nep-mon New Economics Papers
on Monetary Economics
Issue of 2015‒12‒28
25 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Central bank Credibility Before and After the Crisis By Michael D. Bordo; Pierre L. Siklos
  2. Shocking Language: Understanding the macroeconomic effects of central bank communication By Stephen Hansen; Michael McMahon
  3. A New Dilemma: Capital Controls and Monetary Policy in Sudden Stop Economies By Michael B. Devereux; Eric R. Young; Changhua Yu
  4. Self-Oriented Monetary Policy, Global Financial Markets and Excess Volatility of International Capital Flows By Ryan Banerjee; Michael B. Devereux; Giovanni Lombardo
  5. Global Constraints on Central Banking: The Case of Turkey By Ahmet Benlialper; Hasan Cömert
  6. Common Currency versus Currency Union: The U.S. Continental Dollar and Denominational Structure, 1775-1776 By Farley Grubb
  7. Money and Output: Friedman and Schwartz Revisited By Michael T. Belongia; Peter N. Ireland
  8. Credit Frictions and Optimal Monetary Policy By Vasco Cúrdia; Michael Woodford
  9. Measuring the Effects of Unconventional Monetary Policy on Asset Prices By Eric T. Swanson
  10. The real effects of capital requirements and monetary policy: evidence from the United Kingdom By De Marco, Filippo; Wieladek, Tomasz
  11. Working through the Distribution: Money in the Short and Long Run By Guillaume Rocheteau; Pierre-Olivier Weill; Tsz-Nga Wong
  12. Normalizing Monetary Policy When the Neutral Interest Rate Is Low: a speech at the Stanford Institute for Economic Policy Research, Stanford, California, December 1, 2015. By Brainard, Lael
  13. The Economic Outlook and Monetary Policy: a speech at the Economic Club of Washington, Washington, D.C., December 2, 2015. By Yellen, Janet L.
  14. Inflation Targeting Does Not Anchor Inflation Expectations: Evidence from Firms in New Zealand By Saten Kumar; Hassan Afrouzi; Olivier Coibion; Yuriy Gorodnichenko
  15. Forward Guidance in the Yield Curve: Short Rates versus Bond Supply By Robin Greenwood; Samuel Hanson; Dimitri Vayanos
  16. Inflation and Activity – Two Explorations and their Monetary Policy Implications By Olivier Blanchard; Eugenio Cerutti; Lawrence Summers
  17. Collateral Damage? Micro-simulation of transaction cost shocks on the value of central bank collateral. By Rudolf Alvise Lennkh; Florian Walch
  18. Short-Term Pain for Long-Term Gain: Market Deregulation and Monetary Policy in Small Open Economies By Matteo Cacciatore; Romain Duval; Giuseppe Fiori; Fabio Ghironi
  19. Time-Frequency Relationship between Inflation and Inflation Uncertainty for the U.S.: Evidence from Historical Data By Claudiu T. Albulescu; Aviral Kumar Twari; Stephen M. Miller; Rangan Gupta
  20. Price Adjustment in Currency Unions By Michael Bleaney; Lin Yin
  21. The Macroeconomic Determinants of the US Term-Strucutre During The Great Moderation By Alessia Paccagnini
  22. RMBI or RMBR: Is the Renminbi Destined to Become a Global or Regional Currency? By Barry Eichengreen; Domenico Lombardi
  23. The Plaza Accord, 30 Years Later By Jeffrey Frankel
  24. Risk appetite and exchange rates By Adrian, Tobias; Etula, Erkko; Shin, Hyun Song
  25. "The ECB, the Single Financial Market, and a Revision of the Euro Area Fiscal Rules" By Mario Tonveronachi

  1. By: Michael D. Bordo; Pierre L. Siklos
    Abstract: A new measure of credibility is constructed as a function of the differential between observed inflation and some estimate of the inflation rate that the central bank targets. The target is assumed to be met flexibly. Credibility is calculated for a large group of both advanced and emerging countries from 1980 to 2014. Financial crises reduce central bank credibility and central banks with strong institutional determinants tend to do better when hit by a shock of the magnitude of the 2007-2008 financial crisis. The VIX, adopting an inflation target and central bank transparency, are the most common determinants of credibility. Similarly, real economic growth has a significant influence on central bank credibility even in inflation targeting economies. Hence, responding to real economic factors is necessarily detrimental to central bank credibility. Nevertheless, caution is in order about whether monetary authorities should take on broader responsibilities for the financial performance of economies.
