nep-mon New Economics Papers
on Monetary Economics
Issue of 2014‒06‒02
forty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Some Lessons from Six Years of Practical Inflation Targeting By Svensson, Lars E O
  2. Forward Guidance by Inflation-Targeting Central Banks By Woodford, Michael
  3. Monetary Policy Surprises, Credit Costs and Economic Activity By Gertler, Mark; Karadi, Peter
  4. Safe Assets, Liquidity and Monetary Policy By Benigno, Pierpaolo; Nisticò, Salvatore
  5. Understanding the Gains from Wage Flexibility: The Exchange Rate Connection By Galí, Jordi; Monacelli, Tommaso
  6. Surprising Similarities: Recent Monetary Regimes of Small Economies By Rose, Andrew K
  7. State dependent monetary policy By Lippi, Francesco; Ragni, Stefania; Trachter, Nicholas
  8. Labor Force Participation and Monetary Policy in the Wake of the Great Recession By Erceg, Christopher; Levin, Andrew
  9. Stabilization policy, rational expectations and price-level versus infl‡ation targeting: a survey By Hatcher, Michael; Minford, Patrick
  10. The ECB and the banks: the tale of two crises By Reichlin, Lucrezia
  11. Money Demand in Ireland, 1933-2012 By Gerlach, Stefan; Stuart, Rebecca
  12. A Comparison between Optimal Capital Controls under Fixed Exchange Rates and Optimal Monetary Policy under Flexible Rates By Shigeto Kitano; Kenya Takaku
  13. Constrained Discretion and Central Bank Transparency By Bianchi, Francesco; Melosi, Leonardo
  14. Targeting Nominal GDP or Prices: Guidance and Expectation Dynamics By Honkapohja, Seppo; Mitra, Kaushik
  15. Asian Monetary Integration : A Japanese Perspective By Masahiro Kawai
  16. Asset markets and monetary policy shocks at the zero lower bound By Edda Claus; Iris Claus; Leo Krippner
  17. Impact of Interbank Liquidity on Monetary Transmission Mechanism: A Case Study of Pakistan By Muhammad, Omer; de Haan, Jakob; Scholtens, Bert
  18. Optimal Monetary Policy with State-Dependent Pricing By Nakov, Anton; Thomas, Carlos
  19. Optimal Exchange Rate Policy in a Growing Semi-Open Economy By Bacchetta, Philippe; Benhima, Kenza; Kalantzis, Yannick
  20. Monetary/Fiscal Policy Mix and Agents' Beliefs By Bianchi, Francesco; Ilut, Cosmin
  21. Is Bank Debt Special for the Transmission of Monetary Policy? Evidence from the Stock Market By Ippolito, Filippo; Ozdagli, Ali; Perez Orive, Ander
  22. Monetary Policy and Natural Disasters: An Extension and Simulation Analysis in the Framework of New Keynesian Macroeconomic Model By Mitsuhiro Okano
  23. The Effectiveness of Non-Standard Monetary Policy Measures: Evidence from Survey Data By Carlo Altavilla; Domenico Giannone
  24. Exit strategies By Angeloni, Ignazio; Faia, Ester; Winkler, Roland
  25. Market Deregulation and Optimal Monetary Policy in a Monetary Union By Cacciatore, Matteo; Fiori, Giuseppe; Ghironi, Fabio
  26. A note on the long-run neutrality of monetary policy: new empirics By Asongu Simplice
  27. Paths to a Reserve Currency: Internationalization of the Renminbi and Its Implications By Huang, Yiping; Wang, Daili; Fan, Gang
  28. Understanding Money Demand in the Transition from a Centrally Planned to a Market Economy By Delatte, Anne-Laure; Fouquau, Julien; Holz, Carsten
  29. Monetary Policy Under Commodity Price Fluctuations By Roberto Chang
  30. International Liquidity and Exchange Rate Dynamics By Gabaix, Xavier; Maggiori, Matteo
  31. Time-Varying Business Volatility, Price Setting, and the Real Effects of Monetary Policy By Bachmann, Rüdiger; Born, Benjamin; Elstner, Steffen; Grimme, Christian
  32. Patterns of convergence and Divergence in the Euro Area By Estrada García, Ángel; Galí, Jordi; Lopez-Salido, David
  33. The risk-taking channel of monetary policy – exploring all avenues By Diana Bonfim; Carla Soares
  34. Small and large price changes and the propagation of monetary shocks By Alvarez, Fernando; Le Bihan, Hervé; Lippi, Francesco
  35. Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting By Sheedy, Kevin D.
