nep-mon New Economics Papers
on Monetary Economics
Issue of 2014‒07‒28
twenty-one papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Hot Money Flows, Cycles in Primary Commodity Prices, and Financial Control in Developing Countries By Ronald McKINNON
  2. Costs and Benefits to Phasing Out Paper Currency By Rogoff, Kenneth S.
  3. Shocks to Bank Lending, Risk-Taking, Securitization, and their Role for U.S. Business Cycle Fluctuations By G. PEERSMAN; W. WAGNER
  4. Asset markets and monetary policy shocks at the zero lower bound By Edda Claus; Iris Claus; Leo Krippner
  5. Shifting Mandates: The Federal Reserve's First Centennial By Reinhart, Carmen M.; Rogoff, Kenneth S.
  6. Macroeconomic Regimes By L. BAELE; G. BEKAERT; S. CHO; K. INGHELBRECHT; A. MORENO
  7. Reputation and Liquidity Traps By Taisuke Nakata
  8. Are there Differences in the Effectiveness of Quantitative Easing in Japan over Time? By Michaelis, Henrike; Watzka, Sebastian
  9. The Impact of Monetary Policy and Exchange Rate Shocks in Poland: Evidence from a Time-Varying VAR By Arratibel, Olga; Michaelis, Henrike
  10. Monetary and Fiscal Policy with Sovereign Default By Joost Röttger
  11. Households credits and financial stability By Cécile Bastidon
  12. Changes in the Response of Fiscal Policy to Monetary Policy in the EMU By Sanchit Arora; Claire Reicher
  13. How Much Do Official Price Indexes Tell Us About Inflation? By Tsutomu Watanabe; David Weinstein; Jessie Handbury
  14. Inflation Targeting and Public Deficit in Emerging Countries: A Time Varying Treatment Effect Approach By Kadria, Mohamed; Ben Aissa, Mohamed Safouane
  15. Endogenous Fluctuations in an Endogenous Growth Model with Infl ation Targeting By Rangan Gupta; Lardo Stander
  16. Alternatives to Currency Manipulation: What Switzerland, Singapore, and Hong Kong Can Do By Joseph E. Gagnon
  17. Examining real interest parity: which component reverts quickest and in which regime? By Kavita Sirichand; Andrew Vivian
  18. Estimates of Fundamental Equilibrium Exchange Rates, May 2014 By William R. Cline
  19. Internationalization of the Renminbi: The Role of Trade Settlement By Joseph E. Gagnon; Kent Troutman
  20. Bid-Ask Spread Components on the Foreign Exchange Market: Quantifying the Risk Component By M. FRÖMMEL; F VAN GYSEGEM
  21. Is the Eurozone on the Mend? Latin American Examples to Analyze the Euro Question By Eduardo A. Cavallo; Eduardo Fernández Arias; Andrew Powell

  1. By: Ronald McKINNON (Université de Stanford)
    Abstract: Because the U.S. Federal Reserve’s monetary policy is at the center of the world dollar standard, it has a first-order impact on global financial stability. However, except during international crises, the Fed focuses on domestic American economic indicators and generally ignores collateral damage from its monetary policies on the rest of the world. Currently, ultra-low interest rates on short-term dollar assets ignite waves of hot money into Emerging Markets (EM) with convertible currencies. When each EM central bank intervenes to prevent its individual currency from appreciating, collectively they lose monetary control, inflate, and cause an upsurge in primary commodity prices internationally. These bubbles burst when some accident at the center, such as a banking crisis, causes a return of the hot money to the United States (and to other industrial countries) as commercial banks stop lending to foreign exchange speculators. World prices of primary products then collapse. African countries with exchange controls and less convertible currencies are not so attractive to currency speculators. Thus, they are less vulnerable than EM to the ebb and flow of hot money. However, African countries are more vulnerable to cycles in primary commodity prices because food is a greater proportion of their consumption, and—being less industrialized—they are more vulnerable to fluctuations in prices of their commodity exports. Supply-side shocks, such as a crop failure anywhere in the world, can affect the price of an individual commodity.  But joint fluctuations in the prices of all primary products— minerals, energy, cereals, and so on—reflect monetary conditions in the world economy as determined by the ebb and flow of hot money from the United States, and increasingly from other industrial countries with near-zero interest rates.
