nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒10‒11
27 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. What now for monetary policy? By John H. Makin
  2. Monetary Policy Frameworks in Asia : Experience, Lessons, and Issues By Peter J. Morgan
  3. Is Bank Debt Special for the Transmission of Monetary Policy? Evidence from the Stock Market By Filippo Ippolito; Ali K. Ozdagli; Ander Perez
  4. Effect of the zero lower bound on bond yield sensitivity to news in Canada in comparison with the UK and US By Richhild Moessner
  5. The Common Component of CPI: An Alternative Measure of Underlying Inflation for Canada By Mikael Khan; Louis Morel; Patrick Sabourin
  6. Midas, transmuting all, into paper: The Bank of England and the Banque de France during the Revolutionary and Napoleonic Wars By Chadha , Jagjit S.; Newby, Elisa
  7. Central bank liquidity auction mechanism design and the interbank market By Ollikka, Kimmo; Tukiainen , Janne
  8. Banking Globalization, Transmission, and Monetary Policy Autonomy By Linda S. Goldberg
  9. Cash in advance constraint on RD in a Schimpeterian growth model with an endogenous market structure By Chienyu Huang; Juin Jen Chang; Lei Ji
  10. Current-Account Adjustments and Exchange-Rate Misalignments By Blaise Gnimassoun; Valérie Mignon
  11. The European Central Bank in the age of banking union By Zsolt Darvas; Silvia Merler
  12. Credit and Liquidity in Interbank Rates: a Quadratic Approach. By Dubecq, S.; Monfort, A.; Renne, J-P.; Roussellet, G.
  13. How Much Do Official Price Indexes Tell Us about Inflation? By Jessie Handbury; Tsutomu Watanabe; David E. Weinstein
  14. Sector GDP concentration bias in the macro-money demand specification: New evidence for India By Subrahmanyam Ganti; Sridhar Talidevara
  15. Patterns of Convergence and Divergence in the Euro Area By Ángel Estrada; Jordi Galí; David López-Salido
  16. China's Capital Controls - Through the Prism of Covered Interest Differentials By Yin-Wong Cheung; Risto Herrala
  17. Estimating the Indian natural interest rate and evaluating policy By Ashima Goyal; Sanchit Arora
  18. A trojan horse in Daoguang China? Explaining the flows of silver in and out of China By Irigoin, Maria Alejandra
  19. ARCH and structural breaks in United States inflation By Bill Russell
  20. Banking union:a solution to the euro zone crisis ? By Maylis Avaro; Henri Sterdyniak
  21. Currency Union with and without Banking Union. By Bignon, V.; Breton, R.; Rojas Breu, M.
  22. Governing the banking industry: A severe case of supervisory failure By Martín Lagos
  23. Banking Union: integrating components and complementary measures By Santiago Fernandez de Lis; Ana Rubio; Jorge Sicilia
  24. Current Account Adjustment in the Euro-Zone: Lessons from a Flexible-Price-Model By Christoph Zwick
  25. Balance sheet strength and bank lending during the global financial crisis By Kapan, Tümer; Minoiu, Camelia
  26. Market Structure and Exchange Rate Pass-Through By Raphael S. Schoenle; Raphael A. Auer
  27. Financial sector-output dynamics in the euro area: Non-linearities reconsidered By Schleer, Frauke; Semmler, Willi

  1. By: John H. Makin (American Enterprise Institute)
    Abstract: Although the Fed’s original purpose was primarily to provide liquidity during financial crises and ensure a low and stable rate of inflation, it is now expending more energy on targeting lower unemployment and higher growth. Monetary policy, however, is ill-suited to achieving these goals.