  36. The Relevance or Otherwise of the Central Bank's Balance Sheet By Miles, David K; Schanz, Jochen
  37. A Time-Varying Approach of the US Welfare Cost of Inflation By Stephen M. Miller; Luis F. Martins; Rangan Gupta
  38. Escaping the Great Recession By Bianchi, Francesco; Melosi, Leonardo
  39. "Shadow Banking: Policy Challenges for Central Banks" By Thorvald Grung-Moe
  40. Business Cycles, Monetary Policy, and Bank Lending: Identifying the bank balance sheet channel with firm-bank match-level loan data By HOSONO Kaoru; MIYAKAWA Daisuke
  41. Inflation Announcements and Social Dynamics By Kinda Hachem; Jing Cynthia Wu

  1. By: Svensson, Lars E O
    Abstract: My lessons from six years of practical policy-making include (1) being clear about and not deviating from the mandate of flexible inflation targeting (price stability and the highest sustainable employment), including keeping average inflation over a longer period on target; (2) not adding household debt as a new (intermediate) target variable, in addition to inflation and unemployment – not “leaning against the wind,” which is counterproductive, but leaving any problems with household debt to financial policy; (3) using a two-step algorithm to implement “forecast targeting”; (4) using four-panel graphs to evaluate monetary policy ex ante (in real time) and ex post (after the fact); (5) taking a credible inflation target and a resulting downward-sloping Phillips curve into account by keeping average inflation over a longer period on target; and (6) not confusing monetary and financial policy but using monetary policy to achieve the monetary-policy objectives and financial policy to maintain financial stability, with each policy taking into account the conduct of the other.
    Keywords: financial stabiilty; household debt; inflation targeting; Monetary policy
    JEL: E42 E43 E44 E47 E52 E58
    Date: 2013–11
  2. By: Woodford, Michael
    Abstract: This paper assesses the value of central-bank communication about likely future policy, with particular reference to the regular publication of projections for the future path of the policy rate, as with the Riksbank's publication of the repo rate path. It first discusses why publication of a projected interest-rate path represents a natural and desirable evolution of inflation-forecast targeting procedures, and the conditions under which the assumptions about future policy underlying such projections will be intertemporally consistent. It then discusses evidence on the extent to which central-bank statements influence private-sector interest-rate expectations. Particular attention is given to the potential use of forward guidance as an additional tool of policy when an executive lower bound for the policy rate is reached, and alternative approaches to forward guidance in this context are compared, including the recent adoption of quantitative "thresholds" for unemployment and inflation expectations by the U.S. Federal Reserve. The potential role of a nominal GDP level target within an inflation-targeting regime is also considered.
    Date: 2013–11
  3. By: Gertler, Mark; Karadi, Peter
    Abstract: We provide evidence on the nature of the monetary policy transmission mechanism. To identify policy shocks in a setting with both economic and financial variables, we combine traditional monetary vector autoregression (VAR) analysis with high frequency identification (HFI) of monetary policy shocks. We first show that the shocks identified using HFI surprises as external instruments produce responses in output and inflation consistent with those obtained in the standard monetary VAR analysis. We also find, however, that monetary policy responses typically produce “modest” movements in short rates that lead to “large” movements in credit costs and economic activity. The large movements in credit costs are mainly due to the reaction of both term premia and credit spreads that are typically absent from the baseline model of monetary transmission. Finally, we show that forward guidance is important to the overall strength of policy transmission.
    Keywords: Credit Spread; External Instrument; Forward Guidance; High-Frequency Identification; Monetary Policy Transmission; Structural VAR; Term Premium
    JEL: E43 E44 E52
    Date: 2014–02
  4. By: Benigno, Pierpaolo; Nisticò, Salvatore
    Abstract: This paper studies monetary policy in models where multiple assets have different liquidity properties: safe and "pseudo-safe" assets coexist. A shock worsening the liquidity properties of the pseudo-safe assets raises interest-rate spreads and can cause a deep recession cum deflation. Expanding the central bank's balance sheet fills the shortage of safe assets and counteracts the recession. Lowering the interest rate on reserves insulates market interest rates from the liquidity shock and improves risk sharing between borrowers and savers.
    Keywords: liquidity crisis; unconventional policies; zero lower bound
    JEL: E30 E40 E50
    Date: 2013–12
  5. By: Galí, Jordi; Monacelli, Tommaso
    Abstract: We study the gains from increased wage flexibility and their dependence on exchange rate policy, using a small open economy model with staggered price and wage setting. Two results stand out: (i) the impact of wage adjustments on employment is smaller the more the central bank seeks to stabilize the exchange rate, and (ii) an increase in wage flexibility often reduces welfare, and more likely in economies under an exchange rate peg or an exchange rate-focused monetary policy. Our findings call into question the common view that wage flexibility is particularly desirable in a currency union.
