nep-mon New Economics Papers
on Monetary Economics
Issue of 2014‒05‒17
thirty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Communication and transparency in the conduct of monetary policy By Plosser, Charles I.
  2. Inflation Targeting in Colombia, 2002-2012 By Franz Hamann; Marc Hofstetter; Miguel Urrutia
  3. Asian Monetary Integration: A Japanese Perspective By Kawai, Masahiro
  4. Denmark's fixed exchange rate regime and the delayed recovery from the Global Financial Crisis: A comparative macroeconomic analysis By Andersen, Thomas Barnebeck; Malchow-Møller, Nikolaj
  5. Inflation targeting and the anchoring of inflation expectations: cross-country evidence from consensus forecasts By Davis, J. Scott; Presno, Ignacio
  6. Optimal Monetary Responses to Oil Discoveries By Samuel Wills
  7. Monetary and macroprudential policies in an estimated model with financial intermediation By Paolo Gelain; Pelin Ilbas
  8. Optimal Exchange Rate Policy in a Growing Semi-Open Economy By Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
  9. The Taylor Rule and Financial Stability: A Literature Review with Application for the Eurozone By Benjamin Käfer
  10. Forward guidance with an escape clause: When half a promise is better than a full one By Maria Lucia Florez-Jimenez; Julian A. Parra-Polania
  11. Changes in GDP’s measurement error volatility and response of the monetary policy rate: two approaches By Julian A. Parra-Polania; Carmiña O. Vargas
  12. "Monetary Mechanics: A Financial View" By Eric Tymoigne
  13. Monetary Policy and Real Borrowing Costs at the Zero Lower Bound By Simon Gilchrist; David López-Salido; Egon Zakrajšek
  14. Policy Regime Change against Chronic Deflation? Policy option under long-term liquidity trap By Ippei Fujiwara, Yoshiyuki Nakazono, Kozo Ueda
  15. Uncertainty in the Money supply mechanism and interbank markets in Colombia By Camilo González; Luisa Silva; Carmiña Vargas; Andrés M. Velasco
  16. Measuring the Macroeconomic Impact of Monetary Policy at the Zero Lower Bound By Jing Cynthia Wu; Fan Dora Xia
  17. Identifying central bank liquidity super-spreaders in interbank funds networks By Carlos León; Clara Machado; Miguel Sarmiento
  18. The Over-the-Counter Theory of the Fed Funds Market: A Primer By Afonso, Gara M.; Lagos, Ricardo
  19. Firm dollar debt and central bank dollar reserves: Empirical evidence from Latin America By Rajeswari Sengupta
  20. The Effects of Central Bank Independence and Inflation Targeting on Macroeconomic Performance: Evidence from Natural Experiments By Michael Parkin
  21. Addressing weak inflation: The European Central Bank's shopping list By Grégory Claeys; Zsolt Darvas; Silvia Merler; Guntram B. Wolff
  22. How does unconventional monetary policy affect inequality? Evidence from Japan By Ayako Saiki; Jon Frost
  23. Inflation in the Great Recession and New Keynesian Models By Marco Del Negro; Marc P. Giannoni; Frank Schorfheide
  24. Credit shocks and monetary policy in Brazil: A structural FAVAR approach By Fonseca, Marcelo Gonçalves da Silva; Pereira, Pedro L. Valls
  25. Monetary Policy Drivers of Bond and Equity Risks By John Y. Campbell; Carolin Pflueger; Luis M. Viceira
  26. The Effect of Governance and Political Instability Determinants on Inflation in Iran By Khani Hoolari, Seyed Morteza; Abounoori, Abbas Ali; Mohammadi, Teymour
  27. Comments on tailored regulation and forward guidance (with reference to Dr. Seuss, Strother Martin in Cool Hand Luke and other serious economists) By Fisher, Richard W.