    Keywords: the Federal Reserve,Monetary policy,Federal reserve policy,Economic outlook
    JEL: A E
    Date: 2013–10
  2. By: Peter J. Morgan (Asian Development Bank Institute (ADBI))
    Abstract: This paper analyzes the evolution of East Asian monetary policy frameworks over the past two decades, chiefly in response to shocks from the Asian financial crisis of 1997–1998 and the global financial crisis (GFC) of 2007–2009. The Asian financial crisis showed the importance of exchange rate flexibility and credible policy frameworks, leading to increased central bank independence, greater focus on inflation policy and more flexible exchange rates. A key lesson of the GFC was the importance of containing systemic financial risk and the need for a “macroprudential†approach to surveillance and regulation that can identify system-wide risks and take appropriate actions to maintain financial stability. Emerging economies face particular challenges because of their underdeveloped financial systems and vulnerability to volatile international capital flows, especially “sudden stops†or reversals of capital inflows. The paper reviews the history of East Asian monetary policy frameworks since 1990; describes current monetary policy frameworks, including issue of price versus financial stability for a central bank and the policies a central bank can use to manage financial stability; the monetary policy transmission mechanism based on financial linkages and financial deepening; assesses policy outcomes including inflation targeting and responses to the “Impossible Trinityâ€; and makes overall conclusions. The paper finds that East Asian central banks have generally managed inflation and growth well over the past decade, but the difficulties faced by central banks of advanced countries in the aftermath of the GFC suggests that not all problems have been solved yet.
    Keywords: Monetary policy framework, Asia, Asian financial crisis, central bank independence, Capital Inflows, inflation policy
    JEL: E52 E58 F31 F32 G18
    Date: 2013–09
  3. By: Filippo Ippolito; Ali K. Ozdagli; Ander Perez
    Abstract: We combine existing balance sheet and stock market data with two new datasets to study whether, how much, and why bank lending to firms matters for the transmission of monetary policy. The first new dataset enables us to quantify the bank dependence of firms precisely, as the ratio of bank debt to total assets. We show that a two standard deviation increase in the bank dependence of a firm makes its stock price about 25% more responsive to monetary policy shocks. We explore the channels through which this effect occurs, and find that the stock prices of bank-dependent firms that borrow from financially weaker banks display a stronger sensitivity to monetary policy shocks. This finding is consistent with the bank lending channel, a theory according to which the strength of bank balance sheets matters for monetary policy transmission. We construct a new database of hedging activities and show that the stock prices of bank-dependent firms that hedge against interest rate risk display a lower sensitivity to monetary policy shocks. This finding is consistent with an interest rate pass-through channel that operates via the direct transmission of policy rates to lending rates associated with the widespread use of floating-rates in bank loans and credit line agreements.
    Keywords: bank lending channel, monetary policy transmission, firm financial constraints, bank financial health, floating interest rates
    JEL: G21 G32 E52
    Date: 2013–09
  4. By: Richhild Moessner
    Abstract: The interest rate channel of monetary policy works both through short- and long-term interest rates. At the zero lower bound of the policy rate, monetary policy can still be effective through unconventional monetary policy measures. We study whether the sensitivity of Canadian government bond yields to domestic and US macroeconomic data surprises changed at the zero lower bound, and compare the results with those for the United Kingdom and the United States. We find that the sensitivity of government bond yields to domestic economic news was reduced only at shorter maturities in Canada than in the United Kingdom and the United States. Moreover, we find that it was reduced less strongly in Canada than in the United Kingdom. This suggests that in Canada monetary policy lost less of its effectiveness than in the United Kingdom, and only up to shorter horizons than in the United Kingdom and the United States.
    Keywords: Monetary policy; zero lower bound; economic news; government bond yields
    JEL: E52 E58
    Date: 2013–09
  5. By: Mikael Khan; Louis Morel; Patrick Sabourin
    Abstract: In this paper, the authors propose a measure of underlying inflation for Canada obtained from estimating a monthly factor model on individual components of the CPI. This measure, labelled the common component of CPI, has intuitive appeal and a number of interesting features. In particular, it is not affected by sector-specific price movements that can distort the signal in many other measures of underlying inflation, and appears to capture price movements that are indicative of aggregate demand fluctuations in the Canadian economy. This indicator may serve as a useful complement to existing measures of underlying inflation monitored by the Bank of Canada.
