nep-mon New Economics Papers
on Monetary Economics
Issue of 2016‒02‒23
twenty papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Friedman, Monetarism and Quantitative Easing By Olivo, Victor
  2. Monetary policy, excessive risk-taking and banking crisis By Zaghdoudi, Taha
  3. Equity Premium and Monetary Policy in a Model with Limited Asset Market Participation By Jana Votapkova; Pavlina Zilova
  4. Estimating the impact of monetary policy on inequality in China By Sánchez-Fung , José R.
  5. QE and the Bank Lending Channel in the United Kingdom By Nick Butt; Rohan Churm; Michael McMahon; Arpad Morotz; Jochen Schanz
  6. Can we prove a bank guilty of creating systemic risk?: a minority report By Jon Danielsson; Kevin R. James; Marcela Valenzuela; Ilknur Zer
  7. The European Central Bank’s quantitative easing programme: limits and risks By Grégory Claeys; Alvaro Leandro
  8. Monetary Policy, Financial Stability, and the Zero Lower Bound : a speech at the Annual Meeting of the American Economic Association, San Francisco, California, January 3, 2016. By Fischer, Stanley
  9. Monetary Policy Evaluation using a Rational Expectations Model: the UK case By Vasilev, Aleksandar
  10. Brave new world? Macro prudential policy and the new political economy of The Federal Reserve By Lucy Goodhart
  11. Eurosystem debts do matter By Whittaker, John
  12. Monetary policy during financial crises: Is the transmission mechanism impaired? By Jannsen, Nils; Potjagailo, Galina; Wolters, Maik H.
  13. Some Historical Reflections on the Governance of the Federal Reserve By Michael Bordo
  14. Money and monetary policy in Israel during the last decade By Benchimol, Jonathan
  15. A double-edged sword: High interest rates in capital control regimes By Gudmundsson, Gudmundur S.; Zoega, Gylfi
  16. Exchange rates and monetary spillovers By Guillaume Plantin; Hyun Song Shin
  17. The Cost of Euro Adoption in Poland By Svitlana Maksymenko
  18. On the Desirability of Capital Controls By Heathcote, Jonathan; Perri, Fabrizio
  19. Quantitative Easing in Japan and the UK An Econometric Evaluation of the Impacts of Unconventional Monetary Policy on the Returns of Aggregate Output and Price Levels By Troug, Haytem Ahmed; Murray, Matt
  20. Банк России На Перепутье: Стоит Ли Смягчать Денежно-Кредитную Политику? (The Bank of Russia at a Crossroads: Whether to Ease Monetary Policy?) By Pavel Trunin; Eugene Goryunov

  1. By: Olivo, Victor
    Abstract: This paper argues that the theoretical origin of QE programs, as a general concept, clearly links to Friedman’s (and monetarist) ideas, but that the specific implementation of QE operations to cope with the 2008 financial crisis does not comply with key principles developed by Friedman. Based on Friedman’s work during the sixties, I contend that his monetary framework links to QE through what he (and Anna Schwartz) called the “monetary” effects of monetary policy and not the portfolio balance effect highlighted by Nelson (2011) and Bernanke (2012). The combination of the “monetary” effects and the stabilizing role of monetary policy should produce QE programs with a path of the monetary base (central bank assets) and M2 that differs dramatically from what transpired under the 2008-2014 QE arrangements based on the portfolio balance effect.
    Keywords: Monetary policy,monetarism,quantitative easing,open market operations, financial crisis, monetary effects, portfolio balance effect
    JEL: E52 E58
    Date: 2015–06–17
  2. By: Zaghdoudi, Taha
    Abstract: This paper examines the relationship between monetary policy and banks excessive risk-taking and banking crisis. We use a panel of data consisting of 22 Latin American countries, the OECD and South-East Asia, which experienced banking crises between 1990 and 2013. Our empirical results show that the adoption of an expansionary monetary policy via an increase in the money supply and the application of low interest rates over an extended period of time may induce an increase in banks risk-taking. However, a restrictive monetary policy with high interest rates increases the risk of banking crisis.
    Keywords: Monetary policy, bank risk, panel co-integration test
    JEL: E44 E51 E52 G21
    Date: 2015–07
  3. By: Jana Votapkova (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic); Pavlina Zilova (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic)
    Abstract: Using individual level-data, the paper uncovers patient and drug characteristics that determine the probability of using the original patented products despite the presence of generic substitutes in the Czech Republic in the period 2009-2013. Our results reveal different behavioral patterns for drugs against acute and chronic diseases. The results have direct implications for the design of pharmaceutical policies aiming at an increased consumption of generic substitutes.
