nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒02‒03
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Transparency and output stability: Empirical evidence By Ummad Mazhar
  2. Using forecasts to uncover the loss function of FOMC members By Christian Pierdzioch; Jan-Christoph Rülke; Peter Tillmann
  3. The Effectiveness of Central Bank Independence Versus Policy Rules By John B. Taylor
  4. The Missing Transmission Mechanism in the Monetary Explanation of the Great Depression By Christina D. Romer; David H. Romer
  5. Local Inflation: Reconsidering the International Comovement of Inflation By Marcel Förster; Peter Tillmann
  6. The Influence of the Taylor rule on US monetary policy By Pelin Ilbas; Øistein Røisland; Tommy Sveen
  7. Inflation drivers in new EU members By Martina Alexová
  8. International Monetary Coordination and the Great Deviation By John B. Taylor
  9. The Evolution of British Monetarism: 1968-1979 By Aled Davies
  10. Hot Tip: Nominal Exchange Rates and Inflation Indexed Bond Yields By Richard H. Clarida
  11. Transmission Lags of Monetary Policy: A Meta-Analysis By Tomas Havranek; Marek Rusnak
  12. Policy Games with Distributional Conflicts By Alice Albonico; Lorenza Rossi
  13. Exchange rate pass-through and inflation: a nonlinear time series analysis By Mototsugu Shintani; Akiko Terada-hagiwara; Tomoyoshi Yabu
  14. Trend Growth and Learning About Monetary Policy Rules in a Two-Block World Economy By Eric Schaling; Mewael F. Tesfaselassie
  15. Limited Commitment and the Legal Restrictions Theory of the Demand for Money By Leo Ferraris; Fabrizio Mattesini
  16. Markets Evolution After the Credit Crunch By Bianchetti, Marco; Carlicchi, Mattia
  18. The Mystique Surrounding the Central Bank's Balance Sheet, Applied to the European Crisis By Ricardo Reis
  19. The out-of-sample forecasting performance of non-linear models of real exchange rate behaviour: The case of the South African Rand By Goodness C. Aye; Mehmet Balcilar; Adel Bosch; Rangan Gupta; Francois Stofberg
  20. Interaction of Formal and Informal Financial Markets in Quasi-Emerging Market Economies By Harold Ngalawa; Nicola Viegi
  21. Currency Crises in Reverse: Do Large Real Exchange Rate Appreciations Matter for Growth? By Bussière, Matthieu; Lopez, Claude; Tille, Cédric

  1. By: Ummad Mazhar
    Abstract: This paper focuses on the empirical link between monetary policy transparency and output volatility. The questions addressed are: (i) Does transparency about policy processes stabilize output? (ii) Do different aspects of transparency differ qualitatively or quantitatively in terms of their effects on output volatility? Controlling for many standard structural sources of output stability, and using a data set of 80 countries over 1998 to 2007, our results show that transparency has a stabilizing influence on output volatility. However, it has less influence on output volatility than other structural sources of stabilization. Further, among the dimensions of transparency we find that operational transparency (covering control errors and macroeconomic disturbances) has the most robust stabilizing effect on output volatility. Whenever significant, political transparency (covering prioritization of objective and institutional arrangements) tends to increase output volatility, whereas other components have insignificant or negligible influence.
    Keywords: Monetary Policy Transparency; Central Bank Independence; Transparency Index; Output Stabilization
    JEL: E63 C33
    Date: 2013–01–29
  2. By: Christian Pierdzioch (University of Hamburg); Jan-Christoph Rülke (University of Vallendar); Peter Tillmann (University of Giessen)
    Abstract: We revisit the sources of the bias in Federal Reserve forecasts and assess whether a precautionary motive can explain the forecast bias. In contrast to the existing literature, we use forecasts submitted by individual FOMC members to uncover members' implicit loss function. Our key finding is that the loss function of FOMC members is asymmetric: FOMC members incur a higher loss when they underpredict (overpredict) inflation and unemployment (real GDP) as compared to an overprediction (underprediction) of similar size. Our findings add to the recent controversy on the relative quality of FOMC forecasts compared to staff forecasts. Together with Capistran's (2008) finding of similar asymmetries in Federal Reserve staff forecasts our results suggest that differences in predictive ability do not stem from differences in preferences. This is underlined by our second result: forecasts remain biased even after accepting an asymmetric loss function.
