nep-mon New Economics Papers
on Monetary Economics
Issue of 2015‒03‒22
34 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Hawks and Doves at the FOMC By Eijffinger, S.C.W.; Mahieu, R.J.; Raes, L.B.D.
  2. 'Sudden Floods, Macroprudential Regulation and Stability in an Open Economy' By Pierre-Richard Agénor; K. Alper; L. Pereira da Silva
  3. Monetary Union with A Single Currency and Imperfect Credit Market Integration. By V. Bignon; R. Breton; M. Rojas Breu
  4. Comparison of monetary policy effects on lending channel in EMU and non-EMU countries: Evidence from period 1999-2012 By Tomáš Heryán; Iveta PaleÄková; Nemanja Radić
  5. The liquidity preference theory: a critical analysis By Giancarlo Bertocco; Andrea Kalajzic
  6. The Stochastic Volatility in Mean Model with Time-Varying Parameters: An Application to Inflation Modeling By Joshua C.C. Chan
  7. European Central Bank quantitative easing: the detailed manual By Grégory Claeys; Alvaro Leandro; Allison Mandra
  8. Financial Frictions and Reaction of Stock Prices to Monetary Policy Shocks By Ali Ozdagli
  9. Target Controllability and Time Consistency: Complement to the Tinbergen Rule By Huiping Yuan; Stephen M. Miller
  10. Capital Flows and Domestic and International Order: Trilemmas from Macroeconomics to Political Economy and International Relations By Michael Bordo; Harold James
  11. Euro-Dollar Polarixation and Heterogeneity in Exchange Rate Pass-Throughs Within the Euro Zone By Mariarosaria Comunale
  12. The Reserve Bank's method of estimating "potential output" By Ashley Lienert; David Gillmore
  13. Inflation and Professional Forecast Dynamics: An Evaluation of Stickiness, Persistence, and Volatility By Elmar Mertens; James M Nason
  14. Empirical Properties of Inflation Expectations and the Zero Lower Bound By Mirko Wiederholt
  15. Can the Provision of Long-Term Liquidity Help to Avoid a Credit Crunch? Evidence from the Eurosystem's LTROs. By P. Andrade; C. Cahn; H. Fraisse; J-S. Mésonnier
  16. Institution Design for Macroeconomic Policy By Alexander Mihailov; Katrin Ullrich
  17. Monetary Policy with Ambiguity Averse Agents By Riccardo M. Masolo; Francesca Monti
  18. The Limits of Monetary Policy Under Imperfect Knowledge By Marc Giannoni; Bruce Preston; Stefano Eusepi
  19. Central bank intervention in large value payment systems: An experimental approach By Peter Heemeijer; Ronald Heijmans
  20. Dynamic Effect of a Change in the Exchange Rate System: From a Fixed Regime to a Basket-Peg or a Floating Regime By Yoshino, Naoyuki; Kaji, Sahoko; Asonuma, Tamon
  21. Prolonged Reserves Accumulation, Credit Booms, Asset Prices and Monetary Policy in Asia By Andrew J. Filardo, Pierre L. Siklos
  22. A critique of full reserve banking By Sheila Dow; Guðrún Johnsen; Alberto Montagnoli
  23. Uncertainty and the Signaling Channel of Monetary Policy By Jenny Tang
  24. Bank Equity and Macroprudential Policy By Keqing Liu
  25. Contemporary monetary policy in China: A move towards price-based policy? By Nuutilainen, Riikka
  26. Revisiting Bank of Japan’s Policy Duration Commitment: Impact, Consequences and Challenges By Tomohiro Kinoshita
  27. A Simple Model of Price Dispersion and Price Rigidity By Randall Wright; Guido Menzio; Kenneth Burdett
  28. Monetary policy transmission in China: A DSGE model with parallel shadow banking and interest rate control By Funke, Michael; Mihaylovski, Petar; Zhu, Haibin
  29. Evolution of the Monetary Transmission Mechanism in the US: The Role of Asset Returns By Beatrice D. Simo-Kengne; Stephen M. Miller; Rangan Gupta
  30. Sovereign Debt, Bail-Outs and Contagion in a Monetary Union By Eijffinger, S.C.W.; Kobielarz, M.L.; Uras, R.B.
  31. What are the macroeconomic effects of asset purchases? By Weale, Martin; Wieladek, Tomasz
  32. The Flattening of the Phillips Curve and the Learning Problem of the Central Bank By Jean-Paul L'Huillier; William R. Zame
  33. Optimum Currency Area and Business Cycle Synchronization Across U.S. States By Luís Aguiar-Conraria; Pedro Brinca; Haukur Viðar Guðjónsson; Maria Joana Soares
  34. Crash Risk in Currency Markets By Emmanuel Farhi; Samuel Fraiberger; Xavier Gabaix; Romain Ranciere; Adrien Verdelhan

  1. 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: In this paper we estimate ideal points of Bank Presidents and Board Governors at the FOMC. We use stated preferences from FOMC transcripts and estimate a hierarchical spatial voting model. We find a clear difference between the average Board Governor and Bank President. We find little evidence for difference in ideal points according to the appointing president in case of Bank Governors.<br/>Similarly career background has no clear effect on the ideal points. We find that the median ideal point at the FOMC has been fairly stable over our sample period (1989-2007) emphasizing the lack of a political appointment channel. We also show that there was considerable variation in the median ideal point of Bank Presidents and Board Governors, but that these seem to cancel each other out. Also the dispersion of opinions (the spread between the lowest and highest ideal point) varies over time, suggestion variation in agreement at the FOMC.
