of its currency rather than revalue it rapidly to improve the Chinese economy and several recommendations will be listed as well.
    Keywords: exchange rate; FDI; monetary policy
    JEL: E43 F0 E5
    Date: 2012–07–08
  13. By: Fredj Jawadi (University of Evry Val d’Essone & Amiens School of Management); Ricardo M. Sousa (Universidade do Minho - NIPE)
    Abstract: This paper estimates money demand equations for the euro area, the US and the UK using three different econometric methodologies: (i) a linear model based on a dynamic ordinary least squares (DOLS); (ii) a nonlinear technique based on a quantile regression framework; and (iii) a nonlinear model relying on a smooth-transition regression. The linear model shows that the elasticity of money demand with respect to income is positive and large in magnitude, while the elasticity of money demand with respect to the interest rate is negative and generally small. The quantile regression technique highlights that: (i) the income and the interest rate semi-elasticities are significantly different from the OLS estimates at the tails of the distribution of real money holdings; and (ii) the sensitivity of money demand with respect to inflation tends to be larger when real money holdings are extremely low. Finally, the smooth transition model provides two interesting findings. On the one hand, they capture reasonably well the dynamics of the money demand function. On the other hand, they show that the elasticity of money demand with respect to inflation rate, interest rate and GDP varies not only in accordance with the regime considered, but also across the countries under consideration.
    Keywords: money demand, dynamic OLS, smooth transition, quantile regression.
    JEL: C2 E21 E44 D12
    Date: 2012
  14. By: Chuku, Chuku
    Abstract: This paper investigates the rationality of proceeding with a common currency in West Africa by testing for symmetry and speed of adjustment to four underlying structural shocks among a pair of 66 ECOWAS economies. The findings reveal that there is relatively high degree of symmetry in the responses of the economies to external disturbances, while about 85 percent of the correlations in supply, demand and monetary shocks among the countries are asymmetric. The size of the shocks and speed of adjustment among countries are also dissimilar, suggesting that ECOWAS should not yet proceed with the eco, since the costs will outweigh the benefits.
    Keywords: Monetary union; Structural VAR; Optimal currency area; ECOWAS; West Africa
    JEL: F42 E52 F36
    Date: 2012–03–07
  15. By: Junko Koeda (The University of Tokyo)
    Abstract: I construct a no-arbitrage term structure model with endogenous regime shifts and apply it to Japanese government bond (JGB) yields. This application subjects the short-term interest rate to monetary regime shifts, such as a zero interest rate policy (ZIRP) and normal regimes, which depend on macroeconomic variables. The estimated results show that under a ZIRP, the deflationary effect on bond yields increases on the longer end of yield curves; on the other hand, the effect of output gaps on raising bond yields weakens for all maturities.
    Date: 2012–12
  16. By: Fredj Jawadi (University of Evry Val d’Essone & Amiens School of Management); Ricardo M. Sousa (Universidade do Minho - NIPE)
    Abstract: This paper aims at estimating money demand for the euro area, the US and the UK using a dynamic ordinary least squares estimator (DOLS). Our findings show that: (i) wealth effects on money demand are important in the euro area and the UK; (ii) the impact of changes in the interest rate on real money holdings is negative and small; (iii) goods are a reasonable alternative to money; and (iv) international currency substitution has a major influence on the behaviour of real money demand in the UK.
    Keywords: Money demand, dynamic OLS.
    JEL: C2 E21 E44 D12
    Date: 2012
  17. By: Zhang, Zhichao; Chau, Frankie; Xie, Li
    Abstract: This paper proposes a new approach to strategic asset allocation for central banks’ management of foreign reserves. This eclectic approach combines the behavioural portfolio management in the framework of mean-variance mental accounting (MVMA) with the improvements on asset return forecast offered by the Black-Litterman (B-L) model, proving particularly suitable for the reserve management policy with multiple objectives. The B-L model is embedded into the MVMA framework to obtain both the equilibrium and the B-L returns as our improved forecasts, formulating forward-looking investment strategies. The approach is applied to the case of China to derive optimal asset allocation for the Chinese central bank.
    Keywords: Reserve Management; Strategic Asset Allocation; Mental Accounting; Black-Litterman model; China’s Foreign Reserves
    JEL: G11 E58 C61 G0 C11
    Date: 2012–12–21
  18. By: José Antonio Murillo Garza; Paula Sánchez Romeu
    Abstract: This paper introduces an indicator of consumers' inflation expectations based on data from the National Consumer Confidence Survey of Mexico (ENCO, in Spanish), and tests its predictive power over CPI inflation and other measures of inflation that correspond to smaller baskets of consumer goods, for periods that range from 1 to 12 months. Our findings show that between January 2003 and September 2010, the predictive capability of the indicator over the different measures of inflation used was weak. Due to a modification in the survey questionnaire in October 2010, as of that date we observe a significant change in the responses and, thus, in the behavior of the indicator of consumers' inflation expectations. For this reason, from October 2010 on the main use of this indicator is to be a reference of consumers' confidence in price stability.
    Keywords: CPI inflation, consumers' inflation expectations, household surveys, consumer surveys, consumer confidence surveys, ENCO.