    JEL: C31 E31 E58
    Date: 2015–11
  2. By: Stephen Hansen (Departament d'Economia i Empresa (Department of Economics and Business) Universitat Pompeu Fabra (Pompeu Fabra University) Barcelona Graduate School of Economics (Barcelona GSE)); Michael McMahon (Department of Economics University of Warwick; Centre for Macroeconomics (CFM))
    Abstract: We explore how the multi-dimensional aspects of information released by the FOMC has effects on both market and real economic variables. Using tools from computational linguistics, we measure the information released by the FOMC on the state of economic conditions, as well as the guidance the FOMC provides about future monetary policy decisions. Employing these measures within a FAVAR framework, we find that shocks to forward guidance are more important than the FOMC communication of current economic conditions in terms of their effects on market and real variables. Nonetheless, neither communication has particularly strong effects on real economic variables.
    Keywords: Monetary policy, communications, Vector Autoregression
    JEL: E53 E58
    Date: 2015–12
  3. By: Michael B. Devereux; Eric R. Young; Changhua Yu
    Abstract: The dangers of high capital flow volatility and sudden stops have led economists to promote the use of capital controls as an addition to monetary policy in emerging market economies. This paper studies the benefits of capital controls and monetary policy in an open economy with financial frictions, nominal rigidities, and sudden stops. We focus on a time-consistent policy equilibrium. We find that during a crisis, an optimal monetary policy should sharply diverge from price stability. Without commitment, policymakers will also tax capital inflows in a crisis. But this is not optimal from an ex-ante social welfare perspective. An outcome without capital inflow taxes, using optimal monetary policy alone to respond to crises, is superior in welfare terms, but not time-consistent. If policy commitment were in place, capital inflows would be subsidized during crises. We also show that an optimal policy will never involve macro-prudential capital inflow taxes as a precaution against the risk of future crises (whether or not commitment is available).
    JEL: E44 E58 F41
    Date: 2015–12
  4. By: Ryan Banerjee; Michael B. Devereux; Giovanni Lombardo
    Abstract: This paper explores the nature of macroeconomic spillovers from advanced economies to emerging market economies (EMEs) and the consequences for independent use of monetary policy in EMEs. We first empirically document the effects of US monetary policy shocks on a sample group of EMEs. A contractionary monetary shock leads a retrenchment in EME capital flows, a fall in EME GDP, and an exchange rate depreciation. We construct a the- oretical model which can help to account for these findings. In the model, macroeconomic spillovers are exacerbated by financial frictions. We assess the extent to which domestic monetary policy can mitigate the negative spillovers from foreign shocks. Absent financial frictions, international spillovers are minor, and an inflation targeting rule represents an ef- fective policy for the EME. With frictions in financial intermediation, however, spillovers are substantially magnified, and an inflation targeting rule has little advantage over an exchange rate peg. However, an optimal monetary policy markedly improves on the performance of naive inflation targeting or an exchange rate peg. Furthermore, optimal policies don’t need to be coordinated across countries. Under the specific set of assumptions maintained in our model, a non-cooperative, self-oriented optimal policy gives results very similar to those of a global cooperative optimal policy.