    Keywords: central banks; committees; transcripts; ideal points; FOMC
    JEL: E58 E59 C11
    Date: 2015
  2. By: Pierre-Richard Agénor; K. Alper; L. Pereira da Silva
    Abstract: The performance of a countercyclical reserve requirement rule is studied in a dynamic stochastic model of a small open economy with financial frictions, imperfect capital mobility, a managed float regime, and sterilized foreign exchange market intervention. Bank funding sources, domestic and foreign, are imperfect substitutes. The model is calibrated and used to study the effects of a temporary drop in the world risk-free interest rate. Consistent with stylized facts, the shock triggers an expansion in domestic credit and activity, asset price pressures, and a real appreciation. A credit-based reserve requirement rule helps to mitigate both macroeconomic and financial volatility, with the latter defined both in terms of a narrow measure based on the credit-to-output ratio, the ratio of capital flows to output, and interest rate spreads, and a broader measure that includes real asset prices as well. An optimal rule, based on minimizing a composite loss function, is also derived. Sensitivity tests, related to the intensity of sterilization, the degree of exchange rate smoothing, and the rule used by the central bank to set the cost of bank borrowing, are also performed, both in terms of the transmission process and the optimal rule.
    Date: 2015
  3. By: V. Bignon; R. Breton; M. Rojas Breu
    Abstract: With the Euro Area context in mind, we show that currency arrangements impact on credit available through default incentives. To this end we build a symmetric two-country model with money and imperfect credit market integration. Differences in credit market integration are captured by variations in the cost for banks to grant credit for cross-border purchases. We show that for high enough levels of this cost, currency integration may magnify default incentives, leading to more stringent credit rationing and lower welfare than in a regime of two currencies. The integration of credit markets restores the optimality of the currency union.
    Keywords: banks, currency union, monetary union, credit, default.
    JEL: E42 E50 F3 G21
    Date: 2015
  4. By: Tomáš Heryán (Department of Finance and Accounting, School of Business Administration, Silesian University); Iveta PaleÄková (Department of Finance and Accounting, School of Business Administration, Silesian University); Nemanja Radić (The Business School, Middlesex University, The Burroughs, London NW4 4BT)
    Abstract: Current study has focused on the bank lending channel of monetary transmission in EU countries. The aim of the paper is to carry out an empirical investigation of the bank lending channel of monetary transmission in EMU and non-EMU countries. As estimation method we use GMM model with pooled annual data as it was used in previous studies. Our estimation period is from 1999 to 2012. Contribution of the study is in three major ways: (i) we investigated independently panel of EMU and non-EMU countries; (ii) we examined the interaction terms between the bank characteristics and both monetary policy indicators, shortterm interest rates and monetary aggregate M2; (iii) we discussed about possible quantitative easing by the European Central Bank. We have proved some differences between the bank lending channels of monetary transmission of both, the EMU and non-EMU. It has also been proved a higher impact of M2 development than a development of short-term interest rates. Finally, there are definitely some monetary policy implications, too.
    Keywords: monetary policy, bank landing channel, EMU countries, non-EMU countries, GMM
    JEL: E52 C51
    Date: 2015–03–17
  5. By: Giancarlo Bertocco (Department of Economics, University of Insubria, Italy); Andrea Kalajzic (Department of Economics, University of Insubria, Italy)
    Abstract: Keynes in the General Theory, explains the monetary nature of the interest rate by means of the liquidity preference theory. The objective of this paper is twofold. First, to point out the limits of the liquidity preference theory. Second, to present an explanation of the monetary nature of the interest rate based on the arguments with which Keynes responded to the criticism levelled at the liquidity preference theory by supporters of the loanable funds theory such as Ohlin and Robertson. It is shown that this explanation is consistent with the definition of the non-neutrality of money that Keynes presented in his 1933 works in which he underlines the need to elaborate a monetary theory of production in order to explain the phenomena of the crisis and the fluctuations in income and employment.
    Date: 2014–01
  6. By: Joshua C.C. Chan
    Abstract: This paper generalizes the popular stochastic volatility in mean model of Koopman and Hol Uspensky (2002) to allow for time-varying parameters in the conditional mean. The estimation of this extension is nontrival since the volatility appears in both the conditional mean and the conditional variance, and its coefficient in the former is time-varying. We develop an efficient Markov chain Monte Carlo algorithm based on band and sparse matrix algorithms instead of the Kalman filter to estimate this more general variant. We illustrate the methodology with an application that involves US, UK and Germany inflation. The estimation results show substantial time-variation in the coefficient associated with the volatility, high-lighting the empirical relevance of the proposed extension. Moreover, in a pseudo out-of-sample forecasting exercise, the proposed variant also forecasts better than various standard benchmarks.
