nep-mon New Economics Papers
on Monetary Economics
Issue of 2015‒04‒02
24 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Credit, Financial Stability, and the Macroeconomy By Taylor, Alan M.
  2. The transmission of monetary policy in EMEs in a changing financial environment: a longitudinal analysis By Emanuel Kohlscheen; Ken Miyajima
  3. Comparing Inflation and Price Level Targeting: the Role of Forward Guidance and Transparency By Honkapohja, Seppo; Mitra, Kaushik
  4. Inflation surprises and inflation expectations in the euro area By Marcello Miccoli; Stefano Neri
  5. Exchange Rates, Interest Rates, and the Risk Premium By Charles Engel
  6. Empirical Evidence on the Long-Run Money Demand Function in the GCC Countries By Hamdi, Helmi; Sbia, Rashid; said, ali
  7. What Measures Chinese Monetary Policy? By Rongrong Sun
  8. Capital Controls, Monetary Policy, and Balance Sheets in a Small Open Economy By Shigeto Kitano; Kenya Takaku
  9. The financial stability risks of ultra-loose monetary policy By Grégory Claeys; Zsolt Darvas
  10. Modelling Inflation Volatility By Eric Eisenstat; Rodney Strachan
  11. The failure of the monetary model of exchange rate determination By Dinçer Afat; Marta Gómez-Puig; Simón Sosvilla-Rivero
  12. Measuring Core Inflation in South Africa By Stan du Plessis, Gideon du Rand & Kevin Kotzé
  13. The Impossible Trinity: Where does India stand? By Sengupta, Rajeswari
  14. Were Hayek’s Monetary Policy Recommendations Inconsistent?* By Martin Komrska; Marek Hudík
  15. Financial crisis, US unconventional monetary policy and international spillovers By Qianying Chen; Andrew Filardo; Dong He; Feng Zhu
  16. Cross-Border Banking and Business Cycles in Asymmetric Currency Unions By Lena Dräger; Christian R. Proaño
  18. Foreign exchange intervention: strategies and effectiveness By Nuttathum Chutasripanich; James Yetman
  19. Advanced-country policies and emerging-market currencies : the impact of U.S. tapering on India's Rupee By Ikeda,Yuki; Medvedev,Denis; Rama,Martin G.
  20. Explaining the Strength and Efficiency of Monetary Policy Transmission: A Panel of Impulse Responses from a Time-Varying Parameter Model By Jakub Mateju
  21. The international bank lending channel of monetary policy rates and quantitative easing : credit supply, reach-for-yield, and real effects By Morais,Bernardo; Peydró,José-Luis; Ruiz Ortega,Claudia
  22. Determinants of Credit Expansion in Brazil By Barbi, Fernando C.
  23. The macroeconomic effects of the sovereign debt crisis in the euro area By Stefano Neri; Tiziano Ropele
  24. Living (dangerously) without a fiscal union By Ashoka Mody

  1. By: Taylor, Alan M.
    Abstract: Since the 2008 global financial crisis, and after decades of relative neglect, the importance of the financial system and its episodic crises as drivers of macroeconomic outcomes has attracted fresh scrutiny from academics, policy makers, and practitioners. Theoretical advances are following a lead set by a fast-growing empirical literature. Recent long-run historical work has uncovered a range of important stylized facts concerning financial instability and the role of credit in advanced economies, and this article provides an overview of the key findings.
