nep-mon New Economics Papers
on Monetary Economics
Issue of 2014‒12‒13
twenty-one papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Monetary Policy in Open Economies: Practical Perspectives for Pragmatic Central Bankers By Richard Clarida
  2. Unconventional Monetary Policy and Long-Term Interest Rates By Tao Wu
  3. Mutual assistance between Federal Reserve Banks, 1913-1960 as prolegomena to the TARGET2 debate By Eichengreen, Barry; Mehl, Arnaud; Chiţu, Livia; Richardson, Gary
  4. Stability and Identification with Optimal Macroprudential Policy Rules By Jean-Bernard Chatelain; Kirsten Ralf
  5. Does Money Matter in the Euro area? Evidence from a new Divisia Index By Zsolt Darvas
  6. Liquidity Premia and Interest Rate Parity By Ludger Linnemann; Andreas Schabert
  7. Response of Stock Markets to Monetary Policy : An Asian Stock Market Perspective By Naoyuki Yoshino; Farhad Taghizadeh-Hesary; Ali Hassanzadeh; Ahmad Danu Prasetyo
  8. The Impact of Yuan Internationalization on the Euro-Dollar Exchange Rate By Agnès Bénassy-Quéré; Yeganeh Forouheshfar
  9. Lending standards, credit booms and monetary policy By Afanasyeva, Elena; Güntner, Jochen
  10. Collateral monetary equilibrium with liquidity constraints in an infinite horizon economy By Ngoc-Sang Pham
  12. Food Inflation in India: The Role for Monetary Policy By Rahul Anand; Ding Ding; Volodymyr Tulin
  13. The Federal Reserve's Tools for Policy Normalization in a Preferred Habitat Model of Financial Markets By Clouse, James A.; Ihrig, Jane E.; Klee, Elizabeth C.; Chen, Han
  14. The Federal Reserve's Abandonment of its 1923 Principles By Julio J. Rotemberg
  15. Does the clarity of inflation reports affect volatility in financial markets? By Aleš Bulíř; Martin Číhak; David-Jan Jansen
  16. Towards deeper financial integration in Europe: What the Banking Union can contribute By Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
  17. Capital Flows, Financial Intermediation and Macroprudential Policies By Matteo Ghilardi; Shanaka J. Peiris
  18. Vector Autoregressions with Parsimoniously Time Varying Parameters and an Application to Monetary Policy By Laurent Callot; Johannes Tang Kristensen
  19. Dealing with financial crises: How much help from research? By Pagano, Marco
  20. Measuring External Risks for Peru: Insights from a Macroeconomic Model for a Small Open and Partially Dollarized Economy By Fei Han
  21. Dependence Analysis between Foreign Exchange Rates: A Semi-Parametric Copula Approach By Azam, Kazim

  1. By: Richard Clarida
    Abstract: This paper reviews and interprets some of the key policy implications that flow from a class of DSGE models for optimal monetary policy in the open economy. The framework suggests that good macroeconomic outcomes in open economies are possible by focusing inflation targeting that is implemented by a Taylor type rule, a rule that in equilibrium is reflected in the exchange rate as an asset price. Optimal monetary policy will not be able deliver a stationary ('stable') nominal exchange rate - let alone a fixed exchange rate or one that remains inside a target zone ‐ because, absent a commitment device, optimal monetary can't deliver a stationary domestic price level. Another feature in the data for inflation targeting countries that is consistent with monetary policy via Taylor type rule is that it will tend push the nominal exchange rate in the opposite direction from PPP in response to an 'inflation' shock - the 'bad news god news' result of Clarida -Waldman (2008;2014). This is so even though in the long run of these models the nominal exchange rate must in expectation obey PPP.
    JEL: E52 E58 F3
    Date: 2014–10
  2. By: Tao Wu
    Abstract: This paper examines the transmission mechanism through which unconventional monetary policy affects long-term interest rates. I construct a real-time measure summarizing market projections of the magnitude and duration of the Federal Reserve's Large Scale Asset Purchases (LSAP) program, and analyze the determination of term premiums and expectations of future short-term interest rates in a sample spanning more than two decades. Empirical findings suggest that the LSAP has effectively lowered the long-term Treasury bond yields, through both "signaling" and "portfolio balance" channels. On the other hand, the Fed's "forward guidance" also leads to gradual extension of market projections for the duration of the LSAP program, thereby enhancing the LSAP's effect to keep term premiums low. Estimation results also reveal a diminished effectiveness of the LSAP during QE III. Finally, model simulations underscore the importance of policy transparency in minimizing unnecessary market turbulence and ensuring a timely and smooth exit of the unconventional monetary policy stimulus.
