nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒04‒20
nineteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Money demand and the role of monetary indicators in forecasting euro area inflation By Christian Dreger; Jürgen Wolters
  2. Announcements of interest rate forecasts: Do policymakers stick to them? By Nikola Mirkov; Gisle James Natvik
  3. Inflation targeting and interest rates By Lanzafame, Matteo; Nogueira, Reginaldo
  4. Price Stability In Small Open Economies By Dmitriev, Mikhail; Hoddenbagh, Jonathan
  5. Management of Capital Flows in India: 1990-2011 By Sen Gupta, Abhijit; Sengupta, Rajeswari
  6. The Simple Analytics of Monetary Policy: A Post-Crisis Approach By Benjamin M. Friedman
  7. International Fisher Effect under Exchange Rate Regime Shifts: Evidence from 10 Examples By Petr Korab; Svatopluk Kapounek
  8. Prolonged reserves accumulation, credit booms, asset prices and monetary policy in Asia By Filardo , Andrew J.; Siklos , Pierre L.
  9. Countercyclical Bank Capital Requirement and Optimized Monetary Policy Rules By Carlos De Resende; Ali Dib; René Lalonde; Nikita Perevalov
  10. "The Response of Asset Prices to Abenomics: Is It a Case of Self-Fulfilling Expectations?" By Kazuo Ueda
  11. Monetary Policy Regimes and the Term Structure of Interests Rates with Recursive Utility By Tanaka Hiroatsu
  12. A Long-run, Short-run, and Politico-Economic Analysis of the Welfare Costs of Inflation By Scott Dressler
  13. Inflationary Implication of Gold Price in Vietnam By Siregar, Reza Yamora; Nguyen, Thi Kim Cuc
  14. Ingham and Keynes on the Nature of Money By Mark Hayes
  15. Euro – How Big a Difference: Finland and Sweden in Search of Macro Stability By Suni, Paavo; Vihriälä, Vesa
  16. Assessing changes in the global financial architecture from an emerging market perspective By Ashima Goyal
  17. A transfer mechanism for a monetary union By Engler, Philipp; Voigts, Simon
  18. Macroeconomic policy regimes in emerging market candidates for a currency union: The case of Latvia By Kazandziska, Milka
  19. Credit Pro-cyclicality and Bank Balance Sheet in Colombia By Franz Alonso Hamann Salcedo; Rafael Hernández; Luisa Fernanda Silva EScobar; Fernando Tenjo Galarza

  1. By: Christian Dreger; Jürgen Wolters
    Abstract: This paper examines the stability of money demand and the forecasting performance of a broad monetary aggregate (M3) in predicting euro area inflation. Excess liquidity is measured as the difference between the actual money stock and its fundamental value, the latter determined by a money demand function. The out-of sample forecasting performance is compared to widely used alternatives, such as the term structure of interest rates. The results indicate that the evolution of M3 is still in line with money demand even in the period of the financial and economic crisis. Monetary indi-cators are useful to predict inflation, if the forecasting equations are based on measures of excess liquidity.
    Keywords: Money demand, excess liquidity, inflation forecasts
    JEL: C22 C52 E41
    Date: 2013–04
  2. By: Nikola Mirkov (Universität St.Gallen); Gisle James Natvik (Norges Bank (Central Bank of Norway))
    Abstract: If central banks value the ex-post accuracy of their forecasts, previously announced interest rate paths might affect the current policy rate. We explore whether this "forecast adherence" has influenced the monetary policies of the Reserve Bank of New Zealand and the Norges Bank, the two central banks with the longest history of publishing interest rate paths. We derive and estimate a policy rule for a central bank that is reluctant to deviate from its forecasts. The rule can nest a variety of interest rate rules. We find that policymakers appear to be constrained by their most recently announced forecasts.
    Keywords: Interest rates, Forecasts, Taylor rule, Adherence
    JEL: E43 E52 E58
    Date: 2013–04–11
  3. By: Lanzafame, Matteo; Nogueira, Reginaldo
    Abstract: Inflation Targeting (IT) can be expected to play a role in structurally reducing nominal interest rates, by lowering a country’s inflation expectations and risk premium. Relying on a panel of 52 advanced and emerging economies over the 1975-2009 years, we carry out a formal investigation of this hypothesis. Our econometric strategy adopts a flexible and efficient panel estimation framework, controlling for a number of issues usually neglected in the literature, such as parameter heterogeneity and cross-section dependence. Our findings are supportive of the optimistic view on IT, indicating that adoption of this monetary regime leads to lower nominal interest rates.
