nep-mon New Economics Papers
on Monetary Economics
Issue of 2014‒11‒22
twenty papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Optimal Monetary Policy in a Currency Union: Implications of a Country-specific Cost Channel By Jochen Michaelis; Jakob Palek
  2. The Federal Reserve in a Globalized World Economy By Taylor, John B.
  3. Communicating a systematic monetary policy By Plosser, Charles I.
  4. Inflation Dynamics During the Financial Crisis By Simon Gilchrist; Raphael Schoenle; Jae W. Sim; Egon Zakrajsek
  5. Structural Stability of the Generalized Taylor Rule By Barnett, William A.; Duzhak, Evgeniya A.
  6. Review over Empirical Evidence on Real Effects of Monetary Policy By Sun, Rongrong
  7. Analyzing the Taylor Rule with Wavelet Lenses By Luís Aguiar-Conraria; Manuel M. F. Martins; Maria Joana Soares
  8. Towards the end of deflation in Japan ? : Monetary policy under abenomics and the role of the central bank By Mahito Uchida
  9. The Relevance of International Spillovers and Asymmetric Effects in the Taylor Rule By Joscha Beckmann; Ansgar Belke; Christian Dreger
  10. Democratic Republic of the Congo: Financial System Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department
  11. Solving forward-looking models of cross-country adjustment within the euro area By Torój, Andrzej
  12. Examining the Success of the Central Banks in Inflation Targeting Countries: The Dynamics of Inflation Gap and the Institutional Characteristics By Ardakani, Omid; Kishor, N. Kundan
  13. The International Policy Trilemma in the Post-Bretton Woods Era By Alex Mandilaras
  14. From tapering to tightening : the impact of the fed's exit on India By Basu, Kaushik; Eichengreen, Barry; Gupta, Poonam
  15. Options and Central Banks Currency Market Intervention: The Case of Colombia By Helena Glebocki Keefe; Erick W. Rengifo
  16. The Role of Economic Policy Uncertainty in Forecasting US Inflation Using a VARFIMA Model By Mehmet Balcilar; Rangan Gupta; Charl Jooste
  17. Low real rates as driver of secular stagnation: empirical assessment By Jan Willem van den End; Marco Hoeberichts
  18. Bank Size, Risk Diversification and Money Markets By Hugo Rodríguez Mendizábal
  19. Sir John Vickers backs maturity transformation and opposes full reserve banking. By Musgrave, Ralph S.
  20. Trimmed-Mean Inflation Statistics: Just Hit the One in the Middle By Meyer, Brent; Venkatu, Guhan

  1. By: Jochen Michaelis (University of Kassel); Jakob Palek (University of Kassel)
    Abstract: There is growing empirical evidence that the strength of the cost channel of monetary policy differs across countries. Using a New Keynesian model of a two-country monetary union, we show how the introduction of a cost channel (differential) alters the optimal monetary responses to union-wide and national shocks. The cost channel makes monetary policy less effective in combating inflation, but it is shown that the optimal response to the decline in effectiveness is a stronger use of the instrument. On the other hand, the larger the cost channel differential, the less aggressive will the optimal monetary policy be. For almost all parameter constellations, our welfare analysis suggests a clear-cut ranking of policy regimes: commitment outperforms the Taylor rule, the Taylor rule outperforms strict inflation targeting, and strict inflation targeting outperforms discretion.
    Keywords: cost channel; optimal monetary policy; monetary union; open economy macroeconomics
    JEL: E31 E52 F41
    Date: 2014
  2. By: Taylor, John B. (Stanford University)
    Abstract: This paper starts from the theoretical observation that simple rules-based monetary policy will result in good economic performance in a globalized world economy and the historical observation that this occurred during the Great Moderation period of the 1980s and 1990s. It tries to answer a question posed by Paul Volcker in 2014 about the global repercussions of monetary policies pursued by advanced economy central banks in recent years. I start by explaining the basic theoretical framework, its policy implications, and its historical relevance. I then review the empirical evidence on the size of the international spillovers caused by deviations from rules-based monetary policy, and explore the many ways in which these spillovers affect and interfere with policy decisions globally. Finally, I consider ways in which individual monetary authorities and the world monetary system as a whole could adhere better to rules-based policies in the future and whether this would be enough to achieve the goal of stability in the globalized world economy.