    Keywords: banks; financial crisis; financial history; leverage; macroeconomic history; macroprudential policy; monetary policy; recessions
    JEL: E02 E31 E32 E42 E44 E51 E58 F32 F42 G01 G20 G28 N10 N20
    Date: 2015–03
  2. By: Emanuel Kohlscheen; Ken Miyajima
    Abstract: The departure from the Modigliani-Miller conditions, due for instance to market incompleteness, asymmetric information or taxation, tends to increase the importance of indirect channels by which monetary policy affects the level of economic activity in emerging market economies (EMEs). The bank lending channel highlighted by Bernanke and Blinder (1988) is a prominent example of such indirect effect of monetary policy. In this study we investigate how the bank lending channel acts above and beyond the traditional money channel that most macroeconomic models emphasize. We find that, particularly in EMEs with high bank reliance, changes in the volume of bank credit are important drivers of fixed capital formation. Using micro-level bank balance sheet data, we then show how monetary policy and sovereign risk premia affected bank credit growth in EMEs between 2001 and 2013. We find that both, changes in the monetary policy stance and changes in risk premia have had significant effects on credit volumes. Furthermore, we show that these effects tend to affect smaller banks more strongly. Our results suggest that the accommodative monetary policies that have been seen recently were contributing factors to the rapid expansion of credit in many EMEs.
    Keywords: monetary policy, bank credit, emerging markets, risk premia
    Date: 2015–03
  3. By: Honkapohja, Seppo; Mitra, Kaushik
    Abstract: We examine global dynamics under learning in New Keynesian models with price level targeting that is subject to the zero lower bound. The role of forward guidance is analyzed under transparency about the policy rule. Properties of transparent and non-transparent regimes are compared to each other and to the corresponding cases of inflation targeting. Robustness properties for different regimes are examined in terms of the domain of attraction of the targeted steady state and volatility of inflation, output and interest rate. We analyze the effect of higher inflation targets and large expectational shocks for the performance of these policy regimes.
    Keywords: Adaptive learning; monetary policy; zero interest rate lower bound
    JEL: E52 E58 E63
    Date: 2015–03
  4. By: Marcello Miccoli (Bank of Italy); Stefano Neri (Bank of Italy)
    Abstract: Since 2013 the inflation rate in the euro area has fallen steadily, reaching all-time lows at the end of 2014. Market-based measures of inflation expectations (such as inflation swaps) have also declined to extremely low levels, which suggests increasing concern about the credibility of the ECB in maintaining price stability. Inflation releases have often surprised analysts on the downside. Our analysis shows that market-based inflation expectations, at medium-term maturities, are affected by these ‘surprises’, over and above the impact of changing macroeconomic conditions and oil prices.
    Keywords: inflation, inflation expectations, inflation swap contracts
    JEL: E31 E52 C22 C31
    Date: 2015–03
  5. By: Charles Engel
    Abstract: The well-known uncovered interest parity puzzle arises from the empirical regularity that, among developed country pairs, the high interest rate country tends to have high expected returns on its short term assets. At the same time, another strand of the literature has documented that high real interest rate countries tend to have currencies that are strong in real terms - indeed, stronger than can be accounted for by the path of expected real interest differentials under uncovered interest parity. These two strands - one concerning short-run expected changes and the other concerning the level of the real exchange rate - have apparently contradictory implications for the relationship of the foreign exchange risk premium and interest-rate differentials. This paper documents the puzzle, and shows that existing models appear unable to account for both empirical findings. The features of a model that might reconcile the findings are discussed.
    JEL: F31 F41
    Date: 2015–03
  6. By: Hamdi, Helmi; Sbia, Rashid; said, ali
    Abstract: The broad aim of this paper is to estimate the money demand function for the case of six Gulf Cooperation Council countries. By applying panel cointegration tests, the empirical results reveal strong evidence of cointegration between the variables of the model for individual countries as well as for the panel. Moreover, the results support the existence of a stable money function in the long-run estimation. The Granger non-causality test due to Toda and Yamamoto (1995) procedure shows evidence of a bidirectional causal relationship between money demand and income for panel estimation. At an individual level, the results change from one country to another one.