    Keywords: Federal Open Market Committee; forecasting; asymmetric loss function;monetary policy
    JEL: E58 E37 E27
    Date: 2013
  3. By: John B. Taylor (Stanford University)
    Abstract: This paper assesses the relative effectiveness of central bank independence versus policy rules for the policy instruments in bringing about good economic performance. It examines historical changes in (1) macroeconomic performance, (2) the adherence to rules-based monetary policy, and (3) the degree of central bank independence. Macroeconomic performance is defined in terms of both price stability and output stability. Factors other than monetary policy rules are examined. Both de jure and de facto central bank independence at the Fed are considered. The main finding is that changes in macroeconomic performance during the past half century were closely associated with changes the adherence to rules-based monetary policy and in the degree of de facto monetary independence at the Fed. But changes in economic performance were not associated with changes in de jure central bank independence. Formal central bank independence alone has not generated good monetary policy outcomes. A rules-based framework is essential.
    Date: 2013–01
  4. By: Christina D. Romer; David H. Romer
    Abstract: This paper examines an important gap in the monetary explanation of the Great Depression: the lack of a well-articulated and documented transmission mechanism of monetary shocks to the real economy. It begins by reviewing the challenge to Friedman and Schwartz’s monetary explanation provided by the decline in nominal interest rates in the early 1930s. We show that the monetary explanation requires not just that there were expectations of deflation, but that those expectations were the result of monetary contraction. Using a detailed analysis of Business Week magazine, we find evidence that monetary contraction and Federal Reserve policy contributed to expectations of deflation during the central years of the downturn. This suggests that monetary shocks may have depressed spending and output in part by raising real interest rates.
    JEL: E32 E58 N12
    Date: 2013–01
  5. By: Marcel Förster (University of Giessen); Peter Tillmann (University of Giessen)
    Abstract: In this paper we reconsider the degree of international comovement of inflation rates. We use a dynamic hierarchical factor model that is able to decompose Consumer Price Index (CPI) inflation in a panel of countries into (i) a factor common to all inflation series and all countries, (ii) a factor specific to a given sub-section of the CPI, (iii) a country group-factor and (iv) a country-specific component. With its pyramidal structure, the model allows for the possibility that the global factor affects the country-group factor and other subordinated factors but not vice versa. Using quarterly data for industrialized and emerging economies from 1996 to 2011 we find that about two thirds of overall inflation volatility are due to country-specific determinants. For CPI inflation net of food and energy, the global factor and the CPI basketspecific factor account for less than 20% of inflation variation. We argue that "local inflation" rather than "global inflation" (Ciccarelli and Mojon (2010)) is a better description of the evidence. Only energy price inflation in industrial economies is dominated by common factors.
    Keywords: Inflation, Energy Prices, Monetary Policy, Globalization, Dynamic Hierarchical Factor Model
    JEL: E31 E32 F44
    Date: 2013
  6. By: Pelin Ilbas (National Bank of Belgium, Research Department); Øistein Røisland (Norges Bank); Tommy Sveen (BI Norwegian Business School)
    Abstract: We analyze the influence of the Taylor rule on US monetary policy by estimating the policy preferences of the Fed within a DSGE framework. The policy preferences are represented by a standard loss function, extended with a term that represents the degree of reluctance to letting the interest rate deviate from the Taylor rule. The empirical support for the presence of a Taylor rule term in the policy preferences is strong and robust to alternative specifications of the loss function. Analyzing the Fed's monetary policy in the period 2001-2006, we find no support for a decreased weight on the Taylor rule, contrary to what has been argued in the literature. The large deviations from the Taylor rule in this period are due to large, negative demand-side shocks, and represent optimal deviations for a given weight on the Taylor rule.