    JEL: E3 E5 F3 F5 G1
    Date: 2015–11
  5. By: Ahmet Benlialper (Department of Economics, İpek University, Ankara, Turkey; Department of Economics, Middle East Technical University, Ankara, Turkey); Hasan Cömert (Department of Economics, Middle East Technical University, Ankara, Turkey)
    Abstract: This study aims to evaluate the developments in Turkish monetary policy after 2002 and understand the constraints on the effectiveness of the Central Bank of the Republic of Turkey (CBRT). The CBRT has significantly altered its monetary policy in response to the crisis. It became much more experimental and aware of challenges it faced. However, the Bank’s ability to exert influence on key variables seems to have been restrained by factors outside of its control. Financial flows exert great influence on key macroeconomic variables that the Bank monitors closely. Furthermore, energy prices are among the key determinants of inflation in Turkey. As a result, the Bank’s influence on growth and inflation through intermediate variables became a daunting task. The magnitude and direction of flows seem to be mainly related to global risk perception determining the worldwide liquidity conditions rather than to domestic factors. Under these conditions central banks may not set their official interest rates independent of interest rates in advanced countries. Indeed, our VAR analysis exercise supports this argument for the Turkish case. Existing policy framework would not produce desired outcomes unless the sources of the problems such as financial flows as the main global constraints on monetary policy are addressed in a much more serious manner.
    Keywords: Central banking, Economic and financial crisis, Capital inflows, the Turkish economy
    JEL: E52 G01 F31 F32 O53
    Date: 2015–12
  6. By: Farley Grubb
    Abstract: I use denominational structure (the spacing and size of monetary units) to explain how the Continental Congress attempted to manage a successful common currency when sub-national political entities were allowed to have separate currencies and run independent monetary policies. Congress created a common currency that was too large to use in ordinary transactions. Congress hoped this currency would be held for post-war redemption and would not circulate as money during the war. As such, it would not contribute to wartime inflation. By contrast, individual state currencies were emitted in small enough denominations to function as the domestic medium of exchange.
    JEL: E42 E52 H77 N11
    Date: 2015–11
  7. By: Michael T. Belongia; Peter N. Ireland
    Abstract: More than fifty years ago, Friedman and Schwartz examined historical data for the United States and found evidence of pro-cyclical movements in the money stock, which led corresponding movements in output. We find similar correlations in more recent data; these appear most clearly when Divisia monetary aggregates are used in place of the Federal Reserve’s official, simple-sum measures. When we use information in Divisia money to estimate a structural vector autoregression, identified monetary policy shocks appear to have large and persistent effects on output and prices, with a lag that has lengthened considerably since the early 1980s.
    JEL: E31 E32 E51 E52
    Date: 2015–12
  8. By: Vasco Cúrdia; Michael Woodford
    Abstract: We extend the basic (representative-household) New Keynesian [NK] model of the monetary transmission mechanism to allow for a spread between the interest rate available to savers and borrowers, that can vary for either exogenous or endogenous reasons. We find that the mere existence of a positive average spread makes little quantitative difference for the predicted effects of particular policies. Variation in spreads over time is of greater significance, with consequences both for the equilibrium relation between the policy rate and aggregate expenditure and for the relation between real activity and inflation. Nonetheless, we find that the target criterion—a linear relation that should be maintained between the inflation rate and changes in the output gap—that characterizes optimal policy in the basic NK model continues to provide a good approximation to optimal policy, even in the presence of variations in credit spreads. Such a "flexible inflation target" can be implemented by a central-bank reaction function that is similar to a forward-looking Taylor rule, but adjusted for changes in current and expected future credit spreads.
    JEL: E44 E52
    Date: 2015–12
  9. By: Eric T. Swanson
    Abstract: I adapt the methods of Gurkaynak, Sack, and Swanson (2005) to estimate two dimensions of monetary policy during the 2009-2015 zero lower bound period in the U.S. I show that, after a suitable rotation, these two dimensions can be interpreted as "forward guidance" and "large-scale asset purchases" (LSAPs). I estimate the sizes of the forward guidance and LSAP components of each FOMC announcement between January 2009 and June 2015, and show that those estimates correspond closely to identifiable features of major FOMC announcements over that period. Forward guidance has relatively small effects on the longest-maturity Treasury yields and essentially no effect on corporate bond yields, while LSAPs have large effects on those yields but essentially no effect on short-term Treasuries. Both types of policies have significant effects on medium-term Treasury yields, stock prices, and exchange rates.
