nep-mon New Economics Papers
on Monetary Economics
Issue of 2014‒12‒19
29 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Bringing Financial Stability into Monetary Policy By Eric M. Leeper; James M. Nason
  2. Dynamic Analysis of Exchange Rate Regimes : Policy Implications for Emerging Countries in Asia By Naoyuki Yoshino; Sahoko Kaji; Tamon Asonuma
  3. What does US money market mutual fund reform portend for the European Union? By Lewis, Craig M.; Schlag, Christian
  4. Was the ECB’s Comprehensive Assessment up to standard? By De Groen, Willem Pieter
  5. Monetary Policy Effectiveness in China: Evidence from a FAVAR Model By John Fernald; Mark M. Spiegel; Eric T. Swanson
  6. General Theory of Money: A New Approach By Rezaie, Mohsen
  7. Financial Frictions and Optimal Monetary Policy in a Small Open Economy By Jesús A. Bejarano; Luisa F. Charry
  8. Monetarism rides again? US monetary policy in a world of Quantitative Easing By Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick
  9. Policy-making of the European Central Bank during the crisis: Do personalities matter? By Basham, James; Roland, Aanor
  10. Towards a consumer sentiment channel of monetary policy By Debes, Sebastian; Gareis, Johannes; Mayer, Eric; Rüth, Sebastian
  11. News and Monetary Shocks at a High Frequency: A Simple Approach By Troy Matheson; Emil Stavrev
  12. Is there a threat of self-reinforcing deflation in the Euro area? A view through the lens of the Phillips curve By Wieland, Volker; Wolters, Maik
  13. Effectiveness of the Easing of Monetary Policy in the Japanese Economy, Incorporating Energy Prices By Yoshino, Naoyuki; Taghizadeh-Hesary, Farhad
  14. The U.S. economic outlook and monetary policy By Plosser, Charles I.
  15. Central Banking after the Crisis: Brave New World or Back to the Future? Replies to a questionnaire sent to central bankers and economists By Emmanuel Carré; Jézabel Couppey-Soubeyran; Dominique Plihon; Marc Pourroy
  16. Optimal Stabilization Policy with Search Externalities By Berentsen, Aleksander; Waller, Christopher
  17. Dynamic Debt Deleveraging and Optimal Monetary Policy By Pierpaolo Benigno; Gauti B. Eggertsson; Federica Romei
  18. Emerging Market Volatility: Lessons from The Taper Tantrum By Ratna Sahay; Vivek B. Arora; Athanasios V Arvanitis; Hamid Faruqee; Papa N'Diaye; Tommaso Mancini Griffoli
  19. Governing by Panic: The Politics of the Eurozone Crisis By David M. Woodruff
  20. The Effects of Unconventional Monetary Policies on Bank Soundness By Frederic Lambert; Kenichi Ueda
  21. House Prices, Capital Inflows and Macroprudential Policy By Mendicino, Caterina; Punzi, Maria Teresa
  22. Flight to liquidity and the Great Recession By Radde, Sören
  23. Monetary Policy Effects on Financial Intermediation via the Regulated and the Shadow Banking Systems By Falk Mazelis; ; ;
  24. Balance sheet effects, foreign reserves and public policies By Cheng, Gong
  25. Effective Monetary Policy Strategies in New Keynesian Models: A Re-examination By Hess Chung; Edward Herbst; Michael T. Kiley
  26. Financial stress and economic dynamics: the transmission of crises By Hubrich, Kirstin; Tetlow, Robert J.
  27. Interest Rate Uncertainty and Economic Fluctuations By Drew D. Creal; Jing Cynthia Wu
  28. Bernanke/Blinder revisited - The New Keynesian model with credit channel By Offick, Sven; Wohltmann, Hans-Werner
  29. Inflation-Targeting and Foreign Exchange Interventions in Emerging Economies By Marc Pourroy

  1. By: Eric M. Leeper; James M. Nason
    Abstract: This paper arms central bank policy makers with ways to think about interactions between financial stability and monetary policy. We frame the issue of whether to integrate financial stability into monetary policy operating rules by appealing to the observation that in actual economies financial markets are incomplete. Incomplete markets create financial market frictions that prevent economic agents from perfectly sharing risk; in the absence of frictions, financial (in)stability would be of no concern. Overcoming these frictions to improve risk sharing across economic agents is, in our view, the intent of policies geared toward ensuring financial stability. There are many definitions of financial stability. Although the definitions share the notion that financial stability becomes an issue for policy makers when a breakdown in risk-sharing arrangements in financial markets has a negative effect on real economic activity, we give several examples that show this notion is too general for thinking about the role that monetary policy might have in smoothing shocks to financial stability. Examples include statistical models that seek to separate “good” from “bad” changes in private-sector debt aggregates, new Keynesian policy prescriptions grounded in neo-Wicksellian natural rate rules, and a historical episode involving the 1920s Federal Reserve. These examples raise a cautionary flag for policy attempts to control both the growth and the composition of debt that financial markets produce. We conclude with some advice for revising central banks’ Monetary Policy Reports.