    Keywords: optimal monetary policy, simple rules, central bank preferences
    JEL: E42 E52 E58 E61 E65
    Date: 2013–01
  7. By: Martina Alexová (National Bank of Slovakia, Research Department)
    Abstract: This paper focuses on the determinants of inflation for new European Union members during the period from 1996 to 2011. Detecting the drivers of inflation can be essential in designing structural reforms aimed at complementing the main objectives of monetary policy pursued in these countries. We utilize a structural vector error correction model to estimate long run relationships between inflation, mark-up and economic activity incorporating structural factors such as openness of the economy and production and analyse dynamic properties of the models. We find that half of the countries can be characterized by cost-push inflation and the rest by demand side factors. An appropriate monetary strategy to control inflation should accompany ECB monetary strategy in countries belonging to the euro area. The strategy should also maintain a credible currency peg in Lithuania, Latvia and Bulgaria and meet inflation targets in inflation targeting countries in addition with appropriate structural adjustments in labour markets and production capacity.
    Keywords: inflation, long run structural VARs, subset VEC model, mark-up, output gap, deficit, and commodity prices
    JEL: E C
    Date: 2012–12
  8. By: John B. Taylor (Stanford University)
    Abstract: Research in the early 1980s found that the gains from international coordination of monetary policy were quantitatively small compared to simply getting domestic policy right. That prediction turned out to be a pretty good description of monetary policy in the 1980s, 1990s, and until recently. Because this balanced international picture has largely disappeared, the 1980s view about monetary policy coordination needs to be reexamined. The source of the problem is not that the models or the theory are wrong. Rather there was a deviation from the rule-like monetary policies that worked well in the 1980s and 1990s, and this deviation helped break down the international monetary balance. There were similar deviations at many central banks, an apparent spillover culminating in a global great deviation. The purpose of this paper is to examine the possible causes and consequences of these spillovers, and to show that uncoordinated responses of central banks to the deviations can create an amplification mechanism which might be overcome by some form of policy coordination.
    Date: 2013–01
  9. By: Aled Davies
    Abstract: How far were monetary targets imposed on the post-1974 Labour Government by international and domestic financial markets enthused with the doctrines of ‘monetarism’? The following paper attempts to answer this question by demonstrating the complex and contingent nature of the ascent of British ‘monetarism’ after 1968. It describes the post-devaluation valorisation of the ‘money supply’ which led investors to realign their expectations with the behaviour of the monetary aggregates. The collapse of the gobal fixed-exchange rate regime, coupled with vast domestic inflationary pressures after 1973, determined that investors came to employ the ‘money supply’ as a convenient new measure with which to assess the ‘soundness’ of British economic management. The critical juncture of the 1976 Sterling crisis forced the Labour Government into a reluctant adoption of monetary targets as part of a desperate attempt to regain market confidence. The result was to impose significant constraints on the Government’s economic policymaking freedom, as attempts were made to retain favourable money supply figures exposed to the short-term volatility of increasingly-globalised and highly-capitalized financial markets. 
