nep-mon New Economics Papers
on Monetary Economics
Issue of 2015‒01‒09
forty-one papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Money growth and consumer price inflation in the euro area: A wavelet analysis By Mandler, Martin; Scharnagl, Michael
  2. Estimating the Preferences of Central Bankers : An Analysis of Four Voting Records By Eijffinger, S.C.W.; Mahieu, R.J.; Raes, L.B.D.
  3. A Steadier Course for Monetary Policy By John B. Taylor
  4. The Bond Market: An Inflation-Targeter's Best Friend By Rose, Andrew K
  5. Central Banks: Powerful, Political and Unaccountable? By Buiter, Willem H.
  6. Exchange Rate Forecasts and Expected Fundamentals By Christian D. Dick; Ronald MacDonald; Lukas Menkhoff
  7. Are Consumer Expectations Theory-Consistent? The Role of Macroeconomic Determinants and Central Bank Communication By Dräger, L.; Lamla, M.J.; Pfajfar, D.
  8. Exchange rate and price dynamics in a small open economy - the role of the zero lower bound and monetary policy regimes By Gregor Bäurle; Daniel Kaufmann
  9. Menu Costs, Aggregate Fluctuations, and Large Shocks By Karadi, Peter; Reiff, Adam
  10. Exchange Rate Flexibility under the Zero Lower Bound By Cook, David; Devereux, Michael B
  11. Testing 'the trilemma' in post-transitional Europe: a new empirical measure of capital mobility By Tomislav Globan
  12. Sources of exchange rate fluctuation in Vietnam: an application of the SVAR model By Nguyen Van, Phuong
  13. Testing the Expectations Trap Hypothesis: A Time-Varying Parameter Approach By Naveen Srinivasan
  14. Regional Inflation and Financial Dollarization By Brown, M.; de Haas, R.; Sokolov, V.
  15. Shocks to Bank Lending, Risk-Taking, Securitization, and Their Role for U.S. Business Cycle Fluctuations By Peersman, G.; Wagner, W.B.
  16. The Curse of Inflation By Eyster, Erik; Madarász, Kristóf; Michaillat, Pascal
  17. Large banks, loan rate markup and monetary policy By Vincenzo Cuciniello; Federico M. Signoretti
  18. Institutions for Macro Stability in Brazil: Inflation Targets and Fiscal Responsibility By José Roberto Afonso; Eliane Cristina Araújo
  19. Forward and Spot Exchange Rates in a Multi-currency World By Hassan, Tarek; Mano, Rui C.
  20. An Empirical Assessment of Optimal Monetary Policy Delegation in the Euro Area By Xiaoshan Chen; Tatiana Kirsanova; Campbell Leith
  21. Heterogeneity in Inflation Expectations and Macroeconomic Stability under Satisficing Learning By Jaylson Jair da Silveira; Gilberto Tadeu Lima
  22. Exiting from Low Interest Rates to Normality: An Historical Perspective By Michael D. Bordo
  23. Credit Spreads and Credit Policies By Correia, Isabel; De Fiore, Fiorella; Teles, Pedro; Tristani, Oreste
  24. Targeting core inflation in emerging market economies By Stan du Plessis
  25. Unravelling India’s Inflation Puzzle By Pankaj Kumar; Naveen Srinivasan
  26. Can We Stabilize the Price of a Cryptocurrency?: Understanding the Design of Bitcoin and Its Potential to Compete with Central Bank Money By Iwamura, Mitsuru; Kitamura, Yukinobu; Matsumoto, Tsutomu; Saito, Kenji
  27. International House Price Cycles, Monetary Policy and Risk Premiums By Gregory Bauer
  28. Unprecedented Actions: The Federal Reserve’s Response to the Global Financial Crisis in Historical Perspective By Frederic S. Mishkin; Eugene N. White
  29. Measuring the Euro-Dollar Permanent Equilibrium Exchange Rate using the Unobserved Components Model By Chen, Xiaoshan; MacDonald, Ronald
  30. The effect of macroprudential policy on endogenous credit cycles By Clancy, Daragh; Merola, Rossana
  31. Are Central Bankers Inflation Nutters? - A Bayesian MCMC Estimator of the Long Memory Parameter in a State Space Model By Andersson, Fredrik N. G.; Li, Yushu
  32. WAGE INDEXATION AND THE MONETARY POLICY REGIME By Selien De Schryder; Gert Peersman; Joris Wauters
  33. The Demand for Short-Term, Safe Assets and Financial Stability: Some Evidence and Implications for Central Bank Policies By Carlson, Mark A.; Duygan-Bump, Burcu; Natalucci, Fabio M.; Nelson, William R.; Ochoa, Marcelo; Stein, Jerome L.; Van den Heuvel, Skander J.