    Keywords: Inflation targeting; Interest rates; panel data; multifactor modeling.
    JEL: E40 E52 E58
    Date: 2013–03
  4. By: Dmitriev, Mikhail; Hoddenbagh, Jonathan
    Abstract: We study the conduct of monetary policy in a continuum of small open economies. We solve the model globally in closed form without restricting the elasticity of substitution between home and foreign goods to one. Using this global closed-form solution, we give an exact characterization of optimal monetary policy and welfare with and without international policy cooperation. We consider the cases of internationally complete asset markets and financial autarky, producer currency pricing and local currency pricing. Under producer currency pricing, it is always optimal to mimic the flexible-price equilibrium through a policy of price stability. Under local currency pricing, policy should fix the exchange rate. Even if substitutability differs from one, the continuum of small open economies implies that the share of each country's output in the world consumption basket (and therefore the impact of the country's monopoly power) is negligible. This removes the incentive to deviate from price stability under producer currency pricing or a fixed exchange rate under local currency pricing. There are no gains from international monetary cooperation in all cases examined. Our results stand in contrast to those in the literature on optimal monetary policy for large open economies, where strategic interactions drive optimal policy away from price stability or fixed exchange rates, and gains from cooperation are present, when substitutability differs from one.
    Keywords: Open economy macroeconomics; Optimal monetary policy; Price stability.
    JEL: E50 F41 F42
    Date: 2012–11
  5. By: Sen Gupta, Abhijit; Sengupta, Rajeswari
    Abstract: Increased integration with global financial markets has amplified the complexity of macroeconomic management in India. The diverse objectives of a robust growth rate, healthy current account deficit, competitive exchange rate, adequate external capital to finance investment, moderate inflation, targeted monetary and credit growth rate, minimizing financial fragilities and maintaining adequate reserves need to be balanced in an era of volatile capital flows. In this paper we analyze India’s experience in negotiating the trade-offs between these varied objectives. We find that to minimize risks associated with financial fragilities India has adopted a calibrated and gradual approach towards opening of the capital account, prioritizing the liberalization of certain flows. Using empirical methods we find that instead of adopting corner solutions, India has embraced an intermediate approach in managing the conflicting objectives of the well-known Impossible Trinity – monetary autonomy, exchange rate stability and an open capital account. Our results indicate that the intermediate approach has been associated with an asymmetric intervention in the foreign exchange market, with the objective of resisting pressures of appreciation, and resulted in large accumulation of reserves. We also show that sterilization of this intervention has been incomplete at times leading to rapid increase in monetary aggregates and fueling inflation. Finally, we conclude that while the greater flexibility in exchange rate since 2007, has allowed pursuit of a more independent monetary policy and the exchange rate to act as a shock absorber, the hands-off approach has resulted in reserves remaining virtually stagnant since 2007, leading to a significant deterioration in the reserve adequacy measures.
    Keywords: Capital controls, Macroeconomic trilemma, Financial integration, Foreign exchange intervention, Sterilization, Exchange market pressure, Reserve adequacy.
    JEL: E4 E5 F3 F4
    Date: 2013–03–15
  6. By: Benjamin M. Friedman
    Abstract: The standard workhorse models of monetary policy now commonly in use, both for teaching macroeconomics to students and for supporting policymaking within many central banks, are incapable of incorporating the most widely accepted accounts of how the 2007-9 financial crisis occurred and incapable too of analyzing the actions that monetary policymakers took in response to it. They also offer no point of entry for the frontier research that many economists have subsequently undertaken, especially research revolving around frictions in financial intermediation. This paper suggests a simple model that bridges this gap by distinguishing the interest rate that the central bank sets from the interest rate that matters for the spending decisions of households and firms. One version of this model adds to the canonical “new Keynesian” model a fourth equation representing the spread between these two interest rates. An alternate version replaces this reduced-form expression for the spread with explicit supply and demand equations for privately issued credit obligations. The discussion illustrates the use of both versions of the model for analyzing the kind of breakdown in financial intermediation that triggered the 2007-9 crisis, as well as “unconventional” central bank actions like large-scale asset purchases and forward guidance on the policy interest rate.