    Keywords: currency unions; exchange rate policy; exchange rate regime; monetary policy rules.; New Keynesian model; nominal rigidities; stabilization policies; stabilization policy; sticky wages
    JEL: E32 E52 F41
    Date: 2014–02
  6. By: Rose, Andrew K
    Abstract: In contrast to earlier recessions, the monetary regimes of many small economies have not changed in the aftermath of the global financial crisis. This is due in part to the fact that many small economies continue to use hard exchange rate fixes, a reasonably durable regime. However, most of the new stability is due to countries that float with an inflation target. Though a few have left to join the Eurozone, no country has yet abandoned an inflation targeting regime under duress. Inflation targeting now represents a serious alternative to a hard exchange rate fix for small economies seeking monetary stability. Are there important differences between the economic outcomes of the two stable regimes? I examine a panel of annual data from more than 170 countries from 2007 through 2012 and find that the macroeconomic and financial consequences of regime-choice are surprisingly small. Consistent with the literature, business cycles, capital flows, and other phenomena for hard fixers have been similar to those for inflation targeters during the Global Financial Crisis and its aftermath.
    Keywords: crisis; data; empirical; exchange rate; financial; float; hard fix; inflation; panel; recession; target
    JEL: E58 F33
    Date: 2013–10
  7. By: Lippi, Francesco; Ragni, Stefania; Trachter, Nicholas
    Abstract: We study the optimal anticipated monetary policy in a flexible-price economy featuring heterogenous agents and incomplete markets, which give rise to a business cycle. In this setting money policy has distributional effects that depend on the state of the cycle. We parsimoniously characterize the dynamics of the economy and study the optimal regulation of the money supply as a function of the state. The optimal policy prescribes monetary expansions in recessions, when insurance is most needed by cash- poor unproductive agents. To minimize the inflationary effect of these expansions the policy prescribes monetary contractions in good times. Although the optimal money growth rate varies greatly through the business cycle, this policy “echoes” Friedman’s principle in the sense that the expected real return of money approaches the rate of time preference.
    Keywords: distributional effects; heterogenous agents; incomplete markets; liquidity; precautionary savings
    JEL: E50
    Date: 2014–01
  8. By: Erceg, Christopher; Levin, Andrew
    Abstract: In this paper, we provide compelling evidence that cyclical factors account for the bulk of the post-2007 decline in the U.S. labor force participation rate. We then proceed to formulate a stylized New Keynesian model in which labor force participation is essentially acyclical during "normal times" (that is, in response to small or transitory shocks) but drops markedly in the wake of a large and persistent aggregate demand shock. Finally, we show that these considerations can have potentially crucial implications for the design of monetary policy, especially under circumstances in which adjustments to the short-term interest rate are constrained by the zero lower bound.
    Keywords: labor force; policy tradeoffs; simple rules; unemployment rate
    JEL: E24 E32 E52 J21
    Date: 2013–09
  9. By: Hatcher, Michael; Minford, Patrick
    Abstract: We survey recent literature comparing inflation targeting (IT) and price-level targeting (PT) as macroeconomic stabilization policies. Our focus is on New Keynesian models and areas which have seen significant developments since Ambler’s (2009) survey: the zero lower bound on nominal interest rates; financial frictions; and optimal monetary policy. Ambler’s main conclusion that PT improves the inflation-output volatility trade-off in New Keynesian models is reasonably robust to these extensions, several of which are attempts to address issues raised by the recent financial crisis. The beneficial effects of PT therefore appear to hang on the joint assumption that agents are rational and the economy New Keynesian. Accordingly, we discuss recent experimental and survey evidence on whether expectations are rational, as well as the applied macro literature on the empirical performance of New Keynesian models. In addition, we discuss a more recent strand of applied literature that has formally tested New Keynesian models with rational expectations. Overall the evidence is not conclusive, but we note that New Keynesian models are able to match a number of dynamic features in the data and that behavioral models of the macroeconomy are outperformed by those with rational expectations in formal statistical tests. Accordingly, we argue that policymakers should continue to pay attention to PT.
    Keywords: inflation targeting; price level targeting; Rational Expectations
    JEL: E31
    Date: 2014–02
  10. By: Reichlin, Lucrezia
    Abstract: The paper is a narrative on monetary policy and the banking sector during the two recent euro area recessions. It shows that while in the two episodes of recession and financial stress the ECB acted aggressively providing liquidity to banks, the second recession, unlike the first, has been characterized by an abnormal decline of loans with respect to both real economic activity and the monetary aggregates. It conjectures that this fact is explained by the postponement of the adjustment in the banking sector. It shows that euro area banks, over the 2008-2012 period, did not change neither the capital to asset ratio nor the size of their balance sheet relative to GDP keeping them at the pre-crisis level. The paper also describes other aspects of banks’ balance sheet adjustment during the two crises pointing to a progressive dismantling of financial integration involving the inter-bank market since the first crisis and the market for government bonds since the second.
    Keywords: banks; monetary policy; recession
    JEL: E5
    Date: 2013–09
  11. By: Gerlach, Stefan; Stuart, Rebecca
    Abstract: Using annual data from several sources, we study the evolution of M1, M2, income, prices and long and short interest rates in Ireland over the period 1933-2012. We find cointegration and that prices, income and interest rates are weakly exogenous. While the estimates for M2 are stable and close to our priors, for M1 we obtain very low price elasticities, and a relatively high income elasticity, and detect parameter instability. We estimate a short-run M2 demand function that passes a number of diagnostic tests, although the standard errors of the regressions is large.