  34. Common Macro Factors and Currency Premia By Filippou, Ilias; Taylor, Mark P
  35. Re-Normalize, Don't New-Normalize Monetary Policy By John B. Taylor
  36. Central Bank Communication and the Management of Market Confidence: Two Episodes in 2013 in the U.S. and Japan By Koichiro Kamada
  37. Estimating the effects of forward guidance in rational expectations models By Richard Harrison
  38. Targeting Inflation from Below - How Do Inflation Expectations Behave? By Michael Ehrmann
  39. Liquidity Traps and Monetary Policy: Managing a Credit Crunch By Buera, Francisco J.; Nicolini, Juan Pablo
  40. "Outside Money: The Advantages of Owning the Magic Porridge Pot" By L. Randall Wray
  41. Bayesian Combination for Inflation Forecasts: The Effects of a Prior Based on Central Banks’ Estimates By Luis F. Melo Velandia; Rubén A. Loaiza Maya; Mauricio Villamizar-Villegas

  1. By: Mandler, Martin; Scharnagl, Michael
    Abstract: Our paper studies the relationship between money growth and consumer price inflation in the euro area using wavelet analysis. Wavelet analysis allows to account for variations in the money growth-inflation relationship both across the frequency spectrum and across time. We find evidence of strong comovements between money growth and inflation at low frequencies with money growth as the leading variable. However, our analysis of time variation at medium-to-long-run frequencies indicates a weakening of the relationship after the mid 1990s which also reflects in a deterioration of the leading indicator property and a decline in the cross wavelet gain. In contrast, most of the literature, by failing to account for the effects of time variation, estimated stable long-run relationships between money growth and inflation well into the 2000s.
    Keywords: money growth,inflation,wavelet analysis
    JEL: C30 E31 E40
    Date: 2014
  2. By: Eijffinger, S.C.W. (Tilburg University, Center For Economic Research); Mahieu, R.J. (Tilburg University, Center For Economic Research); Raes, L.B.D. (Tilburg University, Center For Economic Research)
    Abstract: Abstract: This paper analyzes the voting records of four central banks (Sweden, Hungary, Poland and the Czech Republic) with spatial models of voting. We infer the policy preferences of the monetary policy committee members and use these to analyze the evolution in preferences over time and the differences in preferences between member types and the position of the Governor in different monetary policy committees.
    Keywords: Ideal points; Voting records; Central Banking; NBP; CNB; MNB; Riksbank
    JEL: E58 E59 C11
    Date: 2013
  3. By: John B. Taylor (Department of Economics, Stanford University)
    Abstract: This testimony before the Joint Economic Committee of the United States Congress discusses the adverse impacts of the Federal Reserve's recent departure from a rules-based monetary policy and the gains to be made by returning to a steadier monetary policy.
    Date: 2013–04
  4. By: Rose, Andrew K
    Abstract: This paper explores the relationship between inflation and the existence of a publicly-traded, long-maturity, nominal, domestic-currency bond market. Bond holders suffer from inflation and could be a potent anti-inflationary force; I ask whether their presence is apparent empirically. I use a panel data approach, examining the difference in inflation before and after the introduction of a bond market. My primary focus is on countries with inflation targeting regimes, though I also examine countries with hard fixed exchange rates and other monetary regimes. Inflation-targeting countries with a bond market experience inflation approximately three to four percentage points lower than those without a bond market. This effect is economically and statistically significant; it is also insensitive to a variety of estimation strategies, including using political and fiscal instrumental variables. The existence of a bond market has little effect on inflation in other monetary regimes, as do indexed or foreign-denominated bonds.
    Keywords: currency; domestic; effect; empirical; fixed; long; maturity; nominal; panel; risk
    JEL: E52 E58
    Date: 2014–09
  5. By: Buiter, Willem H.
    Abstract: Central banks’ economic and political importance has grown in advanced economies since the start of the Great Financial Crisis in 2007. An unwillingness or inability of governments to use countercyclical fiscal policy has made monetary policy the only stabilization tool in town. However, much of the enhanced significance of central banks is due to their lender-of-last-resort and market-maker-of-last-resort roles, providing liquidity to financially distressed and illiquid financial institutions and sovereigns. Supervisory and regulatory functions – often deeply political, have been heaped on central banks. Central bankers also increasingly throw their weight around in the public discussion of and even the design and implementation of fiscal policy and structural reforms - areas which are way beyond their mandates and competence. In this lecture I argue that the preservation of the central bank’s legitimacy requires that a clear line be drawn between the central bank’s provision of liquidity and the Treasury’s solvency support for systemically important financial institutions. All activities of the central bank that expose it to material credit risk should be guaranteed by the Treasury. In addition, central banks must become more accountable by increasing the transparency of their lender-of-last-resort and marketmaker-of-last resort activities. Central banks ought not to engage in quasi-fiscal activities. Finally, central banks should stick to their knitting and central bankers should not become participants in public debates and deeply political arguments about matters beyond their mandate and competence, including fiscal policy and structural reform.
    Keywords: accountability; independence,; legitimacy; monetary policy; quasi-fiscal; regulation; seigniorage,; supervision
    JEL: E02 E42 E52 E58 E61 E62 E63 G18 G28 H63
    Date: 2014–10
  6. By: Christian D. Dick; Ronald MacDonald; Lukas Menkhoff
    Abstract: Using a large panel of individual professionals' forecasts, this paper demonstrates that good exchange rate forecasts are related to a proper understanding of fundamentals, specifically good interest rate forecasts. This relationship is robust to individual fixed effects and further controls. Reassuringly, the relationship is stronger during phases when the impact from fundamentals is more obvious, e.g., when exchange rates substantially deviate from their PPP values. Finally, forecasters largely agree that an interest rate increase relates to a currency appreciation, but only good forecasters get expected interest rates right
    Keywords: Exchange Rate Determination, Individual Expectations, Macroeconomic Fundamentals
    JEL: F31 F37 E44
    Date: 2014–11
  7. By: Dräger, L.; Lamla, M.J.; Pfajfar, D. (Tilburg University, Center For Economic Research)
    Date: 2013
  8. By: Gregor Bäurle; Daniel Kaufmann
    Abstract: We analyse nominal exchange rate and price dynamics after risk premium shocks with short-term interest rates constrained by the zero lower bound (ZLB). In a small-open-economy DSGE model, temporary risk premium shocks lead to shifts of the exchange rate and the price level if a central bank implements an inflation target by means of a traditional Taylor rule. These shifts are strongly amplified and become more persistent once the ZLB is included in the model. We also provide empirical support for this finding. Using a Bayesian VAR for Switzerland, we find that responses of the exchange rate and the price level to a temporary risk premium shock are larger and more persistent when the ZLB is binding. Our theoretical discussion shows that alternative monetary policy rules that stabilise price-level expectations are able to dampen exchange rate and price fluctuations when the ZLB is binding. This stabilisation can be achieved by including either the price level or, alternatively, the nominal exchange rate in the policy rule.