    Keywords: Financial frictions, incomplete markets, crises, new Keynesian, natural rate, monetary transmission mechanism.
    JEL: E3 E4 E5 E6 G2 N12
    Date: 2014–11
  2. By: Naoyuki Yoshino (Asian Development Bank Institute (ADBI)); Sahoko Kaji; Tamon Asonuma
    Abstract: This paper discusses desirable exchange rate regimes and how countries can shift from their current regimes to these regimes over the medium term. We demonstrate the superiority of a basket-peg regime with the basket weight rule over a floating regime with the interest rate rule or the money supply rule in small open economies, during periods when volatility of exchange rates is moderate. Countries which currently have fixed exchange rates would be better moving toward either a basket-peg or a floating regime over the medium term. A shift to a basket-peg regime is preferred when exchange rate fluctuations are large.
    Keywords: Southeast Asia, East Asia, exchange rate regime, Emerging Countries, basket-peg regime, floating regime
    JEL: E42 F33 F41 F42
    Date: 2014–10
  3. By: Lewis, Craig M.; Schlag, Christian
    Abstract: On 23 July 2014, the U.S. Securities and Exchange Commission (SEC) passed the "Money Market Reform: Amendments to Form PF ," designed to prevent investor runs on money market mutual funds such as those experienced in institutional prime funds following the bankruptcy of Lehman Brothers. The present article evaluates the reform choices in the U.S. and draws conclusions for the proposed EU regulation of money market funds.
    Keywords: money market funds,liquidity runs,floating net asset value (FNAV)
    Date: 2014
  4. By: De Groen, Willem Pieter
    Abstract: The Comprehensive Assessment conducted by the European Central Bank (ECB) represents a considerable step forward in enhancing transparency in euro-area banks’ balance sheets. The most notable progress since the previous European stress test has been the harmonisation of the definition of non-performing loans and other concepts as well as uncovering hidden losses, which resulted in a €34 billion aggregate capital-charge net of taxes. Despite this tightening, most banks were able to meet the 5.5% common equity tier 1 (CET1) threshold applied in the test, which suggests that the large majority of the euro-area banks have improved their financial position sufficiently that they should no longer be constrained in financing the economy. As shown in this CEPS Policy Brief by Willem Pieter de Groen, however, the detailed results provide a more nuanced picture: there remain a large number of the banks in the euro area that are still highly leveraged and in many cases unable to meet the regulatory capital requirements that will be introduced in the coming years under the adverse stress test scenario.
    Date: 2014–11
  5. By: John Fernald; Mark M. Spiegel; Eric T. Swanson
    Abstract: We use a broad set of Chinese economic indicators and a dynamic factor model framework to estimate Chinese economic activity and inflation as latent variables. We incorporate these latent variables into a factor-augmented vector autoregression (FAVAR) to estimate the effects of Chinese monetary policy on the Chinese economy. A FAVAR approach is particularly well-suited to this analysis due to concerns about Chinese data quality, a lack of a long history for many series, and the rapid institutional and structural changes that China has undergone. We find that increases in bank reserve requirements reduce economic activity and inflation, consistent with previous studies. In contrast to much of the literature, however, we find that central-bank-determined changes in Chinese interest rates also have substantial impacts on economic activity and inflation, while other measures of changes in credit conditions, such as shocks to M2 or lending levels, do not once other policy variables are taken into account. Overall, our results indicate that the monetary policy transmission channels in China have moved closer to those of Western market economies.