    Keywords: historical statistics; income; Ireland; long time series; money; prices
    JEL: E3 E4 N14
    Date: 2014–05
  12. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Faculty of Business, Aichi Shukutoku University)
    Abstract: We apply a Ramsey-type analysis to a standard sticky price, small open economy model, examining the welfare implications of optimal capital controls under fixed exchange rates and optimal monetary policy under flexible exchange rates. We show that capital controls can significantly reduce the gap between the welfare levels under fixed and flexible exchange rates.
    Keywords: Optimal capital controls, Optimal monetary policy, Ramsey policy, Exchange rate regimes, Small open economy, Sticky prices, Welfare comparison, Incomplete markets
    JEL: E5 F4
    Date: 2014–05
  13. By: Bianchi, Francesco; Melosi, Leonardo
    Abstract: We develop a theoretical framework to quantitatively assess the general equilibrium effects and welfare implications of central bank reputation and transparency. Monetary policy alternates between periods of active inflation stabilization and periods during which the emphasis on inflation stabilization is reduced. When the central bank engages in only short deviations from active monetary policy, inflation expectations remain anchored and the model captures the monetary approach described as constrained discretion. However, if the central bank deviates for a prolonged period of time, agents become pessimistic about future monetary policy and uncertainty gradually rises. Reputation determines the speed with which agents' pessimism accelerates once the central bank starts deviating. When the model is fitted to U.S. data, the Federal Reserve is found to benefit from strong reputation and large flexibility in responding to inflationary shocks. Increasing transparency would improve welfare by anchoring agents' expectations.
    Keywords: Bayesian learning; inflation expectations; Markov-switching models; reputation; uncertainty
    JEL: C11 D83 E52
    Date: 2014–04
  14. By: Honkapohja, Seppo; Mitra, Kaushik
    Abstract: We examine global dynamics under infinite-horizon learning in New Keynesian models where monetary policy practices either price-level or nominal GDP targeting and compare these regimes to inflation targeting. These interest-rate rules are subject to the zero lower bound. Robustness of the three rules in learning adjustment are compared using criteria for the domain of attraction of the targeted steady state, volatility of inflation and output and sensitivity to the speed of learning parameter. Performance of price-level and nominal GDP targeting significantly improves if the additional guidance in these regimes is incorporated in private agents' learning.
    Keywords: Adaptive Learning; Inflation Targeting; Monetary Policy; Zero Interest Rate Lower Bound
    JEL: E52 E58 E63
    Date: 2014–03
  15. By: Masahiro Kawai (Asian Development Bank Institute (ADBI))
    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-à-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: Asian monetary integration, Japan, currency, exchange rate regime, East Asia, SDR, currency basket, monetary zone, PRC, Chiang Mai
    JEL: F31 F32 F33 F42
    Date: 2014–04
  16. By: Edda Claus; Iris Claus; Leo Krippner
    Abstract: This paper quantifies the impact of monetary policy shocks on asset markets in the United States and gauges the usefulness of a shadow short rate as a measure of conventional and unconventional monetary policy shocks. Monetary policy surprises are found to have had a larger impact on asset markets since short term interest rates reached the zero lower bound. Our results indicate that much of the increased reaction is due to changes in the transmission of shocks and only partly due to larger monetary policy surprises.
    Keywords: Monetary policy shocks, zero lower bound, shadow short rate, asset prices, latent factor model.
    JEL: E43 E52 E65
    Date: 2014–05
  17. By: Muhammad, Omer; de Haan, Jakob; Scholtens, Bert
    Abstract: We investigate the transmission mechanism of policy-induced changes in the discount rate and required reserves in Pakistan. Our results suggest that the pass through to the lending rate is complete for the discount rate but incomplete for required reserves. However, only shocks to required reserves have an effect on the deposit rate and the exchange rate in the long run. The observation that the discount rate is not a very effective monetary policy tool is attributed to excess liquidity present in the interbank market of Pakistan. Finally, our findings suggest a structural shift in the interbank money market in Pakistan.
    Keywords: Monetary transmission mechanism, Pakistan, excess liquidity, VAR
    JEL: E51 E52 E58 E61
    Date: 2014–05–23
  18. By: Nakov, Anton; Thomas, Carlos
    Abstract: This paper studies optimal monetary policy from the timeless perspective in a general model of state-dependent pricing. Firms are modeled as monopolistic competitors subject to idiosyncratic menu cost shocks. We find that, under certain conditions, a policy of zero inflation is optimal both in the long run and in response to aggregate shocks. Key to this finding is an "envelope" property: at zero inflation, a marginal increase in the rate of inflation has no effect on firms' profits and hence on their probability of repricing. We offer an analytic solution that does not require local approximation or e¢ ciency of the steady state. Under more general conditions, we show numerically that the optimal commitment policy remains very close to strict inflation targeting.