  28. Reserve currencies: Can multiplicity work? By Satyendra Kumar Gupta; Ashima Goyal
  29. Scotland’s Currency Options By Dr Monique Ebell; Dr Angus Armstrong
  30. The Cost of Collateralized Borrowing in the Colombian Money Market: Does Connectedness Matter? By Constanza Martínez; Carlos León
  31. International Reserves and Gross Capital Flows Dynamics. By Enrique Alberola; Aitor Erce; José Maria Serena

  1. By: Plosser, Charles I. (Federal Reserve Bank of Philadelphia)
    Abstract: Council on Foreign Relations, May 8, 2014, New York, NY President Charles Plosser outlines his views that monetary policy transparency and forward guidance could be enhanced if the central bank would be more explicit about its reaction function.
    Keywords: Monetary policy; Communication; Transparency;
    Date: 2014–05–08
  2. By: Franz Hamann; Marc Hofstetter; Miguel Urrutia
    Abstract: Abstract After decades using monetary aggregates as the main instrument of monetary policy and having different varieties of crawling peg exchange rate regimes, Colombia adopted a full-fledged inflation-targeting (IT) regime in 1999, with inflation as the nominal anchor, a floating exchange rate, and the short-term interest rate as the main instrument. We examine the experience of the Colombian Central Bank over the last decade, a period of consolidation and innovation of its IT strategy. We study the increasing number of instruments used by the CB, including systematic foreign exchange interventions, announcements, and, sporadically, macro-prudential policies, capital controls, and changes in reserve requirements, among others. The study also examines some political economy dimensions that help explain the behavior of the CB during this period. To guide the discussion, we estimate a small-scale open-economy-policy-model.
    Keywords: Inflation Targeting, Monetary Policy, Exchange Rate, Taylor Rule, Colombia.
    JEL: E02 E32 E42 E43 E52 E58 E61 F31 F33 F42
    Date: 2014–03–04
  3. By: Kawai, Masahiro (Asian Development Bank Institute)
    Abstract: This paper discusses Japan's strategy for Asian monetary integration. It argues that Japan faces three major policy challenges when promoting intraregional exchange rate stability. First, there must be some convergence of exchange rate regimes in East Asia, and the most realistic option is for the region's emerging economies to adopt similar managed floating regimes—rather than a peg to an external currency. This requires major emerging economies—particularly the People's Republic of China (PRC)—to move to a more flexible regime vis-á-vis the US dollar. Second, given the limited degree of the yen's internationalization and the lack of the renminbi's (or the prospect of its rapid) full convertibility, it is in the interest of East Asia to create a regional monetary anchor through a combination of some form of national inflation targeting and a currency basket system. Emerging economies in the region need to find a suitable currency basket for their exchange rate target, such as a special drawing rights-plus (SDR+) currency basket—i.e., a basket of the SDR and emerging East Asian currencies. Third, if the creation of a stable regional monetary zone is desirable, the region must have a country or countries assuming a leadership role in this endeavor. There is no question that Japan and the PRC are such potential leaders, and the two countries need to collaborate closely with each other. To assume a leadership role, together with the PRC, in creating a stable monetary zone in Asia, Japan needs to make significant efforts at the national and regional levels and further strengthen financial cooperation. Practical steps that Japan could take include (i) restoring sustained economic growth through Abenomics; (ii) transforming Tokyo into a globally competitive international financial center; (iii) further strengthening regional economic and financial surveillance (Economic Review and Policy Dialogue and ASEAN+3 Macroeconomic Research Office) and regional financial safety nets (Chiang Mai Initiative Multilateralization) and creation of an Asian currency unit index; and (iv) launching serious policy discussions focusing on exchange rate issues to achieve intraregional exchange rate stability.
    Keywords: currency internationalization; regional monetary integration; international policy coordination; exchange rate stability
    JEL: F31 F32 F33 F42
    Date: 2014–04–22
  4. By: Andersen, Thomas Barnebeck (Department of Business and Economics); Malchow-Møller, Nikolaj (Department of Business and Economics)
    Abstract: This paper compares Denmark’s growth performance to that of the other 18 non-Eurozone OECD economies during 2008-12. Denmark is the only country with a fixed exchange rate regime; the other 18 countries all have flexible exchange rates, mostly as part of an inflation-targeting framework. At the same time, Denmark is one of the worst growth performers during 2008-12. Our analysis indicates that the lack of monetary policy independence is central to understanding the meager Danish performance. Aggressive monetary policy during 2008-09 is an important predictor of economic growth during 2008-12; and Denmark, having outsourced monetary policy to the ECB, did not pursue monetary easing as aggressively as most other countries. Overall, the analysis suggests that had Denmark been able to follow Sweden in aggressively cutting interest rates in the wake of the Global Financial Crisis, it would have added three quarters of a percentage point to average annual real GDP growth during 2008-12.