    Keywords: Exchange rate and price dynamics, zero lower bound on short-term interest rates, small-open-economy DSGE model, monetary policy regimes, monetary transmission, Bayesian VAR, sign restrictions
    JEL: C11 C32 E31 E37 E52 E58 F31
    Date: 2014
  9. By: Karadi, Peter; Reiff, Adam
    Abstract: How do frictions in price setting influence monetary non-neutrality? We revisit this classic question in a quantitative menu cost model with multi-product firms that face idiosyncratic shocks with unsynchronized stochastic volatility. The model matches the unconditional distribution of price changes and successfully predicts new evidence on pricing responses to large value-added tax shocks. In particular, it captures both the exploding fraction of price changes and the shape of their conditional distribution, outperforming alternative models. The model generates near money neutrality even to small nominal shocks.
    Keywords: monetary policy transmission; price change distribution; state-dependent pricing; value-added tax
    JEL: E31 E52
    Date: 2014–09
  10. By: Cook, David; Devereux, Michael B
    Abstract: An independent currency and a flexible exchange rate generally helps a country in adjusting to macroeconomic shocks. But recently in many countries, interest rates have been pushed down close to the lower bound, limiting the ability of policy-makers to accommodate shocks, even in countries with flexible exchange rates. This paper argues that if the zero bound constraint is binding and policy lacks an effective `forward guidance' mechanism, a flexible exchange rate system may be inferior to a single currency area. With monetary policy constrained by the zero bound, under flexible exchange rates, the exchange rate exacerbates the impact of shocks. Remarkably, this may hold true even if only a subset of countries are constrained by the zero bound, and other countries freely adjust their interest rates under an optimal targeting rule. In a zero lower bound environment, in order for a regime of multiple currencies to dominate a single currency, it is necessary to have effective forward guidance in monetary policy.
    Keywords: Forward Guidance; Lower Bound; Monetary Policy; Optimal Currency Area
    JEL: E2 E5 E6
    Date: 2014–10
  11. By: Tomislav Globan (Faculty of Economics and Business, University of Zagreb)
    Abstract: This paper develops a new empirical measure of capital mobility. It tests the hypothesis that the degree of capital mobility can be estimated by measuring the reaction intensity of capital flows to shocks in interest rates, on a sample of eight European post-transitional economies. This hypothesis can be derived from the Mundell-Fleming open economy model, implications of which are essentially based on the assumption of a close link between the degree of capital mobility in a country and the reaction of its capital flows to changes in domestic and external interest rates. Precisely because of this interrelationship, policy holders, in theory, face the policy trilemma or the 'impossible trinity', i.e. the inability to achieve three following objectives simultaneously – a stable exchange rate, financial openness, and an independent monetary policy. Using impulse response and historical decomposition analysis in a VAR framework, the results show a significant increase in the explanatory power of interest rates for the movement of capital flows shortly before and after the accession of post-transitional economies to the European Union. On the other hand, the recent financial crisis made capital flows less sensitive to interest rates due to increased risk aversion on international capital markets. Results suggest that the degree of capital mobility, i.e. the level of financial integration with EU-15, is highest in Bulgaria, Latvia and Lithuania, and least pronounced in Poland and Croatia. Results are verified by a number of robustness checks, with three separate alternative measures of capital mobility confirming the results obtained from the econometric model.
    Keywords: capital flows; capital mobility; the trilemma; impossible trinity; interest rate shocks; VAR model; historical decomposition
    JEL: F21 F32 F36
    Date: 2014–11–21
  12. By: Nguyen Van, Phuong
    Abstract: Vietnam has been implementing the export-oriented economy, in which the central bank of Vietnam, well-known as the State Bank of Vietnam (SBV), adopted the managed float exchange rate regime in 1990. Therefore, the exchange rate movement plays an important role in stimulating the Vietnamese export activities. By applying the long-run SVAR model, pioneered by Blanchard and Quah (1989), this research examines how the real and nominal shocks impact the nominal and real exchange rate (USD/VND) in Vietnam. Based on monthly data concerning USD/VND exchange rate and, the price levels in Vietnam and the United States from May 1995 to December 2013, our empirical results reveal that: the real shock primarily leads the real and nominal exchange rate (USD/VND) to fluctuate over time. Meanwhile, the nominal shock has a temporary effect on the movement in the real exchange rate in Vietnam. Our research also finds that the long-run Purchasing Power Parity (PPP) does not hold in Vietnam.
    Keywords: State Bank of Vietnam, the exchange rate, unit root test, SVAR
    JEL: E50 E58 E60 E69
    Date: 2014–12–12
  13. By: Naveen Srinivasan (Madras School of Economics)
    Abstract: The expectations trap hypothesis is an influential but untested model of monetary policy. The hypothesis conjectures that high inflation during the 1970s was the outcome of a shift in private sector beliefs which were then validated by monetary policy. The subsequent fall in inflation was mainly due to changes in those beliefs. We provide a formal test of the model, using US data from 1948-2008. The flexible least squares approach of Kalaba and Tesfatsion (1988, 1989) is used to evaluate its empirical likelihood. Strong formal support is found for this proposition. Specifically, our results suggest that supply shocks interacting with private sector beliefs about the nature of monetary regime together account for the rise and fall of U.S. inflation.