    JEL: E44 E52 E58
    Date: 2015–12
  10. By: De Marco, Filippo (Bocconi University); Wieladek, Tomasz (Bank of England)
    Abstract: We study the effect of changes to UK bank-specific capital requirements on small and medium-sized enterprises (SME) from 1999 to 2005. Following a 1% rise in capital requirements, SME asset growth (and investment) contracts by 3.5% to 6.9% (12%) in the first year of a new bank-firm relationship, but this effect declines over time. These results are robust to a number of different fixed effects specifications and measures of capital requirement changes that are orthogonal to balance sheet characteristics by construction. Banks with tight capital buffers are the most significant transmitters of this shock. Monetary policy only affects the asset growth of small bank borrowers, but has a similar impact on the same sectors as capital requirements. There is evidence that these instruments reinforce each other when tightened, but only for small banks. Firms that borrow from multiple banks and operate in sectors with alternative forms of finance are less (equally) affected by changes in capital requirements (monetary policy).
    Keywords: Capital requirements; firm-level data; SMEs; relationship lending; macroprudential and monetary policy
    JEL: G21 G28
    Date: 2015–12–18
  11. By: Guillaume Rocheteau; Pierre-Olivier Weill; Tsz-Nga Wong
    Abstract: We construct a tractable model of monetary exchange with search and bargaining that features a non- degenerate distribution of money holdings in which one can study the short-run and long-run effects of changes in the money supply. While money is neutral in the long run, a one-time money injection in a centralized market with flexible prices generates an increase in aggregate real balances in the short run, a decrease in the rate of return of money, and a redistribution of consumption levels across agents. The price level in the short run varies in a non-monotonic fashion with the size of the money injection, e.g., small injections can lead to short-run deflation while large injections generate inflation. We extend our model to include employment risk and show that repeated money injections can raise output and welfare when unemployment is high.
    JEL: E0 E4 E52
    Date: 2015–12
  12. By: Brainard, Lael (Board of Governors of the Federal Reserve System (U.S.))
    Date: 2015–12–01
  13. By: Yellen, Janet L. (Board of Governors of the Federal Reserve System (U.S.))
    Date: 2015–12–02
  14. By: Saten Kumar; Hassan Afrouzi; Olivier Coibion; Yuriy Gorodnichenko
    Abstract: We study the (lack of) anchoring of inflation expectations in New Zealand using a new survey of firms. Managers of these firms display little anchoring of inflation expectations, despite twenty-five years of inflation targeting by the Reserve Bank of New Zealand, a fact which we document along a number of dimensions. Managers are unaware of the identities of central bankers as well as central banks’ objectives, and are generally poorly informed about recent inflation dynamics. Their forecasts of future inflation reflect high levels of uncertainty and are extremely dispersed as well as volatile at both short and long-run horizons. Similar results can be found in the U.S. using currently available surveys as shown in Binder (2015).
    JEL: E3 E4 E5
    Date: 2015–12
  15. By: Robin Greenwood; Samuel Hanson; Dimitri Vayanos
    Abstract: We present a model of the yield curve in which the central bank can provide market participants with forward guidance on both future short rates and on future Quantitative Easing (QE) operations, which affect bond supply. Forward guidance on short rates works through the expectations hypothesis, while forward guidance on QE works through expected future bond risk premia. If a QE operation is expected to be undone in the near term, then its announcement will have a hump-shaped effect on the yield and forward-rate curves; otherwise the effect may be increasing with maturity. Humps associated to QE announcements typically occur at maturities longer than those associated to short-rate announcements, even when the effects of the former are expected to last over a shorter horizon. We use our model to re-examine the empirical evidence on QE announcements in the US.
