nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒11‒02
nineteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Gaps in the Institutional Structure of the Euro Area By Christopher A. Sims
  2. Unconventional government debt purchases as a supplement to conventional monetary policy By Martin Ellison
  3. Fragmentation and Monetary Policy in the Euro Area By A. J. Al-Eyd; Pelin Berkmen
  4. Inflation Dynamics: The Role of Public Debt and Policy Regimes By Woong Yong Park; Jae Won Lee; Saroj Bhattarai
  5. Can Monetary Policy Delay the Reallocation of Capital? By Schnell, Fabian
  6. Monetary and Macroprudential Policy in an Estimated DSGE Model of the Euro Area By Dominic Quint; Pau Rabanal
  7. Capital Flows and the Risk-Taking Channel of Monetary Policy By Valentina Bruno; Hyun Song Shin
  8. Does Expansionary Monetary Policy Cause Asset Price Booms; Some Historical and Empirical Evidence By Michael D. Bordo; John Landon-Lane
  9. Distortionary Fiscal Policy and Monetary Policy Goals By Adam, Klaus; Billi, Roberto M.
  10. Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy By Landier, Augustin; Sraer, David; Thesmar, David
  11. Patterns of Convergence and Divergence in the Euro Area By Ángel Estrada; Jordi Galí; David López-Salido
  12. Inflation tax in the lab: a theoretical and experimental study of competitive search equilibrium with inflation By Nejat Anbarci; Richard Dutu; Nick Feltovich
  13. Is There any Rebalancing in the Euro Area? By Benjamin Carton; Karine Hervé
  14. The Continental Dollar: How the American Revolution was Financed with Paper Money—Initial Design and Ideal Performance By Farley Grubb
  15. On the Redistributive Effects of Inflation: an International Perspective By Boel, Paola
  16. Asian and European Financial Crises Compared By Edwin M. Truman
  17. Monetary Policy with Heterogeneous Agents By Makoto Nakajima
  18. Convergence and Divergences in the European Economy: Rebalancing and Being Competitive in a Non-optimal Monetary Union By Ferrán Brunet
  19. Implementing a Fiscal Transfer Mechanism in a Heterogeneous Monetary Union: A DSGE approach. By Thierry Betti

  1. By: Christopher A. Sims
    Abstract: The Euro was created at a time when the conventional view was that a central bank could control inflation by controlling the money supply and that fiscal policy’s interaction with monetary policy took the form of attempts to get the central bank to finance government debt. With a sufficiently firm and independent central bank, this view considered that financial markets would force discipline on fiscal policy. By creating a strong, independent central bank at the European level, facing multiple country-level fiscal authorities, the threat of political pressures for inflationary finance would be lower than with individual country central banks.
    Keywords: central banking, European union, monetary policy
    JEL: E02 E21 F33 F34 G21
    Date: 2013–05
  2. By: Martin Ellison
    Abstract: In response to the Great Financial Crisis, the Federal Reserve, the Bank of England and many other central banks have adopted unconventional monetary policy instruments.� We investigate if one of these, purchases of long-term government debt, could be a valuable addition to conventional short-term interest rate policy even if the main policy rate is not constrained by the zero lower bound.� To do so, we add a stylised financial sector and central bank asset purchases to an otherwise standard New Keynesian DSGE model.� Asset quantities matter for interest rates through a preferred habitat channel.� If conventional and unconventional monetary policy instruments are coordinated appropriately then the central bank is better able to stabilise both output and inflation.
    Keywords: Quantitative Easing, Large-Scale Asset Purchases, Preferred Habitat, Optimal Monetary Policy
    JEL: E40 E43 E52 E58
    Date: 2013–10–16
  3. By: A. J. Al-Eyd; Pelin Berkmen
    Abstract: The ECB has taken a range of actions to address bank funding problems, eliminate excessive risk in sovereign markets, and safeguard monetary transmission. But euro area financial markets have remained fragmented, driving retail interest rates in stressed markets far above those in the core. This has impeded the flow of credit and undermined the transmission of monetary policy. Analysis presented here indicates that the credit channel of monetary policy has broken down during the crisis, particularly in stressed markets, and that SMEs in these economies appear to be most affected by elevated lending rates.Given these stresses, the ECB can undertake additional targeted policy measures, including through additional term loans, collateral policies, and private asset purchases.