    Keywords: Generic substitution, Drug consumption, Pharmaceutical expenditures
    JEL: D19 H51 I18
    Date: 2016–02
  4. By: Sánchez-Fung , José R. (BOFIT)
    Abstract: The paper estimates the impact of monetary policy on income inequality in China. The empirical modelling finds that a battery of monetary indicators, including a monetary overhang measure derived from a money demand equation, and the change in the unemployment rate lead to increases in the Gini coefficient. However, only unemployment is statistically significant. The lack of significance of the monetary indicators is robust to alternative specifications with variability in nominal aggregate demand instead of unemployment.
    Keywords: monetary policy; inequality; inflation; unemployment; China
    JEL: D31 E52
    Date: 2015–05–13
  5. By: Nick Butt (Bank of England); Rohan Churm (Bank of England); Michael McMahon (Centre For Economic Policy Research; Centre For Macroeconomics (CFM); University of Warwick); Arpad Morotz (Bank of England); Jochen Schanz (Bank for International Settlements)
    Abstract: We test whether quantitative easing (QE), in addition to boosting aggregate demand and in ation via portfolio rebalancing channels, operated through a bank lending channel (BLC) in the UK. Using Bank of England data together with an instrumental variables approach, we find no evidence of a traditional BLC associated with QE. We show, in a simple framework, that the traditional BLC is diminished if the bank receives `flighty' deposits (deposits that are likely to quickly leave the bank). We show that QE gave rise to such flighty deposits which may explain why we find no evidence of a BLC.
    Keywords: Monetary policy, bank lending channel, quantative easing
    JEL: E51 E52 G20
    Date: 2015–10
  6. By: Jon Danielsson; Kevin R. James; Marcela Valenzuela; Ilknur Zer
    Abstract: Since increasing a bank's capital requirement to improve the stability of the financial system imposes costs upon the bank, a regulator should ideally be able to prove beyond a reasonable doubt that banks classified as systemically risky really do create systemic risk before subjecting them to this capital punishment. Evaluating the performance of two leading systemic risk models, we show that estimation error alone prevents the reliable identification of the most systemically risky banks. We conclude that it will be a considerable challenge to develop a riskometer that is both sound and reliable enough to provide an adequate foundation for macroprudential policy.
    Keywords: Systemic risk; macroprudential policy; financial stability; risk management
    JEL: G32 F3 G3
    Date: 2015–09
  7. By: Grégory Claeys; Alvaro Leandro
    Abstract: HIGHLIGHTS The European Central Bank (ECB) has made a number of significant changes to the original guidelines of its quantitative easing (QE) programme since the programme started in January 2015. These changes are welcome because the original guidelines would have rapidly constrained the programme’s implementation. The changes announced expand the universe of purchasable assets and give some flexibility to the ECB in the execution of its programme. However, this might not be enough to sustain QE throughout 2017, or if the ECB wishes to increase the monthly amount of purchases in order to provide the necessary monetary stimulus to the euro area to bring inflation back to 2 percent. To increase the programme’s flexibility, the ECB could further alter the composition of its purchases. The extension of the QE programme also raises some legitimate questions about its potential adverse consequences. However, the benefits of this policy still outweigh its possible negative implications for financial stability or for inequality. The fear that the ECB’s credibility will be undermined because of its QE programme also seems to be largely unfounded. On the contrary, the primary risk to the ECB’s credibility is the risk of not reaching its 2 percent inflation target, which could lead to expectations becoming disanchored. EXECUTIVE SUMMARY The European Central Bank (ECB) has made a number of significant changes to the original design of its quantitative easing (QE) programme since the programme started in January 2015. The bank has expanded the list of national agencies whose securities are eligible for the Public Sector Purchase Programme (PSPP); it has changed the issue share limit (ensuring that the Eurosystem will not breach the prohibition on monetary financing), which was originally set at 25 percent, to 33 percent (at least for securities without collective action clauses); it has added regional and local government bonds to the list of eligible assets; it has announced that the programme would continue past September 2016, the previously-announced minimum end-date, to March 2017 “or beyond, if necessary”; and it has declared its intention to reinvest the principal payments on the securities purchased under the programme as they