    Keywords: Monetary policy;Interest rates;Central bank policy;United States;Monetary transmission mechanism;Econometric models;Unconventional monetary policy, Quantitative easing, Large-scale asset purchases, Long-term interest rates, Signaling effect, Portfolio balance, Tapering, Exit strategy
    Date: 2014–10–22
  3. By: Eichengreen, Barry; Mehl, Arnaud; Chiţu, Livia; Richardson, Gary
    Abstract: This paper reconstructs the forgotten history of mutual assistance among Reserve Banks in the early years of the Federal Reserve System. We use data on accommodation operations by the 12 Reserve Banks between 1913 and 1960 which enabled them to mutualise their gold reserves in emergency situations. Gold reserve sharing was especially important in response to liquidity crises and bank runs. Cooperation among reserve banks was essential for the cohesion and stability of the US monetary union. But fortunes could change quickly, with emergency recipients of gold turning into providers. Because regional imbalances did not grow endlessly, instead narrowing when region-specific liquidity shocks subsided, mutual assistance created only limited tensions. These findings speak to the current debate over TARGET2 balances in Europe. JEL Classification: F30, N20
    Keywords: Federal Reserve System, gold standard, liquidity and financial crises, monetary policy, risk sharing, TARGET2 balances
    Date: 2014–07
  4. By: Jean-Bernard Chatelain (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Kirsten Ralf (Ecole Supérieure du Commerce Extérieur - ESCE - International business school)
    Abstract: This paper investigates the identification, the determinacy and the stability of ad hoc, "quasi-optimal" and optimal policy rules augmented with financial stability indicators (such as asset prices deviations from their fundamental values) and minimizing the volatility of the policy interest rates, when the central bank precommits to financial stability. Firstly, ad hoc and quasi-optimal rules parameters of financial stability indicators cannot be identified. For those rules, non zero policy rule parameters of financial stability indicators are observationally equivalent to rule parameters set to zero in another rule, so that they are unable to inform monetary policy. Secondly, under controllability conditions, optimal policy rules parameters of financial stability indicators can all be identified, along with a bounded solution stabilizing an unstable economy as in Woodford (2003), with determinacy of the initial conditions of non-predetermined variables.
    Keywords: Identification; financial stability; monetary policy; optimal policy under Commitment; augmented Taylor rule
    Date: 2014–04
  5. By: Zsolt Darvas
    Abstract: The purpose of this paper is to examine the possible role of money shocks on output and prices in the euro area. Since no Divisia monetary aggregates are available for the euro area, we first create and make available a database on euro-area Divisia monetary aggregates. We plan to update the dataset in the future and keep it publicly available. Using different SVAR models, we find sensible and statistically significant responses to Divisia money shocks, while the responses to simple-sum measures of money and interest rates are not statistically significant, and sometimes even the point estimates are not sensible.
    Date: 2014–11
  6. By: Ludger Linnemann; Andreas Schabert
    Abstract: Due to the US dollar's dominant role for international trade and finance, risk-free assets denominated in US currency not only offer a pecuniary return, but also provide transactions services, both nationally and internationally. Accordingly, the responses of bilateral US dollar exchange rates to interest rate shocks should differ substantially with respect to the (US or foreign) origin of the shock. We demonstrate this empirically and apply a model of liquidity premia on US treasuries originating from monetary policy implementation. The liquidity premium leads to a modification of uncovered interest rate parity (UIP), which enables the model to explain an appreciation of the dollar subsequent to an increase in US interest rates if foreign interest rates follow the US monetary policy rate.
    Keywords: Exchange rate dynamics, uncovered interest rate parity, monetary policy shocks, liquidity premia
    JEL: E4 F31 F41
    Date: 2014–10–28
  7. By: Naoyuki Yoshino (Asian Development Bank Institute (ADBI)); Farhad Taghizadeh-Hesary; Ali Hassanzadeh; Ahmad Danu Prasetyo
    Abstract: We estimate the response of Asian stock market prices to exogenous monetary policy shocks using a vector error correction model. In our paper, monetary policy transmits to stock market price through three routes : money by itself, exchange rate, and inflation. Our result points to the fact that stock prices increase persistently in response to an exogenous easing monetary policy. Variance deposition results show that, after 10 periods, the forecast error variance of beyond 53% of the Tehran Stock Exchange Price Index (TEPIX) can be explained by exogenous shocks to the US dollar–Iranian rial exchange rate, while this ratio for exogenous shocks to Iranian real gross domestic product was only 17%. We argue that such evidence can be accounted for by an endogenous response of the stock prices to the monetary policy shocks.
