nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒03‒23
forty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The decentralised central bank: regional bank rate autonomy in Norway, 1850-1892. By Klovland, Jan Tore; Øksendal, Lars Fredrik
  2. It’s not just for inflation: The usefulness of the median CPI in BVAR forecasting By Brent Meyer; Saeed Zaman
  3. Do heterogeneous expectations constitute a challenge for policy interaction? By Emanuel Gasteiger
  4. Is Inflation Targeting Still on Target? The Recent Experience of Latin America By Luis Felipe Cespedes; Roberto Chang; Andres Velasco
  5. Food Prices and Inflation Targeting in Emerging Economies By Marc Pourroy; Benjamin Carton; Dramane Coulibaly
  6. The high-frequency response of energy prices to monetary policy: understanding the empirical evidence By Carlo Rosa
  7. Towards a pure state theory of money By Ballinger, Clint
  8. Does Monetary Policy Matter in China? A Narrative Approach By Sun, Rongrong
  9. Pre- versus Post-Crisis Central Banking in Qatar By Elsamadisy, Elsayed Mousa; Alkhater, Khalid Rashid; Basher, Syed Abul
  10. Optimal economic policy and oil prices shocks in Russia By Semko Roman
  11. Global dynamics at the zero lower bound By William T. Gavin; Benjamin D. Keen; Alexander Richter; Nathaniel Throckmorton
  12. "Wages, Exchange Rates, and the Great Inflation Moderation: A Post-Keynesian View" By Nathan Perry; Nathaniel Cline
  13. A Tractable Monetary Model Under General Preferences By Tsz-Nga Wong
  14. Modeling monetary economies: an equivalence result By Gabriele Camera; YiLi Chien
  15. Optimal devaluations By Constantino Hevia; Juan Pablo Nicolini
  16. Lessons from the historical use of reserve requirements in the United States to promote bank liquidity By Mark A. Carlson
  17. Shifting Mandates: The Federal Reserve’s First Centennial By Carmen M. Reinhart; Kenneth S. Rogoff
  18. Implicit intraday interest rate in the UK unsecured overnight money market By Marius Jurgilas; Filip Zikes
  19. Using a DSGE Model to Assess the Macroeconomic Effects of Reserve Requirements in Brazil By Waldyr Dutra Areosa; Christiano Arrigoni Coelho
  20. Inflation persistence and the rationality of inflation expectations By Sophocles N. Brissimis; Petros M. Migiakis
  21. Conditiona l Forecast Selection from Many Forecasts: An Application to the Yen/Dollar Exchange Rate By Kei Kawakami
  22. Reengineering EMU for an Uncertain World By Angel Ubide
  23. Early warning for currency crises: what is the role of financial openness? By Jon Frost; Ayako Saiki
  24. Welfare costs of shifting trend inflation By Taisuke Nakata
  25. Exchange rate pass-through, firm heterogeneity and product quality: a theoretical analysis By Zhi Yu
  26. Financial crises and bank funding: recent experience in the euro area By Adrian Van Rixtel; Gabriele Gasperini
  27. Optimal delegation via a strategic intermediary By Liang, Pinghan
  28. Liquidity provision during the crisis of 1914: private and public sources By Margaret Jacobson; Ellis W. Tallman
  29. Financial stability analysis: insights gained from consolidated banking data for the EU By Stefano Borgioli; Ana Cláudia Gouveia; Claudio Labanca
  30. Identifying term interbank loans from Fedwire payments data By Dennis Kuo; David Skeie; James Vickery; Thomas Youle
  31. Capital controls: a normative analysis By Bianca De Paoli; Anna Lipinska
  32. The effect of underreporting on LIBOR rates By Andrea Monticini; Daniel L. Thornton
  33. Trade Intensity and Output Synchronisation: On the Endogeneity Properties of EMU By Guglielmo Maria Caporale; Roberta De Santis; Alessandro Girardi
  34. The Effects of Trade Openness on Malaysian Exchange Rate By Lee, Chin; Law, Chee-Hong
  35. The mutating euro area crisis: is the balance between "sceptics" and "advocates" shifting? By Francesco Paolo Mongelli
  36. On the interdependence of money supply and demand By Cavalieri, Duccio
  37. Cyclical relationship between exchange rates and macro-fundamentals in Central and Eastern Europe By Stavarek, Daniel
  38. The Elephant Hiding in the Room: Currency Intervention and Trade Imbalances By Joseph E. Gagnon
  39. Money market funds intermediation, bank instability, and contagion By Marco Cipriani; Antoine Martin; Bruno M. Parigi
  40. Monetary regimes and statistical regularity: the Classical Gold Standard (1880-1913) through the lenses of Markov models By Daniela Bragoli; Camilla Ferretti; Piero Ganugi; Giancarlo Ianulardo
  41. Monetary Integration, Soft Budget Constraints, and the EMU Sovereign Debt Crises By Thushyanthan Baskaran; Zohal Hessami
  42. Should non-euro area countries join the single supervisory mechanism? By Zsolt Darvas; Guntram B. Wolff

  1. By: Klovland, Jan Tore (Dept. of Economics, Norwegian School of Economics and Business Administration); Øksendal, Lars Fredrik (Dept. of Economics, Norwegian School of Economics and Business Administration)
    Abstract: Before 1893 the regional branches of Norges Bank set their own bank rates. We discuss how bank rate autonomy could be reconciled with the fixed exchange rate commitments of the silver and gold standard. Although the headquarters of the bank was in Trondhjem, we find that the Christiania branch played the key role in providing leadership in bank rate policy. Foreign interest rate impulses were important for bank rate decisions, but there was also some leeway for responding to idiosyncratic shocks facing the Norwegian economy.