    Keywords: Money Demand; GCC, Panel Cointegration; Toda-Yamamoto
    JEL: C22 C23 E41 E42 E52
    Date: 2014
  7. By: Rongrong Sun (University of Nottingham Ningbo China and Hong Kong Institute for Monetary Research)
    Abstract: This paper models the PBC's operating procedures in a two-stage vector autoregression framework. We decompose changes in policy variables into exogenous and endogenous components in order to find a "clean" monetary policy indicator whose changes are mainly policy induced. Our main findings are twofold. First, the PBC¡¦s procedures appear to have changed over time. Second, its operating procedures are neither pure interest rate targeting nor pure reserves targeting, but a mixture of the two. There are a variety of indicators that appear to contain information about the monetary policy stance. It is therefore preferable to use a composite measure to gauge the stance of Chinese monetary policy. We construct a new composite indicator of the overall policy stance, consistent with our model. A comparison with existing indicators suggests that the composite indices, rather than individual indicators, perform better in measuring the stance of Chinese monetary policy.
    Keywords: Monetary Policy, VAR, Operating Procedures, Exogenous (Endogenous) Components
    JEL: E52 E58
    Date: 2015–03
  8. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Faculty of Business, Aichi Shukutoku University)
    Abstract: We develop a small open economy, New Keynesian model that incorporates a financial accelerator in combination with liability dollarization. Applying a Ramsey-type analysis, we compare the welfare implications of an optimal monetary policy under flexible exchange rates and an optimal capital control policy under fixed exchange rates. In an economy without the financial accelerator, an optimal monetary policy under flexible exchange rates is superior to an optimal capital control policy under fixed exchange rates. In contrast, in an economy with the financial accelerator, an optimal capital control under fixed exchange rates yields higher welfare than an optimal monetary policy under flexible exchange rates.
    Keywords: Capital control, Monetary policy, Balance sheets, Ramsey policy, Exchange rate regimes, Small open economy, Nominal rigidities, New keynesian, DSGE, Welfare comparison, Incomplete markets, Financial accelerator, Financial frictions
    JEL: E44 E52 F32 F41
    Date: 2015–03
  9. By: Grégory Claeys; Zsolt Darvas
    Abstract: â?¢ Ultra-loose monetary policies, such as very low or even negative interest rates, large-scale asset purchases, long-maturity lending to banks and forward guidance in central bank communication, aim to increase inflation and output, to the benefit of financial stability. But at the same time, these measures pose various risks and might create challenges for financial institutions. â?¢ By assessing the theoretical literature and developments in the United States, United Kingdom and Japan, where very expansionary monetary policies were adopted during the past six years, and by examining the euro-area situation, we conclude that the risks to financial stability of ultra-loose monetary policy in the euro area could be low. However, vigilance is needed. â?¢ While monetary policy should focus on its primary mandate of area-wide price stability, other policies should be deployed whenever the financial cycle deviates from the economic cycle or when heterogeneous financial developments in the euro area require financial tightening in some but not all countries. These policies include micro-prudential supervision, macro-prudential oversight, fiscal policy and regulation of sectors that pose risks to financial stability, such as construction.
    Date: 2015–03
  10. By: Eric Eisenstat (University of Bucharest, Romania; RIMIR); Rodney Strachan (School of Economics, and Centre for Applied Macroeconomic Analysis, University of Queensland; The Rimini Centre for Economic Analysis, Italy)
    Abstract: This paper discusses estimation of US inflation volatility using time varying parameter models, in particular whether it should be modelled as a stationary or random walk stochastic process. Specifying inflation volatility as an unbounded process, as implied by the random walk, conflicts with priors beliefs, yet a stationary process cannot capture the low frequency behaviour commonly observed in estimates of volatility. We therefore propose an alternative model with a change-point process in the volatility that allows for switches between stationary models to capture changes in the level and dynamics over the past forty years. To accommodate the stationarity restriction, we develop a new representation that is equivalent to our model but is computationally more efficient. All models produce effectively identical estimates of volatility, but the change-point model provides more information on the level and persistence of volatility and the probabilities of changes. For example, we find a few well defined switches in the volatility process and, interestingly, these switches line up well with economic slowdowns or changes of the Federal Reserve Chair. Moreover, a decomposition of inflation shocks into permanent and transitory components shows that a spike in volatility in the late 2000s was entirely on the transitory side and a characterized by a rise above its long run mean level during a period of higher persistence.
