nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒08‒16
fourteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary Policy Regimes and Inflation in the New-Keynesian Model By Bartholomew Moore
  2. Chinese monetary expansion and the U.S. economy By Vespignani, Joaquin L.; Ratti, Ronald A
  3. ECB monetary policy in the recession: a New Keynesian (old monetarist) critique By Robert L. Hetzel
  4. Monetary policy expectations at the zero lower bound By Michael D. Bauer; Glenn D. Rudebusch
  5. U.K. Monetary Policy: Observations on its Theory and Practice By SGB Henry
  6. Markov Switching and the Taylor Principle By Christian Murray; Nikolsko-Rzhevskyy Alex; Papell David
  7. Searching for Irving Fisher By Mitchener, Kris James; Weidenmier, Marc D
  8. Capital Controls and Recovery from the Financial Crisis of the 1930s By Mitchener, Kris James; Wandschneider, Kirsten
  9. (When) does money growth help to predict Euro-area inflation at low frequencies? By Schreiber, Sven
  10. Are Credit Shocks Supply or Demand Shocks? By Bijapur, Mohan
  11. Bank size and macroeconomic shock transmission: Are there economic volatility gains from shrinking large, too big to fail banks? By Uluc Aysun
  12. What Does the 1930s’ Experience Tell Us about the Future of the Eurozone? By Crafts, Nicholas
  13. Macro-Modelling, Default and Money By Charles Goodhart,Dimitrios Tsomocos & Martin Shubik
  14. The determinants of the deviations from the interest rate parity condition By Uluc Aysun; Sanglim Lee

  1. By: Bartholomew Moore (Fordham University)
    Abstract: This paper shows that plausible modifications to the Taylor rule for monetary policy can help explain several empirical anomalies to the behavior of inflation in the new--Keynesian general equilibrium model. The key anomalies considered are (1) the persistence of inflation, both in reduced form and after conditioning on inflation's driving processes, (2) the positive correlation between the output gap and the change in the inflation rate, and (3) the apparent bias in survey measures of expected inflation. The Taylor rule in this model includes the now standard assumption that the central bank smoothes changes to its target interest rate. It also includes Markov switching of a persistent inflation target between a low target rate and a high target rate. The model is calibrated to match Benati's (2008) result that, historically, changes in monetary policy lead to a statistically significant change in the persistence of inflation. Matching Benati's result requires a reduction in an exogenous, hence structural, source of persistence. However, inflation in the model inherits additional, non-structural, persistence from the process that governs the inflation target. As a result, the model is able to replicate measures of inflation persistence, even after conditioning on inflation's driving processes. Agents with rational expectations and knowledge of the current inflation target will be aware of the possibility of a future target switch, causing their expectations to appear biased in small samples. Finally, with sticky nominal prices a discrete drop to the low-inflation target requires a loss of output while previously-set prices adjust.
    Keywords: Monetary Policy, Markov Switching, Inflation Persistence, Expectations
    JEL: E52 E31 D84
    Date: 2013
  2. By: Vespignani, Joaquin L.; Ratti, Ronald A
    Abstract: This paper examines the influence of monetary shocks in China on the U.S. economy over ‎‎1996-2012. The influence on the U.S. is through the sheer scale of China’s growth through ‎effects in demand for imports, particularly that of commodities. China’s growth influences ‎world commodity/oil prices and this is reflected in significantly higher inflation in the U.S. ‎China’s monetary expansion is also associated with significant decreases in the trade ‎weighted value of the U.S. dollar that is due to the operation of a pegged currency. China ‎manages the exchange rate and has extensive capital controls in place. In terms of the ‎Mundell–Fleming model, with imperfect capital mobility, sterilization actions under a ‎managed exchange rate permit China to pursue an independent monetary policy with ‎consequences for the U.S.‎
    Keywords: International monetary transmission, U.S. Macroeconomics, China’s monetary policy
    JEL: E42 E5 E50 E52 E58
    Date: 2013–08–04
  3. By: Robert L. Hetzel
    Abstract: Use of the New Keynesian model to identify shocks points to contractionary monetary policy as the cause of the Great Recession in the Eurozone.
    Keywords: Monetary policy ; Recessions ; Keynesian economics
    Date: 2013
  4. By: Michael D. Bauer; Glenn D. Rudebusch
    Abstract: Obtaining monetary policy expectations from the yield curve is difficult near the zero lower bound (ZLB). Standard dynamic term structure models, which ignore the ZLB, can be misleading. Shadow-rate models are better suited for this purpose, because they account for the distributional asymmetry in projected short rates induced by the ZLB. Besides providing better interest rate fit and forecasts, our shadow-rate models deliver estimates of the future monetary policy liftoff from the ZLB that are closer to survey expectations. We also document significant improvements for inference about monetary policy expectations when macroeconomic factors are included in the term structure model.