    Keywords: Bank rate; gold standard; monetary policy.
    JEL: E58 N23
    Date: 2013–03–11
  2. By: Brent Meyer; Saeed Zaman
    Abstract: In this paper we investigate the forecasting performance of the median CPI in a variety of Bayesian VARs (BVARs) that are often used for monetary policy. Until now, the use of trimmed-mean price statistics in forecasting inflation has often> been relegated to simple univariate or “Philips-Curve” approaches, thus limiting their usefulness in applications that require consistent forecasts of multiple macro variables. We find that inclusion of an extreme trimmed-mean measure—the> median CPI—significantly improves the forecasts of both headline and core CPI. across our wide-ranging set of BVARs. While the inflation forecasting improvements are perhaps not surprising given the current literature on core inflation statistics, we also find that inclusion of the median CPI improves the forecasting> accuracy of the central bank’s primary instrument for monetary policy—the federal funds rate. We conclude with a few illustrative exercises that highlight the usefulness of using the median CPI.>
    Keywords: Bayesian statistical decision theory ; Forecasting ; Monetary policy ; Simulation modeling
    Date: 2013
  3. By: Emanuel Gasteiger
    Abstract: Yes, indeed; at least when it comes to fiscal and monetary policy interaction. We examine a Neo-Classical economy, where agents have either rational or adaptive expectations. We demonstrate that the monetarist solution can be unique and stationary under a passive fiscal/active monetary policy regime, because active monetary policy incorporates expectational heterogeneity. In contrast, under an active fiscal/passive monetary policy regime, the fiscalist solution is prone to explosive dynamics d e to empirically plausible expectational heterogeneity. However, conditional on stationarity, both regimes can yield promising business cycle dynamics, which are absent in the homogeneous expectations benchmark.
    Keywords: Inflation, Heterogeneous Expectations, Fiscal and Monetary Policy
    JEL: E31 D84 E52 E62
    Date: 2013–03–18
  4. By: Luis Felipe Cespedes; Roberto Chang; Andres Velasco
    Abstract: This paper reviews the recent experience of a half-dozen Latin American inflation targeting (IT) nations. Repeated and large deviations from the standard IT framework are documented: exchange market interventions have been lasting and widespread; the real exchange rate has often become a target of policy, though this target is seldom made explicit; a range of other non-conventional policy tools, especially changes in reserve requirements but occasionally taxes or restrictions on international capital movements, also came into common use. As in developed nations, during the 2008-2009 crisis issues of liquidity provision took center stage. A first evaluation of the emerging modified framework of monetary policy is also attempted. In general terms, the new approach seems to have been effective, at the very least since the region weathered the crisis reasonably well. But also, and perhaps more importantly, many questions remain about the desirability of non-conventional monetary policies in Latin America.
    JEL: E52 E58 F41
    Date: 2013–03
  5. By: Marc Pourroy; Benjamin Carton; Dramane Coulibaly
    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 badly-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: 2013
  6. By: Carlo Rosa
    Abstract: This paper examines the impact of conventional and unconventional monetary policy on energy prices, using an event study with intraday data. Three measures for monetary policy surprises are used: 1) the surprise change to the current federal funds target rate, 2) the surprise component to the future path of policy, and 3) the unanticipated announcements of future large-scale asset purchases (LSAPs). Estimation results show that monetary policy news has economically important and highly significant effects on the level and volatility of energy futures prices and their trading volumes. I find that, on average, a hypothetical unanticipated 100 basis point hike in the federal funds target rate is associated with roughly a 3 percent decrease in West Texas Intermediate oil prices. I also document that, in a narrow window around the Federal Open Market Committee meeting, the Federal Reserve’s LSAP1 and LSAP2 programs have a cumulative financial market impact on crude oil equivalent to an unanticipated cut in the federal funds target rate of 155 basis points. Monetary policy affects oil prices mostly by affecting the value of the U.S. dollar exchange rate. Intraday energy prices also respond to news announcements about the U.S. macroeconomy and inventories. The daily responses are never significant, except in the case of inventory news.