    Keywords: nonlinear, state space, inflation forecasting, inflation uncertainty
    JEL: C11 C15 C53 C58 E31
    Date: 2015–03
  7. By: Grégory Claeys; Alvaro Leandro; Allison Mandra
    Abstract: â?¢ The European quantitative easing programme, the Public Sector Purchase Programme (PSPP), started on 9 March 2015 and will last at least until September 2016. Purchases will be composed of sovereign bonds and securities from European institutions and national agencies. â?¢ The European Central Bank Governing Council imposed limits to ensure that the Eurosystem will not breach the prohibition on monetary financing. However, these limits will constrain the size and duration of the programme, especially if it is sustained after September 2016. The possibility for national central banks to also buy national agency securities could alleviate this, but the small number of eligible agencies could limit their role as a back-up purchase. â?¢ The Eurosystem should find other eligible agencies, especially in countries in which public debt is small, or waive the limits for countries respecting the investment grade eligibility criteria. The same issue arises with European institutions: their number and outstanding debt securities are limited. The waiver of the limits proposed for sovereigns should be applied to institutions with high ratings. â?¢ The PSPP profits that will ultimately be repatriated to national treasuries will be small. This was to be expected, given current very low yields. Profits will also come from the major increase in reserves resulting from the implementation of QE, combined with the negative deposit rates on excess reserves at the ECB.
    Date: 2015–03
  8. By: Ali Ozdagli (Federal Reserve Bank of Boston)
    Abstract: This paper reveals a new theoretical implication of the credit channel of monetary policy: the stock prices of financially more constrained firms are less responsive to monetary policy shocks. In order to study this implication, we use Enron scandal as an exogenous variation in the monitoring cost of the Arthur Andersen clients relative to other firms in a difference in differences framework. We find that Arthur Andersen clients have responded about 40 to 50 basis points less than other firms to a 10 basis point surprise reduction in federal funds target rate in the final days of the scandal, which is in line with the new implication of the credit channel.
    Date: 2014
  9. By: Huiping Yuan (Department of Finance, Xiamen University); Stephen M. Miller (Department of Economics, University of Nevada, Las Vegas)
    Abstract: The Tinbergen Rule states that achieving the desired targets requires an equal number of instruments. This paper shows that time inconsistency does not exist in the case of an equal number of instruments and targets. Target uncontrollability and time inconsistency, however, emerge as problems in the case of fewer instruments than targets. In this case, we obtain a necessary and sufficient condition for joint asymptotic controllability of target values, which complements the Tinbergen rule. The condition is identical under commitment and under discretion. If the condition does not hold, the steady-state values of target variables regress to their respective target values. The paper solves both problems by determining the central bank’s target values of inflation and output as well as the relative weight between stabilizing inflation and output. Intuitively, a proper target value trade-off solves target uncontrollability, whereas a proper relative weight achieves optimal target variability trade-off and solves time inconsistency. As a result, target values are controllable, establishing monetary policy credibility. Discretionary policy under the designed loss function, which replicates optimal policy under the social loss function, proves time-consistent. In addition, we identify two situations where the delegated weight equals the social weight, providing additional insight into time inconsistency.
    Keywords: Target controllability; Time inconsistency; Optimal policy; Discretionary policy; Trade-off
    JEL: E52 E58
    Date: 2014–12
  10. By: Michael Bordo; Harold James
    Abstract: This paper explains the problem of adjustment to the challenges of globalization in terms of the logic underpinning four distinct policy constraints or trilemmas, and their interrelationship, and in particular the disturbances that arise from capital flows. The analysis of a policy trilemma was developed first as a diagnosis of exchange rate problems (the incompatibility of free capital flows with monetary policy autonomy and a fixed exchange rate regime); but the approach can be extended. The second trilemma we describe is the incompatibility between financial stability, capital mobility and fixed exchange rates. The third example extends the analysis to politics, and looks at the strains in reconciling democratic politics with monetary autonomy and capital movements. Finally we examine the security aspect and look at the interactions of democracy with capital flows and international order. The trilemmas in short depict the way that domestic monetary, financial, economic and political systems are interconnected with the international. They can be described as the impossible policy choices at the heart of globalization. Frequently, the trilemmas conjure up countervailing anti-globalization tendencies and trends.
    JEL: E4 E6 N1
    Date: 2015–03
  11. By: Mariarosaria Comunale (Economics Department, Bank of Lithuania)
    Abstract: This paper provides an empirical study of the asymmetrical spillovers of the euro-US dollar exchange rate on the inflation in the euro zone, dividing the sample in two groups of countries: core and periphery. Then we test if the euro-US dollar exchange rate is still able to give a different impact on the groups’ performance as in the past US dollar-deutschmark polarization phenomenon studying the intra-euro area differences in exchange rate passthrough (ERPT), as an important element of inflation dynamics. Using a dynamic panel data framework based on an exchange rate pass-through model, we estimate the elasticities of the two groups by system IV-GMM and the common correlated effects mean group estimator, which deals with the presence of cross-sectional dependence. We conclude that the euro-US dollar is still an important factor, but not the only key factor, in determining the asymmetry in HICP inflation between core and periphery. The nominal effective exchange rate instead is an important driver for the inflation, but only considering the euro zone as a whole. The EMU seems to not have insulated enough some member countries from nominal external shocks. The nominal effective exchange rate is also a factor to take into account in order to analyze the recent low inflation in the euro zone, even if the size of the ERPT is relatively small.