    JEL: C38 E43 E52
    Date: 2014–09
  6. By: Rezaie, Mohsen
    Abstract: Money, credit and monetary markets are interlinked with each other and linked to real sector of the economy. There is clearly no single market called money market, but there are two money markets, asset-money and credit-money markets, that money is created by the interactions between them. This created money would, then, enter into economic activities and to facilitate producing and transacting in the real sector. In other words, money is a heavenly creature that is created through interactions between money markets in the sky of monetary markets that returns to the land of real markets. In other words, monetary intermediaries, like firms, produce money within credit and savings process. In addition, monetary integration takes place by interaction of money markets.
    Keywords: Asset-money, Credit-money, Saving, Monetary Theory, Monetary Variables, Monetary Integration
    JEL: E40
    Date: 2014–01–01
  7. By: Jesús A. Bejarano; Luisa F. Charry
    Abstract: In this paper we set up a small open economy model with financial frictions, following Curdia and Woodford (2010)’s model. Unlike other results in the literature such as Curdia and Woodford (2010), McCulley and Ramin (2008) and Taylor (2008), we find that optimal monetary policy should not respond to changes in domestic interest rate spreads when the source of fluctuations are exogenous financial shocks. A novel result here is that the optimal size of policy responses to changes in the credit spread is large when the disturbance source are shocks to the foreign interest rate. Our results suggest that such a response is welfare enhancing. Classification JEL: E44, E50, E52, E58, F41.
    Date: 2014–11
  8. By: Le, Vo Phuong Mai (Cardiff Business School); Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School)
    Abstract: This paper gives money a role in providing cheap collateral in a model of banking; besides the Taylor Rule, monetary policy can affect the risk-premium on bank lending to firms by varying the supply of M0, so at the zero bound monetary policy is effective; fiscal policy crowds out investment via the risk-premium. A rule for making M0 respond to credit conditions can enhance the economy’s stability. Both price-level and nominal GDP targeting rules for interest rates combined with this stabilise the economy further. With these rules for monetary control, aggressive and distortionary regulation of banks’ balance sheets becomes redundant.
    Keywords: DSGE model; Financial Frictions; Crises; Indirect Inference; money supply; QE; monetary policy; fiscal multiplier; zero bound
    JEL: E3 E44 E52 C1
    Date: 2014–10
  9. By: Basham, James; Roland, Aanor
    Abstract: The European sovereign debt crisis represents an interesting opportunity to investigate the reaction of the European Central Bank as a crisis fighting institution and the importance of central bank personalities in policy execution. Accordingly, this paper aims at investigating to what extent the policy-making of the ECB during the crisis has been influenced by Trichet's and Draghi's different personalities. Based on Friedman's hypothesis that "accidents of personality" have a great impact on the functioning of a rulebased institution, we find that the clear differences in policy-making between Trichet and Draghi can be explained by specific features of their respective personalities. Institutions matter, but so do personalities.
    Keywords: European Central Bank,Central Bankers,Personality Theory,European Sovereign Debt Crisis,Monetary Policy
    JEL: E5 E6
    Date: 2014
  10. By: Debes, Sebastian; Gareis, Johannes; Mayer, Eric; Rüth, Sebastian
    Abstract: We investigate the role of consumer confidence in the transmission of monetary policy shocks from an empirical and theoretical perspective. Standard VAR based analysis suggests that an empirical measure of consumer confidence drops significantly after a monetary tightening and amplifies the impact of monetary policy on aggregate consumption. Using a behavioral DSGE model, we show that a consumer sentiment channel can account for the empirical findings. In an environment of heterogeneous expectations, which gives rise to the notion of consumer sentiment, innovations to the Federal Funds rate impact on consumer confidence and thereby the broader economy.
    Keywords: monetary policy,monetary transmission,consumer sentiment
    JEL: E32 E52 D83
    Date: 2014
  11. By: Troy Matheson; Emil Stavrev
    Abstract: We develop a simple approach to identify economic news and monetary shocks at a high frequency. The approach is used to examine financial market developments in the United States following the Federal Reserve’s May 22, 2013 taper talk suggesting that it would begin winding down its quantitative easing program. Our findings show that the sharp rise in 10-year Treasury bond yields immediately after the taper talk was largely due to monetary shocks, with positive economic news becoming increasingly important in subsequent months.