    JEL: E5 F4 F5
    Date: 2014–10–01
  3. By: Plosser, Charles I. (Federal Reserve Bank of Philadelphia)
    Abstract: Society of American Business Editors and Writers Fall Conference, City University of New York (CUNY) Graduate School of Journalism. New York, NY. President Charles Plosser gives his views on the regional and national economy and discusses why he remains optimistic about the economic outlook. He also shares his thoughts about monetary policy and explains why he departed from the majority view at the July and September FOMC meetings.
    Keywords: FOMC; Data; Monetary policy;
    Date: 2014–10–10
  4. By: Simon Gilchrist (Boston University and NBER); Raphael Schoenle (Brandeis University); Jae W. Sim (Federal Reserve Board); Egon Zakrajsek (Federal Reserve Board)
    Abstract: Using confidential product-level price data underlying the U.S. Producer Price Index (PPI), this paper analyzes the effect of changes in firms’ financial conditions on their price-setting behavior during the “Great Recession.” The evidence indicates that during the height of the crisis in late 2008, firms with “weak” balance sheets increased prices significantly, whereas firms with “strong” balance sheets lowered prices, a response consistent with an adverse demand shock. These stark differences in price-setting behavior are consistent with the notion that financial frictions may significantly influence the response of aggregate inflation to macroeco- nomic shocks. We explore the implications of these empirical findings within the New Keynesian general equilibrium framework that allows for customer markets and departures from the fric- tionless financial markets. In the model, firms have an incentive to set a low price to invest in market share, though when financial distortions are severe, firms forgo these investment oppor- tunities and maintain high prices in an effort to preserve their balance-sheet capacity. Consistent with our empirical findings, the model with financial distortions—relative to the baseline model without such distortions—implies a substantial attenuation of price dynamics in response to contractionary demand shocks.
    Keywords: Producer Price Inflation; Customer Markets; Financial Frictions
    JEL: E31 E32 E44
    Date: 2013–09
  5. By: Barnett, William A.; Duzhak, Evgeniya A.
    Abstract: This paper analyzes the dynamical properties of monetary models with regime switching. We start with the analysis of the evolution of inflation when policy is guided by a simple monetary rule where coefficients switch with the policy regime. We rule out the possibility of a Hopf bifurcation and demonstrate the existence of a period doubling bifurcation. As a result, a small change in the parameters (e.g., a more active policy response) can lead to a drastic change in the path of inflation. We demonstrate that while the New Keynesian model with a current-looking Taylor rule is not prone to bifurcations, a hybrid rule exhibits the same pattern of period doubling bifurcations as the basic setup.
    Keywords: New Keynesian, Taylor Rule, regime switching, bifurcation analysis, structural stability.
    JEL: C14 C22 E32 E37
    Date: 2014
  6. By: Sun, Rongrong
    Abstract: This paper reviews and discusses the empirical literature on the impact of monetary policy on output. We focus on the evolution of methods that these studies have applied and demonstrate the established fact that monetary policy has significant impact on output. Throughout the review, we particularly highlight two problems in estimating the effects of monetary policy: the problem of how to measure monetary policy and the identification problem.
    Keywords: monetary policy, non-neutrality, systematic monetary policy reactions, vector autoregression
    JEL: E42 E52 E58
    Date: 2014–08
  7. By: Luís Aguiar-Conraria (NIPE and Department of Economics, University of Minho); Manuel M. F. Martins (cef.up and Faculty of Economics, University of Porto); Maria Joana Soares (NIPE and Department of Mathematics and Applications, University of Minho)
    Abstract: This paper analyses the Taylor Rule in the U.S. 1960-2014 with new lenses: continuous time partial wavelets tools. These allow us to assess the co-movement between the policy interest rate and the macroeconomic variables in the Rule, inflation and the output gap, both jointly and independently, for each frequency and at each moment of time. Our results uncover some new stylized facts about U.S. monetary policy and add new insights to the record of U.S. monetary history since the early 1960s. Among other findings, we conclude that monetary policy has been forward-looking and aimed at stabilizing inflation throughout the whole sample, although with varying effectiveness both across time and frequencies. Monetary policy has lagged the output gap across most of the sample, but in recent times became more reactive. Volcker’s disinflation, and the conquest of credibility in 1979-1986, were achieved with no extra costs in terms of output.