    Date: 2012–10–01
  10. By: Richard H. Clarida
    Abstract: This paper derives a structural relationship between the nominal exchange rate, national price levels, and observed yields on long maturity inflation - indexed bonds. This relationship can be interpreted as defining the fair value of the exchange rate that will prevail in any model or real world economy in which inflation indexed bonds are traded. An advantage of our derivation is that it does not require restrictive assumptions on financial market equilibrium to be operational. We take our theory to a dataset spanning the period January 2001 – February 2011 and study a daily , real time decompositions of pound, euro, and yen exchange rates into their fair value and risk premium components. The relative importance of these two factors varies depending on the sub sample studied. However, sub samples in which we find correlations of 0.30 to 0.60 between daily exchange rate changes and daily changes in fair value are not uncommon. We also show empirically and justify theoretically that a 1 percent rise in the foreign currency risk premium is on average contemporaneously associated with a 50 basis point rise in the inflation indexed bond return differential in favor of the foreign country and an 50 basis point appreciation of the dollar
    JEL: F3 F31
    Date: 2013–01
  11. By: Tomas Havranek; Marek Rusnak
    Abstract: The transmission of monetary policy to the economy is generally thought to have long and variable lags. In this paper we quantitatively review the modern literature on monetary transmission in transition and developed countries to provide stylized facts on the average lag length and the sources of variability. We collect 67 published studies and examine when prices bottom out after a monetary contraction. The average transmission lag is 29 months, and the maximum decrease in prices reaches 0.9% on average after a one-percentagepoint hike in the policy rate. Transmission lags are longer in developed economies (25{50 months) than in transition economies (10{20 months). We nd that the factor most eective in explaining this heterogeneity is nancial development: greater nancial development is associated with slower transmission. Our results also suggest that researchers who use monthly data instead of quarterly data report systematically faster transmission.
    Keywords: Monetary policy transmission, vector autoregressions, metaanalysis
    JEL: C83 E52
    Date: 2012–10–01
  12. By: Alice Albonico (Department of Economics and Management, University of Pavia); Lorenza Rossi (Department of Economics and Management, University of Pavia)
    Abstract: This paper shows that Limited Asset Market Participation generates an extra inflation bias when the fiscal and the monetary authority play strategically. A fully redistributive fiscal policy eliminates the extra inflation-bias, however, the latter is cancelled at the cost of reducing Ricardians' welfare. A fiscal authority which redistributes income only partially, reduces the inflation-bias, but rises Government spending. Despite a fully conservative monetary policy is necessary to get price stability, it implies a reduction in liquidity constrained consumers' welfare, in the absence of redistributive fiscal policies. Finally, under a crisis scenario price stability cannot be ensured by Ramsey without redistribution.
    Keywords: liquidity constrained consumers, optimal monetary and fiscal policy, strategic interaction, inflation bias, redistribution.
    JEL: E3 E5 E62
    Date: 2013–11
  13. By: Mototsugu Shintani (Deaprtment of Economics, Vanderbilt University); Akiko Terada-hagiwara (Economics and Research Department, Asian Development Bank); Tomoyoshi Yabu (Faculty of Business and Commerce, Keio University)
    Abstract: This paper investigates the relationship between the exchange rate pass-through (ERPT) and inflation by estimating a nonlinear time series model. Based on a simple theoretical model of ERPT determination, we show that the dynamics of ERPT can be well approximated by a class of smooth transition autoregressive (STAR) models using the past inflation rate as a transition variable. We employ several U-shaped transition functions in the estimation of the time-varying ERPT to US domestic prices. The estimation result suggests that declines in the ERPT during the 1980s and 1990s are associated with lowered inflation.
    Keywords: import prices, inflation indexation, pricing-to-market, smooth transition autoregressive models, sticky prices.