    JEL: G12 G18
    Date: 2015–12
  16. By: Olivier Blanchard; Eugenio Cerutti; Lawrence Summers
    Abstract: We explore two issues triggered by the crisis. First, in most advanced countries, output remains far below the pre-recession trend, suggesting hysteresis. Second, while inflation has decreased, it has decreased less than anticipated, suggesting a breakdown of the relation between inflation and activity. To examine the first, we look at 122 recessions over the past 50 years in 23 countries. We find that a high proportion of them have been followed by lower output or even lower growth. To examine the second, we estimate a Phillips curve relation over the past 50 years for 20 countries. We find that the effect of unemployment on inflation, for given expected inflation, decreased until the early 1990s, but has remained roughly stable since then. We draw implications of our findings for monetary policy.
    JEL: E31 E32 E50
    Date: 2015–11
  17. By: Rudolf Alvise Lennkh (European Stability Mechanism); Florian Walch (European Central Bank)
    Abstract: Transaction cost shocks in financial markets are known to affect asset prices. This paper analyses how changes in transaction costs may affect the value of assets that banks use to collateralise borrowings in monetary policy operations. Based on a simple asset pricing model and employing a dataset of hypothetical Eurosystem collateral positions, we simulate and quantify the resulting change in collateral value pledged by counterparties to the Eurosystem, resulting from a transaction cost shock. A 10 basis point increase in transaction costs entails a direct -0.30% decrease of collateral value and a -0.07% decrease when adjusted for the expected reduction in the number of trades of each asset. We conclude that banks will on average suffer small collateral losses while selected institutions could face a considerably larger collateral decrease.
    Keywords: Transaction cost, collateral, central bank, monetary policy
    JEL: C15 E59 G12
    Date: 2015–11
  18. By: Matteo Cacciatore; Romain Duval; Giuseppe Fiori; Fabio Ghironi
    Abstract: This paper explores the effects of labor and product market reforms in a New Keynesian, small open economy model with labor market frictions and endogenous producer entry. We show that it takes time for reforms to pay off, typically at least a couple of years. This is partly because the benefits materialize through firm entry and increased hiring, both of which are gradual processes, while any reform-driven layoffs are immediate. Some reforms—such as reductions in employment protection—increase unemployment temporarily. Implementing a broad package of labor and product market reforms minimizes transition costs. Importantly, reforms do not have noticeable deflationary effects, suggesting that the inability of monetary policy to deliver large interest rate cuts in their aftermath—either because of the zero bound on policy rates or because of membership in a monetary union—may not be a relevant obstacle to reform. Alternative simple monetary policy rules do not have a large effect on transition costs.
    JEL: E24 E32 E52 F41 J64 L51
    Date: 2015–12
  19. By: Claudiu T. Albulescu (Management Department, Politehnica University of Timisoara, Romania); Aviral Kumar Twari (Faculty of Management, IBS Hyderabad, IFHE University, India); Stephen M. Miller (Department of Economics, University of Nevada, USA.); Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: We provide new evidence on the relationship between inflation and its uncertainty in the U.S. on an historical basis, covering the period 1775-2014. First, we use a bounded approach for measuring inflation uncertainty, as proposed by Chan et al. (2013), and we compare the results with the Stock and Watson (2007) method. Second, we employ the wavelet methodology to analyze the co-movements and causal effects between the two series. Our results provide evidence of a relationship between inflation and its uncertainty that varies across time and frequency. First, we show that in the medium- and long-runs, the Freidman–Ball hypothesis holds when the measure of uncertainty is unbounded, while if the opposite applies, the Cukierman–Meltzer reasoning prevails. Second, we discover mixed evidence about the inflation–uncertainty nexus in the short-run, findings which explain the mixed results reported to date in the empirical literature.
    Keywords: historical inflation rate, uncertainty, continuous wavelet transform, bounded series, U.S.
    JEL: C22 E31 N11 N12
    Date: 2015–12
  20. By: Michael Bleaney; Lin Yin
    Abstract: In a rational expectations model, wages and prices should respond more to shocks in currency unions than in soft pegs because of the absence of exchange rate adjustment. Empirical evidence from three currency unions tends to support this hypothesis, but the rate of adjustment is slow.
