nep-mon New Economics Papers
on Monetary Economics
Issue of 2014‒08‒02
eleven papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. The Excess Demand Theory of Money By Kehrwald, Bernie
  2. The Macroeconomics of Shadow Banking By Alan Moreira; Alexi Savov
  3. Overaccumulation, Interest, and Prices By Christopher M. Gunn
  4. The role of liquidity shocks in the housing market By de La Paz, Paloma Taltavull; White, Michael
  5. Rebalancing Frequency and the Welfare Cost of Inflation By Andre C. Silva
  6. Foreign exchange reserve diversification and the "exorbitant privilege" By Pietro Cova; Patrizio Pagano; Massimiliano Pisani
  7. A banking union for Europe: making a virtue out of necessity By Maria Abascal; Tatiana Alonso; Santiago Fernandez de Lis; Wojciech Golecki
  8. On the Quantity Theory of Money, Credit, and Seigniorage By Soldatos, Gerasimos T.; Varelas, Erotokritos
  9. Identification of financial factors in economic fluctuations By Francesco Furlanetto; Francesco Ravazzolo; Samad Sarferaz
  10. Lessons from the European Financial Crisis By Marco Pagano
  11. Macroeconomic and credit forecasts in a small economy during crisis: A large Bayesian VAR approach By Dimitris P. Louzis

  1. By: Kehrwald, Bernie
    Abstract: This paper introduces a new monetary theory. A simple model is described in which a central bank sets the interest rate in a way that the excess demand for credits equals the preferred amount of money. It is compatible with the Keynesian liquidity preference theory and the neoclassical loanable funds theory and can be used to explain a series of phenomena. It is very suitable for introductory textbooks.
    Keywords: money, interest rate, credit, central bank, savings, investments
    JEL: E40 E50 E51
    Date: 2014–07–27
  2. By: Alan Moreira; Alexi Savov
    Abstract: We build a macroeconomic model that centers on liquidity transformation in the financial sector. Intermediaries maximize liquidity creation by issuing securities that are money-like in normal times but become illiquid in a crash when collateral is scarce. We call this process shadow banking. A rise in uncertainty raises demand for crash-proof liquidity, forcing intermediaries to delever and substitute toward safe, collateral- intensive liabilities. Shadow banking shrinks, causing the liquidity supply to contract, discount rates and collateral premia spike, prices and investment fall. The model produces slow recoveries, collateral runs, and flight to quality and it provides a framework for analyzing unconventional monetary policy and regulatory reform proposals.
    JEL: E44 E52 G01 G21 G23
    Date: 2014–07
  3. By: Christopher M. Gunn (Department of Economics, Carleton University)
    Abstract: An emerging view of business cycles from the news-shock literature suggests that recessions may occur when agents depress their demand for new capital upon the realization that they have accumulated too much conditional on current information. In this paper I use a New Keynesian model with a financial accelerator to study the behaviour of interest and prices under both a "technology boom-bust" driven by changes in expectation about TFP, and a "credit boom-bust" driven by changes in expectations about the efficiency of the financial sector. While the two scenarios are similar in that they both lead to a run-up and then sharp drop-off in new capital and debt, I show that the behaviour of interest and prices depends critically on the nature of the new-shock driving the overaccumulation. In particular, the boom-phase of the TFP boom-bust is characterized by below-trend inflation or deflation, whereas that of the credit boom-bust is characterized by above-trend but low inflation. In contrast, inflation falls below-trend in the bust phases of both. I show that consistent with results elsewhere in the literature, stricter inflation-targeting fails to pull the economy toward the efficient equilibrium during the boom phase of the TFP boom-bust. In contrast, stricter inflation targeting pushes the economy closer to the flexible-price response during the boom-phase of the credit boom-bust. In both cases however, conditional on realization of overaccumulation, in inflation-targeting pulls the economy towards the flexible price equilibrium.
    Keywords: expectations-driven business cycle, boom-bust, news shock, monetary policy, overaccumulation, in?ation, ?nancial accelerator, Great Recession.