    JEL: N0
    Date: 2012–12–09
  14. By: Eric Schaling; Mewael F. Tesfaselassie
    Abstract: Available evidence supports the view that growth is faster in more open economies. In order to analyze the implications of openness and growth on determinacy and learnability of worldwide rational expectations equilibria we develop a two-country New Keynesian model with growth. We analyze these issues for contemporaneous data and expectations-based monetary policy rules. Our results highlight how growth matters for the overall effect of opening an economy to more trade, as we find that (i) under the contemporaneous data policy rule the conditions for determinacy and learnability become more stringent on account of openness but less stringent on account of growth, so that growth weakens the effect of openness, (ii) under the expectations-based policy rule the conditions for determinacy and learnability also become more stringent on account of openness while on account growth the conditions for determinacy become \emph{more} stringent (thus reinforcing the effect of openness) but those for learnability become \emph{less} stringent (thus weakening the effect of openness). As in \citet{BS09} the elasticity of intertemporal substitution is key to our result but within a framework that is consistent with long-run labor supply and balanced growth facts
    Keywords: trend growth,open economy,monetary policy rules,determinacy,learning
    JEL: E58 E61 F31 F41
    Date: 2013–01
  15. By: Leo Ferraris (University of Rome "Tor Vergata"); Fabrizio Mattesini (University of Rome "Tor Vergata")
    Abstract: This paper addresses the "rate of return" puzzle of monetary theory. Similarly to the legal restrictions theory of the demand for money, we assume that Government bonds are subject to a minimum purchase requirement. Differently from this theory, however, we assume that intermediaries, when issuing private notes, cannot commit to always redeem them. First, we study an environment with legal restrictions to intermediation and show that cash and interest bearing bonds both circulate in the economy. Then, we drop the legal restrictions and show that also with active intermediation, under limited commitment, there is an equilibrium with rate of return dominance. A positive interest rate provides the intermediaries with the incentive to issue and redeem their notes.
    Keywords: Money, Government Bonds, Rate of Return Dominance, Legal Restrictions
    JEL: E40
    Date: 2013–01–21
  16. By: Bianchetti, Marco; Carlicchi, Mattia
    Abstract: We review the main changes in the interbank market after the financial crisis started in August 2007. In particular, we focus on the fixed income market and we analyse the most relevant empirical evidences regarding the divergence of the existing basis between interbank rates with different tenor, such as Libor and OIS. We also discuss a qualitative explanation of these effects based on the consideration of credit and liquidity variables. Then, we focus our attention on the diffusion of collateral agreements among OTC derivatives market counterparties, and on the consequent change of paradigm for pricing derivatives. We illustrate the main qualitative features of the new market practice, called CSA discounting, and we point out the most relevant issues for market players associated to its adoption.
    Keywords: crisis; liquidity; credit; counterparty; risk; fixed income; Libor; Euribor; Eonia; OIS – Libor basis; yield curve; forward curve; discount curve; single curve; multiple curve; collateral; CSA discounting; no arbitrage; pricing; interest rate derivatives; FRA; swap; OIS; basis swap; forward rate; CDS spread; ECB monetary policy; ISDA
    JEL: E43 G12 G13
    Date: 2012–12–19
  17. By: Riane de Bruyn (Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria); Renee van Eyden (Department of Economics, University of Pretoria)
    Abstract: Traditionally, the literature on forecasting exchange rates with many potential predictors have primarily only accounted for parameter uncertainty using Bayesian Model Averaging (BMA). Though BMA-based models of exchange rates tend to outperform the random walk model, we show that when accounting for model uncertainty over and above parameter uncertainty through the use of Dynamic model Averaging (DMA), the gains relative to the random walk model are even bigger. That is, DMA models outperform not only the random walk model, but also the BMA model of exchange rates. We obtain these results based on fifteen potential predictors used to forecast two South African Rand-based exchange rates. In the process, we also unveil variables, which tends to vary over time, that are good predictors of the Rand-Dollar and Rand-Pound exchange rates at different forecasting horizons.
    Keywords: Bayesian, state space models, exchange rates, macroeconomic fundamentals, forecasting
    JEL: C11 C53 F37 F47
    Date: 2013–01
  18. By: Ricardo Reis
    Abstract: In spite of the mystique behind a central bank's balance sheet, its resource constraint bounds the dividends it can distribute by the present value of seignorage, which is a modest share of GDP. Moreover, the statutes of the Federal Reserve or the ECB make it difficult for it to redistribute resources across regions. In a simple model of sovereign default, where multiple equilibria arise if debt repudiation lowers fiscal surpluses, the central bank may help to select one equilibrium. The central bank's main lever over fundamentals is to raise inflation, but otherwise the balance sheet gives it little leeway.