    Keywords: currency union, exchange rate, price JEL codes: F31
    Date: 2015–12
  21. By: Alessia Paccagnini
    Abstract: We study the relation between the macroeconomic variables and the term structure of interest rates during the Great Moderation. We interpolate a term structure using three latent factors of the yield curve to analyze the responses of all maturities to macroeconomic shocks. A Nelson–Siegel model is implemented to estimate the latent factors which correspond to the level, the slope, and the curvature of the curve. As policy implication, the interpolated term structure informs the policymaker how all the macroeconomic shocks impact the whole term structure, even if the impact has a different magnitude across maturities.
    Keywords: Term structure of interest rates; Yield curve; VAR; Factor model
    JEL: G12 E43 E44 E58
    Date: 2016–01
  22. By: Barry Eichengreen; Domenico Lombardi
    Abstract: Previous studies have focused on when the renminbi will play a significant role as an international currency, but less attention has been paid to where. We fill this gap by contrasting two answers to the question. One is that the renminbi will assume the role of a global currency similar to the U.S. dollar. Supporters point to China’s widely diversified trade and financial flows and to its institutional initiatives, not just in Asia but around the world. The other is that the renminbi will play a regional role in Asia equivalent to that of the euro in greater Europe. Proponents of this view argue that China has a natural advantage in leveraging regional supply chains and deepening its links with other Asian countries as well as in developing regional institutions. Asia, they argue on these grounds, will become the natural habitat for the renminbi.
    JEL: F0 F02
    Date: 2015–11
  23. By: Jeffrey Frankel
    Abstract: The paper reviews an event of 30 years ago from the perspective of today: a successful G-5 initiative to reverse what had been an overvalued dollar. The “Plaza Accord” is best viewed not as the precise product of the meeting on September 22, 1985, but as shorthand for a historic change in US policy that began when James Baker became Treasury Secretary in January of that year. The change had the desired effect, bringing down the dollar and reducing the trade deficit. In recent years concerted foreign exchange intervention, of the sort undertaken by the G-7 in 1985 and periodically over the subsequent decade, has died out. Indeed the G-7 in 2013, fearing “currency manipulation,” specifically agreed to refrain from intervention in a sort of “anti-Plaza accord.” But some day coordinated foreign exchange intervention will return.
    JEL: F33 F42 N1
    Date: 2015–12
  24. By: Adrian, Tobias (Federal Reserve Bank of New York); Etula, Erkko (Harvard University); Shin, Hyun Song (Bank for International Settlements)
    Abstract: We present evidence that the growth of U.S.-dollar-denominated banking sector liabilities forecasts appreciations of the U.S. dollar, both in-sample and out-of-sample, against a large set of foreign currencies. We provide a theoretical foundation for a funding liquidity channel in a global banking model where exchange rates fluctuate as a function of banks’ balance sheet capacity. We estimate prices of risk using a cross-sectional asset pricing approach and show that the U.S. dollar funding liquidity forecasts exchange rates because of its association with time-varying risk premia. Our empirical evidence shows that this channel is separate from the more familiar “carry trade” channel. Although the financial crisis of 2007-09 induced a structural shift in our forecasting variables, when we control for this shift, the forecasting relationship is preserved.
    Keywords: asset pricing; financial intermediaries; exchange rates
    JEL: F30 F31 G12 G24
    Date: 2015–12–01
  25. By: Mario Tonveronachi
    Abstract: Mario Tonveronachi, University of Siena, builds on his earlier proposal (The ECB and the Single European Financial Market) to advance financial market integration in Europe through the creation of a single benchmark yield curve based on debt certificates (DCs) issued by the European Central Bank (ECB). In this policy brief, Tonveronachi discusses potential changes to the ECB's operations and their implications for member-state fiscal rules. He argues that his DC proposal would maintain debt discipline while mitigating the restrictive, counterproductive fiscal stance required today, simultaneously expanding national fiscal space while ensuring debt sustainability under the Maastricht limits, and offering a path out of the self-defeating policy regime currently in place.
    Date: 2015–11

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