nep-mon New Economics Papers
on Monetary Economics
Issue of 2015‒04‒25
twenty-six papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Forecast Uncertainty and the Taylor Rule By Christian Bauer; Matthias Neuenkirch
  2. U.S. Monetary Policy Normalization By Bullard, James B.
  3. Monetary Policy Instrument and Inflation in South Africa: Structural Vector Error Correction Model Approach By Bonga-Bonga, Lumengo; Kabundi, Alain
  4. Money markets and monetary policy normalization By Potter, Simon M.
  5. Graph representation of balance sheets: from exogenous to endogenous money By Pitrou, Cyril
  6. Overnight RRP Operations as a Monetary Policy Tool: Some Design Considerations By Frost, Joshua; Logan, Lorie; Martin, Antoine; McCabe, Patrick E.; Natalucci, Fabio M.; Remache, Julie
  7. Central bank independence and political pressure in the Greenspan era By Kuper, Gerard; Veurink, Jan Hessel
  8. Some Considerations for U.S. Monetary Policy Normalization By Bullard, James B.
  9. A Dynamic Yield Curve Model with Stochastic Volatility and Non-Gaussian Interactions: An Empirical Study of Non-standard Monetary Policy in the Euro Area By Geert Mesters; Bernd Schwaab; Siem Jan Koopman
  10. Watering a lemon tree: heterogeneous risk taking and monetary policy transmission By Choi, Dong Boem; Eisenbach, Thomas M.; Yorulmazer, Tanju
  11. The Euro Monetary Fund. A proposal for sovereign-debt redemption By Luís Manuel Seixas
  12. Vector Autoregressions with Parsimoniously Time Varying Parameters and an Application to Monetary Policy By Laurent Callot; Johannes Tang Kristensen
  13. Banking panics and deflation in dynamic general equilibrium By Carapella, Francesca
  14. The optimal supply of liquidity and the regulations of money substitutes: a Baumol-Tobin approach By Benjamin Eden
  15. Shocks to Bank Lending, Risk-Taking, Securitization, and their Role for U.S. Business Cycle Fluctuations By Peersman, Gert; Wagner, Wolf
  16. Fiscal and Monetary Policy Coordination, Macroeconomic Stability, and Sovereign Risk By Dennis Bonam; Jasper Lukkezen
  17. A Theory of Macroprudential Policies in the Presence of Nominal Rigidities By Emmanuel Farhi; Ivan Werning
  18. Consumers' Attitudes and Their Inflation Expectations By Ehrmann, Michael; Pfajfar, Damjan; Santoro, Emilianio
  19. Positive long-run inflation non-super-neutrality in the Euro area By Andrea Vaona
  20. The Cape of Perfect Storms: Colonial Africa’s first financial crash, 1788-1793 By Roy Havemann and Johan Fourie
  21. A model of the Twin Ds: optimal default and devaluation By Na, Seunghoon; Schmitt-Grohe, Stephanie; Uribe, Martin; Yue, Vivian Z.
  22. Why Do We Need Both Liquidity Regulations and a Lender of Last Resort? A Perspective from Federal Reserve Lending during the 2007-09 U.S. Financial Crisis By Carlson, Mark A.; Duygan-Bump, Burcu; Nelson, William R.
  23. Inflation Dynamics During the Financial Crisis By Gilchrist, Simon; Schoenle, Raphael; Sim, Jae W.; Zakrajsek, Egon
  24. Interest Premium, Sudden Stop, and Adjustment in a Small Open Economy By Peter Benczur; Istvan Konya
  25. Indeterminacy, Misspecification and Forecastability: Good Luck in Bad Policy? By Luca Fanelli; Marco M. Sorge
  26. Labor Market Slack and Monetary Policy By David G. Blanchflower; Andrew T. Levin

  1. By: Christian Bauer; Matthias Neuenkirch
    Abstract: In this paper, we derive a modification of a forward-looking Taylor rule, which integrates two variables measuring the uncertainty of inflation and GDP growth forecasts into an otherwise standard New Keynesian model. We show that certainty-equivalence in New Keynesian models is a consequence of log-linearization and that a second-order Taylor approximation leads to a reaction function which includes the uncertainty of macroeconomic expectations. To test the model empirically, we use the standard deviation of individual forecasts around the median Consensus Forecast as proxy for forecast uncertainty. Our sample covers the euro area, Sweden, and the United Kingdom and the period 1992Q4-2014Q2. We find that while all three central banks react significantly to inflation forecast uncertainty by reducing their policy rates in times of higher inflation expectation uncertainty with an average effect of more than 25 basis points, they do not have significant reactions to GDP growth forecast uncertainty. We conclude with some implications for optimal monetary policy rules and central bank watchers.