    Keywords: Monetary policy;United States;External shocks;Financial markets;Treasury bills and bonds;Bond yields;Econometric models;Monetary Policy, Economic News
    Date: 2014–09–12
  12. By: Wieland, Volker; Wolters, Maik
    Abstract: The recent decline in euro area inflation has triggered new calls for additional monetary stimulus by the ECB in order to counter the threat of a self-reinforcing deflation and recession spiral. This note reviews the available evidence on inflation expectations, output gaps and other factors driving current inflation through the lens of the Phillips curve. It also draws a comparison to the Japanese experience with deflation in the late 1990s and the evidence from Japan concerning the outputinflation nexus at low trend inflation. The note concludes from this evidence that the risk of a selfreinforcing deflation remains very small. Thus, the ECB best await the impact of the long-term refinancing operations decided in June that have the potential to induce substantial monetary accommodation once implemented for the first time in September.
    Date: 2014
  13. By: Yoshino, Naoyuki (Asian Development Bank Institute); Taghizadeh-Hesary, Farhad (Asian Development Bank Institute)
    Abstract: Japan has reached the limits of conventional macroeconomic policy. In order to overcome deflation and achieve sustainable economic growth, the Bank of Japan (BOJ) recently set an inflation target of 2% and implemented an aggressive monetary policy so this target could be achieved as soon as possible. Although prices started to rise after the BOJ implemented monetary easing, this may have been for other reasons, such as higher oil prices. Oil became expensive as a result of the depreciated Japanese yen and this was one of the main causes of the rise in inflation. This paper shows that quantitative easing may not have stimulated the Japanese economy either. Aggregate demand, which includes private investment, did not increase significantly in Japan with lower interest rates. Private investment displays this unconventional behavior because of uncertainty about the future and because Japan's population is aging. We believe that the remedy for Japan's economic policy is not to be found in monetary policy. The government needs to implement serious structural changes and growth strategies.
    Keywords: monetary policy; energy; oil prices; japanese economy
    JEL: E47 E52 Q41 Q43
    Date: 2014–11–10
  14. By: Plosser, Charles I. (Federal Reserve Bank of Philadelphia)
    Abstract: UBS European Conference 2014, London, England November 12, 2014 President Charles Plosser gives his views on the economy and discusses why he remains positive about our country's economic prospects. He also shares his thoughts about the stance of monetary policy and the advantages of raising rates gradually and starting sooner instead of being forced to raise them abruptly later.
    Keywords: Economic outlook; Manufacturing Business Outlook Survey; Nonmanufacturing Business Outlook Survey; FOMC
    Date: 2014–11–12
  15. By: Emmanuel Carré (CEPN - Centre d'Economie de l'Université Paris Nord - CNRS : UMR7234 - Université Paris 13 - Université Sorbonne Paris Cité (USPC)); Jézabel Couppey-Soubeyran (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne); Dominique Plihon (CEPN - Centre d'Economie de l'Université Paris Nord - CNRS : UMR7234 - Université Paris 13 - Université Sorbonne Paris Cité (USPC)); Marc Pourroy (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne)
    Abstract: This paper provides a snapshot of the current state of central banking doctrine in the aftermath of the crisis, using data from a questionnaire produced in 2011 and sent to central bankers (from 13 countries plus the euro zone) and economists (31) for a report by the French Council of Economic Analysis to the Prime Minister. The results of our analysis of the replies to the questionnaire are twofold. First, we show that the financial crisis has led to some amendments of pre-crisis central banking. We highlight that respondents to the questionnaire agree on the general principle of a 'broader' view of central banking extended to financial stability. Nevertheless, central bankers and economists diverge or give inconsistent answers about the details of implementation of this 'broader' view. Therefore, the devil is once again in the details. We point out that because of central bankers' conservatism, a return to the status quo cannot be excluded.
    Keywords: Central banking; macroprudential policy; financial stability
    Date: 2013–10
  16. By: Berentsen, Aleksander; Waller, Christopher
    Abstract: We study optimal monetary stabilization policy in a DSGE model with microfounded money demand. A search externality creates ‘congestion’ which causes aggregate output to be inefficient. Due to the informational frictions that give rise to money, households are unable to perfectly insure themselves against aggregate shocks. This gives rise to a welfare improving role for monetary policy that works by adjusting the nominal interest rate in response to these shocks. Optimal policy is determined by choosing a set of state-contingent nominal interest rates to maximize the expected lifetime utility of the agents subject to the constraints of being an equilibrium.