    Keywords: Exchange rate regimes; monetary policy; financial crisis; economic growth
    JEL: E52 E62 E65 F33 O57
    Date: 2014–05–12
  5. By: Davis, J. Scott (Federal Reserve Bank of Dallas); Presno, Ignacio (Federal Reserve Bank of Boston)
    Abstract: Using survey data of inflation expectations across a 36 developed and developing countries, this paper examines whether the adoption of inflation targeting has helped to anchor inflation expectations. We examine the response of inflation expectations following a shock to inflation, inflation expectations, and oil prices. For the 13 countries that adopted inflation targeting midway through the time period used in this study, there is a significant difference in the responses between the earlier and the later subperiods. A shock leads to a positive, significant, and persistent increase inflation expectations in the earlier, pre-targeting subperiod, but the same response is much less significant and persistent in the later, posttargeting subperiod. For the control group of 23 countries that did not adopt inflation targeting during this time period, there is no difference between responses in the earlier and the later sub-periods.
    Keywords: price levels; inflation; deflation; monetary policy
    JEL: D80 E31 E50
    Date: 2014–05–13
  6. By: Samuel Wills
    Abstract: This paper studies how monetary policy should respond to news about an oil discovery, using a workhorse New Keynesian model. Good news about future production can create a recession today under exchange rate pegs and a simple Taylor rule, as seen in practice. This is explained by forward-looking inflation. Recession is avoided by a Taylor rule that accommodates changes in the natural level of output, which closely approximates optimal policy. Central banks have an incentive to exploit oil revenues by appreciating the terms of trade, creating “Dutch disease” and a deflationary bias which is overcome by committing to future policy.
    Keywords: Natural resources, oil, optimal monetary policy, small open economy, news shock.
    JEL: E52 E62 F41 O13 Q30 Q33
    Date: 2014–05
  7. By: Paolo Gelain (Norges Bank); Pelin Ilbas (National Bank of Belgium, Research Department)
    Abstract: We estimate the Smets and Wouters (2007) model augmented with the Gertler and Karadi (2011) financial intermediation sector on US data by using real and financial observables. Given the framework of the estimated model, we address the question whether and how standard monetary policy should interact with macroprudential policy in order to safeguard real and financial stability. For this purpose, monetary policy is described by a flexible inflation targeting regime using the interest rate as instrument, while the macroprudential regulator adopts a tax/subsidy on bank capital in a countercyclical manner in order to stabilize nominal credit growth and the output gap. We look at the gains from coordination between the central bank and the macroprudential regulator under alternative assumptions regarding the degree of importance assigned to output gap fluctuations in the macroprudential mandate. The results suggest that there can be considerable gains from coordination if the macroprudential regulator has been assigned a sufficiently high weight on output gap stabilization, i.e. the common objective with monetary policy. If, on the other hand, the main focus of the macroprudential mandate is on credit growth, the macroprudential policy maker can reach better outcomes, while the central bank does worse, in the absence of coordination. Therefore, whether and to which extent monetary policy gains from coordination with the macroprudential regulator depends on the relative weight assigned to output fluctuations in the macroprudential mandate. Our counterfactual analysis further confirms the effectiveness of the countercyclical macroprudential tax/subsidy in containing the amplification effects triggered by a financial shock, and suggests that having a macroprudential regulatory tool at work could have successfully avoided the massive drop in credit such as the one observed at the onset of the Great Recession.
