nep-mon New Economics Papers
on Monetary Economics
Issue of 2016‒03‒23
35 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. On the Desirability of Capital Controls By Jonathan Heathcote; Fabrizio Perri
  2. Are monetary unions more synchronous than non-monetary unions? By Crowley, Patrick M.; Trombley, Christopher
  3. The EMU and the anchoring of inflation expectations? By Mayes David; Paloviita Maritta; Viren Matti
  4. International housing markets, unconventional monetary policy and the zero lower bound By Huber, Florian; Punzi, Maria Teresa
  5. The future of the euro By Duwicquet, Vincent; Mazier, Jacques; Petit, Pascal; Saadaoui, Jamel
  6. Cost-Benefit Analysis of Leaning Against the Wind: Are Costs Larger Also with Less Effective Macroprudential Policy? By Lars E.O. Svensson
  7. Deposit dollarization in emerging markets: modelling the hysteresis effect By Krupkina, Anna; Ponomarenko, Alexey
  8. Puerto Rico and Greece: A tale of two defaults in a monetary union By Gros, Daniel
  9. Financial Innovation and Money Demand: Evidence from Sub-Saharan Africa By J Paul Dunne and Elizabeth Kasekende
  10. Government Wealth Funds and Monetary Policy By Sergey Sinelnikov-Murylev; Pavel Trunin
  11. Greece is solvent but illiquid: What should the ECB do? By De Grauwe, Paul
  12. How big is the comeback? Japanese exchange rate pass-through assessed by Time-Varying FAVAR By Zakaria Moussa
  13. The Bank Lending Channel in a Dual Banking System: Evidence from Malaysia By Guglielmo Maria Caporale; Abdurrahman Nazif Catik; Mohamad Husam Helmi; Faek Menla Ali; Mohammad Tajik
  14. Bank Lending, Collateral, and Credit Traps in a Monetary Union By Corbisiero, Giuseppe
  15. Optimal Inflation, Average Markups and Asymmetric Sticky Prices By Paczos, Wojtek
  16. When pegging ties your hands By Nikola Tarashev; Anna Zabai
  17. The impact of financial crisis and low inflation environment on short-term inflation expectations in Poland By Tomasz Łyziak
  18. Liquidity Trap and Optimal Monetary Policy Revisited By Kohei Hasui; Tomohiro Sugo; Yuki Teranishi
  19. International Trade Finance and the Cost Channel of Monetary Policy in Open Economies By Nikhil Patel
  20. Nonlinear Pass-Through of Exchange Rate Shocks on Inflation: A Bayesian Smooth Transition VAR Approach By Hernán Rincón-Castro; Norberto Rodríguez-Niño
  21. Optimal Monetary Policy in the Presence of Sizable Informal Sector and Firm Level Credit Constraint By Waqas Ahmed; Sajawal Khan; Muhammad Rehman
  22. Monetary policies to counter the zero interest rate: an overview of research By Honkapohja, Seppo
  23. Estimating the impact of monetary policy on inequality in China By Sánchez-Fung, José R.
  24. Euro area monetary and fiscal policy tracking design in the time-frequency domain By Crowley, Patrick M.; Hudgins, David
  25. Money, Banking, and Monetary Policy from the Formation of the Federal Reserve until Today By Hetzel, Robert L.; Richardson, Gary
  26. Aggregate Stability in Monetary Economy with Consumption Tax and Taylor Rule By Fujisaki, Seiya
  27. International Channels of Transmission of Monetary Policy and the Mundellian Trilemma By Hélène Rey
  28. Estimating the COP Exchange Rate Volatility Smile and the Market Effect of Central Bank Interventions: A CHARN Approach By Juan Manuel Julio; Norberto Rodríguez; Hector Zárate
  29. Strong Sterling Pound and Weak European Currencies in the Crises: Evidence from Covered Interest Parity of Secured Rates By Shin-ichi Fukuda
  30. What signal from the Fed? Should the ECB ease further? By Gros, Daniel
  31. On the relative importance of monetary transmission channels in Turkey By Turhan, Ibrahim M.; Gumus, Nihat
  32. Choice of inflation targeting: Some international evidence By Shakhzod Ismailov; Makoto Kakinaka; Hiroaki Miyamoto
  33. Non-Linearities in the Relationship between House Prices and Interest Rates: Implications for Monetary Policy By Guay Lim; Sarantis Tsiaplias
  34. Endogenous Volatility at the Zero Lower Bound: Implications for Stabilization Policy By Susanto Basu; Brent Bundick
  35. The Negative Rates Club By Gros, Daniel

  1. By: Jonathan Heathcote; Fabrizio Perri
    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.