    Date: 2014–12
  11. By: Dinçer Afat (Department of Economic Theory - Universitat de Barcelona); Marta Gómez-Puig (Department of Economic Theory - Universitat de Barcelona); Simón Sosvilla-Rivero (Department of Quantitative Economics, Universidad Complutense de Madrid)
    Abstract: In this paper, we test three popular versions of the monetary model (flexible price, forward-looking and real interest differential models) for the OECD member countries by applying Johansen cointegration technique. Based on country-by-country analysis, we conclude that monetary models do not provide the expected results. We reveal several shortcomings of the models and examine the building blocks of the fundamental version. Although researchers always blame the deviations from purchasing power parity as the reason for the failure of the monetary model, our analysis indicates that invalidity of Keynesian money demand function is also responsible for unfavourable results.
    Keywords: exchange rate, flexible price monetary model, forward-looking monetary model, real interest differential model, money demand, purchasing power parity
    JEL: F31 F41
    Date: 2015–05
  12. By: Stan du Plessis, Gideon du Rand & Kevin Kotzé
    Abstract: Measures of core inflation convey critical information about an economy. They have a direct effect on the policy-making process, particularly in inflation-targeting countries, and are utilized in forecasting and modelling exercises. In South a Africa the prices indices on which inflation is based have been subject to important structural breaks following changes to the underlying basket of goods and the methodology for constructing price indices. This paper seeks to identify a consistent measure of core inflation for South Africa using trimmed-means estimates, measures that exclude changes in food and energy prices, dynamic factor models and wavelet decompositions. After considering the forecasting ability of these measures, which provide an indication of expected second-round inflationary effects, traditional in-sample criteria were used for further comparative purposes. The results suggest that wavelet decompositions provided a useful measure of this critical variable.
    Keywords: wavelets, trimmed means, dynamic factor mdoels, forecasting, core inflation
    JEL: C43 E31 F31 E52
    Date: 2015
  13. By: Sengupta, Rajeswari
    Abstract: The Global Financial Crisis of 2008 and the heightened macroeconomic and financial volatility that followed the crisis raised important questions about the current international financial architecture as well as about individual countries’ external macroeconomic policies. Policy- makers dealing with the global crisis have been confronted with the ‘impossible trinity’ or the ‘Trilemma’, a potent paradigm of open economy macroeconomics asserting that a country may not target the exchange rate, conduct an independent monetary policy and have full financial integration, all at the same time. This issue is highly pertinent for India. A number of challenges have emanated from India’s greater integration with the global financial markets during the last two decades, one of which includes managing the policy tradeoffs under the Trilemma. In this chapter, I present a comprehensive overview of a few empirical studies that have explored the issue of Trilemma in the Indian context. Based on these studies I attempt to analyze how have Indian policy makers dealt with the various trade-offs while managing the Trilemma over the last two decades.
    Keywords: Impossible Trinity, Financial Integration, Currency Stabilization, International Reserves, Sterilized Intervention
    JEL: F3 F4
    Date: 2015–03–01
  14. By: Martin Komrska (University of Economics, Prague); Marek Hudík (Centre for Theoretical Study, Charles University and Academy of Sciences, Prague)
    Abstract: Contrary to the received view, we maintain that Hayek’s monetary policy recommendations were not inconsistent. The prevalent perception of early Hayek as the money stream stabilizer and late Hayek as the price level stabilizer is attributable to an unjustified normative interpretation of Hayek’s positive analysis. We argue that in his contributions to monetary theory, Hayek took the goals of monetary policy as exogenously given and analysed the efficiency of different means to achieve these goals. Hayek’s allegedly inconsistent switch from being a critic to an advocate of price level stabilization is explained by a change in the issues on which he focused, rather than by a change in his theoretical views. We also claim that Hayek was always aware that every practical monetary policy involves difficult trade-offs and was thus reluctant to impose his own value judgments about what people should strive for.*We would like to thank Pavel Potužák for his helpful comments on an earlier draft. Any mistakes are, of course, ours.