    Keywords: Exchange Rate Pass-Through, Dynamic Panel Data, Inflation, Exchange Rates, European Monetary Union, Cross-sectional dependence
    JEL: C33 E31 F31 F36 F41
    Date: 2015–03–13
  12. By: Ashley Lienert; David Gillmore (Reserve Bank of New Zealand)
    Abstract: Estimates of the "output gap" play a significant role in the thinking of inflation- targeting central banks. This note outlines how the Reserve Bank estimates the level of potential output and the output gap.facing small advanced economies, such as New Zealand.
    Date: 2015–03
  13. By: Elmar Mertens; James M Nason
    Abstract: This paper studies the joint dynamics of U.S. inflation and the average inflation predictions of the Survey of Professional Forecasters (SPF) on a sample running from 1968Q4 to 2014Q2. The joint data generating process (DGP) of these data consists of the unobserved components (UC) model of Stock and Watson (2007, "Why has US inflation become harder to forecast?," Journal of Money, Credit and Banking 39(S1), 3-33) and the sticky information (SI) forecast updating equation of Mankiw and Reis (2002, "Sticky information versus sticky prices: A proposal to replace the New Keynesian Phillips curve," Quarterly Journal of Economics 117, 1295-1328). We introduce timevarying inflation gap persistence into the Stock and Watson (SW)-UC model and a timevarying frequency of forecast updating into the SI forecast updating equating. These models combine to produce a nonlinear state space model. This model is estimated using Bayesian tools grounded in the particle filter, which is an implementation of sequential Monte Carlo methods. The estimates reveal the data prefer the joint DGP of time-varying frequency of SI forecast updating and a SW-UC model with time-varying persistence. The joint DGP produces estimates that indicate the inflation spike of 1974 was explained most by gap inflation, but trend inflation dominates the inflation peak of the early 1980s. We also find the stochastic volatility (SV) of trend inflation exhibits negative co-movement with the time-varying frequency of SI forecast updating while the SV and time-varying persistence of gap inflation often show positive co-movement. Thus, the average SPF respondent is most sensitive to the impact of permanent shocks on the conditional mean of inflation.
    Keywords: Inflation, professional forecasters, sticky information, particle filter, Bayesian estimation, Markov chain Monte Carlo, stochastic volatility, time-varying persistence.
    JEL: E31 C11 C32
    Date: 2015–03
  14. By: Mirko Wiederholt (Goethe University Frankfurt)
    Abstract: Survey data on expectations shows that households have heterogeneous inflation expectations and their inflation expectations respond sluggishly to realized shocks to future inflation. By contrast, in models with a zero bound on the nominal interest rate currently used for monetary and fiscal policy analysis, households' inflation expectations are not heterogeneous and not sticky. This paper solves a New Keynesian model with a zero lower bound in which households have dispersed information. Households' inflation expectations are heterogeneous and sticky. The main properties of the model are: (1) the deflationary spiral in bad states of the world is less severe than under perfect information, (2) central bank communication (without a change in current or future policy) affects consumption and the sign of this effect depends on whether the zero lower bound is binding, i.e., an announcement that increases consumption when the zero lower bound is not binding reduces consumption when the zero lower bound is binding, (3) a commitment to future inflation can reduce consumption, (4) the government spending multiplier can be negative, and (5) shocks to uncertainty can have first-order effects.
    Date: 2014
  15. By: P. Andrade; C. Cahn; H. Fraisse; J-S. Mésonnier
    Abstract: We exploit the Eurosystem’s longer-term refinancing operations (LTROs) of 2011-2012 to analyze the effects that a large provision of central bank liquidity to banks has on the credit supply to firms. We control for credit demand by examining firms that borrow from several banks, in addition to controlling for banks’ risk. We find that LTROs enhanced loan supply in France. Nevertheless, the transmission took place mostly with the first operation of December 2011, in which constrained banks bid more, and larger borrowers benefited more. The opportunity to substitute long-term central bank borrowing for short-term borrowing was instrumental in this transmission.
    Keywords: unconventional monetary policy, bank lending channel, euro area, LTRO, credit supply.
    JEL: C21 E51 G21 G28
    Date: 2015
  16. By: Alexander Mihailov (School of Economics, University of Reading); Katrin Ullrich (KfW Bankengruppe, Germany)
    Abstract: This paper explores the normative aspects of the institution design for macroeconomic policymaking when a society legislates specific objectives and sequencing of decisions for the involved authorities. We develop a general theoretical framework that adds fiscal policy to the flexibility-credibility trade-off well-established in monetary policy. We find that delegation of both monetary and fiscal policy to autonomous institutions of appointed experts improves macroeconomic outcomes by delivering lower average in flation and lower average public-sector deficit-to-output ratio over alternative policies conducted with interference by elected politicians. Yet greater independence of monetary and fiscal policymakers from the government also generates increased output variability around normal output. The latter effect is minor in magnitude, and the simulated expected social losses in all considered 24 institution-design regimes demonstrate the long-run welfare dominance of delegation of both monetary and fiscal policy to independent expert committees over joint government optimization. In addition, preannouncing an escape clause to be activated following extreme negative shocks may help mitigate short-run output and employment fluctuations, but at the cost of expected social losses that rise considerably.