    Date: 2014–07
  2. By: Rogoff, Kenneth S.
    Abstract: Despite advances in transactions technologies, paper currency still constitutes a notable percentage of the money supply in most countries. For example, it constitutes roughly 10% of the US Federal Reserve’s main monetary aggregate, M2. Yet, it has important drawbacks. First, it can help facilitate activity in the underground (tax-evading) and illegal economy. Second, its existence creates the artifact of the zero bound on the nominal interest rate. On the other hand, the enduring popularity of paper currency generates many benefits, including substantial seigniorage revenue. This paper explores some of the issues associated with phasing out paper currency, especially large-denomination notes.
    Date: 2014
  3. By: G. PEERSMAN; W. WAGNER (-)
    Abstract: Shocks to bank lending, risk-taking and securitization activities that are orthogonal to real economy and monetary policy innovations account for more than 30 percent of U.S. output variation. The dynamic effects, however, depend on the type of shock. Expansionary securitization shocks lead to a permanent rise in real GDP and a fall in inflation. Bank lending and risktaking shocks, in contrast, have only a temporary effect on real GDP and tend to lead to a (moderate) rise in the price level. Furthermore, there is evidence for a strong search-for-yield effect on the side of investors in the transmission mechanism of monetary policy. These effects are estimated with a structural VAR model, where the shocks are identified using a model of bank risk-taking and securitization.
    Keywords: Bank lending, risk-taking, securitization, SVARs
    JEL: C32 E30 E44 E51 E52
    Date: 2014–02
  4. By: Edda Claus; Iris Claus; Leo Krippner (Reserve Bank of New Zealand)
    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.
    JEL: E43 E52 E65
    Date: 2014–07
  5. By: Reinhart, Carmen M.; Rogoff, Kenneth S.
    Abstract: The Federal Reserve's mandate has evolved considerably over the organization's hundred-year history. It was changed from an initial focus in 1913 on financial stability, to fiscal financing in World War II and its aftermath, to a strong anti-inflation focus from the late 1970s, and then back to greater emphasis on financial stability since the Great Contraction. Yet, as the Fed's mandate has expanded in recent years, its range of instruments has narrowed, partly based on a misguided belief in the inherent stability of financial markets. We argue for a return to multiple instruments, including a more active role for reserve requirements.
    Date: 2013
    Abstract: We estimate a New-Keynesian macro model accommodating regime-switching behavior in monetary policy and in macro shocks. Key to our estimation strategy is the use of survey-based expectations for inflation and output. Output and inflation shocks shift to the low volatility regime around 1985 and 1990, respectively. However, we also identify multiple shifts between accommodating and active monetary policy regimes, which play an as important role as shock volatility in driving the volatility of the macro variables. We provide new estimates of the onset and demise of the Great Moderation and quantify the relative role played by macro-shocks and monetary policy. The estimated rational expectations model exhibits indeterminacy in the mean-square stability sense, mainly because monetary policy is excessively passive.
    Keywords: Markov-Switching (MS) DSGE models, Survey Expectations, Great Moderation, Monetary Policy, Determinacy in MS DSGE models
    JEL: E31 E32 E52 E58 C42 C53
    Date: 2013–12
  7. By: Taisuke Nakata (Federal Reserve Board)
    Abstract: This paper studies credible policies in a New Keynesian economy in which the nominal interest rate is subject to the ZLB constraint and contractionary shocks hit the economy occasionally. The Ramsey policy involves keeping the policy rate low even after the shock disappears, but the central bank would be tempted to raise the rate to close consumption and inflation gaps if it could re-optimize. I find that the Ramsey policy is credible if the contractionary shock occurs sufficiently frequently. In the best credible plan, if the central bank reneges on the promise of low policy rates, it will lose reputation and the private sector will not believe such promises in future recessions. When the shock hits the economy sufficiently frequently, the incentive to maintain reputation outweighs the short-run incentive to close consumption and inflation gaps, and keeps the central bank on the originally announced path of low nominal interest rates.
    Date: 2014
  8. By: Michaelis, Henrike; Watzka, Sebastian
    Abstract: Using a time-varying parameter vector autoregression (TVP-VAR) with a new sign restriction framework, we study the changing effectiveness of the Bank of Japan's Quantitative Easing policies over time. We analyse the Zero-Interest Rate Policy from 1999 to 2000, the Quantitative Easing Policy from 2001 to 2006, and most recently the ‘Abenomics' monetary policy easing strategy. Our results indicate that there are important differences concerning the effects of Quantitative Easing over time. We find a stronger and longer lasting positive influence of QE shocks on real GDP and CPI especially since 2013. This might reflect the influence of the ‘Abenomics' program.