    Keywords: monetary policy; monopolistic competition; state-dependent pricing
    JEL: E31
    Date: 2014–02
  19. By: Bacchetta, Philippe; Benhima, Kenza; Kalantzis, Yannick
    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.
    Keywords: China; Exchange rate policy; International reserves
    JEL: E58 F31 F41
    Date: 2013–09
  20. By: Bianchi, Francesco; Ilut, Cosmin
    Abstract: We reinterpret post World War II US economic history using an estimated microfounded model that allows for changes in the monetary/fiscal policy mix. We find that the fiscal authority was the leading authority in the '60s and the '70s. The appointment of Volcker marked a change in the conduct of monetary policy, but inflation dropped only when fiscal policy accommodated this change two years later. In fact, a disinflationary attempt of the monetary authority leads to more inflation if not supported by the fiscal authority. If the monetary authority had always been the leading authority or if agents had been confident about the switch, the Great Inflation would not have occurred and debt would have been higher. This is because the rise in trend inflation and the decline in debt of the '70s were caused by a series of fiscal shocks that are inflationary only when monetary policy accommodates fiscal policy. The reversal in the debt-to-GDP ratio dynamics, the sudden drop in inflation, and the fall in output of the early '80s are explained by the switch in the policy mix itself. If such a switch had not occurred, inflation would have been high for another fifteen years. Regime changes account for the stickiness of inflation expectations during the '60s and the '70s and for the break in the persistence and volatility of inflation.
    Keywords: Bayesian estimation; DSGE; Fiscal policy; general equilbrium.; Great Inflation; Markov-switching
    JEL: E31 E52 E58 E62
    Date: 2013–09
  21. By: Ippolito, Filippo; Ozdagli, Ali; Perez Orive, Ander
    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 financial health; bank lending channel; firm financial constraints; floating interest rates; monetary policy transmission
    JEL: E52 G21 G32
    Date: 2013–10
  22. By: Mitsuhiro Okano (Asia Pacific Institute of Research)
    Abstract: In this paper, we show that how monetary policy should respond in the aftermath of a rare but large scale natural disaster such as typhoons and earthquakes, using simulation analysis from the view of New Keynesian perspective. Since the conditions for the simulation is different from previous studies, monetary tightening for inflation stabilization does not necessarily have better performance in the aftermath of a disaster shock.
    Keywords: monetary policynatural disaster
    JEL: E31 E32 E52 Q54
    Date: 2013–07
  23. By: Carlo Altavilla; Domenico Giannone
    Abstract: We assess the perception of professional forecasters regarding the effectiveness of unconventionalmonetary policy measures undertaken by the U.S. Federal Reserve after the collapse of LehmanBrothers. Using individual survey data, we analyse the changes in forecasting of bond yields aroundthe announcement and implementation dates of non-standard monetary policies. The resultsindicate that bond yields are expected to drop significantly for at least one year after theannouncement and the implementation of accommodative policies.
    Keywords: survey of professional forecasters; large scale asset purchases; quantitative easing; operation twist; forward guidance; tapering
    JEL: E58 E65
    Date: 2014–05
  24. By: Angeloni, Ignazio; Faia, Ester; Winkler, Roland
    Abstract: We study alternative scenarios for exiting the post-crisis fiscal and monetary accommodation using a macromodel where banks choose their capital structure and are subject to runs. Under a Taylor rule, the post-crisis interest rate hits the zero lower bound (ZLB) and remains there for several years. In that condition, pre-announced and fast fiscal consolidations dominate - based on output and inflation performance and bank stability - alternative strategies incorporating various degrees of gradualism and surprise. We also examine an alternative monetary strategy in which the interest rate does not reach the ZLB; the benefits from fiscal consolidation persist, but are more nuanced. --
    Keywords: exit strategies,debt consolidation,fiscal policy,fiscal multipliers,monetary policy,bank runs
    JEL: G01 E63 H12
    Date: 2014
  25. By: Cacciatore, Matteo; Fiori, Giuseppe; Ghironi, Fabio
    Abstract: The wave of crises that began in 2008 reheated the debate on market deregulation as a tool to improve economic performance. This paper addresses the consequences of increased flexibility in goods and labor markets for the conduct of monetary policy in a monetary union. We model a two-country monetary union with endogenous product creation, labor market frictions, and price and wage rigidities. Regulation affects producer entry costs, employment protection, and unemployment benefits. We first characterize optimal monetary policy when regulation is high in both countries and show that the Ramsey allocation requires significant departures from price stability both in the long run and over the business cycle. Welfare gains from the Ramsey-optimal policy are sizable. Second, we show that the adjustment to market reform requires expansionary policy to reduce transition costs. Third, deregulation reduces static and dynamic inefficiencies, making price stability more desirable. International synchronization of reforms can eliminate policy tradeoffs generated by asymmetric deregulation.