    Keywords: Monetary policy;Euro Area;Capital markets;Sovereign debt;Bond issues;Banks;Interest rates;Credit risk;Monetary transmission mechanism;European Central Bank;Interest rates, fragmentation, monetary policy
    Date: 2013–10–04
  4. By: Woong Yong Park (University of Hong Kong); Jae Won Lee (Rutgers University); Saroj Bhattarai (Pennsylvania State University)
    Abstract: We investigate the roles of a time-varying inflation target and monetary and fiscal policy stances on the dynamics of inflation in a DSGE model. Under an active monetary and passive fiscal policy regime, inflation closely follows the path of the inflation target and a stronger reaction of monetary policy to inflation decreases the equilibrium response of inflation to non-policy shocks. In sharp contrast, under an active fiscal and passive monetary policy regime, inflation moves in an opposite direction from the inflation target and a stronger reaction of monetary policy to inflation increases the equilibrium response of inflation to non-policy shocks. Moreover, a weaker response of fiscal policy to debt decreases the response of inflation to non-policy shocks. These results are due to variation in the value of public debt that leads to wealth effects on households. Finally, under a passive monetary and passive fiscal policy regime, both monetary and fiscal policy stances affect inflation dynamics, but because of a role for self-fulfilling beliefs due to equilibrium indeterminacy, theory provides no clear answer on the overall behavior of inflation. We characterize these results analytically in a simple model and numerically in a richer quantitative model.
    Date: 2013
  5. By: Schnell, Fabian
    Abstract: This paper examines the medium-run effects of monetary policy and focuses its analyses on the consequences of distorted (in the sense of exogenously influenced) real interest rates that are currently observed in many industrialized countries. In our model, real interest rates that are too low hinder economic recovery because such rates allow relatively unproductive firms to remain in the market. Monetary policy should increase interest rates after a negative macroeconomic shock to force a reallocation of production factors to more productive firms. We show that there is a trade-off between the short-run and medium-run preferences of the central bank as a consequence. From a welfare perspective, the impact of monetary policy depends on the long-run interest rate relative to the welfare-maximizing interest rate because of the preference for variety in the model.
    Keywords: Monetary Policy Design, Reallocation of Capital, Structural Change, Heterogeneous Firms
    JEL: E32 E43 E50 E52
    Date: 2013–10
  6. By: Dominic Quint; Pau Rabanal
    Abstract: In this paper, we study the optimal mix of monetary and macroprudential policies in an estimated two-country model of the euro area. The model includes real, nominal and financial frictions, and hence both monetary and macroprudential policy can play a role. We find that the introduction of a macroprudential rule would help in reducing macroeconomic volatility, improve welfare, and partially substitute for the lack of national monetary policies. Macroprudential policy would always increase the welfare of savers, but their effects on borrowers depend on the shock that hits the economy. In particular, macroprudential policy may entail welfare costs for borrowers under technology shocks, by increasing the countercyclical behavior of lending spreads.
    Keywords: Monetary policy;Euro Area;European Economic and Monetary Union;Macroprudential Policy;Credit expansion;Economic models;Monetary Policy, EMU, Basel III, Financial Frictions.
    Date: 2013–10–14
  7. By: Valentina Bruno (American University); Hyun Song Shin (Princeton University)
    Abstract: We study the dynamics linking monetary policy with bank leverage and show that adjustments in leverage act as the linchpin in the monetary transmission mechanism that works through fluctuations in risk-taking. Motivated by the evidence, we formulate a model of the risk-taking channel of monetary policy in the international context that rests on the feedback loop between increased leverage of global banks and capital flows amid currency appreciation for capital recipient economies.
    Keywords: Bank leverage, monetary policy, capital flows, risk-taking channel
    JEL: F32 F33 F34
    Date: 2013–06
  8. By: Michael D. Bordo; John Landon-Lane
    Abstract: In this paper we investigate the relationship between loose monetary policy, low inflation, and easy bank credit with asset price booms. Using a panel of up to 18 OECD countries from 1920 to 2011 we estimate the impact that loose monetary policy, low inflation, and bank credit has on house, stock and commodity prices. We review the historical narratives on asset price booms and use a deterministic procedure to identify asset price booms for the countries in our sample. We show that “loose” monetary policy – that is having an interest rate below the target rate or having a growth rate of money above the target growth rate – does positively impact asset prices and this correspondence is heightened during periods when asset prices grew quickly and then subsequently suffered a significant correction. This result was robust across multiple asset prices and different specifications and was present even when we controlled for other alternative explanations such as low inflation or “easy” credit.