    Keywords: Certainty-Equivalence, Consensus Forecasts, Forecast Uncertainty, Global Financial Crisis, Optimal Monetary Policy, Taylor Rule
    JEL: E52 E58
    Date: 2015
  2. By: Bullard, James B. (Federal Reserve Bank of St. Louis)
    Date: 2015–03–26
  3. By: Bonga-Bonga, Lumengo; Kabundi, Alain
    Abstract: Since the adoption of inflation rate targeting policy, there has been a great concern on the effectiveness of monetary policy to curb inflation in South Africa. The effectiveness of the repo rate as a policy instrument to control the level of inflation has been widely criticised not only in the South African context but also internationally. With the critics pointing out from a substantial lag for monetary policy changes to affect inflation to the inability of the policy instrument to effectively affect inflation level. In assessing the effectiveness of the monetary policy in South Africa, this paper makes use of the structural vector error correction model (SVECM) to characterise the dynamics of inflation to monetary policy shocks. The results of the impulse response function obtained from the SVECM found that while positive shocks to monetary policy decrease output but do not decrease credit demand and inflation in South Africa.
    Keywords: Inflation rate targeting, Policy instruments, Structural Vector Error Correction Model.
    JEL: C22 E52
    Date: 2015–04–10
  4. By: Potter, Simon M. (Federal Reserve Bank of New York)
    Abstract: Remarks at the Money Marketeers of New York University, New York City.
    Keywords: policy normalization: System Open Market Account (SOMA); Open Market Trading Desk; overnight reverse repurchase agreement (ON RRP); interest on excess reserve balances (IOER); desk; flexibility; investment capacity; testing; data collection; liftoff
    JEL: E52
    Date: 2015–04–15
  5. By: Pitrou, Cyril
    Abstract: A graph representation of the financial relations in a given monetary structure is proposed. It is argued that the graph of debt-liability relations is naturally organized and simplified into a tree structure, around banks and a central bank. Indeed, this optimal graph allows to perform payments very easily as it amounts to the suppression of loops introduced by pending payments. Using this language of graphs to analyze the monetary system, we first examine the systems based on commodity money and show their incompatibility with credit. After dealing with the role of the state via its ability to spend and raise taxes, we discuss the chartalist systems based on pure fiat money, which are the current systems. We argue that in those cases, the Treasury and the central bank can be meaningfully consolidated. After describing the interactions of various autonomous currencies, we argue that fixed exchanged rates can never be maintained, and we discuss the controversial role of the IMF in international financial relations. We finally use graph representations to give our interpretation on open problems, such as the monetary aggregates, the sectoral financial balances and the endogenous nature of money. Indeed, once appropriately consolidated, graphs of financial relations allow to formulate easily unambiguous statements about the monetary arrangements.