    Keywords: delegation, independence, expert committees, monetary-fiscal interactions, policy games, institution design
    JEL: E02 E61 E63
    Date: 2015–02–05
  17. By: Riccardo M. Masolo (Bank of England); Francesca Monti (Bank of England; Centre for Macroeconomics (CFM))
    Abstract: We study a prototypical new-Keynesian model in which agents are averse to ambiguity, and where the ambiguity regards the monetary policy rule. We show that ambiguity has important effects even in steady state, as uncertainty about the policymaker’s response function affects the rest of the model via the consumption-saving decision. A reduction in ambiguity - e.g. due to credible monetary policy actions and communications - results in a fall in inflation and the policy rate, and an increase in welfare. Moreover while, absent ambiguity, the policymaker’s actual responsiveness to inflation does not matter as long as the Taylor principle is satisfied, in the face of ambiguity the exact degree to which the central bank responds to inflation regains importance. Indeed, a high degree of responsiveness to inflation mitigates the welfare costs of ambiguity. We also present various results regarding the optimal choice of an inflation target, both when ambiguity is given and when assuming the policymaker can affect ambiguity with increased transparency and communications.
    Keywords: Ambiguity, aversion, monetary policy
    JEL: D84 E31 E43 E52 E58
    Date: 2015–03
  18. By: Marc Giannoni (Federal Reserve Bank of New York); Bruce Preston (Monash University); Stefano Eusepi (Federal Reserve Bank of New York)
    Abstract: The modern theory of monetary policy emphasizes the management of expectations. In New Keynesian models frequently used for policy evaluation it is well understood that it is not so much the current interest rate, but instead anticipated movements in future interest rates that are central to aggregate demand management. Movements in current and future expected interest rates are linked through arbitrage relationships. Through the appropriate choice of current interest rates, good policy seeks to have these expectations evolve in a way that achieves the most desirable short-run trade-off between inflation and the output gap. <P> An important question then is whether the efficacy of monetary policy is compromised when current interest-rate movements are not efficiently transmitted to various longer-term interest rates relevant to spending and pricing plans of agents in the economy. Is the potency of monetary policy diminished when there is imprecise control of interest-rate expectations? <P> The central focus of this paper are the consequences of imperfect knowledge for monetary control. Under rational expectations, optimal policy prescribes that the nominal interest rate should track the evolution of the natural rate of interest, which in our framework embeds (exogenous) fluctuations in productivity, propensity to work and government spending. Importantly, optimal policy under perfect knowledge can fully stabilize output gap and inflation (the well known divine coincidence). The key result of the paper is that under imperfect knowledge and learning the efficacy of monetary policy can be drastically reduced. It is shown that imperfect knowledge prevents full stabilization of output gap and inflation, even for optimal monetary policy that accounts for imperfect knowledge. More precisely, a policy-maker who knows the structure of the economy and has full information about private agents' expectations formation process will not be able to achieve full economic stability. Optimal monetary policy has the property that the evolution of beliefs is managed in exactly the right way to ensure a bounded equilibrium consistent with maximization of households' welfare. In this sense the economy is stable: it has unique bounded state-contingent evolution for all endogenous variables given bounded stochastic disturbance processes. But this does not necessarily imply that drifting beliefs are not problematic for the transmission of monetary policy. <P> Under imperfect knowledge optimal policy prescribes slow adjustments in current interest-rate policy in response to evolving macroeconomic conditions to limit excess volatility in long-term rates. Changes in current interest rates lead to revisions of beliefs about future interest rates, albeit with a lag due to learning dynamics. The revisions in beliefs in turn feedback on the state of aggregate demand in subsequent periods. Aggressive adjustment of current interest rates, which would promote full stabilization under perfect knowledge, cause excessive movements in long-rates and macroeconomic volatility. Potential instability in long-term interest rates constrains the degree to which current monetary policy can respond to evolving economic conditions. In other words the link between short-term interest setting, and the evolution of long-term interest rates is much weaker under imperfect knowledge than under rational expectations. <P> The results in the paper have two main implications for current monetary policy debate. First, the past recession is widely believed to be caused by a `demand' shock, lowering both the output-gap and inflation. However, despite the monetary stimulus provided by central banks in the form low interest rates from conventional and unconventional policies, the recovery in US and in other countries remains sluggish. Consequently monetary authorities have been criticized for `not doing enough'. This paper suggests that the observed gradual adjustment is not inconsistent with policy being set optimally once we take into account of market participants' uncertainty about economic fundamentals. Second, the paper offers an alternative rationale for gradualism in monetary policy even in normal times, as reflected by high interest smoothing coefficients that are usually found in estimated Taylor rules.
    Date: 2014
  19. By: Peter Heemeijer; Ronald Heijmans
    Abstract: This experimental study investigates the behavior of banks in a large value payment system. More specifically, we look at 1) the reactions of banks to disruptions in the payment system and 2) the way banks behavior changes to incentives of the central bank. The game used in this experiment is a stylized version of a model of Bech and Garratt (2006) in which each bank can choose between paying in the morning (efficient) or in the afternoon (inefficient) and builds on the game by Abbink et al. (2010). The results show that a positive (bail out) or negative (punishment) incentive steers payments to the inefficient or efficient equilibrium, respectively. In contrast to our expectation, providing detailed information on disruptions steers payments towards the inefficient equilibrium.