    JEL: E52
    Date: 2013–04
  7. By: Petr Korab (Department of Finance, Faculty of Business and Economics, Mendel University in Brno); Svatopluk Kapounek (Department of Finance, Faculty of Business and Economics, Mendel University in Brno)
    Abstract: This paper studies the behaviour of inflation rate, short-term interest rate and nominal exchange rate after leaving fixed exchange rate arrangement and move to floating. We find that countries with rigid exchange rate policy, less frequently adjusted central parity and narrow exchange rate bands experienced sharp depreciation after leaving peg, but the depreciation was only temporary with no long trend. In this group of countries the exchange rate adjustment is weakly exogenous to inflation and interest rate differentials and the theory of International Fisher Effect was not mostly confirmed. On the contrary, countries with flexibly adjusted central parity and wider exchange rate bands did not experience rapid depreciation. We applied Johansen's approach to cointegration (Johansen 1988, 1991 and 1994), based on estimation of the Vector Error Correction (VEC) Model, and the Johansen constraint test of exogeneity. Finally, we are discussing a parallel between leaving the peg and leaving the currency union. Since both are considered fixed exchange rate arrangements we argue that leaving the Eurozone by a member state may cause immediate depreciation without long trend and the adjustment would not be caused by inflation and interest rate changes. Classification-JEL: F41, E26, E42
    Keywords: purchasing power parity, uncovered interest parity, debt crisis, parallel currency, dual currency
    Date: 2013–04
  8. By: Filardo , Andrew J. (BOFIT); Siklos , Pierre L. (BOFIT)
    Abstract: This paper examines past evidence of prolonged periods of reserve accumulation in Asian emerging market economies and the direct and indirect implications for monetary stability through the potential impact of such episodes on financial stability. The empirical research focuses on identifying periods of prolonged interventions and correlations with key macrofinancial aggregates. Related changes in central bank balance sheets are also examined, especially in periods when the interventions are linked to strong capital inflows. In particular, we consider whether changes in the central bank's balance sheet from prolonged intervention lead to spillovers to the balance sheet of the private sector. We explore the possible forms of the spillovers and the consequences on asset prices (e.g., housing prices, equity prices, the growth in domestic credit). Policy implications are drawn. Finally, we propose a new indicator of reserves adequacy and excessive foreign exchange reserves accumulation based on a factor model. Two broad conclusions emerge from the stylized facts and the econometric evidence. First, the best protection against costly reserves accumulation is a more flexible exchange rate. Second, the necessity to accumulate reserves as a bulwark against goods price inflation is misplaced. Instead, there is a strong link between asset price movements and the likelihood of accumulating foreign exchange reserves that are costly.
    Keywords: foreign exchange reserves accumulation; monetary and financial stability
    JEL: D52 E44 F32 F41
    Date: 2013–03–28
  9. By: Carlos De Resende; Ali Dib; René Lalonde; Nikita Perevalov
    Abstract: Using BoC-GEM-Fin, a large-scale DSGE model with real, nominal and financial frictions featuring a banking sector, we explore the macroeconomic implications of various types of countercyclical bank capital regulations. Results suggest that countercyclical capital requirements have a significant stabilizing effect on key macroeconomic variables, but mostly after financial shocks. Moreover, the bank capital regulatory policy and monetary policy interact, and this interaction is contingent on the type of shocks that drive the economic cycle. Finally, we analyze loss functions based on macroeconomic and financial variables to arrive at an optimal countercyclical regulatory policy in a class of simple implementable Taylor-type rules. Compared to bank capital regulatory policy, monetary policy is able to stabilize the economy more efficiently after real shocks. On the other hand, financial shocks require the regulator to be more aggressive in loosening/tightening capital requirements for banks, even as monetary policy works to counter the deviations of inflation from the target.
    Keywords: Economic models; Financial Institutions; Financial stability; International topics
    JEL: E32 E44 E5 G1 G2
    Date: 2013
  10. By: Kazuo Ueda (Faculty of Economics, University of Tokyo)
    Abstract:       Japan's Prime Minister, Shinzo Abe, has declared the adoption of a policy package that assigns a key role for aggressive monetary easing by the Bank of Japan—the so-called Abenomics. Since the announcement, the yen has weakened against the dollar by 25% and Nikkei 225 has risen by 40%. In this paper I discuss the backgrounds for such large asset price response. I base the discussion on the theory and empirical analysis of non-conventional monetary policy measures that have been carried out by major central banks so far. I argue that a non-negligible portion of the asset price response seems based on investors' excess optimism concerning the effectiveness of non-conventional monetary policy to stimulate the economy and raise prices. In that sense, there is a good chance that asset prices may go back to previous levels. But I also point out that given that expectations have changed so much, they have a chance of raising inflation to the target rate of 2%, in which case they will have become self-fulfilling.