    Keywords: Market deregulation; Monetary union; Optimal monetary policy
    JEL: E24 E32 E52 F41 J64 L51
    Date: 2013–11
  26. By: Asongu Simplice (Yaoundé/Cameroun)
    Abstract: Economic theory traditionally suggests that monetary policy can influence the business cycle, but not the long-run potential output. Despite well documented theoretical and empirical consensus on money neutrality in the literature, the role of money as an informational variable for monetary policy decision has remained opened to debate with empirical works providing mixed outcomes. This paper addresses two substantial challenges to this debate: the neglect of developing countries in the literature and the use of new financial dynamic fundamentals that broadly reflect monetary policy. The empirics are based on annual data from 34 African countries for the period 1980 to 2010. Using a battery of tests for integration and long-run equilibrium properties, results offer overall support for the traditional economic theory.
    Keywords: Monetary policy; Credit; Empirics; Africa
    JEL: E51 E52 E58 E59 O55
    Date: 2013–09
  27. By: Huang, Yiping (Asian Development Bank Institute); Wang, Daili (Asian Development Bank Institute); Fan, Gang (Asian Development Bank Institute)
    Abstract: In this paper we try to address the question of what could help make the renminbi (RMB) a reserve currency. In recent years, the authorities in the People's Republic of China (PRC) have made efforts to internationalize its currency through a two-track strategy: promotion of the use of the RMB in the settlement of cross-border trade and investment, and liberalization of the capital account. We find that if we use only the quantitative measures of the economy, the predicted share of the RMB in global reserves could reach 12%. However, if institutional and market variables are included, the predicted share comes down to around 2%, which is a more realistic prediction. By reviewing experiences of other reserve currencies, we propose a three-factor approach for the PRC authorities to promote the international role of the RMB: (i) increasing the opportunities of using RMB in the international community, which requires relatively rapid growth of the PRC economy and continuous liberalization of trade and investment; (ii) improving the ease of using RMB, which requires depth, sophistication, and liquidity of financial markets; and (iii) strengthening confidence of using RMB, which requires more transparent monetary policy making, a more independent legal system, and some political reforms. In general, we believe that the RMB's international role should increase in the coming years, but it will take a relatively long period before it plays the role of a global reserve currency.
    Keywords: RMB internationalization; reserve currency; anchor currency; capital account openness
    JEL: F30 F33 F36 F42
    Date: 2014–05–26
  28. By: Delatte, Anne-Laure; Fouquau, Julien; Holz, Carsten
    Abstract: Fundamental changes in institutions during the transition from a centrally planned to a market economy present a formidable challenge to monetary policy decision makers. For the case of China, we examine the institutional changes in the monetary system during the process of transition and develop money demand functions that reflect these institutional changes. We consider seasonal unit roots and estimate long run, equilibrium money demand functions, explicitly taking into consideration the changes in the institutional characteristics of China's financial system. Using a newly compiled dataset that covers an unprecedented long time period of 1984-2010 at the quarterly frequency, we are able to draw conclusions on the transitions in households', firms', and aggregate money demand, on the role of the credit plan and interest rates, on the mechanisms of macroeconomic control during economic transition, and on theoretical questions in the development and money literature.
    Keywords: Chinese economy; cointegration; complementary hyopthesis; money demand; seasonal unit root
    JEL: C51 E41 O11 P24 P52
    Date: 2013–11
  29. By: Roberto Chang
    Date: 2013–12–09
  30. By: Gabaix, Xavier; Maggiori, Matteo
    Abstract: We provide a theory of the determination of exchange rates based on capital flows in imperfect financial markets. Capital flows drive exchange rates by altering the balance sheets of financiers that bear the risks resulting from international imbalances in the demand for financial assets. Such alterations to their balance sheets cause financiers to change their required compensation for holding currency risk, thus impacting both the level and volatility of exchange rates. Our theory of exchange rate determination in imperfect financial markets not only rationalizes the empirical disconnect between exchange rates and traditional macroeconomic fundamentals, but also has real consequences for output and risk sharing. Exchange rates are sensitive to imbalances in financial markets and seldom perform the shock absorption role that is central to traditional theoretical macroeconomic analysis. We derive conditions under which heterodox government financial policies, such as currency interventions and taxation of capital flows, can be welfare improving. Our framework is flexible; it accommodates a number of important modeling features within an imperfect financial market model, such as non-tradables, production, money, sticky prices or wages, various forms of international pricing-to-market, and unemployment.
    Keywords: Capital Flows; Exchange Rate Disconnect; Foreign Exchange Intervention; Limits of Arbitrage
    JEL: E42 E44 F31 F32 F41 F42 G11 G15 G20
    Date: 2014–02
  31. By: Bachmann, Rüdiger; Born, Benjamin; Elstner, Steffen; Grimme, Christian
    Abstract: Does time-varying business volatility affect the price setting of firms and thus the transmission of monetary policy into the real economy? To address this question, we estimate from the firm-level micro data of the German IFO Business Climate Survey the impact of idiosyncratic volatility on the price setting behavior of firms. In a second step, we use a calibrated New Keynesian business cycle model to gauge the effects of time-varying volatility on the transmission of monetary policy to output. Heightened business volatility increases the probability of a price change, though the effect is small: the tripling of volatility during the recession of 08/09 caused the average quarterly likelihood of a price change to increase from 31.6% to 32.3%. Second, the effects of this increase in volatility on monetary policy are also small; the initial effect of a 25 basis point monetary policy shock to output declines from 0.347% to 0.341%.