    Keywords: payment systems; financial stability; experiment; decision making; central bank intervention
    JEL: C92 D70 D78 E58
    Date: 2015–03
  20. By: Yoshino, Naoyuki (Asian Development Bank Institute); Kaji, Sahoko (Asian Development Bank Institute); Asonuma, Tamon (Asian Development Bank Institute)
    Abstract: This paper theoretically evaluates the dynamic effects of a shift in an exchange rate system from a fixed regime to a basket peg, or to a floating regime, and obtains transition paths for the shift based on a dynamic stochastic general equilibrium model of a small open economy. We apply quantitative analysis using data from the People's Republic of China and Thailand and find that a small open country would be better off shifting to a basket peg or to a floating regime than maintaining a dollar-peg regime with capital controls over the long run. Furthermore, due to the welfare losses associated with volatility in nominal interest rates, the longer the transition period, the larger the benefits of shifting suddenly to a basket-peg regime from a dollar-peg regime than proceeding gradually. Regarding sudden shifts to desired regimes, the welfare gains are higher under a shift to a basket peg if the exchange rate fluctuates significantly. Finally, shifting to a managed-floating regime is less attractive than moving to a basket peg, as the interventions necessary to maintain the exchange rate for certain periods result in higher losses and the authority lacks monetary policy autonomy.
    Keywords: basket peg; floating regime; exchange rate transition; peoples republic of china; thailand; monetary policy; Finance
    JEL: F33 F41 F42
    Date: 2015–03–09
  21. By: Andrew J. Filardo, Pierre L. Siklos (Wilfrid Laurier University)
    Abstract: This paper examines past evidence of prolonged periods of foreign exchange reserves accumulation in the Asia-Pacific region. Several proxies for this unobserved variable are considered, including a newly proposed one based on a factor model. We focus on identifying periods of prolonged interventions and identify its key macro-financial determinants. Two broad conclusions emerge from the stylized facts and the econometric evidence. First, the best protection against costly reserves accumulation is a more flexible exchange rate. Second, the necessity to accumulate reserves as a bulwark against goods price inflation is misplaced. Instead, there is a strong link between asset price movements and the likelihood of accumulating foreign exchange reserves that are costly. Policy implications are also drawn.
    Keywords: foreign exchange reserves accumulation, monetary and financial stability
    JEL: F41 F32 E44 D52
    Date: 2015–02–01
  22. By: Sheila Dow (Department of Economics, University of Stirling & University of Victoria); Guðrún Johnsen (University of Iceland); Alberto Montagnoli (Department of Economics, University of Sheffield)
    Abstract: Proposals for full reserve banking have been put forward as a radical way of preventing further financial crises. They rest on the argument that crises are caused by excessive money supply growth brought about by inadequately controlled bank credit creation. Our aim is to provide a critique of the theoretical assumptions underlying the plans for full reserve banking. In particular some of the plans rely on the view that the money supply is a key causal variable and that it is feasible for central banks to identify and enforce an optimal quantity. Second, the plans all rely on an unsupported confidence in the efficiency of financial markets outside the centrally controlled banking system. Third, by removing profit-making opportunities from banks, the proposals may unduly tip the balance further in favour of shadow banking. Finally, as the case of 95% liquidity requirements on Kaupthing, Singer and Friedlander in the wake of the Great Financial Crash shows that modern financial engineering makes such policy-making difficult to execute. A Minskyan analysis rather emphasises the inherent instability of the financial system such that it is subject to systemic crises and the indeterminacy of demand for liquidity, while also emphasising the contribution prudent banking can make to financing economic activity and providing a safe money asset. While a return to a traditional separation of retail banking (regulated and supported by the central bank) from investment banking (regulated differently but not supported) would contribute to financial stability, it is argued that the full reserve banking proposals go too far.
    Keywords: bank regulation, full reserve banking
    JEL: E5 G21 G28
    Date: 2015–03
  23. By: Jenny Tang (Harvard University)
    Abstract: This paper studies optimal monetary policy in an environment where policy actions provide a signal of economic fundamentals to imperfectly informed agents. I derive the optimal discretionary policy in closed form and show that, in contrast to the perfect information case, the signaling channel leads the policymaker to be tougher on inflation. The strength of the signaling effect of policy depends on relative uncertainty levels. As the signaling effect strengthens, the optimal policy under discretion approaches that under commitment to a forward-looking linear rule, thereby decreasing the stabilization bias. This contributes to the central bank finding it optimal to withhold its additional information from private agents. Under a general linear policy rule, inflation and output forecasts can respond positively to a positive interest rate surprise when the signaling channel is strong. This positive response is the opposite of what standard perfect information New Keynesian models predict and it matches empirical patterns found by Romer and Romer (2000) and Campbell, Evans, Fisher, and Justiniano (2012). In addition, I substantiate the existence of a signaling channel by providing new empirical evidence supporting the predicted interaction between uncertainty and the responses of inflation forecasts to interest rate surprises.