    Keywords: F. A. Hayek; monetary policy; Austrian business cycle theory; price level stabilization; money stream stabilization
    JEL: B22 B31 B53
    Date: 2014–07
  15. By: Qianying Chen; Andrew Filardo; Dong He; Feng Zhu
    Abstract: We study the impact of US quantitative easing (QE) on both the emerging and advanced economies, estimating a global vector error correction model (GVECM). We focus on the effects of reductions in the US term and corporate spreads. The estimated effects of QE are sizeable and vary across economies. First, we find the QE impact from reducing the US corporate spread to be more important than that from lowering the US term spread, consistent with Blinder's (2012) argument. Second, counterfactual exercises suggest that US QE measures, especially the cumulative effects of successive QE measures starting with the sizeable impact of the early actions, countered forces that could have led to episodes of prolonged recession and deflation in the advanced economies. Third, the estimated effects on emerging economies are diverse but generally larger than those found for the United States and other advanced economies. The estimates suggest that US monetary policy spillovers contributed to overheating in Brazil, China and some other emerging economies in 2010 and 2011, but supported their respective recoveries in 2009 and 2012. These heterogeneous effects point to unevenly distributed benefits and costs of monetary policy spillovers.
    Keywords: emerging economies; financial crisis; global VAR; international monetary policy spillovers; quantitative easing; unconventional monetary policy
    Date: 2015–03
  16. By: Lena Dräger (Universität Hamburg (University of Hamburg)); Christian R. Proaño (The New School for Social Research)
    Abstract: Against the background of the recent housing boom and bust in countries such as Spain and Ireland, we investigate in this paper the macroeconomic consequences of cross-border banking in monetary unions such as the euro area. For this purpose, we incorporate in an otherwise standard two-region monetary union DSGE model a banking sector module along the lines of Gerali et al. (2010), accounting for borrowing constraints of entrepreneurs and an internal constraint on the bank’s leverage ratio. We illustrate in particular how different lending standards within the monetary union can translate into destabilizing spill-over effects between the regions, which can in turn result in a higher macroeconomic volatility. This mechanism is modelled by letting the loan-to-value (LTV) ratio that banks demand of entrepreneurs depend on either regional productivity shocks or on the productivity shock from one dominating region. Thereby, we demonstrate a channel through which the financial sector may have exacerbated the emergence of macroeconomic imbalances within the euro area. Additionally, we show the effects of a monetary policy rule augmented by the loan rate spread as in Cúrdia and Woodford (2010) in a two-country monetary union context.
    Keywords: Cross-border banking, euro area, monetary unions, DSGE
    JEL: F41 F34 E52
    Date: 2015–03
  17. By: Kalu E. Uma (Department of Economics and Development Studies, Federal University, Ndufu-Alike, Ikwo, Ebonyi State); Benson M. Ogbonna (Department of Economics, Abia State University, Uturu, Abia State); Paul Obidike (Department of Accountancy, Management & Entrepreneurial Studies, Federal University Ndufu Alike Ikwo)
    Abstract: The paper highlights monetary policy transmission mechanism in Nigeria focusing on empirical studies and happenings in the country that retarded the efficiency of the Central Bank of Nigeria over the years in the pursuant of effective transmission mechanism. The empirical reviews from studies show that interest rate, credit channels and exchange rate are among the channels of monetary policy transmission to the economy. It also highlights some of the problems that imposed a serious debility to effective transmission in Nigeria. The authors made some suggestions for improvement, among which includes: the Central Bank must persevere legally, morally and otherwise to make the economy a cashless one. The low patronage of banking services by many Nigerians is a stumbling block in effective control of money supply and has contributed to incessant inflation in the country; any form of disguise or indirect interference by the government has to be put to an end; and the instruments of monetary policy such as interest rate and exchange that are known to be effective in some sectors should be properly managed and monitored.