    Keywords: Business fluctuations and cycles; Econometric and statistical methods; Inflation and prices; Monetary policy framework
    JEL: C1 E31 E32 E52 E58
    Date: 2013
  6. By: Chadha , Jagjit S. (Keynes College, University of Kent, Canterbury); Newby, Elisa (Bank of Finland, Monetary Policy and Research Department)
    Abstract: This paper assesses Revolutionary and Napoleonic wartime economic policy. Suspension of gold convertibility in 1797 allowed the Bank of England to nurture British monetary orthodoxy. The Order of the Privy Council suspended gold payments on Bank of England notes and afforded simultaneous protection to the government and the Bank in pursuit of the conflicting goals of price stability and war finance. The government, the Bank of England and the commercial banks formed a loose alliance drawing on due political and legal processes and also paid close attention to public opinion. We suggest that the ongoing solvency of the Bank of England was facilitated by suspension and allowed the Bank to continue to make substantial profits throughout the Wars. It became acceptable for merchants to continue to trade with non-convertible Bank of England notes and for the government to finance the war effort, even with significant recourse to unfunded debt. These aspects combined to create a suspension of convertibility that did not undermine the currency. By contrast, the Assignats debacle had cost the French monetary system its reputation in the last decade of the 18th century and so Napoleonic .finance had to evolve within a more rigid and limiting framework.
    Keywords: monetary orthodoxy; suspension of convertibility; war finance
    JEL: C61 E31 E42 E58 N13
    Date: 2013–09–16
  7. By: Ollikka, Kimmo (Government Institute for Economic Research); Tukiainen , Janne (Government Institute for Economic Research and Helsinki Center of Economic Research)
    Abstract: We study whether the mechanism design in the central bank liquidity auctions matters for the interbank money market interest rate levels and volatility. Furthermore, we compare different mechanisms to sell liquidity in terms of revenue, efficiency and auction stage interest rate levels and volatility. Most importantly, we ask which mechanism is the best at implementing the target policy interest rates to the interbank market and what are the trade-offs involved. We construct a relatively general model of strategic bidding with interdependent valuations, and combine it with a stylized model of the interbank market. The novel feature of the model is that the expectations of the interbank market outcomes determine the valuations in the liquidity auctions. The model captures the relevant features of how the European Central Bank sells liquidity. We use simulations to compare discriminatory price, uniform price and Vickrey auctions to a posted price mechanism with full allotment. In order to analyze interactions between the primary and the secondary market under four different mechanisms, we need to make a lot of assumptions and simplications. Given this caveat, we find that posted prices with full allotment is clearly the superior alternative in terms of implementing the policy interest rate to the interbank markets. This comes at the cost of less revenue compared to the revenue maximizing discriminatory price auction, but surprisingly, will not result in efficiency losses compared even to the Vickrey auction.
    Keywords: ECB liquidity auctions; interbank markets; mechanism design; multi-unit auctions; monetary policy; posted-prices
    JEL: C63 C72 D02 D44 D53 E43 E44 E52 E58 G21
    Date: 2013–09–17
  8. By: Linda S. Goldberg
    Abstract: International financial linkages, particularly through global bank flows, generate important questions about the consequences for economic and financial stability, including the ability of countries to conduct autonomous monetary policy. I address the monetary autonomy issue in the context of the international policy trilemma: countries seek three typically desirable but jointly unattainable objectives: stable exchange rates, free international capital mobility, and monetary policy autonomy oriented toward and effective at achieving domestic goals. I argue that global banking entails some features that are distinct from broad issues of capital market openness captured in existing studies. In principal, if global banks with affiliates established in foreign markets can reduce frictions in international capital flows then the macroeconomic policy trilemma could bind tighter and interest rates will exhibit more co-movement across countries. However, if the information content and stickiness of the claims and services provided are enhanced relative to a benchmark alternative, then global banks can weaken the trilemma rather than enhance it. The result is a prediction of heterogeneous effects on monetary autonomy, tied to the business models of the global banks and whether countries are investment or funding locations for those banks. Empirical tests of the trilemma support this view that global bank effects are heterogeneous, and also that the primary drivers of monetary autonomy are exchange rate regimes.