    Keywords: Monetary policy, financial frictions, macroprudential policy, policy coordination, capital tax/subsidy
    JEL: E42 E44 E52 E58 E61
    Date: 2014–05
  8. By: Philippe Bacchetta (University of Lausanne and Centre for Economic Policy Research and Hong Kong Institute for Monetary Research); Kenza Benhima (University of Lausanne and Centre for Economic Policy Research); Yannick Kalantzis (Banque de France)
    Abstract: In this paper, we consider an alternative perspective to China's exchange rate policy. We study a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, we assume limited financial development generating a large demand for saving instruments by the private sector. We analyze the optimal exchange rate policy by modelling the central bank as a Ramsey planner. Our main result is that in a growth acceleration episode it is optimal to have an initial real depreciation of the currency combined with an accumulation of reserves, which is consistent with the Chinese experience. This depreciation is followed by an appreciation in the long run. We also show that the optimal exchange rate path is close to the one that would result in an economy with full capital mobility and no central bank intervention.
    JEL: E58 F31 F32
    Date: 2014–05
  9. By: Benjamin Käfer (University of Kassel)
    Abstract: The question of whether central banks should bear responsibility for financial stability is still unan-swered. Regarding interest rate implementation, it is thus not clear if and how the Taylor rule should be augmented by an additional financial stability term. This paper reviews the normative and positive literature on Taylor rules augmented with exchange rates, asset prices, credit, and spreads. These measures have developed as common indicators of financial (in)stability in the Taylor rule literature. In addition, our own analysis describes the development of these indicators for the core and the periphery of the Eurozone. Given the large degree of heterogeneity between euro area countries, the conclusion here is that an interest rate reaction to instability by the European Central Bank would be inappropriate in times of crisis. However, this conclusion is somewhat weakened if there is no crisis.
    Keywords: Taylor rule, financial stability, sovereign debt crisis, Eurozone heterogeneity, exchange rates, asset prices, credit spreads
    JEL: E52 F33 F42
    Date: 2014
  10. By: Maria Lucia Florez-Jimenez; Julian A. Parra-Polania
    Abstract: We incorporate an escape clause into a model with forward guidance and find that such clause is welfare improving as it allows the monetary authority to avoid cases in which the cost of reduced flexibility is too high. The escape clause provides the central bank with another instrument (additional to the promised policy rate), the announced threshold. Under zero-lower-bound episodes, such threshold is a more suitable instrument to respond to an increase in the size of the recessionary shock. However, in extreme cases (i.e. when the shock is enormous), the optimal response is to make an unconditional promise and further reduce the promised rate.
    Keywords: Forward guidance, escape clause, zero lower bound, central bank communication
    JEL: E47 E52 E58
    Date: 2014–03–03
  11. By: Julian A. Parra-Polania; Carmiña O. Vargas
    Abstract: Using a stylized model in which output is measured with error, we derive the optimal policy response to the demand shock signal and to changes in the measurement error volatility from two different perspectives: the minimization of the expected loss (from which we derive the ‘standard’ policy) and the minimization of the maximum possible loss across all potential scenarios (from which we derive the ‘prudent’ or ‘robust’ policy). We find that: 1. the prudent policymaker reacts more aggressively to the shock signal than the standard one and 2. while the standard policymaker always mitigates her reaction if the measurement error volatility rises, the prudent one may even increase her response if her risk aversion is very high. When we incorporate forward-looking expectations, the second result is preserved but, in this case, the prudent policymaker is less aggressive than the standard one in responding to the shock signal.
    Keywords: Prudence, robustness, measurement error, optimal monetary policy.
    JEL: D81 E52 E58
    Date: 2014–03–21
  12. By: Eric Tymoigne
    Abstract: This paper develops the framework of analysis of monetary systems put together by authors such as Macleod, Keynes, Innes, and Knapp. This framework does not focus on the functions performed by an object but rather on its financial characteristics. Anything issued by anybody can be a monetary instrument and any type of material can be used to make a monetary instrument, as these are unimportant determinants of what a monetary instrument is. What matters is the existence of specific financial characteristics. These characteristics lead to a stable nominal value (parity) in the proper financial environment. This framework of analysis leads the researcher to study how the fair value of a monetary instrument changes and how that change differs from changes in the value of the unit of account. It also provides a road map to understanding monetary history and why monetary instruments are held.