    Keywords: Mechanism, monetary, overview, policy, transmission
    JEL: E52
    Date: 2014–10
  18. By: Nuttathum Chutasripanich; James Yetman
    Abstract: Foreign exchange intervention has been actively used as a policy tool in many economies in Asia and elsewhere. In this paper, we examine two intervention rules (leaning against exchange rate misalignment and leaning against the wind), utilised with varying degrees of transparency, based on a simple model with three kinds of agents: fundamentalists, speculators and the central bank. We assess the effectiveness of these rules against five criteria: stabilising the exchange rate, reducing current account imbalances, discouraging speculation, minimising reserves volatility and limiting intervention costs. Overall we find no dominant intervention strategy. Intervention that reduces exchange rate volatility, for example, also reduces the risks of speculation, creating a feedback loop and potentially leading to high levels of speculation, reserves volatility and intervention costs. These intervention costs will be especially large when exchange rate movements are driven by interest rate shocks, although some degree of opaqueness can help to reduce them. Survey evidence from BIS (2005, 2013) indicates that central banks follow a range of different strategies when intervening in foreign exchange rates. Given the trade-offs that different strategies entail in our model, this is not surprising.
    Keywords: foreign exchange intervention; exchange rates; speculation
    Date: 2015–03
  19. By: Ikeda,Yuki; Medvedev,Denis; Rama,Martin G.
    Abstract: The global financial crisis and its aftermath have triggered extraordinary policy responses in advanced countries. The impacts of these policy responses?from asset price bubbles to currency depreciations?have often been felt in the developing world. As tapering talk evolves into actual withdrawal of quantitative easing in the United States, and as the Euro Zone launches its own quantitative easing program, there are good reasons to be concerned about the financial stability of emerging economies. India's experience with U.S. tapering offers insights into what to expect. This paper estimates the contribution of external and domestic factors to short-term fluctuations in the value of the Indian rupee between 2004 and 2014, using a rich dynamic model that controls for a large number of exchange rate determinants. The paper finds that a global surprise factor, more than domestic vulnerabilities, was the main driver of the large rupee depreciation in summer 2013. With the surprise factor gone, further normalization of U.S. monetary policy is unlikely to have significant effects on the rupee exchange rate.
    Keywords: Economic Theory&Research,Debt Markets,Currencies and Exchange Rates,Economic Stabilization,Emerging Markets
    Date: 2015–03–23
  20. By: Jakub Mateju
    Abstract: This paper analyzes both the cross-sectional and time variation in aggregate monetary policy transmission from nominal short-term interest rates to the price level. Using Bayesian TVP-VAR models where structural monetary policy shocks are identified by a mixture of short-term and sign restrictions, I show that monetary policy transmission has become stronger over the last few decades. This finding is robust across both developed and emerging economies. Monetary policy sacrifice ratios (the output costs of disinflation induced by monetary policy tightening) have decreased over the last four decades. Exploring the cross-country and time variation in monetary policy responses using panel regressions, I show that after a country adopted inflation targeting, monetary transmission became stronger and sacrifice ratios decreased. In periods of banking crises, the transmission from monetary policy interest rate shocks to prices is weaker and the related output costs are higher. Furthermore, countries with higher domestic private credit to GDP feature stronger transmission of interest rate shocks.