    Keywords: Monetary policy ; Macroeconomics - Econometric models
    Date: 2013
  5. By: SGB Henry
    Abstract: In a dramatic change from the euphoria in the early 2000s based on a widespread belief in the “success” of the partial independence of the Bank of England, UK policymakers are now faced with great uncertainties about the future. The Coalition government responded to the financial crisis by changing the responsibilities for banking supervision and regulation and creating new institutions to deal with them. The UK was not alone in such moves and there is increased attention world-wide to greater regulatory powers and state-dependent provisioning as key to any future financial architecture. However, changes to the conduct of monetary policy are also necessary. Using the UK experience up to 2008 as a case study, we argue that the authorities here placed too much faith in the proposition that inflation-forecast targeting by an independent central bank was all that was needed. Over the previous two decades evidence accumulated that both undermined the belief that the low inflation with stable growth during the so-called “Great Moderation” was due to the new policy regime and that showed systemic risk in the financial sector was rapidly growing. We maintain that these two things were in evidence well before the financial crisis in 2008–9 and the leadership at the BoE was in error not to factor them into their interest rate decisions early on. Had this evidence been taken more seriously and had proactive action been taken based upon it, the effects of the world-wide financial crisis on the UK would very probably have been smaller. This episode highlights both the shortcomings in the DSGE paradigm favoured by the BoE and other central banks for their macroeconomic analysis as well as the very considerable difficulties in practice in creating the sort of open and transparent monetary institutions envisaged in the academic literature.
    Date: 2013
  6. By: Christian Murray (University of Houston); Nikolsko-Rzhevskyy Alex (Lehigh University); Papell David (University of Houston)
    Abstract: Early research on the Taylor rule typically divided the data exogenously into pre-Volcker and Volcker-Greenspan subsamples.  We contribute to the recent trend of endogenizing changes in monetary policy by estimating a real-time forward-looking Taylor rule with endogenous Markov switching coefficients and variance. The response of the interest rate to inflation is regime dependent, with the pre and post-Volcker samples containing monetary regimes where the Fed did and did not follow the Taylor principle. While the Fed consistently adhered to the Taylor principle before 1973 and after 1984, it followed the Taylor principle from 1975-1979 and did not follow the Taylor principle from 1980-1984.  We also find that the Fed only responded to real economic activity during the states in which the Taylor principle held.  Our results are consistent with the idea that exogenously dividing postwar monetary policy into pre-Volcker and post-Volcker samples misleading. The greatest qualitative difference between our results and recent research employing time varying parameters is that we find that the Fed did not adhere to the Taylor Principle during most of Paul Volcker’s tenure, a finding which accords with the historical record of monetary policy.
    Keywords: Markov Switching, Taylor Principle, Taylor Rule
    JEL: E52 C24
    Date: 2013–08–05
  7. By: Mitchener, Kris James (University of Warwick); Weidenmier, Marc D (Claremont McKenna College)
    Abstract: There is a long-standing debate as to whether the Fisher effect operated during the classical gold standard period. We break new ground on this question by developing a market-based measure of inflation expectations during the gold standard. We derive a measure of silver-gold inflation expectations using the interest-rate differential between Austrian silver and gold perpetuity bonds. Our use of the silver-gold interest rate differential is motivated by the fact that both gold and silver served as numeraires in the pre-WWI period, so that a change in the price of either precious metal would impact the prices of all goods and services. The empirical evidence suggests that silver-gold inflation expectations exhibited significant persistence at the weekly, monthly, and annual frequencies. Further, we find that there is a one-to-one relationship between silver-gold inflation expectations and the interest rate on Austrian perpetuity bonds that were denominated in paper currency. The analysis suggests the operation of a Fisher effect during the classical gold standard period.
    Keywords: Fisher effect, inflation expectations, gold standard
    Date: 2013
  8. By: Mitchener, Kris James (University of Warwick); Wandschneider, Kirsten (Occidental College)
    Abstract: We examine the first widespread use of capital controls in response to a global or regional financial crisis. In particular, we analyze whether capital controls mitigated capital flight in the 1930s and assess their causal effects on macroeconomic recovery from the Great Depression. We find evidence that they stemmed gold outflows in the year following their imposition; however, time-shifted, difference-indifferences (DD) estimates of industrial production, prices, and exports suggest that exchange controls did not accelerate macroeconomic recovery relative to countries that went off gold and floated. Countries imposing capital controls also appear to perform similar to the gold bloc countries once the latter group of countries finally abandoned gold. Time series regressions further demonstrate that countries imposing capital controls refrained from fully utilizing their newly acquired monetary policy autonomy. Even so, capital controls remained in place as instruments for manipulating trade flows and for preserving foreign exchange for the repayment of external debt.