    JEL: N1
    Date: 2013–10
  9. By: Adam, Klaus (Mannheim University); Billi, Roberto M. (Monetary Policy Department, Central Bank of Sweden)
    Abstract: We reconsider the role of an inflation conservative central banker in a setting with distortionary taxation. To do so, we assume monetary and fiscal policy are decided by independent authorities that do not abide to past commitments. If the two authorities make policy decisions simultaneously, inflation conservatism causes fiscal overspending. But if fiscal policy is determined before monetary policy, inflation conservatism imposes fiscal discipline. These results clarify that in our setting the value of inflation conservatism depends crucially on the timing of policy decisions.
    Keywords: optimal policy; lack of commitment; conservative monetary policy
    JEL: E52 E62 E63
    Date: 2013–10–01
  10. By: Landier, Augustin; Sraer, David; Thesmar, David
    Abstract: We show empirically that banks' exposure to interest rate risk, or income gap, plays a crucial role in monetary policy transmission. In a first step, we show that banks typically retain a large exposure to interest rates that can be predicted with income gap. Secondly, we show that income gap also predicts the sensitivity of bank lending to interest rates. Quantitatively, a 100 basis point increase in the Fed funds rate leads a bank at the 75th percentile of the income gap distribution to increase lending by about 1.6 percentage points annually relative to a bank at the 25th percentile.
    Date: 2013–02
  11. 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
    JEL: E24 F31 O47
    Date: 2013–10
  12. By: Nejat Anbarci; Richard Dutu; Nick Feltovich
    Abstract: How does the inflation tax impact on buyers’ and sellers’ behaviour? How strong is its effect on aggregate economic activity? To answer, we develop a model of directed search and monetary exchange with inflation. In the model, sellers post prices, which buyers observe before deciding on cash holdings that are costly due to inflation. We derive simple theoretical propositions regarding the effects of inflation in this environment. We then test the model’s predictions with a laboratory experiment that closely implements the theoretical framework. Our main finding confirms that not only is the inflation tax harmful to the economy – with cash holdings, GDP and welfare all falling as inflation rises – but also that its effect is relatively larger at low rates of inflation than at higher rates. For instance, when inflation rises from 0% to 5%, GDP falls by 2.8 percent, an effect 5 to 7 times stronger than when inflation rises from 5% to 30%. Our findings lead us to conclude that the inflation tax is a monetary policy channel of primary importance, even at low inflation rates.
    Keywords: money, inflation tax, directed search, posted prices, cash balances, welfare loss, frictions, experiment
    JEL: E31 E40 C90
    Date: 2013–10–18
  13. By: Benjamin Carton; Karine Hervé
    Abstract: We assess the evolution of real exchange rate misalignments within the euro area from a Fundamental Equilibrium Exchange Rate (FEER) approach. We test the robustness of the results by comparing three different estimations of the output gap. Whatever the output gap assumption, Southern countries were massively overvalued before the euro area crisis. However, the magnitude of the adjustment since is sensitive to the output gap. In particular, Greece has not registered any improvement considering an output gap that captures the financial cycle (10-15 years) instead of the business cycle (5 years). Spain and Portugal have significantly reduced their misalignment but against France and Italy instead of Germany. As a consequence, imbalances in the euro area have not reduced.
    Keywords: Exchange Rates;Current Account Adjustment;Euro Area
    JEL: F31 F32 F36
    Date: 2013–10
  14. By: Farley Grubb
    Abstract: The purpose of this paper is to convince the reader that the Continental dollar was a zero-interest bearer bond and not a fiat currency—thereby overturning 230 years of scholarly interpretation; to show that the public and leading Americans knew and acted on this fact, and to illustrate the ideal performance of the Continental dollar as a zero-interest bearer bond. The purpose of establishing the ideal performance is to create a benchmark against which empirical measures of depreciation can be evaluated in future papers.
    JEL: E51 E52 E61 E63 H56 H63 N11 N21 N41
    Date: 2013–10
  15. By: Boel, Paola (Monetary Policy Department, Central Bank of Sweden)
    Abstract: I calibrate the microfounded model in Boel and Camera (2009) to quantify the redistributive effects of inflation for a sample of OECD countries. In doing so, I address two important quantitative issues. First, using harmonized microdata from the Luxembourg Wealth Study, I provide an international comparison of the distribution of households' deposit accounts and financial assets. Second, I account for structural breaks when estimating money demand. I find that several results hold for the countries considered. First, the welfare cost of inflation changes over time, but the direction of the change varies across countries. Second, inflation acts as a regressive tax when a nominal asset other than money is held. Third, the magnitude of the redistributive effects differs across countries and it depends not only on wealth inequality, but also on the curvature and the level of the money demand curve. Last, I show that a subset of the population always prefers an inflationary policy when I extend the model to incorporate a political-economy equilibrium where agents can bargain over the inflation rate.