    JEL: E44 F36 G32
    Date: 2013–10
  9. By: Chienyu Huang (Southwestern University of Finance and economics); Juin Jen Chang (Institute of economics, Academia Sinica Taiwan); Lei Ji (Ofce sciences-po,skema Business School)
    Abstract: In this paper we explore the effects of monetary policy on the number of firms, firm market size, inflation and growth in a Schumpeterian growth model with endogenous market structure and cash-in-advance CIA constraints on two distinct types of RD investment in-house RD and entry investment. This allows us to match the empirical evidence and provides novel implications to the literature. We show that if in-house RD (quality improvement-type R&D) is subject to the CIA constraint, raising the nominal interest rate increases the number of firms and inflation, but decreases the firm size and economic growth. By contrast, if entry investment variety expansion-type RD is subject to the CIA constraint, these variables adversely respond to such a monetary policy. Besides, our model generates rich transitional dynamics in response to a change in monetary policy, when RD entry is restricted by a cash constraint.
    Keywords: CIA constraints on RD, endogenous market structure,monetary policy,economic growth
    JEL: O30 O40 E41
    Date: 2013–09
  10. By: Blaise Gnimassoun; Valérie Mignon
    Abstract: This paper aims at studying current-account imbalances by paying a particular attention to exchange-rate misalignments. We rely on a nonlinear model linking the persistence of current account imbalances to the deviation of the exchange rate to its equilibrium value. Estimating a panel smooth transition regression model on a sample of 22 industrialized countries, we show that persistence of current-account imbalances strongly depends on currency misalignments. More specifically, while there is no persistence in cases of currency undervaluation or weak overvaluation, persistence tends to augment for overvaluations higher than 11%. In addition, whereas disequilibria are persistent even for very low overvaluations in the euro area, persistence is observed only for overvaluations higher than 14% for non-eurozone members.
    Keywords: Current-account imbalances;current-account persistence;exchange-rate misalignments;panel smooth transition regression models
    JEL: F32 F31 C33
    Date: 2013–09
  11. By: Zsolt Darvas; Silvia Merler
    Abstract: During the crisis the European Central Bankâ??s roles have been greatly extended beyond its price stability mandate. In addition to the primary objective of price stability and the secondary objective of supporting EU economic policies, we identify ten new tasks related to monetary policy and financial stability. We argue that there are three main constraints on monetary policy: fiscal dominance, financial repercussions and regional divergences. By assessing the ECBâ??s tasks in light of these constraints, we highlight a number of synergies between these tasks and the ECBâ??s primary mandate of price stability. But we highlight major conflicts of interest related to the ECBâ??s participation in financial assistance programmes. We also underline that the ECBâ??s government bond purchasing programmes have introduced the concept of â??monetary policy under conditionalityâ??, which involves major dilemmas. A solution would be a major change towards a US-style system, in which state public debts are small, there are no federal bail-outs for states, the central bank does not purchase state debt and banks do not hold state debt. Such a change is unrealistic in the foreseeable future.
    Date: 2013–10
  12. By: Dubecq, S.; Monfort, A.; Renne, J-P.; Roussellet, G.
    Abstract: We propose a quadratic term-structure model of the EURIBOR-OIS spreads. Contrary to OIS, EURIBOR rates incorporate credit and liquidity risks resulting in compensations for (a) facing default risk of debtors, and (b) possible unexpected funding needs on the lender’s side. Our approach allows us to decompose the whole term structure of spreads into credit- and liquidity-related parts and into an expectation part and risk premiums. Our results shed new light on the effects of unconventional monetary policy carried out in the Eurosystem. In particular, our findings suggest that most of the recent easing in the euro interbank market is liquidity-related.