    Date: 2013–04
  11. By: Tanaka Hiroatsu (Federal Reserve Board)
    Abstract: I study how two different monetary policy regimes characterized by their difference in degrees of credibility (a 'commitment' regime, in which the central bank can credibly commit to future policy and a 'discretion' regime, in which it cannot) affect the term structure of interest rates and attempt to evaluate which monetary policy regime seems more consistent with the data on macroeconomic variables and term structure dynamics. To this end, I construct a no-arbitrage affine-term structure model based on a New-Keynesian type micro-foundation. The model is augmented with Epstein-Zin (EZ) preferences, real wage rigidity and a simple central bank optimization problem. A shock structure that exhibits stochastic volatility in long-run risk of TFP growth parsimoniously generates time-varying term premia. The estimation of the model suggests that the assumption of a discretion regime performs better than a commitment regime in terms of quantitatively ÃÂfitting some salient features of the US data on the term structure and the business cycle during the Volcker-Greenspan-Bernanke era. The lack of policy credibility leads to volatile and persistent inflation, which generates volatile expected long-run inflation that is negatively correlated with future continuation values. This is perceived particularly risky by EZ nominal bond holders and results in upward sloping average nominal yields, long-term yield volatility and excess return predictability closer to the magnitude observed in the data while keeping the unconditional volatilities of consumption growth and inflation realistic.
    Date: 2012
  12. By: Scott Dressler (Villanova University)
    Abstract: This paper assesses the long-run and short-run (i.e. along the transition path) welfare implications of permanent changes in inflation in an environment with essential money and perfectly competitive markets. The model delivers a monetary distribution that matches moments of the distribution seen in the US data. Although there is potential for wealth redistribution to deliver welfare gains from inflation, the (total) costs of 10 percent inflation relative to zero is over 7 percent of consumption. While these results suggest a dominating real-balance effect of inflation, a politico-economic analysis concludes that the prevailing (majority rule) inflation rate is above the Friedman Rule.
    Date: 2012
  13. By: Siregar, Reza Yamora; Nguyen, Thi Kim Cuc
    Abstract: The sustained elevated gold price domestically, hovering persistently above the global market price, underscores the peculiar nature of the gold market in Vietnam and the resiliently strong demand for gold in the local market. In particular, the movements in the price of gold seem to lead a symmetrical trend in the headline inflation since the outbreak of the 2007 global financial crisis. The primary objective of this study is therefore to assess possible inflationary consequence of the gold price movements in Vietnam. Past studies demonstrate that if gold could be viewed as a financial asset, shifts in the gold price should be monitored as one of the determining factors of inflation. Yet, hardly any study has assessed potential inflationary implication of gold in Vietnam, especially during the recent years of volatile and double-digit inflation rates.
    Keywords: Gold Price; Vietnam; Money Demand; and Inflation
    JEL: C24 E31 E41 E52
    Date: 2013–04–12
  14. By: Mark Hayes (University of Cambridge)
    Abstract: This paper compares and contrasts the thinking of Keynes and Geoffrey Ingham, focussing mainly on The General Theory and Ingham’s The Nature of Money (2004). Two points in particular are addressed: first, the relevance of Ingham’s insistence (following Keynes, among others) on the primacy of money of account to an understanding of Keynes’s own insistence that income is intrinsically monetary and upon the importance of the wage unit as an analytical tool; and second, the subtle contrast between Keynes and Ingham in their understandings of the source of interest as a genuinely monetary and not a ‘real’ phenomenon. Where Keynes identifies uncertainty as the source of interest within a methodologically individualistic framework of analysis, Ingham offers a sociological case in terms of the struggle between the debtor and creditor interests that inevitably emerge as a result of the creation of bank money under capitalism. Taking both points together, Ingham’s work not only underpins the crucial distinction between money and ‘real’ wages for the theory of employment but also develops Keynes’s recognition of the potential opposition between the interests of finance and industry.
    Keywords: nature of money – nature of income – theory of interest
    JEL: B22 B31 E01 E42 E43
    Date: 2012–09
  15. By: Suni, Paavo; Vihriälä, Vesa
    Abstract: Abstract: The euro crisis has rekindled questions about the advantages and disadvantages of membership in the European Monetary Union. In the Northern periphery of the EU, the different monetary regime choices of Finland and Sweden have created a particularly interesting testing ground for the benefits of the EMU. The average growth rates were rather similar before the Great Recession that started in the autumn of 2009, while Sweden has grown faster since that. In terms of price stability Sweden has fared somewhat better than Finland in the EMU period. We assess the effects of the regime choice by simulating the behaviour of the Swedish economy with National Institute’s Global Econometric Model (NiGEM) on the assumption that Sweden had joined the EMU in 1999. The simulation exercise suggests that the independent monetary regime reduced the impact of the global shock on Sweden. The different monetary regimes cannot, however, explain the growth gap between Sweden and Finland anymore in 2012. Other factors, such as the decline of the Nokia cluster, are needed for that. As a whole, our results suggest that the different choices with regard to the EMU have not affected the macroeconomic outcomes very much.