    Keywords: Money; Heterogeneity; Friedman Rule; Welfare Cost of Inflation; Calibration
    JEL: E40 E50
    Date: 2013–09–01
  16. By: Edwin M. Truman (Peterson Institute for International Economics)
    Abstract: The European and Asian financial crises are the two most recent major regional crises. This paper compares their origins and evolution. The origins of the two sets of crises were different in some respects, but broadly similar. The two sets of crises also shared similarities in their evolution, but here the differences were more significant. The European crisis countries received more external financial support, despite the fact that they involved more solvency issues while the Asian crises involved more liquidity issues. On balance, the reform programs in the European crises were less demanding and rigorous than in the Asian crises. Partly as a consequence, the negative impacts on the global economy have been larger. Author Edwin M. Truman draws three lessons from this analysis: First, history will repeat itself; there will be other external financial crises. Second, other countries have a stake in appropriate crisis management. Third, the International Monetary Fund (IMF) and other countries were mistaken in treating the European crises as individual country crises rather than as a crisis for the euro area as a whole that demanded policy conditionality on all members of the euro area.
    Keywords: financial crises, Asian financial crises, European financial crises, International Monetary Fund, European Central Bank, crisis management, policy coordination, macroeconomic policies, banking policies
    JEL: F3 F20 F31 F32 F3 F34 F36 F42
    Date: 2013–10
  17. By: Makoto Nakajima (Federal Reserve Bank of Philadelphia)
    Abstract: We build a New Keynesian model in which heterogeneous workers differ with regard to their employment status due to search and matching frictions in the labor market, their potential labor income, and their amount of savings. We use this laboratory to quantitatively assess who stands to win or lose from unanticipated monetary accommodation and who benefits most from systematic monetary stabilization policy. We find substantial redistribution effects of monetary policy shocks; a contractionary monetary policy shock increases income and welfare of the wealthiest 5 percent, while the remaining 95 percent experience lower income and welfare. Consequently, the negative effect of a contractionary monetary policy shock to social welfare is larger if heterogeneity is taken into account.
    Date: 2013
  18. By: Ferrán Brunet
    Abstract: This paper analyzes the structures, tendencies and challenges of the euro zone due to its non-optimal nature. The impact of the euro is asymmetric and contradictory: in the glorious ten first years a miracle and many bubbles appeared in some euro peripheral economies but they collapsed and enter in an inferno, in a trap despite its rescue by the European Union. The European challenges on competitiveness due to the deficits on productivity and competition are concentrated in the periphery. The virtuous euro zone states, reformed and applying ruled policies, have enlarged their competitiveness. The euroimbalances grew changing the convergence into huge divergences. The structural challenges of the European economy were propelled i) by the non-optimal condition of the euro zone, in particular the no movement of workers, the inflexibility of wages and costs and the no banking union; and b) by the European economic governance deficit, in particular the contradiction between a non-optimal monetary union and the divergent state’ fiscal policies. Europe is an anchor… or a torpedo. The euro zone and its member states are rebalancing, deleveraging and adjusting internally the economies, walking to be competitive. The Union is helping on this, reassessing the added value of Europe. Europe is coming to be an optimal currency area. Nevertheless the Union is suffering from two systemic risks: i) economic because of recession, public failure and credit crunch; and ii) institutional because of having no the instruments of his needs, the emerging euroscepticism, and the tendencies to the disintegration both of the Union and of certain member states. Then there is a need for Europe, acute in many countries. And there is a new task for the Union as regulatory quality developer and even as state builder.
    Keywords: Stability, Competitiveness, European Monetary Union, Europe, Economic Policy.
    Date: 2013–03
  19. By: Thierry Betti
    Abstract: This paper deals with the implementation of a fiscal transfer mechanism among countries of a monetary union. I use a DSGE model of a monetary union close to Beetsma and Jensen (2005) and introduce both national fiscal policies and a transfer mechanism. I show the transfer has two effects: an obvious shift in demand but also a destabilizing effect due to a higher degradation of the term of trade for the recipient member. Then, I focus on two structural heterogeneities: the sensitivity to the transfer and the relative size of the two countries. I discuss in what extent these heterogeneities affect the effectiveness of the transfer.
    Keywords: fiscal federalism, transfer mechanism, new-Keynesian models, monetary union.
    JEL: E32
    Date: 2013

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