    Keywords: Bayesian time-varying parameter VAR; monetary policy; quantitative easing; zero lower bound
    JEL: C30 E44 E52 F41
    Date: 2014–06
  9. By: Arratibel, Olga; Michaelis, Henrike
    Abstract: This paper follows the Bayesian time-varying VAR approach with stochastic volatility developed by Primiceri (2005), to analyse whether the reaction of output and prices to interest rate and exchange rate shocks has changed across time (1996-2012) in the Polish economy. The empirical findings show that: (1) output appears more responsive to an interest rate shock at the beginning of our sample. Since 2000, absorbing this shock has become less costly in terms of output, notwithstanding some reversal since the beginning of the global financial crisis. The exchange rate shock also has a time-varying effect on output. From 1996 to 2000, output seems to decline, whereas for periods between 2000 and 2008 it has a positive significant effect. (2) Consumer prices appear more responsive to an interest rate shock during the first half of our sample, when Poland experienced high inflation. The impact of an exchange rate shock on prices seems to slightly decrease across time.
    Keywords: Bayesian time-varying parameter VAR; monetary policy transmission; exchange rate passthrough
    JEL: C30 E44 E52 F41
    Date: 2013–12
  10. By: Joost Röttger
    Abstract: How does the option to default on debt payments affect the conduct of public policy? To answer this question, this paper studies optimal monetary and fiscal policy without commitment in a model with nominal debt and endogenous sovereign default. When the government can default on its debt, public policy changes in the short and the long run relative to a setting without default option. The risk of default increases the volatility of interest rates, impeding the government's ability to smooth tax distortions across states. It also limits public debt accumulation and reduces the government's incentive to implement high inflation in the long run. The welfare costs associated with the short-run effects of sovereign default are found to be outweighed by the welfare gains due to lower average debt and inflation.
    Keywords: Monetary and Fiscal Policy, Lack of Commitment, Sovereign Default, Domestic Debt, Markov-Perfect Equilibrium
    JEL: E31 E63 H63
    Date: 2014–06–02
  11. By: Cécile Bastidon (LEAD - Laboratoire d'Économie Appliquée au Développement - Université de Toulon : EA3163)
    Abstract: This paper develops a theoretical model of financial intermediation with three original features: first, consideration of all sectors within total outstanding credits, including households; second, the possibility of a non monotic relationship between prices and funding supply volumes in periods of high financial strains; last, the link between interbank credit rationing and other sectors funding rationing. The central bank conducts an unconventional type monetary policy. We show that the intermediation chain characteristics then determine the conditions of transmission of a shock on financing costs and the modalities for the resulting monetary policy.
    Keywords: Financial intermediation model, households credits, Central Banks
    Date: 2014–06–04
  12. By: Sanchit Arora; Claire Reicher
    Abstract: We study the evolution of the response of scal policy to monetary policy shocks in the EMU in the light of two important events: the signing of the Maastricht treaty in 1992 and the introduction of the EMU in 1999. Based on impulse responses from a panel VAR, we nd that scal and monetary policy acted neutrally toward each other before the Maastricht Treaty; scal and monetary policy acted as substitutes immediately after the Maastricht Treaty; and scal and monetary policy acted as complements after the introduction of the EMU. These results holds for a set of 11 non-EMU countries as well, which indicates that the evolution of the scal response to monetary shocks within the EMU has broadly mirrored global developments. One example of such a global development is the global shift toward lower interest rates and tighter scal policy during the 1990s
    Keywords: monetary policy, scal policy, panel VAR, Maastricht Treaty, EMU
    JEL: E52 E62 E65
    Date: 2014–06
  13. By: Tsutomu Watanabe (Hitotsubashi University); David Weinstein (Columbia University); Jessie Handbury (University of Pennsylvania)
    Abstract: Official price indexes, such as the CPI, are imperfect indicators of inflation calculated using ad hoc price formulae different from the theoretically well-founded inflation indexes favored by economists. This paper provides the first estimate of how accurately the CPI informs us about “true†inflation. We use the largest price and quantity dataset ever employed in economics to build a Törnqvist inflation index for Japan between 1989 and 2010. Our comparison of this true inflation index with the CPI indicates that the CPI bias is not constant but depends on the level of inflation. We show the informativeness of the CPI rises with inflation. When measured inflation is low (less than 2.4% per year) the CPI is a poor predictor of true inflation even over 12-month periods. Outside this range, the CPI is a much better measure of inflation. We find that the U.S. PCE Deflator methodology is superior to the Japanese CPI methodology but still exhibits substantial measurement error and biases rendering it a problematic predictor of inflation in low inflation regimes as well.