    Keywords: Monetary Instrument; Money; Fair Value; Unit of Account
    JEL: E5 E42 E44
    Date: 2014–05
  13. By: Simon Gilchrist; David López-Salido; Egon Zakrajšek
    Abstract: This paper compares the effects of conventional monetary policy on real borrowing costs with those of the unconventional measures employed after the target federal funds rate hit the zero lower bound (ZLB). For the ZLB period, we identify two policy surprises: changes in the 2-year Treasury yield around policy announcements and changes in the 10-year Treasury yield that are orthogonal to those in the 2-year yield. The efficacy of unconventional policy in lowering real borrowing costs is comparable to that of conventional policy, in that it implies a complete pass-through of policy-induced movements in Treasury yields to comparable-maturity private yields.
    JEL: E43 E52
    Date: 2014–05
  14. By: Ippei Fujiwara, Yoshiyuki Nakazono, Kozo Ueda
    Abstract: The policy package known as Abenomics appears to have influenced the Japanese economy drastically, in particular, in the financial markets. In this paper, focusing on the aggressive monetary easing of Abenomics, the first arrow, we evaluate its role in guiding public perceptions on monetary policy stance through the management of expectations. In order to end chronic deflation, such as that which Japan has been suffering over the last two decades, policy regime change must be perceived by economic agents. Analysis using the QUICK survey system (QSS) monthlysurvey data shows that monetary policy reaction to inflation rates has been in a declining trend since the mid 2000s, implying intensified forward guidance well before Abenomics. However, Japan seems to have moved closer to a long-term liquidity trap, where even long-term bond yields are constrained by the zero lower bound. Consequently, no sizable difference in perceptions has been found before and after the introduction of Abenomics. Estimated changes in perceptions are not abrupt enough to satisfy "Sargent's (1982) criteria for regime change" termed by Eggertsson (2008). This poses a serious challenge to central banks: what is an effective policy option left under the long-term liquidity trap?
    JEL: E47 E50 E60
    Date: 2014
  15. By: Camilo González; Luisa Silva; Carmiña Vargas; Andrés M. Velasco
    Abstract: We set a dynamic stochastic model for the interbank daily market forfunds in Colombia. The framework features exogenous reserve requirements and requirement period, competitive trading among heterogeneouscommercial banks, daily open market operations held by the Central Bank(auctions and window facilities), and idiosyncratic demand shocks anduncertainty in the daily auction. Analytical derivations of their decisionmaking process show that banks involvement in the interbank market andopen market operations depend on their individualrequirement constraintand daily liquid assets. Our results do not show a linkage between theuncertainty in the money supply mechanism and activity in the interbankmarket. Equilibrium interest rate for the interbank market is derived,and is shown that it is distorted by uncertainty at the daily auction heldby the monetary authority. Using data for Colombia, we test the mainresults of the model and corroborate the Martingale hypothesis for theinterbank interest rate.
    Keywords: Interbank Market; Overnight Rates; Reserve Demand
    JEL: E44 E52 G21
    Date: 2013–11–15
  16. By: Jing Cynthia Wu; Fan Dora Xia
    Abstract: This paper employs an approximation that makes a nonlinear term structure model extremely tractable for analysis of an economy operating near the zero lower bound for interest rates. We show that such a model offers an excellent description of the data and can be used to summarize the macroeconomic effects of unconventional monetary policy at the zero lower bound. Our estimates imply that the efforts by the Federal Reserve to stimulate the economy since 2009 succeeded in making the unemployment rate in December 2013 0.13% lower than it otherwise would have been.
    JEL: E43 E44 E52 E58 G12
    Date: 2014–05
  17. By: Carlos León; Clara Machado; Miguel Sarmiento
    Abstract: Evidence suggests that the Colombian interbank funds market is an inhomogeneous and hierarchical network in which a few financial institutions fulfill the role of “super-spreaders” of central bank liquidity among market participants. Results concur with evidence from other interbank markets and other financial networks regarding the flaws of traditional direct financial contagion models based on homogeneous and non-hierarchical networks, and provide further evidence about financial networks’ self-organization emerging from complex adaptive financial systems. Our research work contributes to central bank’s efforts by (i) examining and characterizing the actual connective structure of interbank funds networks; (ii) identifying those financial institutions that may be considered as the most important conduits for monetary policy transmission, and the main drivers of contagion risk within the interbank funds market; (iii) providing new elements for the implementation of monetary policy and for safeguarding financial stability.