    Keywords: Monetary policy; Expectations Trap; Time-varying parameters; Flexible Least Squares
    JEL: E31 E42 E52 E58
    Date: 2014–07
  14. By: Brown, M. (Tilburg University, Center For Economic Research); de Haas, R. (Tilburg University, Center For Economic Research); Sokolov, V.
    Abstract: Abstract: We exploit variation in consumer price inflation across 71 Russian regions to examine the relationship between the perceived stability of the local currency and financial dollarization. Our results show that regions with higher inflation experience an increase in the dollarization of household deposits and a decrease in the dollarization of (long-term) household credit. The negative impact of inflation on credit dollarization is weaker in regions with less-integrated banking markets, suggesting that the asset-liability management of banks constrains the currency-portfolio choices of households.
    Keywords: Financial dollarization; financial integration; regional inflation
    JEL: E31 E42 E44 F36 G21 P22 P24
    Date: 2013
  15. By: Peersman, G. (Tilburg University, Center For Economic Research); Wagner, W.B. (Tilburg University, Center For Economic Research)
    Abstract: Abstract: Shocks to bank lending, risk-taking and securitization activities that are orthogonal to real economy and monetary policy innovations account for more than 30 percent of U.S. output variation. The dynamic effects, however, depend on the type of shock. Expansionary securitization shocks lead to a permanent rise in real GDP and a fall in inflation. Bank lending and risktaking shocks, in contrast, have only a temporary effect on real GDP and tend to lead to a (moderate) rise in the price level. Furthermore, there is evidence for a strong search-for-yield effect on the side of investors in the transmission mechanism of monetary policy. These effects are estimated with a structural VAR model, where the shocks are identified using a model of bank risk-taking and securitization.
    Keywords: Bank lending; risk-taking; securitization; SVARs
    JEL: C32 E30 E44 E51 E52
    Date: 2014
  16. By: Eyster, Erik; Madarász, Kristóf; Michaillat, Pascal
    Abstract: This paper proposes a model that explains the nonneutrality of money from two well-documented psychological assumptions. The model incorporates into the general-equilibrium monopolistic-competition framework of Blanchard and Kiyotaki [1987] the psychological assumptions that (1) consumers dislike paying a price that exceeds some ``fair'' markup on firms' marginal costs, and (2) consumers do not know firms' marginal costs and fail to infer them from prices. The first assumption in isolation renders the economy more competitive without changing any of its qualitative properties; in particular, money remains neutral. The two assumptions together cause money to be nonneutral: greater money supply induces lower monopolistic markups, higher hours worked, and higher output. Whereas an increase in money supply is expansionary, it decreases the fairness of transactions perceived by consumers to such an extent that it reduces overall welfare. The cost of inflation is a psychological one that derives from a mistaken belief by consumers that transactions have become less fair. In fact, it is this misperception that makes an increase in money supply expansionary: consumers misattribute the higher prices arising from higher money supply to higher markups; the misperception of higher markups angers them and makes their demand for goods more elastic; in response, monopolists reduce their markups, thus stimulating economic activity. Through a similar mechanism, an increase in technology induces higher output but higher monopolistic markups and lower hours worked.
    Keywords: cursedness; fairness; markup; nonneutrality of money
    JEL: E10 E31
    Date: 2014–12
  17. By: Vincenzo Cuciniello (Bank of Italy); Federico M. Signoretti (Bank of Italy)
    Abstract: This paper studies the implications of introducing large monopolistic banks, which can affect macroeconomic outcomes and thus the response of monetary policy to inflation, in a model with a collateral constraint linking the borrowers� credit capacity to the value of their durable assets. First, we find that strategic interaction generates a countercyclical loan spread, which amplifies the impact of monetary and technology shocks on the real economy. This type of financial accelerator adds up to the one due to financial frictions and is crucially related to the existence of non-atomistic banks. Second, the level of the spread and the degree of amplification are positively related to the level of entrepreneurs� leverage, reflecting the fact that higher leverage implies greater elasticity of the policy rate to changes in loan rates, which in turn increases banks� market power. Third, we find that amplification is stronger the more aggressive the central bank�s response to inflation, as measured by the inflation coefficient in the Taylor rule.
    Keywords: large banks, bank markup, monetary policy
    JEL: E51 E52 G21
    Date: 2014–10
  18. By: José Roberto Afonso; Eliane Cristina Araújo
    Abstract: Monetary and fiscal institutions have played a decisive role in the stabilisation of the Brazilian economy since the mid-1990s. Brazil’s experience of designing and managing institutions to this end is likely to be of interest to other emerging and low- or middle-income economies. In Brazil institutional reforms were predominantly made in response to a succession of internal and, particularly, external crises. Indeed, perhaps nowhere in the world has inflation received as much attention from economists as in Brazil. The consequent accumulation of theoretical and practical knowledge resulted in a wealth of theories about the nature of Brazilian inflation. As such, the Brazilian experience offers many lessons to be learned, both in the sense of what could be done and what is better avoided. When it abandoned the exchange rate anchor, Brazil was one of the first emerging economies to adopt a system of inflation targets. In the area of fiscal policy, a succession of institutional changes – from changes in the budget and management of the public debt to the fiscal adjustment of regional governments – culminated in the adoption of the Fiscal Responsibility Law shortly after the introduction of new monetary and exchange policies. However, consolidation of the new currency, the Real, and accelerated growth shortly after the turn of the century, followed by the global financial crisis, meant that the agenda of structural reforms was abandoned. New aspects were introduced to economic policy, such as a strong link between the growth of public debt and credit supply.Recent stagnation, with repeated years of low growth, inflation pushing at the ceiling of its target, and primary surplus below its target, sets new challenges for the Brazilian economy.