    Date: 2014
  14. By: Kadria, Mohamed; Ben Aissa, Mohamed Safouane
    Abstract: Several studies including Minea,Tapsoba and Villieu(2012) and Lucotte (2012) claim that in emerging countries, the adoption of inflation targeting(IT) monetary policy and its discipline character allow intensifying their efforts to collect tax revenue and/or expenditure rationalization, and allows the reduction of their budget deficits (Kadria and Ben Aissa, 2014). But, the lag in the effect of monetary policy contains vital information for the policy evaluation (Fang and Miller, 2011). Hence, our contribution to the previous literature is then to evaluate the time varying treatment effect of the IT's adoption by emerging countries on their budgetary discipline in terms of reducing or mastering the public deficit. To do this, we used the propensity score matching approach in order to take account of this "lag effect" or from this effect throughout time. Our empirical analysis, conducted on a sample of 41 economies (20 IT and 21 non-IT economies) for the period from 1990 to 2010, shows that the lag in effect of IT on public deficit performance proves to be shorter and gradual for emerging countries that have adopted this monetary policy framework and our conclusions corroborate the literature disciplining effect of IT on fiscal policy.
    Keywords: Time lag, inflation targeting, public deficit, time varying treatment effect evaluation, propensity score matching, emerging countries.
    JEL: C5 E5 E6 H6
    Date: 2014–05
  15. By: Rangan Gupta (Department of Economics, University of Pretoria); Lardo Stander (Department of Economics, University of Pretoria)
    Abstract: This paper develops a monetary endogenous growth overlapping generations model characterized by production lags - specifically lagged capital inputs - and an infl ation targeting monetary authority, and analyses the growth dynamics that emerge from this framework. The growth process is endogenized by allowing productive government expenditure on infrastructure, complementing the lagged private capital input. Following the extant literature, money is introduced by imposing a cash reserve requirement on an otherwise competitive banking sector. Given this framework, we show that multiple equilibria emerge along different growth paths, with the low-growth (high-growth) equilibrium being unstable (stable) and locally determinate (locally indeterminate). In addition, we show that convergent or divergent endogenous fl uctuations and even topological chaos could emerge around the high-growth equilibrium in the growth path where the monetary authority follows a high infl ation targeting regime. Conversely, when the monetary authority follows a low infl ation targeting regime, oscillations do not occur around either the low-growth or high-growth equilibrium.
    Keywords: Endogenous fl uctuations, in flation targeting, chaos, production lags, indeterminacy
    JEL: C62 E32 O42
    Date: 2014–06
  16. By: Joseph E. Gagnon (Peterson Institute for International Economics)
    Abstract: Economists have long decried the efforts of large, advanced economies to manipulate their currencies to boost net exports at their trading partners' expense. But the International Monetary Fund appears to have ignored the beggar-thy-neighbor exchange rate policies of countries with developed, highly open economies. This Policy Brief examines Switzerland, Singapore, and Hong Kong, which have actively kept the value of their currencies low since the 2008–09 global recession. In each case, greater fiscal and especially domestic monetary ease would have achieved similar macroeconomic outcomes with less currency intervention and declining current account surpluses. If such countries had adopted these strategies to increase domestic demand, the global economy would have rebounded faster.
    Date: 2014–05
  17. By: Kavita Sirichand (School of Business and Economics, Loughborough University); Andrew Vivian (School of Business and Economics, Loughborough University Mark E.Wohar; Department of Economics, University of Nebraska-Omaha, Omaha, Nebraska, USA.)
    Abstract: This article re-examines real interest parity (RIP), focusing upon which component of real interest parity drives convergence to parity. We find that it is the reversion of inflation rather than nominal interest rates which is the primary source of convergence to RIP. Nominal interest rate differential are found to be persistent during both periods. Furthermore, we additionally find that mean reversion in the inflation differentials is faster during the Gold Standard period.