    Keywords: Petroleum products - Prices ; Monetary policy ; Federal funds rate ; Futures ; Open market operations ; Inventories
    Date: 2013
  7. By: Ballinger, Clint
    Abstract: MODERN MONETARY THEORY (MMT) notes correctly that money is a creature of the state, and that important macroeconomic and policy conclusions follow from this understanding, e.g., sovereign states are not revenue constrained and spending is primarily limited by inflation. Taxes give value to state money and maintain its value (i.e., inflation can be controlled through taxes). One (among many) key policy insight is that a job guarantee is possible. A job guarantee not only achieves what many think should for myriad social reasons be a primary goal of macroeconomics but also further creates a buffer stock (the most useful one of any imaginable given the social reasons just mentioned) that achieves an additional primary macroeconomic policy goal – stability. However, there is no state that operates under a pure state system of money. Most of what serves as money in most banking systems in the world is privately created credit money. We can compare the current most common banking system with a pure state system of money:
    Keywords: The chicago plan, Full Reserve Banking, Modern Monetary Theory, 100% reserves, Alfred Mitchell-Innes, Austrian economics, Bagehot, bank reform, banking crisis, chartalism, chartalist, Circuit theory, credit money, endogenous money, financial crisis, Fractional Reserves, Georg Friedrich Knapp, Limited Purpose Banking, Lombard Street, MCT, Misesean banking, mmt, modern monetary theory, narrow banking, neo-chartalism, circuitisme
    JEL: A1 A10 E0 E00 G1 G2 G21
    Date: 2013–03
  8. By: Sun, Rongrong
    Abstract: This paper applies the narrative approach to monetary policy in China to tackle two problems of policy measurement. The first problem arises because the PBC (the central bank of China) applies multiple instruments and none of them per se can adequately reflect changes in its monetary policy. The second one is the classical identification problem: the causation direction of the observed interaction between central bank actions and real activity needs to be identified. The PBC’s documents are used to infer the intentions behind policy movements. Three shocks are identified for the period 2000-2011 that are exogenous to real output. Estimates using these shocks and various robustness tests indicate that monetary policy has large and persistent impact on output in China.
    Keywords: exogenous shocks, the narrative approach, real effects of monetary policy
    JEL: E52 E58
    Date: 2012
  9. By: Elsamadisy, Elsayed Mousa; Alkhater, Khalid Rashid; Basher, Syed Abul
    Abstract: In the years before the global financial crisis of 2008--2010, Qatar experienced a huge build-up of liquidity surplus in the banking system, mainly driven by surging net capital inflows. This paper identifies various sources of interbank liquidity in Qatar and discusses the various implications of structural primary liquidity surplus for the money market in particular and the economy at large. The paper attempts to evaluate the Qatar Central Bank policy making and conduct during the pre- and post-crisis periods within a framework of the Austrian monetary overinvestment theories, and concludes that the central bank had forcibly committed several forced monetary policy mistakes, which resulted in a breakdown in the interest rate channel of the monetary policy transmission mechanism. This led to the inability of the central bank to control the interbank interest rate and to an accelerating inflation rate during the pre-crisis years. In contrast, a dramatic change in the central bank's monetary policy framework and a deliberate monetary policy mistake on behalf of the central bank resulted in a restoration of the interest rate channel of the monetary policy transmission mechanism, stabilization of the interbank interest rate close to the central bank's policy rate and a sharp deceleration in the inflation rate in the post-crisis period. The paper concludes by offering brief policy recommendations.
    Keywords: Monetary policy framework; Monetary policy mistakes; Liquidity management; Structural liquidity surplus; Financial crisis.
    JEL: E51 E52 E58
    Date: 2013–03–21
  10. By: Semko Roman
    Abstract: The goal of the paper is to explain and analyze whether Central Bank of Russia should include commodity prices into the lists of variables they try to respond. We augmented New Keynesian DSGE small open economy model of Dib (2008) with the oil stabilization fund and new Taylortype monetary policy rule and estimated the model using Bayesian econometrics. The results show that Central Bank’s mild response to the oil price changes may be desired in terms of minimizing fluctuations of inflation and output only in the case when stabilization fund would be absent, while this response is redundant when “excess” oil revenues can be saved in the fund.
    JEL: E12 E52 E58 F41
    Date: 2013–03–15
  11. By: William T. Gavin; Benjamin D. Keen; Alexander Richter; Nathaniel Throckmorton
    Abstract: This article presents global solutions to standard New Keynesian models to show how economic dynamics change when the nominal interest rate is constrained at its zero lower bound (ZLB). We focus on the canonical New Keynesian model without capital, but we also study the model with capital, with and without investment adjustment costs. Our solution method emphasizes accuracy to capture the expectational effects of hitting the ZLB and returning to a positive interest rate. We find that the response to a technology shock has perverse consequences when the ZLB binds, even when a discount factor shock drives the interest rate to zero. Although we do not model the large scale asset purchases used by the Fed since 2009, our results suggest that the economy may have trouble recovering if the interest rate remains at zero. Given the perverse dynamics at the ZLB, we evaluate how monetary policy affects the likelihood of encountering the ZLB. We find that the probability of hitting the ZLB depends importantly on the monetary policy rule. A policy rule based on a dual mandate, such as the one proposed by Taylor (1993), is more likely to cause ZLB events when the central bank places greater emphasis on the output gap.