    Keywords: monetary theory; graph theory; chartalism; endogenous money; central bank; sectoral financial balances; budgetary policy; monetary policy
    JEL: E42 E50 E52 E58 F33 F34
    Date: 2015–04–14
  6. By: Frost, Joshua (Federal Reserve Bank of New York); Logan, Lorie (Federal Reserve Bank of New York); Martin, Antoine (Federal Reserve Bank of New York); McCabe, Patrick E. (Board of Governors of the Federal Reserve System (U.S.)); Natalucci, Fabio M. (Board of Governors of the Federal Reserve System (U.S.)); Remache, Julie (
    Abstract: We review recent changes in monetary policy that have led to development and testing of an overnight reverse repurchase agreement (ON RRP) facility, an innovative tool for implementing monetary policy during the normalization process. Making ON RRPs available to a broad set of investors, including nonbank institutions that are significant lenders in money markets, could complement the use of the interest on excess reserves (IOER) and help control short-term interest rates. We examine some potentially important secondary effects of an ON RRP facility, both positive and negative, including impacts on the structure of short-term funding markets and financial stability. We also investigate design features of an ON RRP facility that could mitigate secondary effects deemed undesirable. Finally, we discuss tradeoffs that policymakers may face in designing an ON RRP facility, as they seek to balance the objectives of setting an effective floor on money market rates during t he normalization process and limiting any adverse secondary effects.
    Keywords: Federal Reserve Board and Federal Reserve System; monetary policy; interest on excess reserves; money market funds; overnight RRP; repo; reverse repo
    JEL: E52 E58 G21 G23
    Date: 2015–02–19
  7. By: Kuper, Gerard; Veurink, Jan Hessel (Groningen University)
    Abstract: This paper investigates whether political pressure from incumbent<br/>presidents influences the Fed?s monetary policy during the period that Alan Greenspan was the chairman of the United States Federal Reserve Board. A modified Taylor rule - featuring the inflation rate and the unemployment<br/>gap rather than the output gap - with time-varying coefficients will be used to test well-known political-economic theories of Nordhaus (1975) and Hibbs (1987). This novel approach addresses some of the disadvantages of Ordinary Least Squares, and has the additional benefit of allowing the use of mixed frequency data. Our findings suggest that the Fed under Greenspan did not create election driven monetary cycles, but was less inflation avers<br/>with a Democratic president.
    Date: 2014
  8. By: Bullard, James B. (Federal Reserve Bank of St. Louis)
    Abstract: St. Louis Fed President James Bullard discussed factors that are weighing on the decision to begin normalizing U.S. monetary policy and the recent removal of the word “patient” from the FOMC statement, during the 24th Annual Hyman P. Minsky Conference, in Washington, D.C. He said that now may be a good time to begin normalizing monetary policy so that it is set appropriately for an improving economy over the next two years.
    Date: 2015–04–15
  9. By: Geert Mesters (VU University Amsterdam, the Netherlands); Bernd Schwaab (European Central Bank); Siem Jan Koopman (VU University Amsterdam, the Netherlands)
    Abstract: We develop an econometric methodology for the study of the yield curve and its interactions with measures of non-standard monetary policy during possibly turbulent times. The yield curve is modeled by the dynamic Nelson-Siegel model while the monetary policy measurements are modeled as non-Gaussian variables that interact with latent dynamic factors, including the yield factors of level and slope. Yield developments during the financial and sovereign debt crises require the yield curve model to be extended with stochastic volatility and heavy tailed disturbances. We develop a flexible estimation method for the model parameters with a novel implementation of the importance sampling technique. We empirically investigate how the yields in Germany, France, Italy and Spain have been affected by monetary policy measures of the European Central Bank. We model the euro area interbank lending rate EONIA by a log-normal distribution and the bond market purchases within the ECB's Securities Markets Programme by a Poisson distribution. We find evidence that the bond market interventions had a direct and temporary effect on the yield curve lasting up to ten weeks, and find limited evidence that purchases changed the relationship between the EONIA rate and the term structure factors.