    Keywords: Monetary Policy, Taylor Rule, Continuous Wavelet Transform, Partial Wavelet Coherency, Partial Phase-difference
    JEL: C49 E43 E52
    Date: 2014–10
  8. By: Mahito Uchida
    Abstract: In this paper, I investigate the Bank of Japan's monetary policy effects under Abenomics at the initial stage. First, I describe briefly what is “Abenomics” and “New monetary policy under Abenomics” since April 2013. I also examine the causes of the sharp response of the yen and Japanese stock prices, the increase of consumer price index and the change of the public's expectations for economic activity and prices on surveys. In the second part I explain why the new monetary policy was effective in 2013, comparing the previous policy until 2012. Although there is not so big difference between monetary policies before and after 2012 theoretically, I point out the importance of the strong commitment by central bank, the cooperation with the government and “psychological impact” on public. The third part discusses the durability of the new monetary policy. The policy effects will be sustainable if a price becomes lastingly positive, which needs a durably positive output gap. Therefore, growth strategy by Abenomics plays an important role. I also point out that the BOJ has to perform the policy over side effects such as the impact on the government bond markets, the impact on other financial market and an outflow of money to overseas.
    Keywords: Abenomics; Monetary policy; Interest rates; Inflation target
    Date: 2014–04
  9. By: Joscha Beckmann; Ansgar Belke; Christian Dreger
    Abstract: Deviations of policy interest rates from the levels implied by the Taylor rule have been persistent before the financial crisis and increased especially after the turn of the century. Compared to the Taylor benchmark, policy rates were often too low. This paper provides evidence that both international spillovers, for instance international dependencies in the interest rate setting of central banks, and nonlinear reaction patterns can offer a more realistic specification of the Taylor rule in the main industrial countries. The inclusion of international spillovers and, even more, nonlinear dynamics improves the explanatory power of standard Taylor reaction functions. Deviations from Taylor rates tend to be smaller and their negative trend can be eliminated.
    Keywords: Taylor rule, international spillovers, monetary policy interaction, smooth transition models
    JEL: E43 F36 C22
    Date: 2014–09
  10. By: International Monetary Fund. Monetary and Capital Markets Department
    Keywords: Financial system stability assessment;Financial sector;Banks;Nonbank financial sector;Bank supervision;Basel Core Principles;Bank resolution;Stress testing;Monetary policy;Central bank autonomy;Anti-money laundering;Economic indicators;Democratic Republic of the Congo;
    Date: 2014–10–22
  11. By: Torój, Andrzej (Ministry of Finance in Poland)
    Abstract: This paper generalizes the standard methods of solving rational expectations models to the case of time-varying nonstochastic parameters, recurring in a finite cycle. Such a specification occurs in a simple stylized New Keynesian model of the euro area when we combine the rotation in the ECB Governing Council (as constituted by the Treaty of Nice) and home bias in the interest rate decisions taken by its members. In small and mid-size economies, this combination slightly increases output and inflation volatility, as compared to a monetary policy setup without rotation. The method of Christiano (2002) has also been applied to solve the model when we assume a lagged perception of foreign macroeconomic shocks by domestic agents. When the cross-country synchronization of shocks is low or moderate and when these shocks are relatively persistent, the exclusion of contemporaneous foreign shocks from domestic agents' information sets may raise the volatility of output. There is also some tentative evidence that this effect could particularly affect mid-size economies.
    Keywords: EMU; monetary policy; solving rational expectations models; generalized Schur decomposition; heterogeneity
    JEL: C32 C61 E52 F15
    Date: 2009–09–04
  12. By: Ardakani, Omid; Kishor, N. Kundan
    Abstract: This paper analyzes the performance of central banks in 27 inflation targeting countries by examining their success in achieving their explicit inflation targets. For this purpose, we decompose the inflation gap, the difference between actual inflation and inflation target, into predictable and unpredictable components. We argue that the central banks are successful if the predictable component in the inflation gap diminishes over time. The predictable component of inflation gap is measured by the conditional mean of a time-varying autoregressive model. Our results find considerable heterogeneity in the success of these IT countries in achieving their targets at the start of this policy regime. Our findings also suggest that the central banks of the IT adopting countries started targeting inflation implicitly before becoming an explicit inflation targeter. The panel data analysis suggests that the relative success of these countries in reducing the gap is influenced by their institutional characteristics particularly by fiscal discipline and macroeconomic performance.