    Keywords: Monetary policy ; Bonds
    Date: 2013
  12. By: Nathan Perry; Nathaniel Cline
    Abstract: Several explanations of the "great inflation moderation" (1982-2006) have been put forth, the most popular being that inflation was tamed due to good monetary policy, good luck (exogenous shocks such as oil prices), or structural changes such as inventory management techniques. Drawing from Post-Keynesian and structuralist theories of inflation, this paper uses a vector autoregression with a Post-Keynesian identification strategy to show that the decline in the inflation rate and inflation volatility was due primarily to (1) wage declines and (2) falling import prices caused by international competition and exchange rate effects. The paper uses a graphical analysis, impulse response functions, and variance decompositions to support the argument that the decline in inflation has in fact been a "wage and import price moderation," brought about by declining union membership and international competition. Exchange rate effects have lowered inflation through cheaper import and oil prices, and have indirectly affected wages through strong dollar policy, which has lowered manufacturing wages due to increased competition. A "Taylor rule" differential variable was also used to test the "good policy" hypothesis. The results show that the Taylor rule differential has a smaller effect on inflation, controlling for other factors.
    Keywords: Inflation; Taylor Rule; Post-Keynesian; Structuralist
    JEL: E12 E31
    Date: 2013–03
  13. By: Tsz-Nga Wong
    Abstract: Consider the monetary model of Lagos and Wright (JPE 2005) but with general preferences and general production. I show that preferences satisfying UXXUHH – (UXH)2 = 0 is a sufficient condition for the existence and uniqueness of monetary equilibrium with degenerate money distribution. I solve for the entire class of exact solutions to the above non-linear second order partial differential equation. This class of preferences includes ones with constant return to scale, for example, constant elasticity of substitution (CES), and ones used in many other macroeconomics literatures. I also analyze the welfare implication of monetary policy in this economy.
    Keywords: Economic models
    JEL: E40 D83
    Date: 2013
  14. By: Gabriele Camera; YiLi Chien
    Abstract: This paper offers a methodological contribution to monetary theory. First, it presents a model economy with cash-in-advance constraints, following the work of Lucas in the early 80’s; then, it specializes the model to preferences and shocks assumed in the Lagos and Wright (2005) framework. Second, it derives the main equations describing allocations under competitive pricing and demonstrates that the two models—which on the surface appear different—are mathematically equivalent. Such equivalence result is extended to stationary equilibrium under non-competitive pricing; in both models, allocations depend on a free parameter controlling price markups.
    Keywords: Monetary theory ; Money ; Inflation (Finance)
    Date: 2013
  15. By: Constantino Hevia; Juan Pablo Nicolini
    Abstract: We analyze optimal policy in a simple small open economy model with price setting frictions. In particular, we study the optimal response of the nominal exchange rate following a terms of trade shock. We depart from the New Keynesian literature in that we explicitly model interna-tionally traded commodities as intermediate inputs in the production of local final goods and assume that the small open economy takes this price as given. This modification not only is in line with the long-standing tradition of small open economy models, but also changes the optimal movements in the exchange rate. In contrast with the recent small open economy New Keynesian literature, our model is able to reproduce the comovement between the nominal exchange rate and the price of exports, as it has been documented in the commodity currencies literature. Although we show there are preferences for which price stability is optimal even without flexible fiscal instruments, our model suggests that more attention should be given to the coordination between monetary and fiscal policy (taxes) in small open economies that are heavily dependent on exports of commodities. The model we propose is a useful framework in which to study fear of floating.
    Keywords: Monetary policy
    Date: 2013
  16. By: Mark A. Carlson
    Abstract: Efforts in the United States to promote bank liquidity through reserve requirements, a minimum ratio of liquid assets relative to liabilities, extend at least as far back as the aftermath of the Panic of 1837. These requirements were quite important during the National Banking Era. Nevertheless, suspensions of deposit convertibility and liquidity shortfalls continued to occur during banking panics. Eventually, efforts to ensure that banks remained liquid resulted in a shift away from reserve requirements in favor of a central bank able to add liquidity to the financial system. This paper reviews the issues raised in the historical debates about reserve requirements along with some empirical evidence on banks' holdings of reserves, to provide some insights and lessons that are relevant today. A key lesson is that individual bank liquidity during stress periods is inherently and intricately tied to the liquidity policies of the central bank.
    Date: 2013
  17. By: Carmen M. Reinhart; Kenneth S. Rogoff
    Abstract: The mandate of the Federal Reserve has evolved considerably over its hundred-year history. From an initial focus in 1913 on financial stability, to fiscal financing in World War II and its aftermath, to a strong anti-inflation focus from the late 1970s, and then back to greater emphasis on financial stability since the Great Contraction. Yet, as the Fed’s mandate has expanded in recent years, its range of instruments has narrowed, partly based on a misguided belief in the inherent stability of financial markets. We briefly discuss the active use in an earlier era of multiple instruments, including reserve requirements, credit controls and interest rate ceilings.
    JEL: E02 E5 N1 N12 N2
    Date: 2013–03
  18. By: Marius Jurgilas (Norges Bank (Central Bank of Norway)); Filip Zikes (Bank of England)
    Abstract: This paper estimates the intraday value of money implicit in the UK unsecured overnight money market. Using transactions data on overnight loans advanced through the UK large value payments system CHAPS in 2003-2009, we find a positive and economically significant intraday interest rate. While the implicit intraday interest rate is quite small pre-crisis, it increases more than tenfold during the financial crisis of 2007-2009. The key interpretation is that an increase in implicit intraday interest rate reects the increased opportunity cost of pledging collateral intraday and can be used as an indicator to gauge the stress of the payment system. We obtain qualitatively similar estimates of the intraday interest rate by using quoted intraday bid and offer rates and confirm that our results are not driven by the intraday variation in the bid-ask spread.