    Date: 2014
  24. By: Keqing Liu (Department of Economics, University of Exeter)
    Abstract: We investigate a new macroprudential policy in a DSGE model with fi?nancial frictions. As Gertler, Kiyotaki and Queralto (2012), we propose to subsidize bank equities. However, our tax rate is different from their policy. The tax rate in our macroprudential policy is proportional to capital ratio gap while it is proportional to the shadow price of bank deposit in Gertler et al. (2012). Our policy has two advantages: Firstly, because bank?s balance sheet structure is observable target for central bank, our policy is more applicable for practical policy design. Secondly, our policy makes individual banks choose to raise more capital. While it tightens the moral hazard constraint, the policy could raise the future value of investment and it shows the modi?fied policy is welfare dominant.
    Keywords: Macroprudential policy, Bank equity, Capital ratio, DSGE model
    JEL: C61 E61 G28
    Date: 2015
  25. By: Nuutilainen, Riikka (BOFIT)
    Abstract: This paper focuses on monetary policy in China. A set of different specifications for the monetary policy reaction function are empirically evaluated using monthly data for 1999––2012. Variation is allowed both in the policy targets as well as in the monetary policy instrument itself. Overall, the performance of the estimated policy rules is surprisingly good. Chinese monetary policy displays countercyclical reactions to inflation and leaning-against-the-wind behaviour. The paper shows that there is a notable increase in the overall responsiveness of Chinese monetary policy over the course of the estimation period. The central bank interest rate is irresponsive to economic conditions during the earlier years of the sample but does respond in the later years. This finding supports the view that the monetary policy settings of the People's Bank of China have come to place more weight on price-based instruments. A time-varying estimation procedure suggests that the two monetary policy objectives are assigned to different instruments. The money supply instrument is utilised to control the price level and (after 2008) the interest rate instrument has been used to achieve the targeted output growth.
    Keywords: China; Monetary policy; Taylor rule; McCallum rule
    JEL: E52 E58
    Date: 2015–03–12
  26. By: Tomohiro Kinoshita (National Graduate Institute for Policy Studies)
    Abstract: Forward guidance or more specifically policy duration commitment invented and developed by the Bank of Japan has become an essential part of unconventional monetary policy instruments employed by modern central banks. This paper’s simple empirical analysis finds that the market believes or perceives Bank of Japan’s policy duration commitment to be credible, which has in turn helped the Bank to manage expectations of future interest rates and control the level and shape of the yield curve at an extraordinarily low range. The suppressed yield curve has contributed to reduction of financing costs for businesses and households and has supported macroeconomic growth through the conventional interest rate channel of policy transmission. However, forward guidance including policy duration commitment does have difficulties. The magnitude of its impact has been time-variant, which appears to depend on evolution in policy frameworks and communication skills. More importantly, this paper projects that the extraordinarily low and flattened yield curve coupled with maturity extension of the Bank assets could pose threats to the future income of the central bank in the event of policy normalization, which could have unintended fiscal implications.
    Date: 2015–03
  27. By: Randall Wright (U Wisconsin); Guido Menzio (University of Pennsylvania); Kenneth Burdett (UPenn)
    Abstract: There are two facts about the world that we take as given: First the "law of one price" is false – one can find many different prices for what appears to be, beyond reasonable doubt, the same good. Second, prices are set in nominal terms and appear, beyond reasonable doubt, to be sticky – some sellers keep their prices rigid when the aggregate price level increases. We shown these phenomena emerge naturally together in a search model. In contrast to theories that assume nominal price rigidities, when they are endogenous, they cannot be exploited by monetary policy, even though money is not neutral. The object of this study is to explain the above in a tractable model of money and search.
    Date: 2014
  28. By: Funke, Michael (BOFIT); Mihaylovski, Petar (BOFIT); Zhu, Haibin (BOFIT)
    Abstract: The paper sheds light on the interplay between monetary policy, the commercial banking sector and the shadow banking sector in mainland China by means of a nonlinear stochastic general equilibrium (DSGE) model with occasionally binding constraints. In particular, we analyze the impacts of interest rate liberalization on monetary policy transmission as well as the dynamics of the parallel shadow banking sector. Comparison of various interest rate liberalization scenarios reveals that monetary policy results in increased feed-through to the lending and investment under complete liberalization. Furthermore, tighter regulation of interest rates in the commercial banking sector in China leads to an increase in loans provided by the shadow banking sector.
    Keywords: DSGE model; monetary policy; financial market reform; shadow banking; China
    JEL: E32 E42 E52 E58
    Date: 2015–03–09
  29. By: Beatrice D. Simo-Kengne (Department of Economics, University of Pretoria); Stephen M. Miller (Department of Economics, University of Nevada, Las Vegas); Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: This paper investigates whether changes in the monetary transmission mechanism as captured by the interest rate respond to variations in asset returns. We distinguish between low-volatility (bull) and high-volatility (bear) markets and employ a TVP-VAR approach with stochastic volatility to assess the evolution of the interest rate in relation to housing and stock returns. We measure the relative importance of housing and stock returns in the movements of the interest rate and their possible feedback effects over both time and horizon and across regimes. Empirical results from annual data on the US spanning the period from 1890 to 2012 indicate that the interest rate responds more strongly to asset returns during low-volatility (bull) regimes. While the bigger interest-rate effect of stock-return shocks occurs prior to the 1970s, the interest rate appears to respond more strongly to housing-return than stock return shocks after the 1970s. Similarly, a higher interest rate exerts a larger effect on both asset categories during low-volatility (bull) markets. Particularly, larger negative responses of housing return to interest-rate shocks occur after the 1980s, corresponding to the low-volatility (bull) regime in the housing market. Conversely, the stock-return effect of interest-rate shocks dominates before the 1980s, where stock-market booms achieved more importance.