    Keywords: dynamic Nelson-Siegel models, Central bank asset purchases, non-Gaussian, state space methods, importance sampling, European Central Bank
    JEL: C32 C33 E52 E58
    Date: 2014–06–17
  10. By: Choi, Dong Boem (Federal Reserve Bank of New York); Eisenbach, Thomas M. (Federal Reserve Bank of New York); Yorulmazer, Tanju
    Abstract: We build a general equilibrium model with financial frictions that impede the effectiveness of monetary policy in stimulating output. Agents with heterogeneous productivity can increase investment by levering up, but this increases interim liquidity risk. In equilibrium, the more productive agents choose higher leverage, invest more, and take on higher liquidity risk. Therefore, these agents respond less than the agents with lower productivity to monetary policy that reduces the equilibrium interest rate. Overall quality of investment deteriorates, which can generate a negative spiral, dampening the effect of a monetary stimulus: Worse overall quality leads to lower liquidation values, increasing the cost of liquidity risk. This reduces the demand for loanable funds, further decreasing the interest rate, which then leads to further quality deterioration. When this feedback is strong, monetary policy can lose its effectiveness in stimulating aggregate output even if it leads to significant drops in the interest rate.
    Keywords: monetary policy transmission; financial frictions; heterogeneous agents; financial intermediaries
    JEL: E52 E58 G20
    Date: 2015–04–01
  11. By: Luís Manuel Seixas
    Abstract: Debt restructuration is lately a recurring theme in the affairs of the Euro. The economic and financial crisis set for unconventional and extraordinary policies, so that the actions of major Central Banks are to become more decisive in the economic dynamics. This article focuses on a proposal for debt redemption and restructuration with central-bank money emissions. It does so by elaborating in the sense of economic treasury, and consequently of European Treasury. The modern Central Banks (CBs) practices, the present-day money circulation characteristics and the agent’s financial heuristics are therefore assessed. A quantitative plan for debt redemption and restructuration with a nexus on the finance of productive investment is also presented.
    Keywords: debt-restructuration, money circulation, treasury, central-banks.
    Date: 2015–04
  12. By: Laurent Callot (VU University Amsterdam); Johannes Tang Kristensen (University of Southern Denmark, Denmark)
    Abstract: This paper proposes a parsimoniously time varying parameter vector autoregressive model (with exogenous variables, VARX) and studies the properties of the Lasso and adaptive Lasso as estimators of this model. The parameters of the model are assumed to follow parsimonious random walks, where parsimony stems from the assumption that increments to the parameters have a non-zero probability of being exactly equal to zero. By varying the degree of parsimony our model can accommodate constant parameters, an unknown number of structural breaks, or parameters with a high degree of variation. We characterize the finite sample properties of the Lasso by deriving upper bounds on the estimation and prediction errors that are valid with high probability; and asymptotically we show that these bounds tend to zero with probability tending to one if the number of non zero increments grows slower than √T . By simulation experiments we investigate the properties of the Lasso and the adaptive Lasso in settings where the parameters are stable, experience structural breaks, or follow a parsimonious random walk. We use our model to investigate the monetary policy response to inflation and business cycle fluctuations in the US by estimating a parsimoniously time varying parameter Taylor rule. We document substantial changes in the policy response of the Fed in the 1980s and since 2008.
    Keywords: Parsimony, time varying parameters, VAR, structural break, Lasso
    JEL: C01 C13 C32 E52
    Date: 2014–11–07
  13. By: Carapella, Francesca (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper develops a framework to study the interaction between banking, price dynamics, and monetary policy. Deposit contracts are written in nominal terms: if prices unexpectedly fall, the real value of banks' existing obligations increases. Banks default, panics precipitate, economic activity declines. If banks default, aggregate demand for cash increases because financial intermediation provided by banks disappears. When money supply is unchanged, the price level drops, thereby providing incentives for banks to default. Active monetary policy prevents banks from failing and output from falling. Deposit insurance can achieve the same goal but amplifies business cycle fluctuations by inducing moral hazard.
    Keywords: banking panics; deflation; deposit insurance
    JEL: E53 E58 G21 N12
    Date: 2015–03–04
  14. By: Benjamin Eden (Vanderbilt University)
    Abstract: I use the Baumol-Tobin approach to examine the following propositions: (a) The optimal supply of liquidity requires a government loan program in addition to paying interest on reserves held by banks, (b) The adoption of the optimal policy will crowd out private credit arrangement and will thus shrink the financial sector and (c) regulations aimed at eliminating money substitutes may be redundant if the optimal policy is adopted but otherwise may improve welfare.