    Date: 2014
  19. By: Hassan, Tarek; Mano, Rui C.
    Abstract: We decompose violations of uncovered interest parity into a cross-currency, a betweentime-and-currency, and a cross-time component. We show that most of the systematic violations are in the cross-currency dimension. By contrast, we find no statistically reliable evidence that currency risk premia respond to deviations of forward premia from their time- and currency-specific mean. These results imply that the forward premium puzzle (FPP) and the carry-trade anomaly are separate phenomena that may require separate explanations. The carry trade is driven by static differences in interest rates across currencies, whereas the FPP appears to be driven primarily by cross-time variation in all currency risk premia against the US dollar. Models that feature two symmetric countries thus cannot explain either of the two phenomena. Once we make the appropriate econometric adjustments we also cannot reject the hypothesis that the elasticity of risk premia with respect to forward premia in all three dimensions is smaller than one. As a result, currency risk premia need not be correlated with expected changes in exchange rates.
    Keywords: carry trade; forward premium puzzle; risk premia in foreign exchange markets
    JEL: F31 G12 G15
    Date: 2014–07
  20. By: Xiaoshan Chen; Tatiana Kirsanova; Campbell Leith
    Abstract: We estimate a New Keynesian DSGE model for the Euro area under alternative descriptions of monetary policy (discretion, commitment or a simple rule) after allowing for Markov switching in policy maker preferences and shock volatilities. This reveals that there have been several changes in Euro area policy making, with a strengthening of the anti-inflation stance in the early years of the ERM, which was then lost around the time of German reunification and only recovered following the turnoil in the ERM in 1992. The ECB does not appear to have been as conservative as aggregate Euro-area policy was under Bundesbank leadership, and its response to the financial crisis has been muted. The estimates also suggest that the most appropriate description of policy is that of discretion, with no evidence of commitment in the Euro-area. As a result although both ‘good luck’ and ‘good policy’ played a role in the moderation of inflation and output volatility in the Euro-area, the welfare gains would have been substantially higher had policy makers been able to commit. We consider a range of delegation schemes as devices to improve upon the discretionary outcome, and conclude that price level targeting would have achieved welfare levels close to those attained under commitment, even after accounting for the existence of the Zero Lower Bound on nominal interest rates.
    Keywords: Bayesian Estimation, Interest Rate Rules, Optimal Monetary Policy, Great Moderation, Commitment, Discretion, Zero Lower Bound, Financial Crisis, Great Recession
    JEL: E58 E32 C11 C51 C52 C54
    Date: 2014–11
  21. By: Jaylson Jair da Silveira; Gilberto Tadeu Lima
    Abstract: Drawing on a considerable empirical and experimental literature that finds persistent and endogenously time-varying heterogeneity in inflation expectations, this paper embeds two inflation forecasting strategies – one based on costly full rationality or perfect foresight, the second based on costless bounded rationality or adaptive foresight – in a basic macroeconomic model. Drawing in particular on the significant evidence that forecast errors have to pass some threshold before agents abandon their previously selected inflation forecasting strategy, we assume that agents switch between these forecasting strategies based on satisficing evolutionary dynamics. We find that convergence to a long-run equilibrium configuration consistent with output growth, unemployment and inflation at their natural levels is achieved even when heterogeneity in inflation expectations (with predominance of the adaptive foresight strategy) is an attractor of a noisy satisficing evolutionary dynamics. Therefore, in accordance with the empirical evidence, persistent heterogeneity in inflation expectations (with prevalence of bounded rational expectations) emerges as a long-run equilibrium outcome.
    Keywords: Heterogeneous inflation expectations; perfect foresight; adaptive foresight; noisy satisficing evolutionary dynamics
    JEL: E31 C62 C73
    Date: 2014–11–26
  22. By: Michael D. Bordo (Rutgers University)
    Abstract: This paper examines the Federal Reserve's recent policy of quantitative easing by looking back at the experience of the 1930s and 1940s when the Fed, under Treasury control, kept interest rates at levels comparable to today and its balance sheet increased similarly. The paper also presents macroeconomic evidence based on the labor market, the growth of the money supply, and the behavior of real GDP and the unemployment rate in addition to a comparison of the Federal funds rate with the Taylor Rule rate and the shadow funds rate. Because of issues connected to its large balance sheet, the Fed may use tools other than the federal funds rate to tighten monetary policy. Returning to a higher (more normal) rate environment will remove some of the distortions that have accompanied the long period of abnormally low interest rates. But rising rates will also present problems for public finance and for the distribution of income that all but guarantees political rancor in the future.
    Date: 2014–11
  23. By: Correia, Isabel; De Fiore, Fiorella; Teles, Pedro; Tristani, Oreste
    Abstract: How should monetary and fiscal policy react to adverse financial shocks? If monetary policy is constrained by the zero lower bound on the nominal interest rate, subsidising the interest rate on loans is the optimal policy. The subsidies can mimic movements in the interest rate and can therefore overcome the zero bound restriction. Credit subsidies are optimal irrespective of how they are financed. If debt is not state contingent, they result in a permanent increase in the level of public debt and future taxes, and in a permanent reduction in output.