mature. As explained in Claeys et al (2015b), the programme’s original guidelines would have constrained the size and duration of the programme, especially if it was sustained throughout 2017. The changes to the design of the programme announced during 2015 greatly expand the universe of purchasable assets and should therefore delay the point at which limits will be reached. However, the decision to reinvest the principal payments as bonds mature, by increasing the monthly monetary purchase after March 2017, would also lead to the limits being reached sooner. In the same way, a decision by the ECB to increase the amount of PSPP purchases each month, for instance from €44 billion to €64 billion, would also frontload the purchases. In the end, because of the issue share limit, for a given set of securities there will always be a trade-off between larger monthly purchases and a prolonged programme. Further changes to the design of the programme will have to be implemented in order to increase the duration of the programme if the limit is binding in a major country before inflation is on the path towards 2 percent. These could include waiving the issue limit for AAA-rated bonds, or purchasing senior uncovered bank bonds as well corporate bonds. A more radical change could be to move away from an allocation of asset purchases between countries based on the ECB capital keys to an allocation based on the actual size of their outstanding debt. We also discuss the possible financial stability risks of a prolonged and large-scale QE programme, and conclude that the benefits of large-scale asset purchases outweigh their potential risks in terms of financial stability. However, micro- and macro-prudential policies should be used forcefully to prevent such risks from materialising. We also consider the potential effects that a prolonged asset-purchase programme could have on inequality. The increase in inequality observed in many advanced countries in recent decades is a long-term trend and primarily the result of deep structural changes. Our view is that the primary mandate of the ECB is to maintain price stability, and considerations of inequality are not within its purview, unless inequality prevents the transmission of monetary policy in some way. The ECB should therefore focus on fulfilling its price stability mandate by supporting the fragile recovery now taking place in the euro area. This is the best way for monetary policy to contribute to the avoidance of an increase in inequality. The fear that the ECB will lose its credibility solely because it is currently buying a large amount of sovereign bonds appears to be largely unfounded. The primary risk to the ECB’s credibility is the risk of not reaching its inflation target.
    Date: 2016–02
  8. By: Fischer, Stanley (Board of Governors of the Federal Reserve System (U.S.))
    Date: 2016–01–03
  9. By: Vasilev, Aleksandar
    Abstract: This study follows Rotemberg and Woodford (1998) and estimates a three-equation model of output, interest rate and inflation, in order to evaluate alternative rules by which the UK monetary authority may decide on setting the main interest rate. As in the original paper, the model setup is a rational-expectations setup, augmented with nominal price-setting frictions a la Calvo (1983). The model-generated impulse responses match quite well the estimated responses to a monetary shock. In addition, when additional technology and taste shocks are added, the theoretical model can account for the fluctuations in the UK data as well as an unrestricted VAR(1) does.
    Keywords: VAR,Taylor rule
    JEL: E37
  10. By: Lucy Goodhart
    Abstract: The Financial Crisis that started in 2007 ushered in new responsibilities for central banks, particularly for what is termed “macro-prudential policy,” or MPP. The goal of this policy is to monitor and contain overall risk in the financial sector. Implementing MPP, however, carries the potential for distributional conflict with the largest financial firms and the politicization of central bank policy. In light of this risk, this essay analyses the institutional implications of MPP for a leading central bank, the U.S. Federal Reserve. Specifically, how will MPP affect the autonomy of the Fed to set the policy it thinks right? The analysis is based on interviews with financial regulators, including Fed staffers and policymakers, and with journalists who report on financial regulation. It is also informed by a case study of the “Volcker Revolution” in monetary policy. Based on these sources, I identify the factors that contributed to Fed autonomy in the conduct of monetary policy during the Volcker Revolution and assess the extent to which those same factors hold for MPP. I close with an assessment of what MPP means for the new political economy of the Fed in particular and developed world central banks more broadly.
    Keywords: Sovereign Default; Debt Crises; Political Survival; Networks; Voter Behavior.