    Keywords: Interbank, monetary policy, contagion, networks, super-spreader, central bank.
    JEL: E5 G2 L14
    Date: 2014–04–28
  18. By: Afonso, Gara M. (Federal Reserve Bank of New York); Lagos, Ricardo (Federal Reserve Bank of Minneapolis)
    Abstract: We present a dynamic over-the-counter model of the fed funds market and use it to study the determination of the fed funds rate, the volume of loans traded, and the intraday evolution of the distribution of reserve balances across banks. We also investigate the implications of changes in the market structure, as well as the effects of central bank policy instruments such as open market operations, the discount window lending rate, and the interest rate on bank reserves.
    Keywords: Fed funds market; Search; Bargaining; Over-the-counter market
    JEL: C78 D83 E44 G10
    Date: 2014–04–18
  19. By: Rajeswari Sengupta (Indira Gandhi Institute of Development Research; Institute of Economic Growth)
    Abstract: I explore an empirically robust but previously undocumented association between the foreign exchange reserves accumulated by central banks of emerging market economies and dollar-denominated debt held in the balance sheets of non financial sector firms. Borrowing in dollars can have damaging effects on corporate balance sheets in the event of exchange rate depreciation. However, firms may discount such risk because of the implicit insurance provided by the central banks ex-ante reserve accumulation: in the event of a currency depreciation, firms may expect the central bank to stabilize the exchange rate using its stock of reserves. Using a novel firm-level balance sheet database, I investigate this possibility for close to 1500 firms in six of the largest Latin American economies, Argentina, Brazil, Chile, Colombia, Mexico and Peru. Results suggest that over the sample period, 1995-2007, an increase in the level of reserves is statistically and economically associated with an increase in the dollar borrowing of non financial sector firms of these economies. This could hint at a possible paradox: a higher level of reserves need not necessarily signify an economy that is more resilient to shocks. While reserve accumulation enables governments to weather macroeconomic risks arising from sudden stops in international capital flows, it can also increase the vulnerability of the corporate sector to currency risks by distorting incentives. Thus central banks, while formulating their foreign exchange intervention policies, may need to take into consideration the impact of the resultant reserve stockpiling on the private sector.
    Keywords: Foreign exchange reserves, foreign currency denominated debt, exchange rate regimes, currency crisis
    JEL: F3 F4
    Date: 2014–04
  20. By: Michael Parkin (University of Western Ontario, Canada)
    Date: 2014–04
  21. By: Grégory Claeys; Zsolt Darvas; Silvia Merler; Guntram B. Wolff
    Abstract: See comments by the authors 'Addressing weak inflation: The ECBâ??s Shopping List' and by Ashoka Mody 'The ECB must - and can - act' Euro-area inflation has been below 1 percent since October 2013, and medium-term inflation expectations are well below 2 percent. Forecasts of the return to target inflation have proved wrong. The European Central Bank should act forcefully, but should undermine neither the major relative price adjustments between the euro-area core and the periphery that are needed, nor the ongoing process of addressing weaknesses in Europeâ??s banking system. Reducing the deposit rate or introducing another long-term refinancing operation could be beneficial, but would be unlikely to change substantially inflation expectations. Government bond purchases would be significantly beneficial, but in a monetary union with 18 different treasuries, such purchases are difficult for economic, political and legal reasons. We recommend a monthly asset-purchase programme of â?¬35 billion with a review of the amount after three months. EFSF/ESM/EU/EIB bonds, corporate bonds and assetbacked securities should be purchased, of which at least â?¬490 billion, â?¬900 billion and â?¬330 billion respectively are suitables. Bonds of sound banks could be considered after the completion of the ECBâ??s assessment of bank balance sheets. While bond purchases distort incentives and make the ECB subject to private and public sector pressure, with potential consequences for inflation, such risks need to be weighed against the risk of persistently low inflation.