    Keywords: monetary; New Keynesian model; price setting; survey data; time-varying volatility
    JEL: E30 E31 E32 E50
    Date: 2013–10
  32. By: Estrada García, Ángel; Galí, Jordi; Lopez-Salido, David
    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: competitiveness; current account imbalances; inflation differentials; labor markets; macroeconomic convergence; relative prices
    JEL: E24 F31 O47
    Date: 2013–10
  33. By: Diana Bonfim; Carla Soares
    Abstract: It is well established that when monetary policy is accommodative, banks tend to grant more credit. However, only recently attention was given to the quality of credit granted and, naturally, the risk assumed during those periods. This article makes an empirical contribution to the analysis of the so-called risk-taking channel of monetary policy. We use bank loan level data and different methodologies to test whether banks assume more credit risk when monetary policy interest rates are lower. Our results provide evidence in favor of this channel through different angles. We show that banks, most notably smaller banks, grant more loans to non-financial corporations with recent defaults or without credit history when policy interest rates are lower. We also find that loans granted when interest rates are low are more likely to default in the hiking phase of the interest rate cycle. However, the level of policy interest rates at the moment of loan concession does not seem to be relevant for the ex-post probability of default of the overall loan portfolio.
    JEL: E44 E5 G21
    Date: 2014
  34. By: Alvarez, Fernando; Le Bihan, Hervé; Lippi, Francesco
    Abstract: We document the presence of both small and large price changes in individual price records from the CPI in France and the US. After correcting for measurement error and cross-section heterogeneity we find that the size distribution of price changes has a positive excess kurtosis, with a shape that lies between a Normal and a Laplace distribution. We propose a model, featuring random menu-costs and multi product firms, that is capable to reproduce the observed empirical patterns. We characterize analytically the response of the aggregate economy to a monetary shock. Different propagation mechanism, spanning the models of Taylor (1980), Calvo (1983) and Golosov and Lucas (2007), are nested under different combination of 4 fundamental parameters. We dis- cuss the identification of these parameters using data on the size-distribution of price changes and the actual cost of price adjustments borne by firms. The output effect is proportional to the ratio of kurtosis to the frequency of price changes.
    Keywords: Calvo pricing rule; distribution of price changes; menu cost; micro evidence; monetary shocks; rice setting
    JEL: E3 E5
    Date: 2013–12
  35. By: Sheedy, Kevin D.
    Abstract: Financial markets are incomplete, thus for many households borrowing is possible only by accepting a financial contract that specifies a fixed repayment. However, the future income that will repay this debt is uncertain, so risk can be inefficiently distributed. This paper argues that a monetary policy of nominal GDP targeting can improve the functioning of incomplete financial markets when incomplete contracts are written in terms of money. By insulating households' nominal incomes from aggregate real shocks, this policy effectively completes financial markets by stabilizing the ratio of debt to income. The paper argues the objective of replicating complete financial markets should receive substantial weight even in an environment with other frictions that have been used to justify a policy of strict inflation targeting.
    Keywords: heterogeneous agents; incomplete markets; nominal GDP targeting; risk sharing
    JEL: E21 E31 E44 E52
    Date: 2014–02
  36. By: Miles, David K; Schanz, Jochen
    Abstract: This paper explores the impacts on an economy of a central bank changing the size and composition of its balance sheet. One of the ways in which such asset purchases could influence prices and demand is via portfolio balance effects. We develop and calibrate a simple OLG model in which risk-averse households hold money and bonds to insure against risk. Central bank asset purchases have the potential to affect households' choices by changing the composition and return of their asset portfolios. We find that the effect is weak, and that its size depends on how fiscal policy is conducted. That is not to say that the big expansion of central bank balance sheets in recent years has been ineffective. Our finding is rather that the portfolio balance channel evaluated in an environment of normally functioning (though nonetheless incomplete) asset markets is weak. That is not inconsistent with the evidence that large-scale asset purchases by central banks since 2008 have had significant effects, because those purchases were made when financial markets were, to varying extents, dysfunctional. Nonetheless our results are relevant to those purchases because they may be unwound in an environment where financial markets are no longer dysfunctional.