    Keywords: Quadratic term-structure model, liquidity risk, credit risk, interbank market, unconventional monetary policy.
    JEL: E43 E44 G12 G21
    Date: 2013
  13. By: Jessie Handbury; Tsutomu Watanabe; David E. Weinstein
    Abstract: Official price indexes, such as the CPI, are imperfect indicators of inflation calculated using ad hoc price formulae different from the theoretically well-founded inflation indexes favored by economists. This paper provides the first estimate of how accurately the CPI informs us about “true” inflation. We use the largest price and quantity dataset ever employed in economics to build a Törnqvist inflation index for Japan between 1989 and 2010. Our comparison of this true inflation index with the CPI indicates that the CPI bias is not constant but depends on the level of inflation. We show the informativeness of the CPI rises with inflation. When measured inflation is low (less than 2.4% per year) the CPI is a poor predictor of true inflation even over 12-month periods. Outside this range, the CPI is a much better measure of inflation. We find that the U.S. PCE Deflator methodology is superior to the Japanese CPI methodology but still exhibits substantial measurement error and biases rendering it a problematic predictor of inflation in low inflation regimes as well.
    JEL: E01 E31 E5
    Date: 2013–10
  14. By: Subrahmanyam Ganti (Indira Gandhi Institute of Development Research); Sridhar Talidevara
    Abstract: Money serves as an intermediate target variable for transmitting monetary policy actions in macroeconomic management. In this connection, no other macro-behavioural function is subjected to more modelling modifications and regression rigors than the macro-money demand function. Monetary policy planning crucially depends on the parameters of the money demand function. An emerging market economy undergoes structural change in the sector GDP composition when compared to that of a structurally (invariant) mature advanced economy. This obviously introduces a bias in the estimation of the income elasticity of money demand parameter if the structural change were not modelled into the money demand function. The present study tries to incorporate this structural change into the money demand function as an additional variable besides the aggregate GDP and interest rate as the conventional scale and opportunity cost parameters variables respectively. The simplified algebra permits us to proxy the sector GDP concentration variable by the numbers equivalent Herfindahl index(H) For the opportunity cost variable,1-3 year deposit rate and the call money rate are alternatively used. Maximum Likelihood estimates of the have thrown up a statistically highly significant positive coefficient of the H variable besides equally highly significant scale and opportunity cost variables with their expected positive and negative coefficients respectively. This empirical evidence suggests that without this variable, the conventional specification of the money demand function contains a serious policy-centric specification error. Also, the implication of the result is that as the sector GDP concentration increases, the demand for real money balances increases less proportionately, indicating presence of economies of scale.
    Keywords: Sector GDP Concentration, Macro-Money Demand Specification, Numbers Equivalent Herfindahl Index
    JEL: E01 E41 E51 E52
    Date: 2013–09
  15. By: Ángel Estrada; Jordi Galí; David López-Salido
    Abstract: We study the extent of macroeconomic convergence/divergence among euro area countries. Our analysis focuses on four variables (unemployment, inflation, relative prices and the current account), and seeks to uncover the role played by monetary union as a convergence factor by using non-euro developed economies and the pre-EMU period as control samples.
    Keywords: macroeconomic convergence, labor markets, competitiveness, inflation differentials, current account imbalances, relative prices
    JEL: E24 F31 O47
    Date: 2013–10
  16. By: Yin-Wong Cheung (City University of Hong Kong and Hong Kong Institute for Monetary Research); Risto Herrala (Bank of Finland)
    Abstract: We study the renminbi (RMB) covered interest differential - an indicator of the effectiveness of capital controls. It is found that the differential is not shrinking over time and, in fact, appears larger after the global financial crisis than before. That is, capital controls in China are still substantial and effective. In addition to exchange rate changes and volatilities, the RMB covered interest differential is affected by credit market tightness indicators. The marginal explanatory power of these macroeconomic factors, however, is small relative to the autoregressive component and the dummy variables that capture changes in China's policy.