    Keywords: Finland, Sweden, EMU, simulation, counter factual
    JEL: C15 F17 F37 P52
    Date: 2013–04–04
  16. By: Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: The paper assesses changes in the global financial architecture and related global governance. Despite useful reforms lacunae remain. Analysis of financial regulations and measures to address global imbalances show serious weaknesses in addressing risks from shadow banking and large banks that are responsible for volatile capital flows to emerging markets (EMs). The underlying philosophy that intervention and controls distort markets and manipulate currencies weakens the toolbox available to EMs to deal with volatile capital flows. The use of interest rates, quantitative easing, and deficits are regarded as a valid response to domestic conditions, and their effect on commodity price inflation hitting EMs not acknowledged. Despite greater representation of EMs in the G-20 adjustment continues to be asymmetric. This harms global stability and recovery. Universal adoption of some basic minimal measures can close arbitrage gaps and resolve many problems.
    Keywords: Global financial architecture, regulations, imbalances, currency wars, international governance
    JEL: F02 F32 F33
    Date: 2013–04
  17. By: Engler, Philipp; Voigts, Simon
    Abstract: We show in a dynamic stochastic general equilibrium framework that the introduction of a common currency by a group of countries with only partially integrated goods markets, incomplete financial markets and no labor migration across member states, significantly increases volatility of consumption and employment in the face of asymmetric shocks. We propose a simple transfer mechanism between member countries of the union that reduces this volatility. Furthermore, we show that this mechanism is more efficient than anticyclical policies at the national level in terms of a better stabilization for the same budgetary effects for households while in the long run deeper integration of goods markets could reduce volatility significantly. Regarding its implementation, we show that the centralized provision of public goods and services at the level of the monetary union implies cross-country transfers comparable to the scheme under study. --
    Keywords: monetary union,asymmetric shocks,fiscal policy,fiscal transfers
    JEL: F41 F44 E2 E3 E52
    Date: 2013
  18. By: Kazandziska, Milka
    Abstract: This paper has the goal to explore the functionality of the economic development in emerging countries, which are on their way of joining a currency union based on the concept of macroeconomic policy regimes (MPRs). Functional MPRs are considered those that deliver sustainable economic growth, employment and more equitable income distribution. A macroeconomic policy regime consists of policies (foreign economic policy, industrial policy, wage policy, monetary policy and fiscal policy), the financial system, and the institutional frameworks in which the economies are embedded. The MPRs of emerging countries, candidates for a currency union, applied to the case of Latvia will be analysed using a Post Keynesian approach. It will be argued that the institutional changes in Latvia have paved the way for a dysfunctional policy mix, such that led to high current account deficits, capital flow volatility, large employment losses and instable economic development. This paper suggests that to reduce the current account deficits and achieve a more sustainable growth, foreign economic policy and the industrial policy should be given high priority. --
    Keywords: macroeconomic regime,open economy policies and institutions,emerging countries,industrial policy,Latvia
    JEL: E02 E58 E61 E65 F41 F43
    Date: 2013
  19. By: Franz Alonso Hamann Salcedo; Rafael Hernández; Luisa Fernanda Silva EScobar; Fernando Tenjo Galarza
    Abstract: The recent financial crisis has renewed the interest of economists, both at the theoretical and empirical level, in developing a better understanding of credit and its mechanisms. A rapidly growing strand of the literature views banks as facing funding restrictions that condition their borrowing to a risk-based capital constraint which, in turn, affects bank lending. This work explores the way banks in Colombia manage their balance sheet and sheds light into the dynamics of credit and leverage during the business cycle. Using a sample of monthly bank balance sheets for the period 1994-2012, we find not only that the Colombian banking sector is predominantly pro-cyclical, but also that the composition of bank liabilities provides important information to policy makers regarding the phase of the cycle of the economy. Shifts from low non-core liability ratios to higher ones during the upward phase of the leverage cycle could play the role of an early warning indicator of financial vulnerability. In addition, we find that bank heterogeneity matters and thus, an aggregate measure of bank leverage can mask successfully a fragile financial sector.
    Keywords: Banks, credit, leverage, non-core liabilities, balance sheet, business cycle, Colombia. Classification JEL: E32, G21, G32
    Date: 2013–04

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