    JEL: E3 E44
    Date: 2014–07–10
  4. By: de La Paz, Paloma Taltavull; White, Michael
    Abstract: In a previous paper (Taltavull and White, 2012) we analysed the role of money supply, migration and mortgage finance in house price evolution. Using a VECM framework we examined these variables together with income, inflation, and interest rates for both Spain and the UK. The results indicated an important role for income, mortgages and migration in UK house price movements, more so than in Spain. Financial deregulation, and increasing monetary integration have been the background against which flows of liquidity have increased. Increasing interbank flows have also linked markets in different countries providing increased liquidity that can impact the mortgage market. Traditionally, monetary policy used interest rate changes to affect GDP. However this policy tool impacts asymmetrically in Eurozone economies and is generally constrained by the highly internationally interconnected money market. In this paper we build upon our previous work and focus on the role that changes in liquidity have played in the evolution of house prices. In doing this we identify the main channels of transmission affecting the housing market. In addition we also consider how the housing market, being impacted by increased liquidity can also feedback to aggregate money supply. The models tested examine Spain and the UK and identify short run and permanent effects in the relationship between liquidity and house prices.
    Date: 2014
  5. By: Andre C. Silva
    Abstract: Cash-in-advance models usually require agents to reallocate money and bonds in fixed periods, every month or quarter, for example. I show that fixed periods underestimate the welfare cost of inflation. I use a model in which agents choose how often they exchange bonds for money. In the benchmark specification, the welfare cost of ten percent instead of zero inflation increases from 0.1 percent of income with fixed periods to one percent with optimal periods. The results are robust to different preferences, to different compositions of income in bonds or money, and to the introduction of capital and labor. JEL codes: E3, E4, E5
    Keywords: portfolio rebalancing frequency, welfare cost of inflation, money demand, cash-in-advance models, market segmentation
    Date: 2014
  6. By: Pietro Cova (Bank of Italy); Patrizio Pagano (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: We assess the global macroeconomic implications of different strategies of official reserve management by developing a large scale new-Keynesian dynamic general equilibrium model of the world economy, calibrated on the euro area, the United States, China, Japan and the rest of the world. An increase in global demand for euros would boost euro-area aggregate demand because of the reduction in euro-area interest rates (the main benefit associated with the “privilege” of being a global currency). If the higher demand for euros is associated with lower demand for US dollars, then US economic activity falls because of higher interest rates, which depress domestic aggregate demand, while the external balance improves; countries accumulating reserves continue to run a trade surplus, as exports to the euro-area increase. We also compute welfare gains/costs for all economies.
    Keywords: global imbalances, global currency, dynamic general equilibrium modelling
    JEL: F33 F41 C51 E52
    Date: 2014–07
  7. By: Maria Abascal; Tatiana Alonso; Santiago Fernandez de Lis; Wojciech Golecki
    Abstract: Banking union is the most ambitious European project undertaken since the introduction of the single currency. It was launched in the summer of 2012, in order to send the markets a strong signal of unity against a looming financial fragmentation problem that was putting the euro on the ropes. The main goal of banking union is to resume progress towards the single market for financial services and, more broadly, to preserve the single market by restoring the proper functioning of monetary policy in the eurozone through restoring confidence in the European banking sector. This will be achieved through new harmonised banking rules and stronger systems for both banking supervision and resolution, that will be managed at the European level. The EU leaders and co-legislators have been working against the clock to put in place a credible and effective set-up in record time, amid intense negotiations (with final deals often closed at the last minute) and very significant concessions by all parties involved (most of which would have been simply unthinkable just a few years ago). Despite the fact that the final set-up does not provide for the optimal banking union, we still hold to its extraordinary political value and see its huge potential. By putting Europe back on the right integration path, banking union will restore the momentum towards a genuine economic and monetary union. Nevertheless, in order to put an end to the sovereign/banking loop, further progress in integration is needed including key fiscal, economic and political elements.