    Keywords: Asset Prices, Monetary policy, housing return, stock return, TVP-VAR
    JEL: C32 E52 G10
    Date: 2014–12
  30. By: Eijffinger, S.C.W. (Tilburg University, Center For Economic Research); Kobielarz, M.L. (Tilburg University, Center For Economic Research); Uras, R.B. (Tilburg University, Center For Economic Research)
    Abstract: Abstract: The European sovereign debt crisis is characterized by the simultaneous surge in borrowing costs in the GIPS countries after 2008. We present a theory, which can account for the behavior of sovereign bond spreads in Southern Europe between 1998 and 2012. Our key theoretical argument is related to the bail-out guarantee provided by a monetary union, which endogenously varies with the number of member countries in sovereign debt trouble. We incorporate this theoretical foundation in an otherwise standard small open economy DSGE model and explain (i) the convergence of interest rates on sovereign bonds following the European monetary integration in late 1990s, and (ii) - following the heightened default risk of Greece - the sudden surge in interest rates in countries with relatively sound economic and financial fundamentals. We calibrate the model to match the behavior of the Portuguese<br/>economy over the period of 1998 to 2012.
    Keywords: EMU; sovereign debt crisis; contagion; bail-out; interest rate spread
    JEL: F33 F34 F36 F41
    Date: 2015
  31. By: Weale, Martin; Wieladek, Tomasz
    Abstract: We examine the impact of large scale asset purchase announcements of government bonds on real GDP and the CPI in the United Kingdom and the United States with a Bayesian VAR, estimated on monthly data from 2009M3 to 2014M5. We identify an asset purchase announcement shock with four different identification schemes, always leaving the reactions of real GDP and CPI unrestricted, to test whether these variables react to asset purchases. We then explore the transmission channels of this policy. The results suggest that an asset purchase announcement of 1% of GDP leads to a statistically significant rise of .58% (.25%) and .62% (.32%) rise in real GDP and CPI for the US (UK). In the US, this policy is transmitted through the portfolio balance channel and a reduction in household uncertainty. In the UK, the policy seems to be mainly transmitted through the impact on investors’ risk appetite and household uncertainty.
    Keywords: Bayesian VAR; unconventional monetary policy
    JEL: E50 E51 E52
    Date: 2015–03
  32. By: Jean-Paul L'Huillier (EIEF); William R. Zame (University of California, Los Angeles)
    Abstract: We illustrate an intuitive channel through which price stickiness limits the ability of a central bank to improve welfare through stabilization policy. If the central bank uses infl ation to obtain information about nominal spending, sticky prices impair the learning ability of the central bank and hence its ability to implement the right stabilization policy. Infl ation targeting makes prices stickier, and worsens this learning problem. The key is a microfounded information-based model for price stickiness: taking into account how agents react to the adoption of infl ation targeting makes explicit a basic confl ict between in flation targeting and stabilization policy.
    Date: 2015
  33. By: Luís Aguiar-Conraria (Universidade do Minho, NIPE and Departamento de Economia); Pedro Brinca (European University Institute); Haukur Viðar Guðjónsson (Stockholm University); Maria Joana Soares (Universidade do Minho, NIPE and Departmento de Matemática e Aplicações)
    Abstract: We use wavelet analysis to investigate to what extent individual U.S. states' business cycles are synchronized. The results show that the U.S. states are remarkably well synchronized compared to the previous findings w.r.t. the Euro Area. There is also a strong and significant correlation between business cycle dissimilitudes and the distance between each pair of states, consistent to gravity type mechanisms where distance affects trade. Trade, in turn, increases business cycle synchronization. Finally we show that a higher degree of industry specialization is associated with a higher dissimilitude of the state cycle with the aggregate economy.
    Keywords: Optimum currency areas, business cycle synchronization, continuous wavelet transform, trade
    JEL: E37 E52 R11
    Date: 2015
  34. By: Emmanuel Farhi; Samuel Fraiberger; Xavier Gabaix; Romain Ranciere; Adrien Verdelhan
    Abstract: Since the Fall of 2008, out-of-the money puts on high interest rate currencies have become significantly more expensive than out-of-the-money calls, suggesting a large crash risk of those currencies. To evaluate crash risk precisely, we propose a parsimonious structural model that includes both Gaussian and disaster risks and can be estimated even in samples that do not contain disasters. Estimating the model for the 1996 to 2014 sample period using monthly exchange rate spot, forward, and option data, we obtain a real-time index of the compensation for global disaster risk exposure. We find that disaster risk accounts for more than a third of the carry trade risk premium in advanced countries over the period examined. The measure of disaster risk that we uncover in currencies proves to be an important factor in the cross-sectional and time-series variation of exchange rates, interest rates, and equity tail risk.
    Date: 2015–01

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