    JEL: C14 E31 E58
    Date: 2012–12
  19. By: Bernard Shull
    Abstract: Several years before the onset of the recent financial crisis, ex -- Federal Reserve Board Member Lawrence Meyer wrote that the Fed "is often called the most powerful institution in America," its key decisions made by 19 people whose names are known by few, meeting regularly behind closed doors. Bernard Shull examines the origin and nature of Fed authority and independence, and reviews the impact of Dodd-Frank on our central bank. His conclusion? The new constraints placed on the Fed are modest at best, and its continued expansion inexorably raises questions of governance.
    Date: 2013–01
  20. By: Raquel Almeida Ramos (IPC-IG)
    Abstract: Developing countries? positions regarding the capital account have changed significantly in the last decade. After a period of wide liberalisation, country authorities have now been constantly increasing their policy toolkit with new instruments to intervene in the capital account and limit the consequences of excessively volatile capital flows. This change is a response to the increasing size and volatility of capital flows, which is associated with the process of financialisation that has been taking place in recent decades, where financial actors and motives have assumed more important roles. The increasing magnitude and volatility of finance-related flows are clearly shown in Figure 1, which presents the net financial flows excluding Foreign Direct Investment (FDI) received by developing and emerging countries since 1990. (?)
    Keywords: Dealing with Exchange Rate Issues: Reserves or Capital Controls?
    Date: 2012–11
  21. By: Robert J. Barro (Department of Economics Littauer Center 120 Harvard University; NBER)
    Abstract: Data for around 100 countries from 1960 to 1990 are used to assess the effects of inflation on economic performance. If a number of country characteristics are held constant, then regression results indicate that the impact effects from an increase in average inflation by 10 percentage points per year are a reduction of the growth rate of real per capita GDP by 0.2-0.3 percentage points per year and a decrease in the ratio of investment to GDP by 0.4-0.6 percentage points. Since the statistical procedures use plausible instruments for inflation, there is some reason to believe that these relations reflect causal influences from inflation to growth and investment. However, statistically significant results emerge only when high-inflation experiences are included in the sample. Although the adverse influence of inflation on growth looks small, the long-term effects on standards of living are substantial. For example, a shift in monetary policy that raises the long-term average inflation rate by 10 percentage points per year is estimated to lower the level of real GDP after 30 years by 4-7%, more than enough to justify a strong interest in price stability.
    Date: 2012
  22. By: Lawrence Christiano; Roberto Motto; Massimo Rostagno
    Abstract: We augment a standard monetary DSGE model to include a Bernanke-Gertler-Gilchrist financial accelerator mechanism. We fit the model to US data, allowing the volatility of cross-sectional idiosyncratic uncertainty to fluctuate over time. We refer to this measure of volatility as 'risk'. We find that fluctuations in risk are the most important shock driving the business cycle.
    JEL: E2 E3 E44
    Date: 2013–01
  23. By: Livia Chițu; Barry Eichengreen; Arnaud J. Mehl
    Abstract: We analyze patterns of bilateral financial investment using data on US investors' holdings of foreign bonds. We document a "history effect" in which the pattern of holdings seven decades ago continues to influence holdings today. 10 to 15% of the cross-country variation in US investors' foreign bond holdings is explained by holdings 70 years ago, plausibly reflecting fixed costs of market entry and exit together with endogenous learning. This effect is twice as large for bonds denominated in currencies other than the dollar, suggesting the existence of even higher fixed costs of initiating US foreign investment in such currencies. Our findings point to history and path dependence as key sources of financial market segmentation.
    JEL: F30 N20
    Date: 2013–01
  24. By: Kees, De KONING
    Abstract: Money can create jobs and thereby incomes for individual households, but money can equally destroy jobs and income. Added values can be created with the assets which are based on the savings levels -the net worth of individual households- but the "money managers": a government, a central bank, banks and (international) bureaucrats can also create losses to the savings level. This dilemma should be at the heart of economic thinking. For instance in the U.S in 2006 a dollar saved and used for a home mortgage loan only returned 69 cents in home value increase. In 2007 a dollar saved and used in the same way lost 2.5 dollars. Banks moved the goalposts from relying on the income of individual households to wanting their money back out of the assets -the homes-. Individual households were never asked. The effects were that all 132 million home owners were affected rather than the 5.3 million doubtful debtors. This paper sets out the causes of such money destruction. It also explains that money can act in a positive manner to repair the damage done. Banking reforms, quantitative strenghthening as opposed to QE, economic easing and changing the focus of national accounting away from economic growth to Country Profit -the increase/decrease in the net worth of individual households are discussed.
    Keywords: Balance sheet of households; money power; money crisis; jobs and savings; ownership of savings; income lending and asset based lending; securitisation; savings behaviour; Quantitative easing and strengthening; bank reforms; economic easing; country profit
    JEL: E0 E58 E24 E44 E21 E61
    Date: 2013–01–10
  25. By: Schuseil, Philine
    Abstract: Do German business leaders support measures to prop up the Euro and prevent Greece from exiting the currency? Philine Schuseil writes that there seems to be a division in support, with German family businesses in favour of regulatory rules and less integration for the Eurozone, and those who run larger firms and export-orientated businesses defending the Euro and moves towards greater integration.
    Date: 2012–07–14

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