    Keywords: Asian stock market, monetary policy shocks, Variance Decomposition
    JEL: E44 G10 G12
    Date: 2014–09
  8. By: Agnès Bénassy-Quéré (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Yeganeh Forouheshfar (Université Paris-Dauphine - Université Paris-Dauphine)
    Abstract: We study the implication of a multipolarization of the international monetary system on crosscurrency volatility. More specifically, we analyze whether the internationalization of the yuan could modify the impact of asset supply and trade shocks on the euro-dollar exchange rate, within a threecountry, three-currency portfolio model. Our static model shows that the internationalization of the yuan (defined as a rise in the yuan in international portfolios) would be either neutral or stabilizing for the euro-dollar rate, whatever the exchange-rate regime of China. Moving to a dynamic, stockflow framework, we show that the internationalization of the yuan would make exchange-rate variations more efficient to stabilize net foreign asset positions after a trade shock.
    Keywords: China ; Yuan ; Exchange-rate regime ; Euro ; Dollar
    Date: 2013–02
  9. By: Afanasyeva, Elena; Güntner, Jochen
    Abstract: This paper investigates the risk channel of monetary policy on the asset side of banks' balance sheets. We use a factoraugmented vector autoregression (FAVAR) model to show that aggregate lending standards of U.S. banks, such as their collateral requirements for firms, are significantly loosened in response to an unexpected decrease in the Federal Funds rate. Based on this evidence, we reformulate the costly state verification (CSV) contract to allow for an active financial intermediary, embed it in a New Keynesian dynamic stochastic general equilibrium (DSGE) model, and show that - consistent with our empirical findings - an expansionary monetary policy shock implies a temporary increase in bank lending relative to borrower collateral. In the model, this is accompanied by a higher default rate of borrowers.
    Keywords: Bank lending standards,Credit supply,Monetary policy,Risk channel
    JEL: E44 E52
    Date: 2014
  10. By: Ngoc-Sang Pham (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne)
    Abstract: This paper considers an infinite-horizon monetary economy with collateralized assets. A Central BanK lends money to households by creating short- and long-term loans. Households can deposit or borrow money on both short- and long-term maturity loans. If households want to sell a financial asset, they are required to hold certain commodities as collateral. They face a cash-in-advance constraints when buying commodities and financial assets. Under Uniform or Sequential Gains to Trade Hypothesis, the existence of collateral monetary equilibrium is ensured. I also provide some properties of equilibria, including the liquidity trap.
    Keywords: Monetary economy; liquidity constraint; collateralized asset; infinite horizon; liquidity trap
    Date: 2013–07
  11. By: Saghaian, Sayed; Reed, Michael R.
    Keywords: Monetary Policy, agricultural commodities, historical decomposition, Agricultural and Food Policy,
    Date: 2014–05–27
  12. By: Rahul Anand; Ding Ding; Volodymyr Tulin
    Abstract: Indian food and fuel inflation has remained high for several years, and second-round effects on core inflation are estimated to be large. This paper estimates the size of second-round effects using an estimated reduced-form general equilibrium model of the Indian economy, which incorporates pass-through from headline inflation to core inflation. The results indicate that India's inflation is highly inertial and persistent. Due to second-round effects, the gap between headline inflation and core inflation decreases by about three fourths within one year as core inflation catches up with headline inflation. Large second-round effects stem from several factors, such as the high share of food in household expenditure and the role of food inflation in informing inflation expectations and wage setting. Analysis suggests that in order to durably reduce the current high inflation, the monetary policy stance needs to remain tight for a considerable length of time. In addition, progress on structural reforms to raise potential growth is critical to reduce the burden on monetary policy.
    Keywords: Food prices;India;Inflation;Monetary policy;Econometric models;Monetary policy, forecasting, food inflation, India.
    Date: 2014–09–24
  13. By: Clouse, James A. (Board of Governors of the Federal Reserve System (U.S.)); Ihrig, Jane E. (Board of Governors of the Federal Reserve System (U.S.)); Klee, Elizabeth C. (Board of Governors of the Federal Reserve System (U.S.)); Chen, Han (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper develops a model of the financial system that provides a framework for analyzing monetary policy implementation in a world with multiple Federal Reserve liabilities and a superabundant supply of reserves. The analysis demonstrates that the Federal Reserve's suite of policy tools including interest on excess reserves (IOER), overnight and term reverse repurchase agreements, and term deposits should allow the Federal Reserve to raise the level of short-term interest rates at the appropriate time. The model also demonstrates that these tools could be used in different ways to achieve any given desired level of interest rates. The choices among alternative combinations of tools, of course, have implications for patterns of financial intermediation. Specifically, the quantity of Federal Reserve liabilities held outside of the banking system is shown to depend importantly on the spread between various policy rates.