    Keywords: NDF Implied RMB Interest Rate, Capital Controls, Asymmetric Response, Macro Determinants, Credit Market Tightness
    JEL: E44 F31 F32
    Date: 2013–09
  17. By: Ashima Goyal (Indira Gandhi Institute of Development Research); Sanchit Arora (Indira Gandhi Institute of Development Research)
    Abstract: We estimate the unobserved time-varying natural interest rate (NIR) and potential output for the Indian economy using the Kalman Filter. Estimation is a special challenge in an emerging market because of limited length of data series and ongoing structural change. A key result in the literature is the NIR is imprecisely estimated. Structural aspects of the economy used in our estimation turn out, however, to improve the precision of the NIR estimates, although potential output continues to be imprecisely estimated. Turning points are well captured and estimates obtained for the output gap elasticity of aggregate supply and the interest elasticity of aggregate demand.The estimated NIR is used as an indicator of the monetary policy stance, which is found to be broadly contractionary and procyclical for the period under study.
    Keywords: Natural interest rate; potential output; Kalman filter; monetary policy
    JEL: E32 E43 E52
    Date: 2013–09
  18. By: Irigoin, Maria Alejandra
    Abstract: Written on board of US Steamer San Jacinto – anchored in Shanghai in October 1856 - a report to the New York Times on the “Progress of the Rebellion in China” indicated that the US government “was forced to buy the Carolus dollars at an increasing sacrifice in order to pay its high salaried officers, not for what they are bought, for a Carolus dollars count not more than a Mexican or American with the pursers of the US navy”. In Shanghai the coin was at 50% premium above of the Mexican coin or any other silver coin of equal weight in circulation. No reason was given for such wild appreciation other than “the prejudice of the Chinese” in favour of the old Spanish American coin. According to the source “one hundred Carolus could buy in any established commercial house in China 150 American dollar or other silver dollars (and) a hundred pound draft on the bank of England maybe had for 250 or 270 Carolus, and larger or smaller ones in the same ratio” at the time when 450 or more pesos were required elsewhere in Europe or America for a sterling. The reporter concluded that in no other place the famous coin was worth more than its standard value. That China had a problem with silver is well known to the economic and monetary history literature. In the last 20 years or so the silverization of China has been pivotal in the explanation of the Great Divergence and more traditionally has occupied the interest of economic historians of China and Asia since, probably it firstly occurred in the late 18th century. There is a wealth of studies on trade and monetary history of China, the Pacific Rim and globally which have emphasized the role of silver in the Middle Kingdom since the 16th century. A more traditional historiography has insisted on the de-silverization of China by mid-19th century, which some associate with the Daoguang Depression – provoked by the acute alteration in the exchange rate of copper cash to silver that characterized the period.
    JEL: N0 R14 J01
    Date: 2013–01
  19. By: Bill Russell
    Abstract: United States Phillips curves are routinely estimated without accounting for the shifts in mean inflation. As a result we may expect the standard estimates of Phillips curves to be biased and suffer from ARCH. We demonstrate this is indeed the case. We also demonstrate that once the shifts in mean inflation are accounted for the ARCH is largely eliminated in the estimated model and the model defining expected rate of inflation in the New Keynesian model plays no significant role in the dynamics of inflation.