    Date: 2014–05
  22. By: Ayako Saiki; Jon Frost
    Abstract: Inequality has been largely ignored in the literature and practice of monetary policy, but is gaining more attention recently. We look at how a decade of unconventional monetary policy (UMP) in Japan affected inequality among households using survey data. Our vector auto regression (VAR) results show that UMP widened income inequality, especially after 2008 when quantitative easing became more aggressive. This is largely due to the portfolio channel. To the best of our knowledge, this is the first study to empirically analyze the distributional impact of UMP. Japan's extensive experience with UMP may hold important policy implications for other countries.
    Keywords: Monetary Policy; Central Banking; Stabilization Policy; Inequality
    JEL: E52 E63 D63
    Date: 2014–05
  23. By: Marco Del Negro; Marc P. Giannoni; Frank Schorfheide
    Abstract: It has been argued that existing DSGE models cannot properly account for the evolution of key macroeconomic variables during and following the recent great recession. We challenge this argument by showing that a standard DSGE model with financial frictions available prior to the recent crisis successfully predicts a sharp contraction in economic activity along with a modest and protracted decline in inflation, following the rise in financial stress in 2008Q4. The model does so even though inflation remains very dependent on the evolution of economic activity and of monetary policy.
    JEL: C52 E31 E32 E37
    Date: 2014–04
  24. By: Fonseca, Marcelo Gonçalves da Silva; Pereira, Pedro L. Valls
    Abstract: This paper investigates the implications of the credit channel of the monetary policy transmission mechanism in the case of Brazil, using a structural FAVAR (SFAVAR) approach. The term structural comes from the estimation strategy, which generates factors that have a clear economic interpretation. The results show that unexpected shocks in the proxies for the external nance premium and the bank balance sheetchannel produce large and persistent uctuations in in ation and economic activity accounting for more than 30% of the error forecast variance of the latter in a three-year horizon. The central bank seems to incorporate developments in credit markets especially variations in credit spreads into its reaction function, as impulse-response exercises show the Selic rate is declining in response to wider credit spreads and acontraction in the volume of new loans. Counterfactual simulations also demonstrate that the credit channel ampli ed the economic contraction in Brazil during the acute phase of the global nancial crisis in the last quarter of 2008, thus gave an important impulse to the recovery period that followed.
    Date: 2014–05–05
  25. By: John Y. Campbell; Carolin Pflueger; Luis M. Viceira
    Abstract: The exposure of US Treasury bonds to the stock market has moved considerably over time. While it was slightly positive on average in the period 1960-2011, it was unusually high in the 1980s and negative in the 2000s, a period during which Treasury bonds enabled investors to hedge macroeconomic risks. This paper explores the effects of monetary policy parameters and macroeconomic shocks on nominal bond risks, using a New Keynesian model with habit formation and discrete regime shifts in 1979 and 1997. The increase in bond risks after 1979 is attributed primarily to a shift in monetary policy towards a more anti-inflationary stance, while the more recent decrease in bond risks after 1997 is attributed primarily to a renewed emphasis on output stabilization and an increase in the persistence of monetary policy. Endogenous responses of bond risk premia amplify these effects of monetary policy on bond risks.
    JEL: E43 E44 E52 G12
    Date: 2014–04
  26. By: Khani Hoolari, Seyed Morteza; Abounoori, Abbas Ali; Mohammadi, Teymour
    Abstract: Empirical literature that examines the determinants of inflation in Iran has suggested inflation as a monetary phenomenon. This study investigates the effect of political instability and governance parameters on inflation in Iran over 1959 to 2010. This research sought to identify the profound factors which determine inflation in Iran. Using a combination of the predictions of Fiscal Theory of Price Level (FTPL) determination and Political Economy of Macroeconomic Policy (PEMP) literature and applying the Generalized Method of Moments (GMM), we study this relationship through two different models. The results of monetary model indicate that the effects of monetary determinants depend on the political environment of Iran. The political model expresses a positive relationship between inflation and political instability and governance parameters.