    Keywords: Policy normalization; preferred habitat; financial markets; Federal Reserve liabilities; interest on excess reserves (IOER); overnight and term reverse repurchase agreements (ON and term RRP); term deposits (TDF)
    Date: 2014–10–02
  14. By: Julio J. Rotemberg
    Abstract: This paper studies the persistence and some of the consequences of the eventual abandonment by the FOMC of the principles embedded in the Federal Reserve's Tenth Annual Report of 1923. The three principles I focus on are 1) the discouraging of speculative lending by commercial banks, 2) the desire to meet the credit needs of business and 3) the preference of a focus on credit over a focus on monetary aggregates. I show that the first two principles remained important in FOMC deliberations until the mid-1960's. After this, the FOMC also spent less time discussing the composition of bank loans.
    JEL: E42 E58 N1
    Date: 2014–09
  15. By: Aleš Bulíř; Martin Číhak; David-Jan Jansen
    Abstract: We study whether clarity of central bank inflation reports affects return volatility in financial markets. We measure clarity of reports by the Czech National Bank, the European Central Bank, the Bank of England, and Sveriges Riksbank using the Flesch-Kincaid grade level, a standard readability measure. We find some evidence, mainly for the euro area, of a negative relationship between clarity and market volatility prior to and during the early stage of the global financial crisis. As the crisis unfolded, there is no longer robust evidence of a negative connection. We conclude that reducing noise using clear reports is possible but not without challenges, especially in times of crisis.
    Keywords: central bank communication; clarity; financial markets; inflation reports; volatility
    JEL: E44 E52 E58
    Date: 2014–09
  16. By: Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
    Abstract: The European Banking Union is a major step forward in fixing major deficiencies in the institutional framework of the Euro area. The absence of effective banking supervision and resolution powers at the European level promoted excessive private risk-taking in the up-run to the Euro crisis. Effective private risk sharing once risks materialized has been hampered. A properly designed Banking Union facilitates and improves private risk sharing, and it is thus a necessary institutional complement to a monetary union. Yet, the institutional framework of the Banking Union needs further strengthening in three regards. First, the supervisory framework needs to ensure uniform supervisory standards for all banks, including those located in non-Euro area countries. Also, conflicts of interest between monetary policy and banking supervision need to be mitigated. Second, bank resolution suffers from a highly complex governance structure. Restructuring and bail-in rules allow for a high degree of discretion at the level of the resolution authority. We propose to introduce a statutory systemic risk exception, by which the exercise of discretion would be reduced, thereby strengthening the credibility of the bail-in. Third, in order to enhance the credibility of creditor involvement, fiscal backstops and ex-ante specified cross-border burden-sharing agreements are needed.
    Keywords: European Banking Union,Single Supervisory Mechanism,Single Resolution Mechanism,Risk Sharing
    JEL: E02 E42 G18
    Date: 2014
  17. By: Matteo Ghilardi; Shanaka J. Peiris
    Abstract: This paper develops an open-economy DSGE model with an optimizing banking sector to assess the role of capital flows, macro-financial linkages, and macroprudential policies in emerging Asia. The key result is that macro-prudential measures can usefully complement monetary policy. Countercyclical macroprudential polices can help reduce macroeconomic volatility and enhance welfare. The results also demonstrate the importance of capital flows and financial stability for business cycle fluctuations as well as the role of supply side financial accelerator effects in the amplification and propagation of shocks.
    Keywords: Capital flows;Asia;Emerging markets;Business cycles;Macroprudential policies and financial stability;Financial intermediation;Monetary policy;Banking sector;Open economies;General equilibrium models;Financial Frictions, Capital Regulation, Monetary Policy
    Date: 2014–08–21
  18. By: Laurent Callot (VU University Amsterdam); Johannes Tang Kristensen (University of Southern Denmark, Denmark)
    Abstract: This paper proposes a parsimoniously time varying parameter vector autoregressive model (with exogenous variables, VARX) and studies the properties of the Lasso and adaptive Lasso as estimators of this model. The parameters of the model are assumed to follow parsimonious random walks, where parsimony stems from the assumption that increments to the parameters have a non-zero probability of being exactly equal to zero. By varying the degree of parsimony our model can accommodate constant parameters, an unknown number of structural breaks, or parameters with a high degree of variation. We characterize the finite sample properties of the Lasso by deriving upper bounds on the estimation and prediction errors that are valid with high probability; and asymptotically we show that these bounds tend to zero with probability tending to one if the number of non zero increments grows slower than √T . By simulation experiments we investigate the properties of the Lasso and the adaptive Lasso in settings where the parameters are stable, experience structural breaks, or follow a parsimonious random walk. We use our model to investigate the monetary policy response to inflation and business cycle fluctuations in the US by estimating a parsimoniously time varying parameter Taylor rule. We document substantial changes in the policy response of the Fed in the 1980s and since 2008.