    Keywords: comovement, real interest rate parity, inflation differential, nominal interest
    JEL: G10 G15 G30
    Date: 2014–07
  18. By: William R. Cline (Peterson Institute for International Economics)
    Abstract: The latest estimates of fundamental equilibrium exchange rates (FEERs) in this semiannual series indicate that the currencies of the United States, the euro area, China, and Japan are approximately at their FEER levels and need no adjustment to reduce excessive external imbalances. The medium-term current account, however, is at the lower bound of the desired range for the United States and at the upper bound for the euro area and China. For Japan, even though a large improvement in the current account remains in the pipeline from the lagged influence of the past sharp depreciation of the yen, higher fuel import costs and export weakness mean the surplus is unlikely to rise above 3 percent of GDP; the new FEER estimate for the yen is therefore significantly lower than before. A familiar list of currencies remain persistently overvalued (New Zealand, Turkey, South Africa, and Brazil) and undervalued (Singapore, Taiwan, Sweden, and Switzerland).
    Date: 2014–05
  19. By: Joseph E. Gagnon (Peterson Institute for International Economics); Kent Troutman (Peterson Institute for International Economics)
    Abstract: The renminbi (RMB) is not yet an international currency that could challenge the position of the dollar or the euro, but it is heading in that direction. Chinese officials support the limited goal of increasing usage of the RMB in international transactions, but they do not publicly advocate full reserve-currency status and free convertibility that such status would require. Yet international use of the RMB is an important element of China's reform agenda. China has announced the opening of offshore RMB centers in Hong Kong, Singapore, Taipei, London, Frankfurt, Paris, and Luxembourg, to the delight of offshore investors eager to invest in the RMB, which has not depreciated significantly against the dollar since 1994 and is widely viewed as having further room for appreciation given China's strong economic fundamentals. The ability of Chinese exporters and importers to make and accept payments in RMB is helping to drive the growth of offshore RMB markets. The excess of settlements in RMB by Chinese importers over RMB settlement by Chinese exporters leads to growing volumes of RMB deposits offshore. But the RMB cannot become a true international currency until Chinese authorities drop their strict limits on capital flows between China and the rest of the world.
    Date: 2014–05
    Abstract: We study the tightness of the complete electronic interbank foreign exchange market for the HUF/ EUR over a two year period. First, we review the cost components that a liquidity provider on this type of market faces, and integrate them in an empirical spread decomposition model. Second, we estimate the bid-ask spread components on an intraday basis, and find that order processing costs account for 47.09% of the spread and that, the combined inventory holding and adverse selection risk component accounts for 52.52% of the spread. In addition, we provide evidence for an endogenous tick size that accounts for one third of the order processing costs and we also estimate the number of liquidity providers based on the risk component. Third, we apply the model to some interesting spread patterns. Using our model we investigate the stylized difference in spreads between peak-times and non-peak times. We find that the combined compensation for inventory holding and adverse selection risk increases during non-peak times, particularly because the risk that a liquidity provider will have to carry an inventory overnight rises. Furthermore, we apply the model to the interesting spread pattern around a speculative attack. Here, credibility of the exchange rate band, competition amongst liquidity providers and increased volatility are key in understanding what happens during this episode of extreme turmoil.
    Keywords: microstructure, foreign exchange, spread, Hungary, inventory, adverse selection, liquidity
    JEL: F31 G15
    Date: 2014–03
  21. By: Eduardo A. Cavallo; Eduardo Fernández Arias; Andrew Powell
    Abstract: Several European countries face challenges reminiscent of those faced by the emerging economies of Latin America. The economic booms in some peripheral Euro-zone countries financed by large capital inflows; the credit and asset price booms and then the busts including Sudden Stops in capital flows; the strong interaction between sovereign debt and domestic banking systems; the role of foreign banks and contagion; and all in the context of a fixed exchange rate, are familiar plotlines for Latin American audiences. For those Euro-zone countries that built up large Euro-denominated external liabilities, Latin America's experience is particularly relevant and worrisome. Still, Europe may be in a better position to navigate a path out of the crisis given cooperative mechanisms that were absent in Latin America, particularly the availability of massive liquidity support. Nonetheless, while such support buys time, it does not guarantee success. This paper argues that reflecting on Latin America's experience provides useful lessons for Europe to improve the chances for a successful resolution.
    Keywords: Financial Crises & Economic Stabilization, Financial Policy, Public debt, Latin America, Financial crisis, Euro, Debt overhang, Banking crisis, Sudden Stops, Real devaluations, Currency union, Fiscal devaluation
    Date: 2014–07

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