    Keywords: Interbanl money market, Intraday liquidity
    JEL: E42 E58 G21
    Date: 2013–03–14
  19. By: Waldyr Dutra Areosa; Christiano Arrigoni Coelho
    Abstract: The goal of this paper is to present how a Dynamic General Equilibrium Model (DSGE) can be used by policy makers in the qualitative and quantitative evaluation of the macroeconomics impacts of two monetary policy instruments: (i) short term interest rate and (ii) reserve requirements ratio. In our model, this last instrument affects the leverage of banks that have to deal with agency problems in order to raise funds from depositors. We estimated a modified version of Gertler and Karadi (2011), incorporating a reserve requirement ratio, in order to answer two questions: (i) what is the impact of a transitory increase of 1% p.y. of the short term interest rate on macroeconomic variables like GDP, inflation and investment? (ii) what is the macroeconomic impact of a transitory increase of 10% in the reserve requirement ratio? We found that these two shocks have the same qualitative effects on the most of the macroeconomic variables, but that the impact of interest rate is much stronger.
    Date: 2013–01
  20. By: Sophocles N. Brissimis (University of Piraeus); Petros M. Migiakis (Bank of Greece)
    Abstract: The rational expectations hypothesis for survey and model-based inflation forecasts ? from the Survey of Professional Forecasters and the Greenbook respectively ? is examined by properly taking into account persistence in the data. The finding of near-unit-root effects in inflation and inflation expectations motivates the use of a local-to-unity specification of the inflation process that enables us to test whether the data are generated by locally non-stationary or stationary processes. Thus, we test, rather than assume, stationarity of near-unit-root processes. In addition, we set out an empirical framework for assessing relationships between locally non-stationary series. In this context, we test the rational expectations hypothesis by allowing the co-existence of a long-run relationship obtained under the rational expectations restrictions with short-run "learning" effects. Our empirical results indicate that the rational expectations hypothesis holds in the long run, while forecasters adjust their expectations slowly in the short run. This finding lends support to the hypothesis that the persistence of inflation comes from the dynamics of expectations.
    Keywords: Inflation; rational expectations; high persistence
    JEL: C50 E31 E52
    Date: 2013–01
  21. By: Kei Kawakami
    Abstract: This paper proposes a new method for forecast selection from a pool of many forecasts. The method uses conditional information as proposed by Giacomini and White (2006). It also extends their pairwise switching method to a situation with many forecasts. I apply the method to the monthly yen/dollar exchange rate and show empirically that my method of switching forecasting models reduces forecast errors compared with a single model.
    Keywords: Conditional predictive ability; Exchange rate; Forecasting; Forecast combinations; Model selection
    JEL: C52 C53 F31 F37
    Date: 2013
  22. By: Angel Ubide (Peterson Institute for International Economics)
    Abstract: The euro area crisis has probably passed the acute phase, but it has entered a chronic and unstable phase of fractured credit markets, too high funding costs, very weak growth, and dim expectations. More austerity and reforms at the national level alone will not be enough to stabilize the euro area. To ensure its sustainability, the euro area needs to be reengineered to restore political solidarity, end the debate on default and exit, strengthen its institutions and launch eurobonds, and refocus cyclical policies towards stabilizing the business cycle. Without these steps, the euro will never be a credible and sustainable monetary union.
    Date: 2013–02
  23. By: Jon Frost; Ayako Saiki
    Abstract: We explore the role of financial openness – capital account openness and gross capital inflows – and a newly constructed gravity-based contagion index to assess the importance of these factors in the run-up to currency crises. Using a quarterly data set of 46 advanced and emerging market economies (EMEs) during the period 1975Q1-2011Q4, we estimate a multi-variable probit model including in the post-Lehman period. Our key findings are as follows. First, capital account openness is a robust indicator, reducing the probability of currency crisis for advanced economies, but less so for EMEs. Second, surges in gross (but not net) capital inflows in general increase the risk of a currency crisis, but looking at a disaggregated level, gross portfolio flows increase the risk of a currency crisis for advanced economies, whereas gross FDI inflows decrease the risk of a crisis for EMEs. Third, contagion has a very strong impact, consistent with the past literature, especially during the post-Lehman shock episode. Last, our model performs well out-of-sample, confirming that early warning models were helpful in judging relative vulnerability of countries during and since the Lehman crisis.
    Keywords: Currency crisis; early warning; financial stability; capital account openness; capital flows; contagion; exchange rate regime
    JEL: F31 F32 F33 F41 G10 G15
    Date: 2013–03
  24. By: Taisuke Nakata
    Abstract: This paper studies the welfare consequences of exogenous variations in trend inflation in a New Keynesian economy. Consumption and leisure respond asymmetrically to a rise and a decline in trend inflation. As a result, an increase in the variance of shocks to the trend inflation process decreases welfare not only by increasing the volatilities of consumption and leisure, but also by decreasing their average levels. I find that the welfare cost of drifting trend inflation is modest and that it comes mainly from reduced average levels of consumption and leisure, not from their increased volatilities.