    JEL: E0 E5
    Date: 2014–01–10
  15. By: Peersman, Gert; Wagner, Wolf
    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 risk-taking 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: 2015–04
  16. By: Dennis Bonam (VU University Amsterdam, The Netherlands); Jasper Lukkezen (Utrecht University, Utrecht, and CPB Netherlands Bureau for Economic Policy Analysis, The Hague, The Netherlands)
    Abstract: In standard macroeconomic models, debt sustainability and price level determinacy are achieved when fiscal policy avoids explosive debt and monetary policy controls inflation, irrespective of the relative strengths of each policy stance. We examine how these policy requirements for equilibrium stability and determinacy change in the presence of sovereign risk. An increase in sovereign risk reduces lender's willingness to hold government debt and raises consumption and inflation. Therefore, inflation and debt dynamics are determined jointly. To ensure stable macroeconomic conditions, both the fiscal and monetary stance must shift to offset debt sustainability concerns. We find that the adoption of a deficit target helps alleviate such concerns and raises the scope for macroeconomic stability.
    Keywords: Fiscal and monetary policy coordination, equilibrium determinacy and stability, sovereign risk, policy rules
    JEL: E52 E62 E63
    Date: 2014–01–07
  17. By: Emmanuel Farhi; Ivan Werning
    Abstract: Abstract We provide a unifying foundation for monetary policy and macroprudential policies in financial markets for economies with nominal rigidities in goods and labor markets and constraints on monetary policy such as the zero lower bound or fixed exchange rates. Macroprudential interventions in financial markets are beneficial because of an aggregate demand externality. Ex post, the distribution of wealth across agents affects aggregate demand and output through Keynesian channels. However, ex ante, these effects are not privately internalized in the financial decisions agents make. We obtain a simple formula that characterizes the size and direction for optimal financial market interventions as a function of a small number of empirically measurable sufficient statistics. We also characterize optimal monetary policy. We then show how to extend our framework to also incorporate financial markets frictions giving rise to pecuniary externalities. Finally, we provide a number of relevant concrete applications of our general theory.
    Date: 2015–01
  18. By: Ehrmann, Michael (Bank of Canada); Pfajfar, Damjan (Board of Governors of the Federal Reserve System (U.S.)); Santoro, Emilianio (University of Copenhagen)
    Abstract: This paper studies consumers' inflation expectations using micro-level data from the Surveys of Consumers conducted by University of Michigan. It shows that beyond the well-established socio-economic factors such as income, age or gender, other characteristics such as the households' financial situation and their purchasing attitudes are important determinants of their forecast accuracy. Respondents with current or expected financial difficulties, pessimistic attitudes about major purchases, or expectations that income will go down in the future have a stronger upward bias in their expectations than other households. However, their bias shrinks by more than that of the average household in response to increasing media reporting about inflation. Equivalent results are found during recessions.
    Keywords: Consumer Attitudes; Inflation Expectations; News on Inflation
    JEL: C53 D84 E31
    Date: 2015–03–10
  19. By: Andrea Vaona (Department of Economics (University of Verona))
    Abstract: By means of structural VARs we investigate the long-run nexus between inflation and output in the Eurozone under different identification schemes and model specifications. The Eurozone is an interesting case study due to its very low inflation rate and to the official adherence of its monetary authority to the classical dichotomy. We find a strong positive long-run connection between inflation and output, supporting recent theoretical models arguing that this might exist at low long-run inflation rates.
    Keywords: long-run, non-vertical Phillips curve, empirical evidence
    JEL: E31 E40 E50 J64
    Date: 2015–04
  20. By: Roy Havemann and Johan Fourie
    Abstract: This paper investigates the causes and consequences of colonial Africa’s first financial crash, which happened in South Africa’s Dutch Cape Colony. The 1788–1793 crisis followed a common sequence of events: trade and fiscal deficits were monetized by printing money, credit extension accelerated, the exchange rate fell sharply and inflation spiked. The domestic conditions were compounded by a deterioration of international conditions and political uncertainty. The final straw was the collapse of the Cape’s own Lehman Brothers – an unregulated merchant house, run by a prominent Cape family, which had been indiscriminately issuing the equivalent of promissory notes. The policy response during the crisis included fiscal austerity, an attempted reorganization of domestic financial intermediation and continued monetary easing, which depreciated the exchange rate and triggered inflation. A new domestic bank was created. Yet the Cape economy would not recover quickly; the effects of the Cape’s first financial crash would be felt deep into the nineteenth century.