    JEL: F32 F41 F42
    Date: 2016–01
  2. By: Crowley, Patrick M.; Trombley, Christopher
    Abstract: Within currency unions, the conventional wisdom is that there should be a high degree of macroeconomic synchronicity between the constituent parts of the union. But this conjecture has never been formally tested by comparing sample of monetary unions with a control sample of countries that do not belong to a monetary union. In this paper we take euro area data, US State macro data, Canadian provincial data and Australian state data — namely real Gross Domestic Product (GDP) growth, the GDP deflator growth and unemployment rate data — and use techniques relating to recurrence plots to measure the degree of synchronicity in dynamics over time using a dissimilarity measure. The results show that for the most part monetary unions are more synchronous than non-monetary unions, but that this is not always the case and particularly in the case of real GDP growth. Furthermore, Australia is by far the most synchronous monetary union in our sample.
    Keywords: business cycles, growth cycles, frequency domain, optimal currency area, macroeconomic synchronization, monetary policy, single currency
    JEL: C49 E32 F44
    Date: 2015–07–31
  3. By: Mayes David (Auckland University); Paloviita Maritta (Bank of Finland); Viren Matti (Bank of Finland and Department of Economics, University of Turku)
    Abstract: It has been argued that one advantage of EMU in the EU has been an improvement in the credibility of monetary policy. This paper provides a new way of assessing the credibility of monetary policy by analyzing the dispersion of inflation–unemployment observations over time. In this way, we may reveal whether the short run Phillips curves have shifted due to changes in inflation expectations. This way of analyzing the anchoring of inflation expectations is both simple and free from ambiguities that are related to the choice of the Phillips curve specification and modelling of inflation expectations. The analysis uses data from eleven EMU countries and nine non-EMU countries that are used as points of comparison. The sample periods are 1984-1998 and 1999-2013. The analysis is based on dispersion measures where we use alternative weights for inflation and unemployment and also on a simple Misery index which is just a sum of inflation and unemployment values. The general outcome of the paper is that dispersion (and the Misery index) has decreased during the EMU period. The decrease has, however, been smaller than in control group countries. This implies that while the credibility of monetary policy may have increased under EMU, this just mirrors the general experience in the OECD over the same period.
    Keywords: Misery-index, inflation, unemployment, Phillips curve
    JEL: E31 E61
    Date: 2015–12
  4. By: Huber, Florian; Punzi, Maria Teresa
    Abstract: In this paper we propose a time-varying parameter VAR model for the housing market in the United States, the United Kingdom, Japan and the Euro Area. For these four economies, we answer the following research questions: (i) How can we evaluate the stance of monetary policy when the policy rate hits the zero lower bound? (ii) Can developments in the housing market still be explained by policy measures adopted by central banks? (iii) Did central banks succeed in mitigating the detrimental impact of the financial crisis on selected housing variables? We analyze the relationship between unconventional monetary policy and the housing markets by using the shadow interest rate estimated by Krippner (2013b). Our findings suggest that the monetary policy transmission mechanism to the housing market has not changed with the implementation of quantitative easing or forward guidance, and central banks can affect the composition of an investor's portfolio through investment in housing. A counterfactual exercise provides some evidence that unconventional monetary policy has been particularly successful in dampening the consequences of the financial crisis on housing markets in the United States, while the effects are more muted in the other countries considered in this study.
    Keywords: Zero Lower Bound,Shadow interest rate,Housing Market,Time-varying parameter VAR
    JEL: C32 E23 E32
    Date: 2016
  5. By: Duwicquet, Vincent; Mazier, Jacques; Petit, Pascal; Saadaoui, Jamel
    Abstract: The euro crisis illustrates the deficiencies of adjustment mechanisms in a monetary union characterized by a large heterogeneity. Exchange rate adjustments being impossible, few alternative mechanisms are available. Nevertheless, fiscal policy could play an active role. The chapter is organized as follow. In the first part, we give a new evaluation of these exchange rate misalignments inside the eurozone, using a FEER approach, and we discuss the structural character of these misalignments. In the second part, we analyse the deadlock of the actual European institutional framework and propose two alternative exit strategies, a first step towards a fiscal federalism or, on the opposite, a new monetary regime based on a multi-euro system.
    Keywords: Euro Crisis, Exchange Rate Misalignments, Fallback Strategies.