    Keywords: banks; credit policies; credit subsidies; monetary policy; zero bound on interest rates
    JEL: E31 E40 E44 E52 E58 E62 E63
    Date: 2014–05
  24. By: Stan du Plessis (Department of Economics, University of Stellenbosch)
    Abstract: The pre-crisis monetary policy consensus has been challenged on a number of fronts. Even the nominal target, around which the modern consensus developed, has been called into question, with a vigorous recent debate ensuing about nominal income targeting as an alternative. This paper contributes to the controversy by arguing that one important reform of inflation-targeting regimes that deserves more attention is reformulating their targets explicitly in terms of core inflation. Core inflation targeting has a better theoretical grounding from both welfare economics and business cycle perspectives, holds practical advantages for inflation-targeting central banks, and has the promising feature of improving the frankness and accountability of monetary policy.
    Keywords: Inflation, Core inflation, Inflation-targeting, Monetary policy
    JEL: E31 E52 E58
    Date: 2014
  25. By: Pankaj Kumar (Indira Gandhi Institute of Development Research); Naveen Srinivasan (Madras School of Economics)
    Abstract: From 2003, the Indian economy enjoyed a boom in growth coupled with moderate inflation for five years. The economy grew at a rate close to 9 percent per year, until it was punctured by the global financial crisis of 2008. Since then, the persistence of inflation in an environment of falling economic growth has come out as a “puzzle” to policymakers’ and many in the financial market. Why has the current slowdown in growth not been disinflationary? This paper contends that there were two important policy errors that are behind the stagflationary outcome. The rapid deterioration in public finances in response to the global economic crisis while stimulating demand temporarily managed to pull down the potential growth rate of the economy. The RBI compounded the problem by being sluggish and soft on inflation after the economy bounced back from the effects of the global economic crisis because it systematically overestimated the potential growth rate of the economy. This meant that by the time monetary policy was tightened, high inflation and inflation expectations had already become entrenched. That is why the current growth slowdown has not been disinflationary
    Keywords: India; Inflation; Potential Output; Taylor Rule
    JEL: E31 E32 E52
    Date: 2014–06
  26. By: Iwamura, Mitsuru; Kitamura, Yukinobu; Matsumoto, Tsutomu; Saito, Kenji
    Abstract: This paper discusses the potential and limitations of Bitcoin as a digital currency. Bitcoin as a digital asset has been extensively discussed from the viewpoints of engineering and security design. But there are few economic analyses of Bitcoin as a currency. Bitcoin was designed as a payments vehicle and as a store of value (or speculation). It has no use bar as money or currency. Despite recent enthusiasm for Bitcoin, it seems very unlikely that currencies provided by central banks are at risk of being replaced, primarily because of the market price instability of Bitcoin (i.e. the exchange rate against the major currencies). We diagnose the instability of market price of Bitcoin as being a symptom of the lack of flexibility in the Bitcoin supply schedule ‐ a predetermined algorithm in which the proof of work is the major driving force. This paper explores the problem of instability from the viewpoint of economics and suggests a new monetary policy rule (i.e. monetary policy without a central bank) for stabilizing the values of Bitcoin and other cryptocurrencies.
    Keywords: Bitcoin, Cryptocurrency, Currency competition, Friedrich A. Hayek, Proof of work
    JEL: B31 E42 E51
    Date: 2014–11
  27. By: Gregory Bauer
    Abstract: Using a panel logit framework, the paper provides an estimate of the likelihood of a house price correction in 18 OECD countries. The analysis shows that a simple measure of the degree of house price overvaluation contains a lot of information about subsequent price reversals. Corrections are typically triggered by a sharp tightening in the monetary policy interest rate relative to a baseline level in each country. Two different assessments of the current and future baseline estimates of monetary policy interest rates are provided: a simple Taylor rule and one extracted from a term structure model. A case study based on the Canadian housing market is presented.
    Keywords: Econometric and statistical methods, Housing
    JEL: C2 E43 R21
    Date: 2014
  28. By: Frederic S. Mishkin; Eugene N. White
    Abstract: Interventions by the Federal Reserve during the financial crisis of 2007-2009 were generally viewed as unprecedented and in violation of the rules—notably Bagehot’s rule—that a central bank should follow to avoid the time-inconsistency problem and moral hazard. Reviewing the evidence for central banks’ crisis management in the U.S., the U.K. and France from the late nineteenth century to the end of the twentieth century, we find that there were precedents for all of the unusual actions taken by the Fed. When these were successful interventions, they followed contingent and target rules that permitted pre-emptive actions to forestall worse crises but were combined with measures to mitigate moral hazard.
    JEL: E58 G01 N10 N20
    Date: 2014–12
  29. By: Chen, Xiaoshan; MacDonald, Ronald
    Abstract: This paper employs an unobserved component model that incorporates a set of economic fundamentals to obtain the Euro-Dollar permanent equilibrium exchange rates (PEER) for the period 1975Q1 to 2008Q4. The results show that for most of the sample period, the Euro-Dollar exchange rate closely followed the values implied by the PEER. The only significant deviations from the PEER occurred in the years immediately before and after the introduction of the single European currency. The forecasting exercise shows that incorporating economic fundamentals provides a better long-run exchange rate forecasting performance than a random walk process.