    Keywords: financial crisis, Eighteenth century, institutions, banking, Africa
    JEL: N27 N17 N20
    Date: 2015
  21. By: Na, Seunghoon (Columbia University); Schmitt-Grohe, Stephanie (Columbia University, CEPR, and NBER); Uribe, Martin (Columbia University and NBER); Yue, Vivian Z. (Emory University and Federal Reserve Bank of Atlanta)
    Abstract: This paper characterizes jointly optimal default and exchange-rate policy in a small open economy with limited enforcement of debt contracts and downward nominal wage rigidity. Under optimal policy, default occurs during contractions and is accompanied by large devaluations. The latter inflate away real wages, thereby avoiding massive unemployment. Thus, the Twin Ds phenomenon emerges endogenously as the optimal outcome. In contrast, under fixed exchange rates, optimal default takes place in the context of large involuntary unemployment. Fixed-exchange-rate economies are shown to have stronger default incentives and therefore support less external debt than economies with optimally floating rates.
    Keywords: sovereign default; exchange rates; optimal monetary policy; capital controls; downward nominal wage rigidity; currency pegs
    JEL: E43 E52 F31 F34 F41
    Date: 2015–04–01
  22. 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.)); Nelson, William R. (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: During the 2007-09 financial crisis, there were severe reductions in the liquidity of financial markets, runs on the shadow banking system, and destabilizing defaults and near-defaults of major financial institutions. In response, the Federal Reserve, in its role as lender of last resort (LOLR), injected extraordinary amounts of liquidity. In the aftermath, lawmakers and regulators have taken steps to reduce the likelihood that such lending would be required in the future, including the introduction of liquidity regulations. These changes were motivated in part by the argument that central bank lending entails extremely high costs and should be made unnecessary by liquidity regulations. By contrast, some have argued that the loss of liquidity was the result of market failures, and that central banks can solve such failures by lending, making liquidity regulations unnecessary. In this paper, we argue that LOLR lending and liquidity regulations are complementary tools. Liquidity shortfalls can arise for two very different reasons: First, sound institutions can face runs or a deterioration in the liquidity of markets they depend on for funding. Second, solvency concerns can cause creditors to pull away from troubled institutions. Using examples from the recent crisis, we argue that central bank lending is the best response in the former situation, while orderly resolution (by the institution as it gets through the problem on its own or via a controlled failure) is the best response in the second situation. We also contend that liquidity regulations are a necessary tool in both situations: They help ensure that the authorities will have time to assess the nature of the shortfall and arrange the appropriate response, and they provide an incentive for banks to internalize the externalities associated with any liquidity risks.
    Keywords: Lender of last resort; central banks; financial crises; liquidity regulation
    JEL: E58 G01 G28
    Date: 2015–02–10
  23. By: Gilchrist, Simon (Boston University); Schoenle, Raphael (Brandeis University); Sim, Jae W. (Board of Governors of the Federal Reserve System (U.S.)); Zakrajsek, Egon (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Firms with limited internal liquidity significantly increased prices in 2008, while their liquidity unconstrained counterparts slashed prices. Differences in the firms' price-setting behavior were concentrated in sectors likely characterized by customer markets. We develop a model, in which firms face financial frictions, while setting prices in a customer-markets setting. Financial distortions create an incentive for firms to raise prices in response to adverse demand or financial shocks. These results reflect the firms' reaction to preserve internal liquidity and avoid accessing external finance, factors that strengthen the countercyclical behavior of markups and attenuate the response of inflation to fluctuations in output.