    Keywords: Philips curve, ARCH, structural breaks, inflation, markup
    JEL: C22 E31
    Date: 2013–10
  20. By: Maylis Avaro (ENS Cachan); Henri Sterdyniak (Ofce)
    Abstract: The banking union emerged from the June 2012 European Council as a new project expected to help and solve the euro area crisis. Is banking union a necessary supplement to monetary union or a new rush forward? The banking union would break the link between the sovereign debt crisis and the banking crisis, by asking the ECB to supervise banks, establishing common mechanisms to solve banking crises, and encouraging banks to diversify their activities. The banking union project is based on three pillars: a Single Supervisory Mechanism (SSM), a Single Resolution Mechanism (SRM) a European Deposit Guarantee Scheme. Each of these pillars raises specific problems. Some are related to the current crisis (can deposits in euro area countries facing difficulties be guaranteed?); some other are related to the EU complexity (should the banking union include all EU member states? Who will decide on banking regulations?),some other are related to the EU specificity (is the banking union a step towards more federalism?), the more stringent are related to structural choices regarding the European banking system. The banks' solvency and their ability to lend would primarily depend on their capital ratios, and thus on financial markets' sentiment. The links between the government, firms, households and domestic banks would be cut, which is questionnable. Will governments be able tomorrow to intervene to influence bank lending policies, or to settle specific public banks? An opposite strategy could be promoted: restructuring the banking sector, and isolating retail banking activity from risky activities. Retail banks would focus on lending to domestic agents, and their solvency would be guaranteed because they would not be allowed to run risky activity.Can European peoples leave such strategic choices in the hands of the ECB?
    Keywords: Banking un, Eion, European Construction
    JEL: G21 G28
    Date: 2013–09
  21. By: Bignon, V.; Breton, R.; Rojas Breu, M.
    Abstract: This paper analyzes a two-country model of currency, banks and endogenous default to study whether impediments to credit market integration across jurisdictions impact the desirability of a currency union. We show that when those impediments induce a higher cost for banks to manage cross-border credit compared to domestic credit, welfare may not be maximal under a regime of currency union. But a banking union that would suppress hurdles to banking integration restores the optimality of that currency arrangement. The empirical and policy implications in terms of banking union are discussed.
    Keywords: banks, currency union, credit, default, limited commitment.
    JEL: E42 E50 F3 G21
    Date: 2013
  22. By: Martín Lagos
    Abstract: After summarizing the birth and basic notions of credit, money and banking, sections 1 to 4 review the extraordinary potential, but also the substantial core risks of fractional reserve banking. The appearance of central banks, fiduciary monies, prudential regulation and supervision, as well as technological change, had huge impact on banking, but its basic business model remained the same old, risky one. Sections 5 and 6 describe how the contagion risk proper of the opaqueness and informational asymmetries of commercial banking plus the external diseconomies associated to systemic crises have justified the growth of thick safety nets, guarantees and government involvement in critical situations. These realities require not only top-level technical expertise in the supervisory bodies, but also outstanding moral integrity and political independence within their heads. Sections 7 and 8 pretend to summarize the key factors surrounding the subprime mortgage lending bubble and the supervisory failure leading to the worst economic crisis in seventy years.
    Date: 2013–09
  23. By: Santiago Fernandez de Lis; Ana Rubio; Jorge Sicilia
    Abstract: The crisis has led to increased financial fragmentation and revealed the link between sovereign and national banking risks, whose persistence over time would be incompatible with the euro. The solution to these problems must be the banking union, which should be constructed at the same time as the current crisis is being resolved. The process will be eventually complemented by the creation of cross-border banks. The process of the banking union does not have an optimal design, it will be long and will generate tensions during the transition period, but it is politically feasible. In the end, we will have a Europe that is much more integrated from the monetary, banking, fiscal and political points of view.
    Keywords: banking union, Europe, supervision, fragmentation
    JEL: F33 F34 F36 G18 G21
    Date: 2013–08
  24. By: Christoph Zwick (Karl-Franzens University of Graz)
    Abstract: This paper deals the ongoing current account adjustment process in the southern Euro - area countries. It applies an extended version of the Obstfeld/Rogoff (2005) model to Euro-Zone- imbalances and provides an interpretation of the results. I develop a five-region-version of the model, consisting of a EMU – deficit (GIPS)- and a EMU – surplus region besides the United States, Asia and OPEC. The model also allows for changes in the relative size of the tradable- to the non- tradable sector, induced by changes in the relative prices of tradable- to non-tradable goods. The paper shows the approximated sizes and the directions of price movements, which are implied by the current account adjustment process that started in the GIPS countries after the financial crisis. It argues, that declines in output and employment during the adjustment process follow intuitively from the model results. These output losses result from sticky prices in combination with a limited nominal depreciation of the common currency and the importance of intra-EMU adjustment. The paper further shows that supply-side changes, global rebalancing issues and the time horizon of the rebalancing process have an important impact on the size of the price movements. Despite the discussed weaknesses of the model, the analysis clearly suggests unfinished real effective exchange rate adjustment in Greece, Spain and Portugal implying further negative economic consequences on these economies by the rebalancing process. Italy might be an exception.