    JEL: E1 E12 E42 F41 F42
    Date: 2015–02
  6. By: Lars E.O. Svensson
    Abstract: “Leaning against the wind” (LAW) with a higher monetary policy interest rate may have benefits in terms of lower real debt growth and associated lower probability of a financial crisis but has costs in terms of higher unemployment and lower inflation. LAW has a cost if no crisis occurs, but, importantly, it also has an additional cost if a crisis occurs, because the cost of a crisis is higher if the economy initially is weaker due to LAW. This additional cost, disregarded by the previous literature, is the main part of the costs of LAW. With that additional cost, for existing empirical estimates, costs of LAW exceed benefits by a substantial margin, even if monetary policy is non-neutral and permanently affects real debt. Somewhat surprisingly, less effective macroprudential policy, and generally a credit boom, with resulting higher probability, severity, or duration of a crisis, increases costs of LAW more than benefits, thus making costs exceed benefits by an even larger margin.
    JEL: E52 E58 G01
    Date: 2016–01
  7. By: Krupkina, Anna; Ponomarenko, Alexey
    Abstract: We apply empirical modelling set-ups developed to capture the hysteresis effect in the data on deposit dollarization in a cross-section of emerging market economies. Specifically, we estimate a nonlinear relationship that determines two equilibrium levels of deposit dollarization depending on the current value of dollarization and previous episodes of sharp depreciation of the national currency over the past five years. When exchange rates are stable, convergence to a higher equilibrium level of dollarization begins when the 45–50% thresh-old of deposit dollarization is exceeded. We estimate the model for short-run dynamics of dollarization and find that the speed of convergence to the higher equilibrium implies quarterly increases of 1.2–3 percentage points in the ratio of foreign currency deposits to total deposits.
    Keywords: dollarization, hysteresis, nonlinear model, emerging markets
    JEL: C23 E41 F31
    Date: 2015–11–10
  8. By: Gros, Daniel
    Abstract: By the end of June, both Greece and Puerto Rico seem to have arrived at the end of the road. The governor of the Commonwealth has announced that the public debt needs to be restructured (although there are no legal provisions to do so). In Greece, the government is organising a referendum, calling on the people of Greece to reject the latest proposal of its official creditors (the Troika, composed of the IMF, the ECB and the European Commission) for a further adjustment programme. This coincidence illustrates that the difference between the two cases is not the underlying economic problems, but the political context: in Greece, both the liquidity provision to banks and the debt problems are politically charged because both are in the hands of official institutions. In Puerto Rico, by contrast, both of these issues are determined by the market. In Greece, the government and the Greek people feel that they have to battle ‘foreigners’, i.e. other political institutions. In Puerto Rico, the government (and the banks) has a problem with anonymous market forces and investors. This is why nobody argues that the ‘dollar’ has failed when Puerto Rico fails, but many argue that the ‘euro’ fails if Greece fails.
    Date: 2015–06
  9. By: J Paul Dunne and Elizabeth Kasekende
    Abstract: While the effect of financial innovation on money demand has been widely researched in industrialised countries, because of its major role in monetary policy, few studies have focussed on developing countries. This is surprising given the considerable growth in financial innovation in Sub-Saharan Africa in recent years and its potential implications for developing country macroeconomic policy. This paper investigates the development of financial innovation and its impact on money demand in the region using panel data estimation techniques for 34 countries between 1980 and 2013. The results indicate that there is a negative relationship between financial innovation and money demand. This implies that financial innovation plays a crucial role in explaining money demand in Sub-Saharan Africa and given innovations such as mobile money in the region this can have important implications for future policy design.
    Keywords: Money demand, financial innovation
    JEL: E41
    Date: 2016
  10. By: Sergey Sinelnikov-Murylev (Russian Foreign Trade Academy); Pavel Trunin (RANEPA)
    Abstract: Both economic theory and economic practice reveal a high degree of interdependence between fiscal and monetary policies. This relationship is especially evident if the government accumulates a considerable amount of money in its accounts with the central bank. The article analyzes the impact of the formation and spending of the Reserve Fund and the National Wealth Fund on the monetary policy of the Bank of Russia. This effect is considered from the point of view of the current economic crisis and the need to spend resources accumulated in sovereign wealth funds. Length: 13 pages
    Keywords: Russian economy, fiscal policy, monetary policy, sovereign wealth funds, forex interventions, international reserves
    JEL: E43 E52 E62 E63
    Date: 2016
  11. By: De Grauwe, Paul
    Abstract: In a CEPS Commentary, Paul De Grauwe argues that the Greek government is solvent but is trapped in a liquidity dilemma in which cannot find liquidity because markets believe it cannot find liquidity. He then explores the role of the European Central Bank in this self-fulfilling problem and ask specifically whether its outright monetary transactions (OMT) programme, introduced in September 2012, should be used to ease the constraints on Greece.