    Keywords: Exchange rate forecasting; Unobserved Components Model; Permanent Equilibrium Exchange Rate
    Date: 2014–11
  30. By: Clancy, Daragh (European Stability Mechanism); Merola, Rossana (International Labour Office)
    Abstract: The financial sector played a key role in triggering the recent crisis. Negative feedback loops between the financial sector and the real economy have further increased the persistence and amplitude of the downturn. We examine such macrofinancial linkages through the lens of the housing market. We develop a model capable of replicating some key stylised facts from the bursting of the Irish property bubble. We show that expectations of future favourable events may accelerate credit growth and potentially result in a more vulnerable economy susceptible to downward revisions to the original expectations. We find that macro-prudential policy, in particular counter-cyclical capital requirements and larger capital buffers, can play a role in insulating the economy from these risks.
    Keywords: DSGE, macro-prudential policy, macro-financial linkages, capital requirements, Ireland.
    JEL: E44 E51 G10 G28
    Date: 2014–11
  31. By: Andersson, Fredrik N. G. (Dept. of Economics, Lund University); Li, Yushu (Dept. of Business and Management Science, Norwegian School of Economics)
    Abstract: Several central banks have adopted inflation targets. The implementation of these targets is flexible; the central banks aim to meet the target over the long term but allow inflation to deviate from the target in the short-term in order to avoid unnecessary volatility in the real economy. In this paper, we propose modeling the degree of flexibility using an ARFIMA model. Under the assumption that the central bankers control the long-run inflation rates, the fractional integration order captures the flexibility of the inflation targets. A higher integration order is associated with a more flexible target. Several estimators of the fractional integration order have been proposed in the literature. Grassi and Magistris (2011) show that a state-based maximum likelihood estimator is superior to other estimators, but our simulations show that their finding is over-biased for a nearly non-stationary time series. We resolve this issue by using a Bayesian Monte Carlo Markov Chain (MCMC) estimator. Applying this estimator to inflation from six inflation-targeting countries for the period 1999M1 to 2013M3, we find that inflation is integrated of order 0.8 to 0.9 depending on the country. The inflation targets are thus implemented with a high degree of flexibility.
    Keywords: Fractional integration; inflation-targeting; state space model
    JEL: C10 C11 C15
    Date: 2014–11–28
  32. By: Selien De Schryder; Gert Peersman; Joris Wauters (-)
    Abstract: We estimate a New Keynesian wage Phillips curve for a panel of 24 OECD countries, and allow the degree of wage indexation to past inflation to vary according to the monetary policy regime. We .find that the extent of wage indexation is significantly lower in an inflation targeting regime, in contrast to monetary targeting, exchange rate targeting and policy regimes without an explicit quantitative anchor. The results put into question whether embedding a constant degree of wage indexation in standard DSGE models is truly structural.
    Keywords: wage indexation, monetary policy regimes, cross-country panel, Phillips curve
    JEL: C23 E42 J30
    Date: 2014–11
  33. By: Carlson, Mark A. (Board of Governors of the Federal Reserve System (U.S.)); Duygan-Bump, Burcu (Board of Governors of the Federal Reserve System (U.S.)); Natalucci, Fabio M. (Board of Governors of the Federal Reserve System (U.S.)); Nelson, William R. (Board of Governors of the Federal Reserve System (U.S.)); Ochoa, Marcelo (Board of Governors of the Federal Reserve System (U.S.)); Stein, Jerome L. (Board of Governors of the Federal Reserve System (U.S.)); Van den Heuvel, Skander J. (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: A number of researchers have recently argued that the growth of the shadow banking system in the years preceding the recent U.S. financial crisis was driven by rising demand for "money-like" claims--short-term, safe instruments (STSI)--from institutional investors and nonfinancial firms. These instruments carry a money premium that lowers their yields. While government securities are an important part of the supply of STSI, financial intermediaries also take advantage of this money premium when they issue certain types of low-risk, short-term debt, such as asset-backed commercial paper or repo. In this paper, we take the demand for STSI as given and consider the extent to which central banks can improve financial stability and manage maturity transformation by the private sector through their ability to affect the public supply of STSI. The first part of the paper provides new evidence that complements the existing literature on two key ingredients that are necessary for there to be a role for policy: the extent to which public short-term debt and private short-term debt might be substitutes, and the relationship between the money premium and the supply of STSI. The second part of the paper then builds on this evidence and discusses potential ways a central bank could use its balance sheet and monetary policy implementation framework to affect the quantity and mix of short-term liquid assets that will be available to financial market participants.
    Keywords: Financial stability; safe assets; money-like instruments; central bank policies
    Date: 2014–11–25
  34. By: Filippou, Ilias; Taylor, Mark P
    Abstract: We study the role of domestic and global factors on payoffs of portfolios built to mimic carry, dollar carry and momentum strategies. We construct domestic and global factors from a large dataset of macroeconomic and financial variables and find that global equity market factors render strong predictive power for carry trade returns, while U.S. inflation and consumption variables drive dollar carry trade payoffs and momentum returns are driven by global commodity and U.S. inflation factors. We find evidence of predictability in the exchange rate component of each strategy and demonstrate strong economic value to a risk-averse investor with mean-variance preferences.
    Keywords: Carry Trade; Factor Analysis; Foreign Exchange; Forward Premium Puzzle; Momentum
    JEL: F31 G11 G15
    Date: 2014–06
  35. By: John B. Taylor
    Abstract: In this paper I argue that central banks should re-normalize monetary policy, including the de facto independence of policy, rather than new-normalize policy to some so called new normal. I explain his view and show that it follows from a review of the actual practice of monetary policy in recent years. I also consider some objections that might be raised to this position. I focus mainly on the United States and go back to the time before the recent financial crisis.