    Date: 2013
  25. By: Zhi Yu
    Abstract: This paper theoretically explores how exchange rate pass-through depends on firm heterogeneity in productivity and product differentiation in quality. Using an extended version of the Melitz and Ottaviano (2008) model, I show that exporting firms absorb exchange rate changes by adjusting both their markups and product quality, which leads to an incomplete exchange rate pass-through. Moreover, the absolute value of exchange rate absorption elasticity (the percentage change in the export prices denominated in the currency of the exporting country in response to a one percent change in the exchange rate rate) negatively depends on firm productivity for products with high scope for quality differentiation, but positively depends on firm productivity for products with low scope for quality differentiation.
    Keywords: Trade ; Markets
    Date: 2013
  26. By: Adrian Van Rixtel; Gabriele Gasperini
    Abstract: This paper provides an overview of bank funding trends in the euro area following the 2007-09 global financial crisis and the euro area crisis. It shows that funding has become segmented along national borders and that secured instruments are much more prevalent than previously. Rising debt retention by euro area banks has accompanied greater dependence on liquidity provided by the ECB.
    Keywords: euro area, financial crisis, bank funding, renationalisation, secured issuance, debt retention
    Date: 2013–03
  27. By: Liang, Pinghan
    Abstract: This paper studies the optimal design of delegation rule in a three-tier principal-intermediary-agent hierarchy. In this hierarchy, monetary transfer is not feasible, delegation is made sequentially, and all players are strategic. We characterize the optimal delegation mechanism. It is shown that the single-interval delegation a la Holmstrom is optimal only when the intermediary is moderately biased. Otherwise, as responses to the distortion caused by a biased intermediary, the optimal delegation set may involve a hole. Thus, multi-interval delegation set would arise when subordinates have opposing biases. This result sheds some light on policy threshold effects: "slight" changes in the underlying state cause a jump in the policy responses.
    Keywords: Delegation, Intermediary, Hierarchies
    JEL: D73 D78 D86
    Date: 2013
  28. By: Margaret Jacobson; Ellis W. Tallman
    Abstract: Caught between the end of the National Banking Era and the beginning of the Federal Reserve System, the crisis of 1914 provides an example of a banking panic avoided. We investigate how this outcome was achieved by examining data on the issues of Aldrich-Vreeland emergency currency and clearing house loan certificates to New York City institutions that identify borrower and quantity requested for each type of temporary liquidity measure. Combined with balance sheet data, we illustrate how temporary liquidity borrowing was essential for maintaining transactions volumes among New York City financial intermediaries. We highlight a significant role for clearing house loan certificates that is distinct from the influence of Aldrich-Vreeland emergency currency issues.
    Keywords: Financial markets ; Payment systems ; Money supply
    Date: 2013
  29. By: Stefano Borgioli (European Central Bank); Ana Cláudia Gouveia; Claudio Labanca
    Abstract: This occasional paper explores the Consolidated Banking Data (CBD), a key component of the ECB statistical toolbox for financial stability analysis. We show that non-consolidated, host-country Monetary Financial Institutions (MFI) balance sheet data, which constitutes a key source of input into monetary analysis, are a rather weak proxy for consolidated, home-country data and therefore cannot easily substitute CBD for the purposes of macro-prudential assessment. In addition, it is argued that, notwithstanding the relevance of large banks, medium-sized and small banks must also be taken into account in financial stability analysis, given their relevance in several EU countries and their different business models. A discussion follows on how aggregate data, broken down by bank size, can be used to complement micro data, in particular by signalling where and what to look for, again highlighting the differences between large banks on the one hand and small and mediumsized banks on the other. JEL Classification: C82, G21
    Keywords: Macro-prudential analysis, Consolidated Banking Data, banking indicators
    Date: 2013–01
  30. By: Dennis Kuo; David Skeie; James Vickery; Thomas Youle
    Abstract: Interbank markets for term maturities experienced great stress during the 2007-09 financial crisis, as illustrated by the behavior of one- and three-month Libor. Despite widespread interest in these markets, little data are available on dollar interbank lending for maturities beyond overnight. We develop a methodology to infer individual term dollar interbank loans (for maturities between two days and one year) by applying a set of filters to payments settled on the Fedwire Funds Service, the large-value bank payment system operated by the Federal Reserve Banks. Our approach introduces several innovations and refinements relative to previous research by Furfine (1999) and others that measures overnight interbank lending. Diagnostic tests to date suggest our approach provides a novel and useful source of information about the term interbank market, allowing for a number of research applications. Limitations of the algorithm and caveats on its use are discussed in detail. We also present stylized facts based on the algorithm's results, focusing on the 2007-09 period. At the crisis peak following the failure of Lehman Brothers in September 2008, we observe a sharp increase in the dispersion of inferred term interbank interest rates, a shortening of loan maturities, and a decline in term lending volume.