    Keywords: Governance Political instability Major Cabinet Changes Government Crisis Inflation
    JEL: C52 O38 P48
    Date: 2014–01
  27. By: Fisher, Richard W. (Federal Reserve Bank of Dallas)
    Abstract: The Federal Reserve knows what community and regional banks do for their communities. We appreciate that you are the backbone for the homeowners, small businesses, service clubs and school sports teams and scouts and churches and myriad other activities that make for better communities. We want you not only to endure, but to succeed and grow.
    Keywords: community banks; monetary policy
    Date: 2014–05–09
  28. By: Satyendra Kumar Gupta (Indira Gandhi Institute of Development Research); Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: The paper analyzes the potential rise of new reserve currencies in the context of the economic and political determinants of an international currency. Two models analyze the role of soft political power, switching costs to a new currency and transaction costs in the rise of a new currency. Quantitative indices are developed to measure these factors, which are then empirically tested and found to be statistically significant in determining the rise of international currency. The study further explores the greater use of Renminbi in East Asia and the trade integration in this region.
    Keywords: Reserve currencies, network benefilts, transaction costs, bargaining power, Renminbi
    JEL: F33 F55 O53
    Date: 2014–03
  29. By: Dr Monique Ebell; Dr Angus Armstrong
    Abstract: This paper considers which currency option would be best for an independent Scotland. We examine three currency options: being part of a sterling currency union, adopting the euro, or having an independent currency. No currency option is the best when considered against all criteria. Therefore, making the decision requires deciding which criteria are most important. Recent events around the world, particularly in Europe, have shown that fiscal sustainability and currency arrangements cannot be considered in isolation. Hence, the share of the existing UK public debt that an independent Scotland would inherit is central to understanding its currency choices. We consider how the debt may be divided, and the ability of an independent Scotland to pay its share. For an independent Scotland to prosper it requires a 'hard' currency, one in which investors are willing to hold long-dated Scottish government debt at a reasonable price. A necessary condition for a ‘hard’ currency is that government solvency is always beyond doubt.
    Date: 2013–10
  30. By: Constanza Martínez; Carlos León
    Abstract: Under the view that the market is a weighted and directed network (Barabási, 2003), this document is a first attempt to model the Colombian money market within a spatial econometrics framework. By estimating two standard spatial econometric models, we study the cost of collateralized borrowing (i.e. sell/buy backs) among Colombian financial institutions, and its relationship with the effects induced by traditional variables (leverage, size and borrowing levels), and by spatial variables resulting from observed linkages among financial institutions. The model that best fits the data is the Spatial Durbin Model, whose main findings indicate that (i) traditional variables are of low explanatory power by themselves; (ii) there exists a significant spatial dependence with regard to the cost of collateralized borrowing; (iii) the inclusion of spatial lags of the same traditional factors results in a model able to explain the existence of borrowing spreads that vary across financial institutions despite the collateralized nature of sell/buy backs; (iv) direct and spill-over effects from the spatially lagged value of financial leverage are the most significant for determining the cost of collateralized borrowing. Results are valuable since making connectedness an explanatory variable breaks with the traditional (reductionist) understanding of financial markets, which concurs with the current interest in the macro-prudential perspective of financial stability.
    Keywords: Money market, interbank, collateral, collateralized borrowing, spatial econometrics.
    JEL: C31 G21 G32
    Date: 2014–01–13
  31. By: Enrique Alberola; Aitor Erce; José Maria Serena
    Abstract: This paper explores the role of international reserves as a stabilizer of international capital flows, in particular during periods of global financial stress. In contrast with previous contributions, aimed at explaining net capital flows, we focus on the behavior of gross capital flows. We analyze an extensive cross-country quarterly database -63 countries, 1991-2010- using standard panel regressions. We document significant heterogeneity in the response of resident investors to financial stress and relate it to a previously undocumented channel through which reserves act as a buffer during financial stress. A robust result of the analysis is that international reserves facilitate financial disinvestment overseas by residents –a fall in capital outflows-. This partially offsets the drop in foreign capital inflows in such periods, which are only marginally mitigated by reserves under some specifications of the model. For the whole period, we also find that larger stocks of reserves are linked to higher gross inflows and lower gross outflows.
    Date: 2014–01–11

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