    Keywords: Quantitative Easing; Unconventional Monetary Policy
    JEL: E51 E52
    Date: 2014–02
  37. By: Stephen M. Miller (Department of Economics, University of Nevada, Las Vegas, Las Vegas, Nevada, 89154-6005 USA); Luis F. Martins (ISCTE-IUL Business School, Lisbon, Portugal); Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: Money demand specifications exhibits instability, especially for long spans of data. This paper reconsiders the welfare cost of inflation for the US economy using a flexible time-varying cointegration methodology to estimate the money demand function. We find evidence that the time-varying cointegration estimation provides a better fit of the actual data than a time-invariant estimation and that the throughout unitary income elasticity only exists for the log-log form over the entire sample period. Our estimate of the welfare cost of inflation for a 10-percent inflation rate lies in the range of 0.025 to 0.75 percent of GDP and averages 0.27 percent. In sum, our findings fall well within the ranges of existing studies of the welfare cost of inflation. Finally, the interest elasticity of money demand shows substantial variability over our sample period.
    Keywords: Money Demand Function, Welfare cost of inflation, Time-varying cointegration
    JEL: C32 E52 G10
    Date: 2014–05
  38. By: Bianchi, Francesco; Melosi, Leonardo
    Abstract: While high uncertainty is an inherent implication of entering the zero lower bound, deflation is not, because agents are likely to be uncertain about the way policy makers will deal with the large stock of debt arising from a severe recession. We draw this conclusion based on a standard new-Keynesian model in which policy makers' behavior can move between a Monetary and a Fiscally led regime and zero lower bound episodes are recurrent. Given that policy makers' behavior is constrained at the zero lower bound, beliefs about the exit strategy play a key role. Announcing a period of austerity is detrimental in the short run, but it preserves macroeconomic stability in the long run. A large recession can be avoided by abandoning fiscal discipline, but this results into a sharp increase in macroeconomic instability once out of the recession. Contradictory announcements by the fiscal and monetary authorities can lead to high inflation and large output losses. However, the policy makers' dilemma can be resolved by committing to inflate away only the portion of debt resulting from an unusually large recession.
    Keywords: Markov-switching DSGE; Monetary and fiscal policy interaction; shock-specific policy rules; Uncertainty; zero lower bound
    JEL: D83 E31 E52 E62 E63
    Date: 2013–09
  39. By: Thorvald Grung-Moe
    Abstract: Central banks responded with exceptional liquidity support during the financial crisis to prevent a systemic meltdown. They broadened their tool kit and extended liquidity support to nonbanks and key financial markets. Many want central banks to embrace this expanded role as "market maker of last resort" going forward. This would provide a liquidity backstop for systemically important markets and the shadow banking system that is deeply integrated with these markets. But how much liquidity support can central banks provide to the shadow banking system without risking their balance sheets? I discuss the expanding role of the shadow banking sector and the key drivers behind its growing importance. There are close parallels between the growth of shadow banking before the recent financial crisis and earlier financial crises, with rapid growth in near monies as a common feature. This ebb and flow of shadow-banking-type liabilities are indeed an ingrained part of our advanced financial system. We need to reflect and consider whether official sector liquidity should be mobilized to stem a future breakdown in private shadow banking markets. Central banks should be especially concerned about providing liquidity support to financial markets without any form of structural reform. It would indeed be ironic if central banks were to declare victory in the fight against too-big-to-fail institutions, just to end up bankrolling too-big-to-fail financial markets.
    Keywords: Financial Regulation; Financial Stability; Monetary Policy; Central Bank Policy
    JEL: E44 E52 E58 G28
    Date: 2014–05
  40. By: HOSONO Kaoru; MIYAKAWA Daisuke
    Abstract: This paper examines the impact of business cycles and monetary policy on bank loan supply. To this end, we use a unique firm-bank match-level dataset covering listed firms in Japan that allows us to control for firms' time-varying unobservable loan demand and endogenous bank-firm matching, so that we can identify the effects of business cycles and monetary policy on loan supply through the bank balance sheet channel. The estimation results indicate that banks with more liquidity or capital tend to lend more to their client firms. The quantitative impact of bank liquidity and capital on loan supply was economically sizable and larger when economic growth was lower. Furthermore, the quantitative impact of bank liquidity on the growth rate of loans more than doubled when quantitative easing was terminated. Overall, these results imply that changes in economic growth and monetary policy significantly affected loan supply through the bank balance sheet channel. We also find evidence that fluctuations in economic growth and monetary policy are transmitted to capital investment through the bank balance sheet channel in the case of firms with high investment opportunities.
    Date: 2014–05
  41. By: Kinda Hachem; Jing Cynthia Wu
    Abstract: We investigate the effectiveness of central bank communication when firms have heterogeneous inflation expectations that are updated through social dynamics. The bank's credibility evolves with these dynamics and determines how well its announcements anchor expectations. We find that trying to eliminate high inflation by abruptly introducing low inflation targets generates short-term overshooting. Gradual targets, in contrast, achieve a smoother disinflation. We present empirical evidence to support these predictions. Gradualism is not equally effective in other situations though: our model predicts aggressive announcements are more powerful when combating deflation.
    JEL: E17 E3 E58
    Date: 2014–05

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