    Keywords: Interbank market ; Fedwire ; Financial crises
    Date: 2013
  31. By: Bianca De Paoli; Anna Lipinska
    Abstract: Countries' concerns about the value of their currency have been studied and documented extensively in the literature. Capital controls can be—and often are—used as a tool to manage exchange rate fluctuations. This paper investigates whether countries can benefit from using such a tool. We develop a welfare-based analysis of whether (or, in fact, how) countries should tax international borrowing. Our results suggest that restricting international capital flows through the use of these taxes can be beneficial for individual countries, although it would limit cross-border pooling of risk. The reason is because, while consumption risk-pooling is important, individual countries also care about domestic output fluctuations. Moreover, the results show that countries decide to restrict the international flow of capital exactly when this flow is crucial to ensure cross-border risk sharing. Our findings point to the possibility of costly "capital control wars" and thus to significant gains from international policy coordination.
    Keywords: Foreign exchange rates ; Devaluation of currency ; Taxation ; Capital movements ; Risk
    Date: 2013
  32. By: Andrea Monticini; Daniel L. Thornton
    Abstract: On May 29, 2008, the Wall Street Journal reported that several large international banks were reporting unjustifiably low LIBOR rates. Since then two large banks, Barclays and UBS, have paid significant fines for manipulating their LIBOR rates, and additional banks are expected to be fined. This paper investigates whether the underreporting of LIBOR rates by some banks significantly affected the reported LIBOR rate by testing whether there was a significant change in the relationship between the LIBOR rate and another rate that reflects the default risk of banks.
    Keywords: Interbank market ; Interest rates ; Risk management
    Date: 2013
  33. By: Guglielmo Maria Caporale; Roberta De Santis; Alessandro Girardi
    Abstract: Using annual bilateral data over the period 1988-2011 for a panel of 24 industrialised and emerging economies, we analyse in a time-varying framework the determinants of output synchronisation in EMU (European Monetary Union) distinguishing between core and peripheral member states. The results support the specialisation paradigm rather than the endogeneity hypothesis. Evidence is found in the euro period of diverging patterns between the core and the peripheral EMU countries raising questions about the future stability of EMU.
    Keywords: output synchronisation, trade intensity, endogeneity, European Monetary Union (EMU)
    JEL: F10 F15 F17 F4
    Date: 2013
  34. By: Lee, Chin; Law, Chee-Hong
    Abstract: This study investigates the impact of trade openness on Malaysian exchange rate. The findings show that most of the variables are statistically significant and carried the expected signs. As predicted by the theory, the rise of the income level and stock market index in Malaysia will lead to the appreciation of domestic currency. On the other hand, the increase in trade openness and interest rate can lead to depreciation of Malaysian Ringgit. In addition, the results suggested that a rise in money supply differential caused RM to appreciate. However, increase in trade balance caused the depreciation of RM.
    Keywords: Exchange Rate, Trade Openness, Malaysia
    JEL: F31 F41 G15
    Date: 2013
  35. By: Francesco Paolo Mongelli (European Central Bank)
    Abstract: The destructive potential of the sovereign debt crisis of the euro area has been slowly abating since last summer, but still remains considerable. One reason for it is the sheer complexity of the crisis, which brings together several harmful factors, some long-standing, others more recent, like acts of an ever-growing and mutating tragedy. It combines the features of a financial crisis in some countries with those of a balance-of-payment crisis or sluggish growth in another, overlapping group of countries. All these factors have struck Europe before, but never all at the same time, in so many countries sharing a currency, and with limited adjustment mechanisms. Some countries must undertake sizeable stock-flow adjustments, and reinvent parts of their economies. But the crisis also has two additional dimensions, one being flaws in the governance of the euro area, and the other being an erosion of trust in the viability of the euro area itself. Such concerns have led to talk of a “bailout union”, a “permanent transfer union”, or the hegemony of a country, the lack of solidarity or of risk-sharing, the lack of vision, the risks of fiscal or financial dominance, and so on. The aim of this paper is to give expression to some thoughts on the various dimensions of the crisis without claiming to offer a coherent and conclusive view either of the crisis or the future of the euro area. While the crisis is a traumatic wake-up call, it is also a catalyst for change. Understanding the reform efforts under way will help rebalancing the views of sceptics. JEL Classification: F33, F42, N24
    Keywords: Economic and Monetary Union, Euro, Sovereign Crisis, Optimum Currency Area Theory, Governance Reform, Risk-Sharing, and Moral Hazard
    Date: 2013–02
  36. By: Cavalieri, Duccio
    Abstract: This is a short essay on the present state of a controversial problem: that of the relationship between the supply and the demand for money. Exogeneous or endogenous money supply? The different positions taken in the literature on the subject are examined and discussed. The author's confidence in their interdependence is then expressed and motivated.
    Keywords: Money, horizontalism, verticalism, structuralism
    JEL: E41 E51 E58
    Date: 2013–02
  37. By: Stavarek, Daniel
    Abstract: We present empirical evidence on the business cycle relationship between nominal and real effective exchange rate, real GDP, consumption, investment, export, import and general government debt for a group of ten countries from the Central and Eastern Europe. We apply cross-correlation on cyclically filtered and seasonally adjusted quarterly time series over the period 1998-2010. The results are mixed in intensity, direction and cyclicality but show generally weak correlation between exchange rates and fundamentals. Sufficiently high coefficients are found only for government debt and import. We also apply simple regressions to relate the correlation to openness and welfare of the economy. The correlation between exchange rates and macroeconomic aggregates tends to be more pronounced in less open and relatively poorer countries.