    Keywords: monetary policy, optimal stabilization policy, search equilibrium, microfoundation of money
    JEL: E00 E40
    Date: 2013–09
  17. By: Pierpaolo Benigno; Gauti B. Eggertsson; Federica Romei
    Abstract: This paper studies optimal monetary policy under dynamic debt deleveraging once the zero bound is binding. Unlike the existing literature, the natural rate of interest is endogenous and depends on macroeconomic policy. Optimal monetary policy successfully raises the natural rate of interest by creating an environment that speeds up deleveraging, thus endogenously shortening the duration of the crisis and a binding zero bound. Inflation should be front loaded. Fiscal-policy multipliers can be even higher than in existing models, but depend on the way in which public spending is financed.
    JEL: E31 E32 E52
    Date: 2014–10
  18. By: Ratna Sahay; Vivek B. Arora; Athanasios V Arvanitis; Hamid Faruqee; Papa N'Diaye; Tommaso Mancini Griffoli
    Abstract: Accommodative monetary policies in advanced economies have spurred increased capital inflows into emerging markets since the global financial crisis. Starting in May 2013, when the Federal Reserve publicly discussed its plans for tapering unconventional monetary policies, these emerging markets have experienced financial turbulence at the same that their domestic economic activity has slowed. This paper examines their experiences and policy responses and draws broad policy lessons. For emerging markets, good macroeconomic fundamentals matter, and early and decisive measures to strengthen macroeconomic policies and reduce vulnerabilities help dampen market reactions to external shocks. For advanced economies, clear and effective communication about the exit from unconventional monetary policy can and did help later to reduce the risk of excessive market volatility. And for the global community, enhanced global cooperation, including a strong global financial safety net, offers emerging markets effective protection against excessive volatility.
    Keywords: Emerging markets;International capital market volatility;Capital flows;Monetary policy;Macroprudential Policy;United States;Developed countries;Tapering, unconventional monetary policy, volatility, macroprudential, capital flow measures, foreign exchange intervention
    Date: 2014–10–02
  19. By: David M. Woodruff
    Abstract: The Eurozone’s reaction to the economic crisis beginning in late 2008 involved both efforts to mitigate the arbitrarily destructive effects of markets and vigorous pursuit of policies aimed at austerity and deflation. To explain this paradoxical outcome, this paper builds on Karl Polanyi’s account of how politics reached a similar deadlock in the 1930s. Polanyi argued that democratic impulses pushed for the protective response to malfunctioning markets. However, under the gold standard the prospect of currency panic afforded great political influence to bankers, who used it to push for austerity, deflationary policies, and the political marginalization of labor. Only with the achievement of this last would bankers and their political allies countenance surrendering the gold standard. The paper reconstructs Polanyi’s theory of governing by panic and uses it to explain the course of the Eurozone policy over three key episodes in the course of 2010-2012. The prospect of panic on sovereign debt markets served as a political weapon capable of limiting a protective response, wielded in this case by the European Central Bank (ECB). Committed to the neoliberal Brussels-Frankfurt consensus, the ECB used the threat of staying idle during panic episodes to push policies and institutional changes promoting austerity and deflation. Germany’s Ordoliberalism, and its weight in European affairs, contributed to the credibility of this threat. While in September 2012 the ECB did accept a lender-of-last-resort role for sovereign debt, it did so only after successfully promoting institutional changes that severely complicated any deviation from its preferred policies.
    Keywords: Euro; European Central Bank; European Central Bank; fiscal policy
    Date: 2014–10–24
  20. By: Frederic Lambert; Kenichi Ueda
    Abstract: Unconventional monetary policy is often assumed to benefit banks. However, we find little supporting evidence. Rather, we find some evidence for heightened medium-term risks. First, in an event study using a novel instrument for monetary policy surprises, we do not detect clear effects of monetary easing on bank stock valuation but find a deterioration of medium-term bank credit risk in the United States, the euro area, and the United Kingdom. Second, in panel regressions using U.S. banks’ balance sheet information, we show that bank profitability and risk taking are ambiguously affected, while balance sheet repair is delayed.