    Keywords: Parsimony, time varying parameters, VAR, structural break, Lasso
    JEL: C01 C13 C32 E52
    Date: 2014–11–07
  19. By: Pagano, Marco
    Abstract: Has economic research been helpful in dealing with the financial crises of the early 2000s? On the whole, the answer is negative, although there are bright spots. Economists have largely failed to predict both crises, largely because most of them were not analytically equipped to understand them, in spite of their recurrence in the last 25 years. In the pre-crisis period, however, there have been important exceptions - theoretical and empirical strands of research that largely laid out the basis for our current thinking about financial crises. Since 2008, a flurry of new studies offered several different interpretations of the US crisis: to some extent, they point to potentially complementary factors, but disagree on their relative importance, and therefore on policy recommendations. Research on the euro debt crisis has so far been much more limited: even Europe-based researchers - including CEPR ones - have often directed their attention more to the US crisis than to that occurring on their doorstep. In terms of impact on policy and regulatory reform, the record is uneven. On the one hand, the swift and massive liquidity provision by central banks in the wake of both crises is, at least partly, to be credited to previous research on the role of central banks as lenders of last resort in crises and on the real effects of bank lending and monetary policy. On the other hand, economists have had limited impact on the reform of prudential and security market regulation. In part, this is due to their neglect of important regulatory choices, which policy-makers are therefore left to take without the guidance of academic research-based analysis.
    Keywords: financial crisis,risk taking,systemic risk,financial regulation,monetary policy,politics
    JEL: G01 G18 G21 G28 H81 O16
    Date: 2014
  20. By: Fei Han
    Abstract: This paper quantifies the effects of external risks for Peru, with particular attention to two major external risks, China’s investment slowdown and the U.S. monetary policy tightening. In particular, a macroeconomic model for a small open and partially dollarized economy is developed and estimated for Peru to measure the risk spillovers, and simulate domestic macroeconomic responses in different scenarios with these two external risks. The simulation results suggest that Peru’s output is vulnerable to both risks, particularly the U.S. monetary policy tightening. Simulations also highlight the importance of higher exchange rate flexiblity and a lower degree of dollarization, which could help mitigate the negative spillover effects of these external risks.
    Keywords: External shocks;Peru;Foreign investment;China;United States;Monetary policy;Dollarization;Small open economies;Economic models;Macroeconomic Model, Partial Dollarization, External Risk, Monetary Policy, Spillovers, Macroeconomic Forecast
    Date: 2014–09–02
  21. By: Azam, Kazim (Vrije Universiteit, Amsterdam)
    Abstract: Not only currencies are assets in investor's portfolio, central banks use them for implementing economic policies. This implies existence of some type of dependence pattern among the currencies. We investigate such patterns among daily Deutsche Mark (DM) (Euro later), UK Sterling (GBP) and the Japanese Yen (JPY) exchange rate, all considered against the US Dollar during various economic conditions. To overcome the short-comings of misspecification, normality and linear dependence for such time series, a exible semi-parametric copula methodology is adopted where the marginals are non-parametric but the copula is parametrically specified. Dependence is estimated both as a constant and time-varying measure. During the Pre-Euro period, we nd slightly more dependence when both DM (Euro)/USD and GBP/USD jointly appreciate as compared to joint depreciation, especially in the late 90s. Such results are reversed for GBP/USD and JPY/USD in the early 90s. Post-Euro, DM (Euro)/USD and GBP/USD exhibit stronger dependence when they jointly appreciate, which could indicate preference for price-stability in EU zone. Whereas the dependence of JPY/USD with both DM (Euro)/USD and GBP/USD is stronger when they jointly depreciate, this could imply preference for export competitiveness among the countries. In the beginning of Recent-Crisis period, DM (EURO)/USD and GBP/USD show more dependence when they jointly depreciate, but later we see the similar tendency for these currencies to be related more when they jointly appreciate. Such measures of asymmetric dependence among the currencies provide vital insight into Central banks preferences and investors portfolio balancing. Key words: Copula ; exchange rates ; semi-parametric ; time series JEL classification: C14 ; C58 ; F31
    Date: 2014

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