    JEL: R21
    Date: 2015–01–08
  11. By: Whittaker, John
    Abstract: Since September 2015, the European Central Bank has been publishing Target2 balances of the eurozone national central banks. But this presents an incomplete picture of intra-eurosystem debts because it does not include those arising from the issue of banknotes. The ECB also plays down the importance of Target2 debts as a “normal feature of the decentralised implementation of monetary policy in the euro area”. But if Greece were to leave the euro and its eurosystem debt (currently €114bn) were written off, other eurozone countries would bear the loss, in addition to losses on official loans. There is no effective mechanism for limiting eurosystem debts. And exit risk – the risk that Greece or some other eurozone country with large eurosystem debts will leave the euro – will always be present.
    Keywords: Target2, eurosystem, monetary union, euro banknotes
    JEL: E42 E52 E58 F33
    Date: 2016–02–01
  12. By: Jannsen, Nils; Potjagailo, Galina; Wolters, Maik H.
    Abstract: We study the macroeconomic effects of monetary policy during financial crises using a Bayesian panel vector autoregressive (PVAR) model for 20 advanced economies. We interact all of the endogenous variables with financial crisis dummies, which are constructed using the narrative approach. We also distinguish between an acute initial phase of financial crises and a subsequent recovery phase. We show that an expansionary monetary policy shock has large positive effects on output and inflation during the acute phase of a financial crisis. These effects are larger than those during non-crisis periods. Decreased uncertainty as well as increases in consumer confidence and share prices explain these large effects, whereas these variables are much less relevant for monetary policy transmission outside financial crises. Counterfactual analysis shows that the transmission mechanism would be impaired without the effects of monetary policy on these variables, where credit would not react at all and the response of output would be substantially lower. During the recovery phase of a financial crisis, output and inflation are generally non-responsive to monetary policy shocks.
    Keywords: fiscal monetary policy transmission,financial crisis,financial stability,state-dependence,uncertainty,panel VAR
    JEL: C33 E52 E58 G01
    Date: 2015
  13. By: Michael Bordo
    Abstract: This paper examines the historical record on Federal Reserve governance and especially the relationship between the Reserve banks and the Board from the early years of the Federal Reserve to the recent crisis. From the record I consider some lessons for the current debate over reform of the Federal Reserve. It was prepared for the May 21, 2015 Hoover Institution conference, "Central Bank Governance and Oversight Reform: A Policy Conference."
    Date: 2015–05
  14. By: Benchimol, Jonathan
    Abstract: This study examines how money and monetary policy have influenced output and inflation during the past decade in Israel by comparing two New Keynesian DSGE models. One is a baseline separable model (Galí, 2008) and the other assumes non-separable household preferences between consumption and money (Benchimol & Fourçans, 2012). We test both models by using rolling window Bayesian estimations over the last decade (2001–2013). The results of the presented dynamic analysis show that the sensitivity of output with respect to money shocks increased during the Dot-com, Intifada, and Subprime crises. The role of monetary policy increased during these crises, especially with regard to inflation, even though the effectiveness of conventional monetary policy decreased during the Subprime crisis. In addition, the non-separable model including money provides lower forecast errors than the baseline separable model without money, while the influence of money on output fluctuations can be seen as a good predictive indicator of bank and debt risks. By impacting and monitoring households’ money holdings, policy makers could improve their forecasts and crisis management through models considering monetary aggregates.
    Keywords: Divisia monetary aggregates; Monetary policy; DSGE; Crises; Israel
    JEL: E31 E32 E37 E51 E52 E58
    Date: 2016–02–09
  15. By: Gudmundsson, Gudmundur S.; Zoega, Gylfi
    Abstract: This paper describes the relationship between central bank interest rates and exchange rates under a capital control regime. Higher interest rates may strengthen the currency by inducing owners of local currency assets not to sell local currency off shore. There is also an effect that goes in the opposite direction: higher interest rates may also increase the flow of interest income to foreigners through the current account, making the exchange rate fall. The historical financial crisis now under way in Iceland provides excellent testing grounds for the analysis. Overall, the experience does not suggest that cutting interest rates moderately from a very high level is likely to make a currency depreciate in a capital control regime, but it highlights the importance of effective enforcement of the controls.
    Keywords: financial crises,capital controls,policy rates,exchange rates
    JEL: G01 E42 E52 E58
    Date: 2016
  16. By: Guillaume Plantin; Hyun Song Shin
    Abstract: When does the combination of flexible exchange rates and domestic inflation-oriented monetary policy guarantee insulation from global financial conditions? We examine a dynamic global game model of international portfolio flows where, for some combination of parameters, the unique equilibrium exhibits the observed empirical feature that currency appreciation goes hand-in-hand with lower domestic interest rates and higher credit growth. When reversed, tighter monetary conditions go hand-in-hand with capital outflows and currency depreciation.