    Keywords: Monetary policy;Interest rate policy;United States;Euro Area;United Kingdom;Banks;Credit risk;Bank soundness;Balance sheets;Regression analysis;Monetary Policy, Bank Profitability, Bank Risk, Balance Sheet Repair
    Date: 2014–08–13
  21. By: Mendicino, Caterina; Punzi, Maria Teresa
    Abstract: This paper evaluates the monetary and macroprudential policies that mitigate the procyclicality arising from the interlinkage4s between current account deficits and financial vulnerabilities. We develop a two-country dynamic stochastic general equilibrium (DSGE) model with heterogeneous households and collateralised debt. The model predicts that external shocks are important in driving current account deficits that are coupled with run-ups in house prices and household dept. In this context, optimal policy features an interestrate response to credit and a LTV ration that countercyclically responds to house price dynamics. By allowing an interest-rate response to changes in financial variables, the monetary policy authority improves social welfare, because of the large welfare gains accrued to the savers. The additional use of a countercyclical LTV ratio that responds to house prices, increases the ability of borrowers to smooth consumption over the cycle and is Pareto improving. Domestic and foreign shocks account for a similar fraction of the welfare gains delivered by such a policy.
    Keywords: house prices,financial frictions,global imbalances,saving glut,dynamic loan-to value ratios,monetary policy,optimized simple rules
    JEL: C33 E51 F32 G21
    Date: 2014
  22. By: Radde, Sören
    Abstract: This paper argues that counter-cyclical liquidity hoarding by financial intermediaries may strongly amplify business cycles. It develops a dynamic stochastic general equilibrium model in which banks operate subject to agency problems and funding liquidity risk in their inter- mediation activity. Importantly, the amount of liquidity reserves held in the financial sector is determined endogenously: Balance sheet constraints force banks to trade off insurance against funding outflows with loan scale. A financial crisis, simulated as an abrupt decline in the collateral value of bank assets, triggers a flight to liquidity, which strongly amplifies the initial shock and induces credit crunch dynamics sharing key features with the Great Recession. The paper thus develops a new balance sheet channel of shock transmission that works through the composition of banks' asset portfolios. JEL Classification: E22, E32, E44
    Keywords: bank capital channel, credit crunch, funding liquidity risk, liquidity hoarding, macro-finance
    Date: 2014–09
  23. By: Falk Mazelis; ; ;
    Abstract: We extend the monetary DSGE model by Gertler and Karadi (2011) with a non-bank financial intermediary to investigate the impact of monetary policy shocks on aggregate loan supply. We distinguish between bank and non-bank intermediaries based on the liquidity of their credit claims. While banks can endogenously create deposits to fund firm loans, non-banks have to raise deposits on the funding market to function as intermediaries. The funding market is modeled via search and matching by non-banks for available deposits of households. Because deposit creation responds to economy-wide productivity automatically, bank reaction to shocks corresponds to the balance sheet channel. Non-banks are constrained by the available deposits and their behavior is better explained by the lending channel. The two credit channels are affected differently following a monetary policy shock. As a result of these counteracting effects, an increasing non-bank sector leads to a reduced reaction of aggregate loan supply following a monetary policy shock, which is consistent with the data. An extension to deposit like-issuance by the non-bank sector will allow further studies of re-regulating the non-bank sector.
    Keywords: Shadow Banking, Monetary Transmission Mechanism, Credit Channel
    JEL: E32 E44 E51 G20
    Date: 2014–10
  24. By: Cheng, Gong
    Abstract: Based on a theoretical model, this paper shows that foreign reserves are useful for a country to enhance the resilience of its domestic economy against balance sheet effects in the context of external financing strains. Using foreign reserves, the government can either lend in foreign currency to the private sector or conduct expenditure-switching policy to increase fiscal spending on domestic goods. Both policies cam remove the bad equilibrium represented by a large depreciation of the domestic currency and a very low level of investment. Nevertheless, these two policy tools differ in the ways they stabilize the domestic economy and in terms of the minimum required amount of foreign reserves. A targeted lending works by altering investors’ expectation on domestic exchange rate and firms’ net worth. As long as foreign reserves are sufficient to cover the private sector’s external debt, the bad equilibrium is removed even without an actual depletion of reserves. On the contrary, fiscal spending increases the demand for domestic goods and affects the relative price, leading to domestic exchange rate appreciation that increases firms’ net worth and facilitates investment.