    Keywords: Inflation targeting, inflation gap, predictability, time-varying autoregressive model, institutional characteristics
    JEL: C32 C53 E31 E37 E52 E58
    Date: 2014–09–07
  13. By: Alex Mandilaras (University of Surrey)
    Abstract: The international macroeconomic policy trilemma suggests that de- spite the appeal of exchange rate stability, financial account openness and monetary sovereignty, these cannot be achieved simultaneously. Us- ing elements of Euclidean geometry, this paper proposes a new method for testing the trilemma and finds considerable evidence in support of it. Further tests indicate that, on average, policy configurations are not on the trilemma constraint, i.e. there is a degree of `trilemma- ineffectiveness’, which is costly for real output growth and price inflation. It is shown that these costs can be attributed to limited exchange rate stability and financial account openness, respectively.
    JEL: F33
    Date: 2014–11
  14. By: Basu, Kaushik; Eichengreen, Barry; Gupta, Poonam
    Abstract: The"tapering talk"starting on May 22, 2013, when Federal Reserve Chairman Ben Bernanke first spoke of the possibility of the U.S. central bank reducing its security purchases, had a sharp negative impact on emerging markets. India was among those hardest hit. The rupee depreciated by 18 percent at one point, causing concerns that the country was heading toward a financial crisis. This paper contends that India was adversely impacted because it had received large capital flows in prior years and had large and liquid financial markets that were a convenient target for investors seeking to rebalance away from emerging markets. In addition, India's macroeconomic conditions had weakened in prior years, which rendered the economy vulnerable to capital outflows and limited the policy room for maneuver. The paper finds that the measures adopted to handle the impact of the tapering talk were not effective in stabilizing the financial markets and restoring confidence, implying that there may not be any easy choices when a country is caught in the midst of rebalancing of global portfolios. The authors suggest putting in place a medium-term policy framework that limits vulnerabilities in advance, while maximizing the policy space for responding to shocks. Elements of such a framework include a sound fiscal balance, sustainable current account deficit, and environment conducive to investment. In addition, India should continue to encourage relatively stable longer-term flows and discourage volatile short-term flows, hold a larger stock of reserves, avoid excessive appreciation of the exchange rate through interventions with the use of reserves and macroprudential policy, and prepare the banks and firms to handle greater exchange rate volatility.
    Keywords: Debt Markets,Emerging Markets,Currencies and Exchange Rates,Economic Theory&Research,Macroeconomic Management
    Date: 2014–10–01
  15. By: Helena Glebocki Keefe (Fordham University); Erick W. Rengifo (Fordham University)
    Abstract: Several central banks in emerging economies are concerned with excessive volatility in foreign exchange markets and would like to control the direction and speed with which the value of their currency changes. Historically, currency market interventions have consisted of using foreign exchange reserves to purchase and sell foreign currency directly in the spot market. However, these spot interventions are not the only type of interventions available to central banks. The Colombian central bank implemented various strategies to intervene into currency markets to smooth volatility, build reserves, and influence the direction of the exchange rate by issuing options contracts as well as using daily discretionary purchases of US dollars. In this paper we analyze these recent strategies employed by Colombia, with a special focus on the volatility option strategy. We argue that the abandonment of the options program was premature and that its success was not fully appreciated in previous literature.
    Keywords: Exchange Rates, Intervention, Foreign Exchange Markets, Currency Options, International. Reserves, International Finance.
    JEL: F31 G15
    Date: 2014
  16. By: Mehmet Balcilar (Department of Economics, Eastern Mediterranean University, Famagusta, Northern Cyprus , via Mersin 10, Turkey; Department of Economics, University of Pretoria, Pretoria, 0002, South Africa); Rangan Gupta (Department of Economics, University of Pretoria); Charl Jooste (Department of Economics, University of Pretoria)
    Abstract: We compare inflation forecasts of a vector fractionally integrated autoregressive moving average (VARFIMA) model against standard forecasting models. U.S. inflation forecasts improve when controlling for persistence and economic policy uncertainty (EPU). Importantly, the VARFIMA model, comprising of inflation and EPU, outperforms commonly used inflation forecast models.