    Keywords: currency appreciation, capital flows, global games
    Date: 2016–01
  17. By: Svitlana Maksymenko
    Abstract: The paper investigates potential effects of euroization on the economy of Poland. It develops an empirical framework to provide estimations of the euro adoption costs arising from a loss of exchange rate regime as a macro-stabilization tool. The paper quantifies how a replacement of zloty with the euro, and thus the elimination of exchange rate would affect output fluctuations in Poland. Our analysis of the forecast error variance decomposition confirms that the real exchange rate served as an external shock absorber for Polish economy in 1990-2014. We find that external shocks on average explain up to 12-13% of the exchange rate variation and up to 5% in variation of Polish log-transformed output. We also find that over the past two decades the Poland’s economy has become more resilient to external shocks, and thus it is reasonable to expect the cost of euro adoption to decline with further EU integration.
    Date: 2015–01
  18. By: Heathcote, Jonathan (Federal Reserve Bank of Minneapolis); Perri, Fabrizio (Federal Reserve Bank of Minneapolis)
    Abstract: In a standard two-country international macro model, we ask whether imposing restrictions on international non contingent borrowing and lending is ever desirable. The answer is yes. If one country imposes capital controls unilaterally, it can generate favorable changes in the dynamics of equilibrium interest rates and the terms of trade, and thereby benefit at the expense of its trading partner. If both countries simultaneously impose capital controls, the welfare effects are ambiguous. We identify calibrations in which symmetric capital controls improve terms of trade insurance against country-specific shocks and thereby increase welfare for both countries.
    Keywords: Capital controls; Terms of trade; International risk sharing
    JEL: F32 F41 F42
    Date: 2016–01–15
  19. By: Troug, Haytem Ahmed; Murray, Matt
    Abstract: The research finds that the actions of the BoJ were more successful in raising aggregate levels of output and price than those of the BoE. In Japan, all financial variables analysed were found to transmit the benefits of QME, whilst in the UK the effect only occurs through the stock market and bank lending. The overall results however, are found to be small. To analyse the effects of the most recent policies of QME by the Bank of Japan (BoJ) and the Bank of England (BoE) on aggregate levels of output and prices in Japan and the UK, We perform two-step VAR and VEC analysis to first identify the effects of QMEP before determining the financial transmission mechanism by which these effects take place. This analysis aims to make contribution to the research surrounding the effects of QMEP. It is wholly reasonable to presume that both the Japanese and UK economies may experience similar economic difficulties in the future and further understanding of the effects of QMEP will enable more targeted policy decisions to be implemented to effectively protect stable inflation levels and stimulate future economic growth.
    Keywords: Quantitative Easing, Monetary Policy, Bank of Japan, Bank of England, Vector Auto-Regression, Vector Error Correction
    JEL: C1 C13 E5 E52 E58
    Date: 2015–09
  20. By: Pavel Trunin (Gaidar Institute for Economic Policy); Eugene Goryunov (Gaidar Institute for Economic Policy)
    Abstract: The position of supporters of the policy easing by the Bank of Russia is the following: if the monetary authorities of developed countries abandon their principles, then why do they rely on Russia? Is it not better instead to do exactly what the central banks in the US, UK, Japan and the euro area do - to stimulate economic growth by quantitative easing? According to adherents of monetary policy easing, it is necessary to turn the Bank of Russia into the institute of development, making it one of the investors of economic growth. Furthermore, it should be included in the process of creating "long cheap money", as it occurs in the US and the European Union. Позиция сторонников смягчения политики Банка России следующая: если денежные власти развитых стран отказываются от своих принципов, то зачем тогда России на них полагаться? Не лучше ли вместо этого делать ровно то, что делают центральные банки в США, Великобритании, Японии и еврозоне — стимулировать экономический рост денежной эмиссией? По мнению адептов смягчения монетарной политики, нужно превратить Банк России в институт развития, сделав его соинвестором экономического роста. Кроме того, он должен быть включен в процесс создания «длинных дешевых денег», как это происходит в США и Европе.
    Keywords: Russian economy, Bank of Russia, monetary policy, quantitative easing
    JEL: E31 E43 E44 E51 E52 E58
    Date: 2013

This nep-mon issue is ©2016 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.