    Date: 2013–08
  25. By: Kapan, Tümer; Minoiu, Camelia
    Abstract: We examine the role of bank balance sheet strength in the transmission of financial sector shocks to the real economy. Using data from the syndicated loan market, we exploit variation in banks' reliance on wholesale funding and their structural liquidity positions in 2007Q2 to estimate the impact of exposure to market freezes during 2007-08 on the supply of bank credit. We find that banks with strong balance sheets were better able to maintain lending during the crisis. In particular, banks that were ex ante more dependent on market funding and had lower structural liquidity reduced the supply of credit more than other banks. However, higher levels of better-quality capital mitigated this effect. Our results suggest that strong bank balance sheets are key for the recovery of credit following crises, and provide support for regulatory proposals under the Basel III framework. --
    Keywords: bank lending channel,wholesale funding,capital,net stable funding ratio,Basel III
    JEL: G21 G18 G01
    Date: 2013
  26. By: Raphael S. Schoenle (Economics Department, Brandeis University); Raphael A. Auer (Swiss National Bank)
    Abstract: In this paper, we first document that two predictions of the heterogeneous firm version of the Dornbusch (1987) pricing model are confirmed in micro data on US import prices: while the rate at which a firm reacts to changes in its own cost is U-shaped in market share, the rate at which it reacts to competitors’ prices is hump-shaped in market share. Second, using the theory as a guidance, we present an expression for price changes in industry equilibrium that can be broken down into a component due to the direct cost response at the firm level, and another one due to price complementarities faced by the firm at the industry level. We show empirically that taking into account a sector’s market structure and the interplay of heterogeneity in reaction to own cost and reaction to the competition can substantially improve our understanding of the variation in pass-through rates across sectors and trade partners. The direct imperfect cost pass-through channel and the indirect price complementarity channel play approximately equally important roles in determining pass-through but partly offset each other. Including only one of these channels in an empirical analysis results in a failure to explain variation in the aggregate equilibrium rate of pass-through.
    Keywords: Exchange Rate Pass-Through, U.S. Import Prices, Market Structure, Price Complementarities
    JEL: E3 E31 F41
    Date: 2013–09
  27. By: Schleer, Frauke; Semmler, Willi
    Abstract: We analyze the feedback mechanisms between economic downturns and financial stress for euro area countries. Our study employs newly constructed financial condition indices that incorporate extensively banking variables. We apply a nonlinear Vector Smooth Transition Autoregressive (VSTAR) model for investigating instabilities in the financial sector-output linkages. The VSTAR model appears appropriate since it allows for smooth regime changes and asymmetric dynamics. We find that regime-switching takes place rather smoothly which dampens the negative output response after a shock in the financial sector in the selected euro area countries. Moreover, linearity cannot be rejected for all countries over some extensive time period questioning non-linearities in the financial sector-output nexus as unambiguous feature. In particular, we show that the negative effect of financial stress on output typically observed is not always present. This holds specifically for the time before the Lehman collapse, even if this is a model-defined high stress regime. After the collapse, we observe strong amplification mechanisms. This suggests that events leading to a strong economic breakdown are rare but large events and related to financial cycles which exhibit low frequency. --
    Keywords: Vector STAR,financial stress,financial cycle,real economy,regime-switching,euro area
    JEL: E2 E44 G01
    Date: 2013

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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.