    Keywords: Foreign reserves; currency mismatch; balance sheet effects
    JEL: F31 F32 F41 G01 H30
    Date: 2014–01–14
  25. By: Hess Chung; Edward Herbst; Michael T. Kiley
    Abstract: We explore the importance of the nature of nominal price and wage adjustment for the design of effective monetary policy strategies, especially at the zero lower bound. Our analysis suggests that sticky-price and sticky-information models fit standard macroeconomic time series comparably well. However, the model with information rigidity responds differently to anticipated shocks and persistent zero-lower bound episodes - to a degree important for monetary policy and for understanding the effects of fundamental disturbances when monetary policy cannot adjust. These differences may be important for understanding other policy issues as well, such as fiscal multipliers. Despite these differences, many aspects of effective policy strategy are common across the two models: In particular, highly inertial interest rate rules that respond to nominal income or the price level perform well, even when hit by adverse supply shocks or large demand shocks that induce the zero-lower bound. Rules that respond to the level or change in the output gap can perform poorly under those conditions.
    JEL: E31 E37 E52
    Date: 2014–10
  26. By: Hubrich, Kirstin; Tetlow, Robert J.
    Abstract: A financial stress index for the United States is introduced – an index that was used in real time by the staff of the Federal Reserve Board to monitor the financial crisis of 2008-9 – and the interaction with real activity, inflation and monetary policy is demonstrated using a richly parameterized Markov-switching VAR model, estimated using Bayesian methods. A "stress event" is defined as a period where the latent Markov states for both shock variances and model coefficients are adverse. Results show that allowing for time variation is economically and statistically important, with solid (quasi) real-time properties. Stress events line up well with financial events in history. A shift to a stress event is highly detrimental to the outlook for the real economy, and conventional monetary policy is relatively weak during such periods. JEL Classification: E44, C11, C32
    Keywords: financial crises, Markov switching, monetary policy, nonlinearity
    Date: 2014–09
  27. By: Drew D. Creal; Jing Cynthia Wu
    Abstract: Uncertainty associated with the monetary policy transmission mechanism is a key driving force of business cycles. To investigate this link, we propose a new term structure model that allows the volatility of the yield curve to interact with macroeconomic indicators. The data favors a model with two volatility factors that capture short-term and long-term interest rate uncertainty. Increases in either of them lead higher unemployment rates, but they interact with inflation in opposite directions.
    JEL: C5 E4
    Date: 2014–10
  28. By: Offick, Sven; Wohltmann, Hans-Werner
    Abstract: This paper integrates a money and credit market into a static approximation of the baseline New Keynesian model based on a money-and-credit-in-the-utility approach, in which real balances and borrowing contribute to the household's utility. In this framework, the central bank has no direct control over the interest rate on bonds. Instead, the central bank's instrument variables are the monetary base and the refinancing rate, i.e. the rate at which the central bank provides loans to the banking sector. Our approach gives rise to a credit channel, in which current and expected future interest rates on the bond and loan market directly affect current goods demand. The credit channel amplifies the output effects of isolated monetary disturbances. Taking changes in private (inflation and interest rate) expectations into account, we find that - contrarily to Bernanke and Blinder (1988) - the credit channel may also dampen the output effects of monetary disturbances.
    Keywords: Money,Loan,Money-and-credit-in-the-utility,Credit channel,New Keynesian model,Monetary policy
    JEL: A20 E51 E52
    Date: 2014
  29. By: Marc Pourroy (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne)
    Abstract: Are emerging economies implementing inflation targeting (IT) with a perfectly flexible exchange-rate arrangement, as developed economies do, or have these countries developed their own IT framework? This paper offers a new method for assessing exchange-rate policies that combines the use of "indicator countries", providing an empirical definition of exchange-rate flexibility or rigidity, and clustering through Gaussian mixture estimates in order to identify countries' de facto regimes. By applying this method to 19 inflation-targeting emerging economies, I find that the probability of those countries having a perfectly flexible arrangement as developed economies do is 52%, while the probability of having a managed float system, obtained through foreign exchange market intervention, is 28%, and that of having a rigid exchange-rate system (similar to those of pegged currencies) is 20%. The results also provide evidence of two different monetary regimes under inflation targeting: flexible IT when the monetary authorities handle only one tool, the interest rate, prevailing in ten economies, and hybrid IT when the monetary authorities add foreign exchange interventions to their toolbox, prevailing in the remaining nine economies.
    Keywords: Inflation-targeting; foreign exchange interventions; Gaussian mixture model
    Date: 2013–10

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