    Keywords: Monetary policy transmission, sign-restrictions, TVP-VAR
    JEL: C54 E52
    Date: 2014–04
  21. By: Morais,Bernardo; Peydró,José-Luis; Ruiz Ortega,Claudia
    Abstract: This paper identifies the international credit channel of monetary policy by analyzing the universe of corporate loans in Mexico, matched with firm and bank balance-sheet data, and by exploiting foreign monetary policy shocks, given the large presence of European and U.S. banks in Mexico. The paper finds that a softening of foreign monetary policy increases the supply of credit of foreign banks to Mexican firms. Each regional policy shock affects supply via their respective banks (for example, U.K. monetary policy affects credit supply in Mexico via U.K. banks), in turn implying strong real effects, with substantially larger elasticities from monetary rates than quantitative easing. Moreover, low foreign monetary policy rates and expansive quantitative easing increase disproportionally more the supply of credit to borrowers with higher ex ante loan rates -- reach-for-yield -- and with substantially higher ex post loan defaults, thus suggesting an international risk-taking channel of monetary policy. All in all, the results suggest that foreign quantitative easing increases risk-taking in emerging markets more than it improves the real outcomes of firms.
    Keywords: Access to Finance,Debt Markets,Bankruptcy and Resolution of Financial Distress,Banks&Banking Reform,Economic Stabilization
    Date: 2015–03–19
  22. By: Barbi, Fernando C.
    Abstract: Brazilian economy has experienced a major boost in leverage in the first decade of 2000 as a result of a set factors ranging from macroeconomic stability to the abundant liquidity in international financial markets before 2008 and a set of deliberate decisions taken by President Lula's to expand credit, boost consumption and gain political support from the lower social strata. This paper analyzes the determinants of credit using an extensive bank level panel dataset. As relevant conclusions to our investigation we verify that: credit expansion relied on the reduction of the monetary policy rate, international financial markets are an important source of funds, payroll-guaranteed credit and investment grade status affected positively credit supply. We were not able to confirm the importance of financial inclusion efforts. The importance of financial sector sanity indicators of credit conditions cannot be underestimated. These results raise questions over the sustainability of this expansion process and financial stability in the future.
    Keywords: bank credit, public credit, emerging markets, financial stability
    JEL: E44 G18 G21 H21
    Date: 2014–04–08
  23. By: Stefano Neri (Bank of Italy); Tiziano Ropele (Bank of Italy)
    Abstract: This paper uses a Factor Augmented Vector Autoregressive model to assess the macroeconomic impact of the euro-area sovereign debt crisis and the effectiveness of the European Central Bank's conventional monetary policy. First, our results show that in the countries most affected by the crisis, the tensions in sovereign debt markets made credit conditions significantly worse and weighed on economic activity and unemployment. The disruptive effects of the sovereign tensions propagated to the core economies of the euro area through the trade and confidence channels. Second, "modest" (in the sense of Leeper and Zha, 2003) counterfactual simulations suggest that the accommodative monetary policy stance of the ECB helped to moderate the negative effects of the sovereign debt tensions.
    Keywords: sovereign debt crisis, FAVAR models, Bayesian methods, monetary policy
    JEL: C32 E44 E52 F41
    Date: 2015–03
  24. By: Ashoka Mody
    Abstract: The euro areaâ??s political contract requires member nations to rely principally on their own resources when confronted with severe economic distress. Since monetary policy is the same for all, national fiscal austerity is the default response to counter national fiscal stress. Moreover, the monetary policy was itself stodgy in countering the crisis, and banking-sector problems were allowed to fester. And it was considered inappropriate to impose losses on private sector creditors. Thus, the nature of the incomplete monetary union and the self-imposed taboos led deep and persistent fiscal austerity to become the norm. As a consequence, growth was hurt, which undermined the primary objective of lowering the debt burden. To prevent a meltdown, distressed nations were given official loans to repay private creditors. But the stress and instability continued and soon it became necessary to ease the repayment terms on official loans. When even that proved insufficient, the German-inspired fiscal austerity was combined with the deep pockets of the European Central Bank. The ECBâ??s safety net for insolvent or near-insolvent banks and sovereigns, in effect, substituted for the absent fiscal union and drew the central bank into the political process.
    Date: 2015–03

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