    JEL: E58 F34
    Date: 2013–01
  19. By: Goodness C. Aye (Department of Economics, University of Pretoria); Mehmet Balcilar (Department of Economics, Eastern Mediterranean University, Famagusta, North Cyprus,via Mersin 10, Turkey); Adel Bosch (Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria); Francois Stofberg (Department of Economics, University of Pretoria)
    Abstract: This paper analyses the out-of-sample forecasting performance of non-linear vs. linear models for the South African Rand against the United States dollar and the British Pound, in real terms. We compare the forecasting performance of point, interval and density forecasts for non-linear Band- TAR and ESTAR models to linear autoregressive models. Our data spans from 1970:01 to 2012:07, and we found that there are no significant gains from using either the Band-TAR or ESTAR non-linear models, compared to the linear AR model in terms of out-of-sample forecasting performance, especially at short horizons. We draw similar conclusions to other literature, and find that for the South African rand against the United States dollar and British pound, non-linearities are too weak for Band-TAR and ESTAR models to estimate.
    Keywords: Real exchange rate; Transaction costs; Band-threshold autoregressive model; Exponential smooth transition autoregressive model; Point forecast; Interval forecast; Density forecast; South Africa
    JEL: C22 C52 C53 F31 F47
    Date: 2013–01
  20. By: Harold Ngalawa (School of Economics and Finance, University of KwaZulu-Natal); Nicola Viegi (Department of Economics, University of Pretoria)
    Abstract: The primary objective of this paper is to investigate the interaction of formal and informal financial markets and their impact on economic activity in quasi-emerging market economies. Using a four-sector dynamic stochastic general equilibrium model with asymmetric information in the formal financial sector, we come up with three fundamental findings. First, we demonstrate that formal and informal financial sector loans are complementary in the aggregate, suggesting that an increase in the use of formal financial sector credit creates additional productive capacity that requires more informal financial sector credit to maintain equilibrium. Second, it is shown that interest rates in the formal and informal financial sectors do not always change together in the same direction. We demonstrate that in some instances, interest rates in the two sectors change in diametrically opposed directions with the implication that the informal financial sector may frustrate monetary policy, the extent of which depends on the size of the informal financial sector. Thus, the larger the size of the informal financial sector the lower the likely impact of monetary policy on economic activity. Third, the model shows that the risk factor (probability of success) for both high and low risk borrowers plays an important role in determining the magnitude by which macroeconomic indicators respond to shocks.
    Keywords: Informal financial sector, formal financial sector, monetary policy, general equilibrium
    JEL: E44 E47 E52 E58
    Date: 2013–01
  21. By: Bussière, Matthieu; Lopez, Claude; Tille, Cédric
    Abstract: While currency crises have been extensively studied, the opposite phenomenon, large appreciations, has been far less researched. We fill this gap by providing an empirical exploration of historical episodes of large real exchange rate appreciations, using a sample of 28 advanced and 25 emerging market economies, with annual data going back to 1970. We focus on the impact of large appreciations on output growth. Our first finding is that countries experiencing large real exchange rate appreciations display distinct patterns: large appreciations significantly lower export growth and boost import growth on impact. Strikingly, however, output growth is higher, on average, despite the adverse impact on exports. Our second finding is that these aggregate numbers hide substantial heterogeneity, which we link to the nature of the shocks that cause the appreciation. In particular, appreciations associated with so-called “capital flow bonanzas” have a marked downward effect on growth. This pattern is consistent with the insights from a simple model that contrasts the impact of productivity shocks with that of capital inflows shocks. Higher productivity in the traded sector leads to a boom in traded output and a current account surplus, while higher foreign lending leads to a boom in non-traded output and an external deficit as traded output falls and consumption increases.
    Keywords: exchange rate, currency crises, endaka, international trade, international capital flows, lending booms, small open economy macroeconomics
    JEL: F10 F30 F41
    Date: 2013–01

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