    Keywords: Inflation, long-range dependency, economic policy uncertainty
    JEL: C53 E37
    Date: 2014–10
  17. By: Jan Willem van den End; Marco Hoeberichts
    Abstract: We empirically test whether there is a causal link between the real interest rate and the natural rate of interest, which could be a harbinger of secular stagnation if the real rate declines. Outcomes of VAR models for Japan, Germany and the US show that a fall in the real rate indeed affects the natural rate. This causality is significant for Japan, borderline significant for Germany and not significant for the US. The outcomes for Japan confirm that a prolonged period of low real rates can affect potential economic growth. The policy implication is that implementing measures that raise the natural rate will be more effective in avoiding secular stagnation than reducing the real rate through higher inflation expectations.
    Keywords: interest rates; financial markets and the macroeconomy; monetary policy
    JEL: E43 E44 E52
    Date: 2014–10
  18. By: Hugo Rodríguez Mendizábal
    Abstract: This paper presents a theoretical model based on risk diversification to rationalize the observed dichotomy in the federal funds market by which small banks are net providers of funds while large banks become net purchasers. As larger banks are more diversified they can raise a larger proportion of funds as equity and provide more loans. To finance these loans, they will need to obtain funds in the wholesale money market. In contrast, smaller banks will be less diversified and will find it harder to raise equity which means producing a lower amount of loans and supplying the extra funds in the wholesale money market. The model also produces a set of testable predictions about the performance of large and small banks that are in line with data for the US.
    Keywords: bank size, diversification, money market, bank solvency
    JEL: E4 E5 G21
    Date: 2014–09
  19. By: Musgrave, Ralph S.
    Abstract: Sir John Vickers (Chairman of the UK’s Independent Commission on Banking (2011)), published a discussion paper entitled “Some Economics of Banking Reform†(Vickers (2012)). This is my contribution to the “discussionâ€, that is, I make some criticisms of the paper. The Independent Commission on Banking is referred to as the “Vickers commission†below, while the word “Vickers†(without an accompanying date) refers to his 2012 discussion paper. Two central points in Vickers’s paper are addressed here. First Vickers defends the existing banking system partially on the grounds that it engages in “borrow short and lend longâ€, i.e. “maturity transformation†(MT), which Vickers claims brings a large benefit. Vickers makes the standard claim for MT, namely that depositors gain the additional interest that comes from having their money invested in long term loans or investments while still retaining quick access to their money, i.e. liquidity. One flaw in that argument is that MT involves risk, a risk which went wrong around five years ago and would have crashed the world economy far more seriously than it actually did, had banks not been rescued with trillions of dollars of public money. A second flaw in MT is that if it is curtailed, the resulting reduced quantity of money / liquidity can be made good at zero real cost by having central banks issue more money. And that involves no risk of the bank runs, credit crunches and so on that are inherent to MT. Thus the case for MT is badly flawed. The second central point addressed below, in Part II, is Vickers’s claim that full reserve banking or “narrow banking†as he calls it, is defective. The paragraphs below are not supposed to be a REVIEW of Vickers’s paper: to repeat, it is just the above two points made in the paper which are considered here. That is, there are various parts of Vickers’s paper which I agree with, or which I am not qualified to judge.
    Keywords: maturity transformation; John Vickers; full reserve banking; narrow banking.
    JEL: G21 G28
    Date: 2014–10–31
  20. By: Meyer, Brent (Federal Reserve Bank of Atlanta); Venkatu, Guhan (Federal Reserve Bank of Cleveland)
    Abstract: This paper reinvestigates the performance of trimmed-mean inflation measures some 20 years since their inception, asking whether there is a particular trimmed-mean measure that dominates the median consumer price index (CPI). Unlike previous research, we evaluate the performance of symmetric and asymmetric trimmed means using a well known equality of prediction test. We find that there is a large swath of trimmed means that have statistically indistinguishable performance. Also, although the swath of statistically similar trims changes slightly over different sample periods, it always includes the median CPI - an extreme trim that holds conceptual and computational advantages. We conclude with a simple forecasting exercise that highlights the advantage of the median CPI (and trimmed-mean estimators in general) relative to other standard measures in forecasting headline inflation.
    Keywords: inflation; inflation forecasting; trimmed-mean estimators
    JEL: E31 E37
    Date: 2014–03–01

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