    Keywords: capital controls, financial crises, Great Depression, interwar gold standard
    Date: 2013
  9. By: Schreiber, Sven
    Abstract: Short answer: It helps a lot when other important variables are excluded from the information set. Longer answer: We revisit claims in the literature that money growth is Granger-causal for inflation at low frequencies. Applying frequency-specific tests in a comprehensive system setup for euro-area data we consider various theoretical predictors of inflation. A general-to-specific testing strategy reveals a recursive structure where only the unemployment rate and long-term interest rates are directly Granger-causal for low-frequency inflation movements, and all variables affect money growth. We therefore interpret opposite results from bivariate inflation/money growth systems as spurious due to omittedvariable biases. We also analyze the resulting four-dimensional system in a cointegration framework and find structural changes in the long-run adjustment behavior, which do not affect the main conclusions, however. --
    Keywords: money growth,granger causality,quantity theory,unemployment
    JEL: E31 E40
    Date: 2013
  10. By: Bijapur, Mohan
    Abstract: This paper provides new insights into the relationship between the supply of credit and the macroeconomy. We present evidence that credit shocks constitute shocks to aggregate supply in that they have a permanent effect on output and cause inflation to rise in the short term. Our results also suggest that the effects on aggregate supply have grown stronger in recent decades.
    Keywords: Financial crisis; Potential output; Inflation; Credit crunch.
    JEL: E31 E32
    Date: 2013–07–21
  11. By: Uluc Aysun (University of Central Florida, Orlando, FL)
    Abstract: This paper investigates the transmission of macroeconomic shocks to production in a model that includes a large and a small bank. The two banks are differentiated by parameters that govern their sensitivities to their own and their borrowers’ balance sheets and simulations show that the large (small) bank responds more to demand/financial (supply) shocks. Bank-level evidence generally supports the model’s assumptions but indicates that the large banks’ sensitivities and the sensitivity to borrower balance sheets are more important. Incorporating U.S. macroeconomic shocks into the empirical model illustrates a stronger transmission through large bank lending. Shrinking banks can, therefore, decrease volatility.
    Keywords: bank size, economic fluctuations, call report data, too big to fail, DSGE model
    JEL: E44 E32 G21 E02
    Date: 2013–08
  12. By: Crafts, Nicholas (University of Warwick)
    Abstract: If the Eurozone follows the precedent of the 1930s, it will not survive. The attractions of escaping from the gold standard then were massive and they point to a strategy of devalue and default for today’s crisis countries. A fully-federal Europe with a banking union and a fiscal union is the best solution to this problem but is politically infeasible. However, it may be possible to underpin the Euro by a ‘Bretton-Woods compromise’ that accepts a retreat from some aspects of deep economic integration since exit entails new risks of financial crisis that were not present eighty years ago.
    Keywords: economic disintegration; Eurozone; financial repression; gold standard; macroeconomic trilemma; political trilemma
    Date: 2013
  13. By: Charles Goodhart,Dimitrios Tsomocos & Martin Shubik
    Abstract: Mainstream macro-models have assumed away financial frictions, in particular default. The minimum addition in order to introduce financial intermediaries, money and liquidity into such models is the possibility of default. This, in turn, requires that institutions and price formation mechanisms become a modelling part of the process, a ‘playable game’. Financial systems are not static, nor necessarily reverting to an equilibrium, but evolving processes, subject to institutional control mechanisms themselves subject to socio/political development. Process-oriented models of strategic market games can be translated into consistent stochastic models incorporating default and boundary constraints.
    Date: 2013
  14. By: Uluc Aysun (University of Central Florida, Orlando, FL); Sanglim Lee (Korea Energy Economics Institute, 132 Naesonsunhwan-ro, Uiwang-si, Gyeonggi-do, Korea)
    Abstract: This paper shows that the deviation from the uncovered interest parity (UIP) condition is equally large in advanced and emergingmarket economies. Using monthly data, and a GARCH-M model we find that a large share of these deviations in both country groups are explained by time varying risk premium. To more clearly identify risk premium shocks, we then estimate a two country, New Keynesian, DSGE model using a Bayesian methodology and quarterly data. The results suggest that at the quarterly frequency, the large deviations from the UIP condition and the high explanatory power of risk premium is only observed for emerging market economies.
    Keywords: Uncovered Interest Rate Parity, Forward Premium Puzzle, Time Varying Risk Premium
    JEL: E32 E44 F31 F33 F44
    Date: 2013–08

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