    JEL: E31 E32 E44 E51
    Date: 2015–03–03
  24. By: Peter Benczur (Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences and European Commission, Joint Research Centre (JRC) Central European University); Istvan Konya (Institute of Economics Centre for Economic and Regional Studies, Hungarian Academy of Sciences and Central European University)
    Abstract: We study the adjustment process of a small open economy to a sudden worsening of external conditions. To model the sudden stop, we use a highly non-linear specification that captures credit constraints in a convenient way. The advantage of our approach is that the effects of the shock become highly conditional on the external debt position of the economy. We adopt a two-sector model with money-in-the-utility, which allows us to study sectoral asymmetries in the adjustment process, and also the role of currency mismatch. We calibrate the model to the behavior of the Hungarian economy in the 2000s and its crisis experience in 2008-11 in particular. We also calculate four counterfactuals: two with different exchange rate policies (a more flexible float and a perfect peg), and then these two policy regimes with smaller initial indebtedness. Overall, our model is able to fit movements of key aggregate and sectoral macroeconomic variables after the crisis by producing a large and protracted deleveraging process. It also offers a meaningful quantification of the policy tradeoff between facilitating the real adjustment by letting the currency depreciate and protecting consumption expenditures by limiting the adverse effect of exchange rate movements on household balance sheets.
    Keywords: interest premium, sudden stop, small open economy
    JEL: E21 E41 E5 F3
    Date: 2015–01
  25. By: Luca Fanelli (University of Bologna); Marco M. Sorge (University of Göttingen and CSEF)
    Abstract: A recent debate in the forecasting literature revolves around the inability of macroecono-metric models to improve on simple univariate predictors, since the onset of the so-called Great Moderation. This paper explores the consequences of equilibrium indeterminacy for quantitative forecasting through standard reduced form forecast models. Exploiting U.S. data on both the Great Moderation and the preceding era, we first present evidence that (i) higher (absolute) forecastability obtains in the former rather than the latter period for all models considered, and that (ii) the decline in volatility and persistence captured by a .nite-order VAR system across the two samples is not associated with inferior (absolute or relative) predictive accuracy. Then, using a small-scale New Keynesian monetary DSGE model as laboratory, we generate arti.cial datasets under either equilibrium regime and investigate numerically whether (relative) forecastability is improved in the presence of indeterminacy. It is argued that forecasting under indeterminacy with e.g. unrestricted VAR models entails misspecification issues that are generally more severe than those one typically faces under determinacy. Irrespective of the occurrence of non-fundamental (sunspot) noise, for certain values of the arbitrary parameters governing solution multiplicity, the pseudo out-of-sample VAR-based forecasts of in.ation and output growth can outperform simple univariate predictors. For other values of these parameters, by contrast, the opposite occurs. In general, it is not possible to establish a one-to-one relationship between indeterminacy and superior forecastability, even when sunspot shocks play no role in generating the data. Overall, our analysis points towards a 'good luck in bad policy' explanation of the (relative) higher forecastability of macroeconometric models prior to the Great Moderation period.
    Keywords: DSGE, Forecasting, Indeterminacy, Misspecification, VAR system
    JEL: C53 C62 E17
    Date: 2015–04–19
  26. By: David G. Blanchflower; Andrew T. Levin
    Abstract: In the wake of a severe recession and a sluggish recovery, labor market slack cannot be gauged solely in terms of the conventional measure of the unemployment rate (that is, the number of individuals who are not working at all and actively searching for a job). Rather, assessments of the employment gap should reflect the incidence of underemployment (that is, people working part time who want a full-time job) and the extent of hidden unemployment (that is, people who are not actively searching but who would rejoin the workforce if the job market were stronger). In this paper, we examine the evolution of U.S. labor market slack and show that underemployment and hidden unemployment currently account for the bulk of the U.S. employment gap. Next, using state-level data, we find strong statistical evidence that each of these forms of labor market slack exerts significant downward pressure on nominal wages. Finally, we consider the monetary policy implications of the employment gap in light of prescriptions from Taylor-style benchmark rules.
    JEL: E24 E32 E52 E58 J21
    Date: 2015–04

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