    Date: 2014–04
  36. By: Koichiro Kamada (Bank of Japan)
    Abstract: Confidence has a strong influence on security prices and volatility, but has received little attention in mainstream macroeconomics. Kamada and Miura (2014) have recently revived this concept in their double-layered model of private and public information and shown how herding behavior emerges in sovereign bond markets. This article looks at two episodes that occurred in 2013 in the U.S. and Japan and uses their model to explain how the interest rate hikes and subsequent increase in volatility emerged. The analysis indicates that central bank communication is a promising policy tool to manage market confidence, but at the same time, could create unintended market turbulence.
    Keywords: Central bank; communication; market confidence; bond market; volatility
    JEL: D40 D83 E58 G12
    Date: 2014–12–01
  37. By: Richard Harrison (Centre for Macroeconomics (CFM); Bank of England)
    Abstract: Simulations of forward guidance in rational expectations models should be assessed using the “modest interventions” framework introduced by Eric Leeper and Tao Zha. That is, the estimated effects of a policy intervention should be considered reliable only if that intervention is unlikely to trigger a revision in private sector beliefs about the way that policy will be conducted. I show how to constrain simulations of forward guidance to ensure that they are regarded as modest policy interventions and illustrate the technique using a medium-scale DSGE model estimated on US data. I find that, in many cases, experiments that generate the large responses of macroeconomic variables that many economists deem implausible – the so-called “forward guidance puzzle” – would not be viewed as modest policy interventions by the agents in the model. Those experiments should therefore be treated with caution, since they may prompt agents to believe that there has been a change in the monetary policy regime that is not accounted for within the model. More reliable results can be obtained by constraining the experiment to be a modest policy intervention. The quantitative effects on macroeconomic variables are more plausible in these cases.
    Date: 2014–11
  38. By: Michael Ehrmann
    Abstract: Inflation targeting (IT) had originally been introduced as a device to bring inflation down and stabilize it at low levels. Given the current environment of persistently weak inflation in many advanced economies, IT central banks must now bring inflation up to target. In this paper, the author tests to what extent inflation expectations are anchored in such circumstances, by comparing (i) IT and non-IT countries, and (ii) across periods when inflation is at normal levels, (persistently) high, or (persistently) weak. He finds that under low and persistently low inflation, some disanchoring can occur - inflation expectations are more dependent on lagged inflation; forecasters tend to disagree more; and inflation expectations get revised down in response to lower-than-expected inflation, but do not respond to higher-than-expected inflation. Since inflation expectations in IT countries are substantially better anchored than those in the control group, policy rates in IT countries need to react less to changes in inflation, making IT central banks considerably less likely to hit the zero lower bound.
    Keywords: Inflation and prices; Inflation targets
    JEL: E52 E58 E31 C53
    Date: 2014
  39. By: Buera, Francisco J. (Federal Reserve Bank of Chicago); Nicolini, Juan Pablo (Federal Reserve Bank of Minneapolis)
    Abstract: We study a model with heterogeneous producers that face collateral and cash in advance constraints. These two frictions give rise to a non-trivial financial market in a monetary economy. A tightening of the collateral constraint results in a credit-crunch generated recession. The model can suitable be used to study the effects on the main macroeconomic variables - and on welfare of each individual - of alternative monetary - and fiscal - policies following the credit crunch. The model reproduces several features of the recent financial crisis, like the persistent negative real interest rates, the prolonged period at the zero bound for the nominal interest rate, the collapse in investment and low inflation, in spite of the very large increases of liquidity adopted by the government. The policy implications are in sharp contrast with the prevalent view in most Central Banks, based on the New Keynesian explanation of the liquidity trap.
    Keywords: Liquidity; monetary policy; interest rate
    JEL: E12 E42 E43 E51
    Date: 2014–05–14
  40. By: L. Randall Wray
    Abstract: Over the past two decades there has been a revival of Georg Friedrich Knapp's "state money" approach, also known as chartalism. The modern version has come to be called Modern Money Theory. Much of the recent research has delved into three main areas: mining previous work, applying the theory to analysis of current sovereign monetary operations, and exploring the policy space open to sovereign currency issuers. This paper focuses on "outside" money--the currency issued by the sovereign--and the advantages that accrue to nations that make full use of the policy space provided by outside money.
    Keywords: Central Bank Independence; Chartalism; Fiat Money; Functional Finance; Innes; Keynes; Knapp; Modern Money Theory; Outside Money; Sovereign Currency; State Money
    JEL: B1 B2 B3 B5 E5 E6
    Date: 2014–12
  41. By: Luis F. Melo Velandia; Rubén A. Loaiza Maya; Mauricio Villamizar-Villegas
    Abstract: Typically, central banks use a variety of individual models (or a combination of models) when forecasting inflation rates. Most of these require excessive amounts of data, time, and computational power; all of which are scarce when monetary authorities meet to decide over policy interventions. In this paper we use a rolling Bayesian combination technique that considers inflation estimates by the staff of the Central Bank of Colombia during 2002-2011 as prior information. Our results show that: 1) the accuracy of individual models is improved by using a Bayesian shrinkage methodology, and 2) priors consisting of staff's estimates outperform all other priors that comprise equal or zero-vector weights. Consequently, our model provides readily available forecasts that exceed all individual models in terms of forecasting accuracy at every evaluated horizon.
    Keywords: Bayesian shrinkage, inflation forecast combination, internal forecasts, rolling window estimation
    JEL: C22 C53 C11 E31
    Date: 2014–11–20

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