    Keywords: European Single Market, European Monetary Union, Banking Union, Banking resolution, Banking supervision, Single rulebook, Financial fragmentation
    JEL: G21 G28 H12 F36
    Date: 2014–07
  8. By: Soldatos, Gerasimos T.; Varelas, Erotokritos
    Abstract: According to this note, the sectoral approach towards a quantity theory of credit is too vague in its predictions. A quantity theory of seigniorage approach is proposed in its place, arriving at the conclusion that the financial system may be held responsible for price and output fluctuations to the extent commercial bank seigniorage alters the stock of money in circulation considerably. If not, the financial sector can become the source of instability by affecting profitability in the real sector through a Goodwin-type interaction. These trends could be countered by an interest rate rule based on deposit habits and on the deposit rate, and supplemented perhaps by a policy of influencing these habits and manipulating the deposit rate.
    Keywords: Quantity theory, Commercial bank seigniorage, Instability
    JEL: E3 E4 E5
    Date: 2014
  9. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Francesco Ravazzolo (Norges Bank (Central Bank of Norway) and BI Norwegian Business School); Samad Sarferaz (ETH Zürich)
    Abstract: We estimate demand, supply, monetary, investment and financial shocks in a VAR identified with a minimum set of sign restrictions on US data. We find that financial shocks are major drivers of fluctuations in output, stock prices and investment but have a limited effect on inflation. In a second step we disentangle shocks originating in the housing sector, shocks originating in credit markets and uncertainty shocks. In the extended set-up financial shocks are even more important and a leading role is played by housing shocks that have large and persistent effects on output.
    Keywords: VAR, Sign restrictions, Financial shocks, External finance premium, Housing, Uncertainty
    JEL: C11 C32 E32
    Date: 2014–07–18
  10. By: Marco Pagano (Università di Napoli Federico II CSEF, EEIF, CEPR and ECGI)
    Abstract: This paper distils three lessons for bank regulation from the experience of the 2009-12 euro-area financial crisis. First, it highlights the key role that sovereign debt exposures of banks have played in the feedback loop between bank and fiscal distress, and inquires how the regulation of banks’ sovereign exposures in the euro area should be changed to mitigate this feedback loop in the future. Second, it explores the relationship between the forbearance of non-performing loans by European banks and the tendency of EU regulators to rescue rather than resolving distressed banks, and asks to what extent the new regulatory framework of the euro-area “banking union” can be expected to mitigate excessive forbearance and facilitate resolution of insolvent banks. Finally, the paper highlights that capital requirements based on the ratio of Tier-1 capital to banks’ risk-weighted assets were massively gamed by large banks, which engaged in various forms of regulatory arbitrage to minimize their capital charges while expanding leverage. This argues in favor of relying on a set of simpler and more robust indicators to determine banks’ capital shortfall, such as book and market leverage ratios. JEL Classification: G01, G21, G28, G33.
    Keywords: bank regulation, euro, financial crisis, sovereign exposures, forbearance, bank resolution, bank capital requirements.
    Date: 2014–07–24
  11. By: Dimitris P. Louzis (Bank of Greece)
    Abstract: We examine the ability of large-scale vector autoregressions (VARs) to produce accurate macroeconomic (output and inflation) and credit (loans and lending rates) forecasts in Greece, during the latest sovereign debt crisis. We implement recently proposed Bayesian shrinkage techniques and we evaluate the information content of forty two (42) monthly macroeconomic and financial variables in a large Bayesian VAR context, using a five year out-of-sample forecasting period from 2008 to 2013. The empirical results reveal that, overall, large-scale Bayesian VARs, enhanced with key financial variables and coupled with the appropriate level of shrinkage, outperform their small- and medium-scale counterparts with respect to both macroeconomic and credit variables. The forecasting superiority of large Bayesian VARs is particularily clear at long-term forecasting horizons. Finally, empirical evidence suggests that large Bayesian VARs can significantly improve the directional forecasting accuracy of small VARs with respect to loans and lending rates variables.
    Keywords: Forecasting; Bayesian VARs; Crisis; Financial variables
    Date: 2014–06

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