    Keywords: business cycle; cross correlation; exchange rate; macroeconomic fundamental; openness; wealth
    JEL: E32 E44 F31
    Date: 2013–03–21
  38. By: Joseph E. Gagnon (Peterson Institute for International Economics)
    Abstract: Official purchases of foreign assets--a broad definition of currency intervention--are strongly correlated with current account (trade) imbalances. Causality runs in both directions, but statistical analysis using instrumental variables reveals that the effect of official asset purchases on current accounts is very large. A country’s current account balance increases between 60 and 100 cents for each dollar spent on intervention. This is a much larger effect than is widely assumed. These results raise serious questions about the efficiency of international financial markets.
    Keywords: current account, financial flows, foreign exchange reserves
    JEL: F30 F31 F32
    Date: 2013–03
  39. By: Marco Cipriani; Antoine Martin; Bruno M. Parigi
    Abstract: In recent years, U.S. banks have increasingly relied on deposits from financial intermediaries, especially money market funds (MMFs), which collect funds from large institutional investors and lend them to banks. In this paper, we show that intermediation through MMFs allows investors to limit their exposure to a given bank (i.e., reap gains from diversification). However, since MMFs are themselves subject to runs from their own investors, a banking system intermediated through MMFs is more unstable than one in which investors interact directly with banks. A mechanism through which instability can arise in an MMF-intermediated financial system is the release of private information on bank assets, which is aggregated by MMFs and could lead them to withdraw en masse from a bank. In addition, we show that MMF intermediation can also be a channel of contagion among banking institutions.
    Keywords: Intermediation (Finance) ; Money market funds ; Bank investments ; Financial crises
    Date: 2013
  40. By: Daniela Bragoli (Department of Economics and Social Sciences, Universita Cattolica del Sacro Cuore); Camilla Ferretti (Department of Economics and Social Sciences, Universita Cattolica del Sacro Cuore); Piero Ganugi (Department of Industrial Engineering, Universita degli Studi di Parma); Giancarlo Ianulardo (Department of Economics, University of Exeter)
    Abstract: We aim at characterizing the Classical Gold Standard period (CGS) in order to verify if it is endowed with statistical regularity. We study the statistical properties of two-state annual transition matrices of countries switching from a sound state to a crisis state focusing on Reinhart and Rogoff 2009 dataset on external debt crises. The CGS period is governed by homogeneity both in time and across statistical units: the Homogeneous Markov Chain Model holds whereas the Mover Stayer Model does not. Our work is linked to the literature on the CGS and credibility (Bordo and Rockoff 1996). We follow a pure statistical approach to highlight two decisive channels of the credibility mechanism. The first is the stabilization of the probability of default of sound countries. The second is the fact that the CGS makes periphery/deficit countries homogeneous to the core with respect to the probability of default. Both channels are decisive because poor developing countries can borrow at favorable conditions and finance a level of investment greater than their capacity of saving.
    Keywords: Classical Gold Standard; Credibility; Time Homogeneous Markov Chain; Mover Stayer.
    JEL: E42 N10 C13
    Date: 2013
  41. By: Thushyanthan Baskaran (Department of Economics, University of Göttingen, Germany); Zohal Hessami (Department of Economics, University of Konstanz, Germany)
    Abstract: One possible explanation for the European sovereign debt crises is that the European Economic and Monetary Union (EMU) gave rise to consolidation fatigue or even deliberate over-borrowing. This paper explores the validity of this explanation by studying how three decisive stages in the history of the EMU affected public borrowing in EU member states: the signing of the Maastricht treaty in 1992, the introduction of the Euro in 1999, and the suspension of the SGP in late 2003. The methodology relies on difference-in-difference regressions covering 26 OECD countries over the 1975-2009 period. The findings indicate that the first two 'treatments' reduced deficits especially in traditional high-deficit countries. In contrast, the watering down of the original SGP encouraged borrowing in countries which traditionally have had high deficits.
    Keywords: EMU, monetary union, fiscal policy, public deficits
    JEL: F15 F42 H62 H63
    Date: 2013–03–14
  42. By: Zsolt Darvas; Guntram B. Wolff
    Abstract: Irrespective of the euro crisis, a European banking union makes sense, including for non-euro area countries, because of the extent of European Union financial integration.The Single Supervisory Mechanism (SSM) is the first element of the banking union. From the point of view of non-euro countries, the draft SSM regulation as amended by the EU Council includes strong safeguards relating to decision-making, accountability,attention to financial stability in small countries and the applicability of national macro-prudential measures. Non-euro countries will also have the right to leave the SSM and thereby exempt themselves from a supervisory decision. The SSM by itself cannot bring the full benefits of the banking union, but would foster financial integration, improve the supervision of cross-border banks, ensure greater consistency of supervisory practices, increase the quality of supervision,avoid competitive distortions and provide ample supervisory information. While the decision to join the SSM is made difficult by the uncertainty about other elements of the banking union, including the possible burden sharing, we conclude that non-euro EU members should stand ready to join the SSM and be prepared for the negotiations of the other elements of the banking union.
    Date: 2013–03

This nep-mon issue is ©2013 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.