    Date: 2015–06
  12. By: Zakaria Moussa (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - UN - Université de Nantes)
    Abstract: We examine the evolution and the magnitude of exchange rate pass-through (ERPT) to Japanese prices. We employ the Time-Varying-Parameters Factor-Augmented Vector autoregression model (TVP-FAVAR), which enables us to include a large enough of data to better control for variables impacting prices and exchange rate. Our results confirm the decline in ERPT rates until the late 2000s and their resurgence in last years. Our findings provide additional support to the notion that exchange rates can impact import and domestic prices, possibly helping avoid deflation. We also find that the ERPT into aggregate prices can hide considerable variation in price sensitivity to exchange rates across stages of demand and industries. ERPT decreases along the pricing chain, from imported raw materials and intermediate goods prices to domestic prices. Finally, we find price sensitivity consistent throughout, indicating that incorporating extra information leads to more robust estimates.
    Keywords: exchange rate pass-through, Japan, import prices, domestic prices, TVP-FAVAR model.
    Date: 2016–03–04
  13. By: Guglielmo Maria Caporale; Abdurrahman Nazif Catik; Mohamad Husam Helmi; Faek Menla Ali; Mohammad Tajik
    Abstract: This paper examines the bank lending channel of monetary transmission in Malaysia, a country with a dual banking system including both Islamic and conventional banks, over the period 1994:01-2015:06. A two-regime threshold vector autoregression (TVAR) model is estimated to take into account possible nonlinearities in the relationship between bank lending and monetary policy under different economic conditions. The results indicate that Islamic credit is less responsive than conventional credit to interest rate shocks in both the high and low growth regimes. By contrast, the relative importance of Islamic credit shocks in driving output growth is much greater in the low growth regime, their effects being positive. These findings can be interpreted in terms of the distinctive features of Islamic banks.
    Keywords: Bank lending channel, Malaysia, Monetary transmission, Threshold VAR
    JEL: C32 E31 E42 E58
    Date: 2016
  14. By: Corbisiero, Giuseppe (Central Bank of Ireland)
    Abstract: This paper provides a theory to investigate the transmission of non-standard monetary policy to corporate lending in a monetary union where financial frictions limit firms’ access to external finance. The model incorporates a banking-sovereign nexus by assuming that sovereign default would generate a liquidity shock severely hitting domestic banks’ balance sheet. I find that this feature crucially impairs the transmission of monetary policy, generating asymmetric lending responses and the risk of contagion across economies. In particular I show that, in some circumstances, the liquidity injected into the risky country’s banks results in financing the sovereign rather than boosting lending, and sovereign risk in one country generates negative spillover effects on lending throughout the monetary union via the collateral channel. The model sheds light on the troubled transmission of the ECB’s policy measures to the economy of stressed countries during the euro sovereign debt crisis.
    Keywords: Bank Lending, Sovereign Risk, Monetary Policy, Crisis, Euro Area
    JEL: E44 E52 F36 G01 G33
    Date: 2016–03
  15. By: Paczos, Wojtek
    Abstract: In state-of-the-art New Keynesian model firms are monopolistically competitive and prices are sticky. However, the average markup resulting from the monopolistic competition is usually assumed away either by production subsidy or by the zero-inflation steady state. Also, in models of an open economy the same level of price stickiness is assumed for both countries. In this paper I study the optimal rate of inflation in a two country model keeping the average markup and allowing price stickiness to differ between countries. There are two channels that govern the optimal rate of inflation. First, with local currencies an inflation tax is partly imposed on the foreign country, so it is optimal to inflate. Second, the average markup constitutes a cost of holding money so it is optimal to deflate, to compensate this cost. The paper has four novel findings: 1) in the local currencies regime the first motive dominates and the optimal inflation is positive. 2) In a monetary union the first motive is absent and the optimal inflation is negative and below the Friedman rule. 3) A monetary union improves global welfare even when stickiness is different in two countries. However, when this difference is large, only one country (the one with higher stickiness) benefits from the integration. 4) A monetary union can be welfare improving for each of both countries, if a transfer is introduced from the more sticky to the more flexible country of (depending on the parameters up to) 2% of its GDP.
    Keywords: Monetary Union, International Spillovers, Monetary Policy
    JEL: E52 F41 F42
    Date: 2016
  16. By: Nikola Tarashev; Anna Zabai
    Abstract: Could a less conservative central bank - one that faces a more severe time inconsistency problem - be less likely to succumb to an attack on a currency peg? Traditional currency-crisis models provide a firm answer: No. We argue that the answer stems from these models' narrow focus on how a central bank's response to a speculative attack affects output and inflation in the short run. The answer may reverse if we recognize that a credible currency peg solves time consistency issues in the long run. As a less conservative central bank stands to benefit more from tying its own hands, it should find a peg more valuable.
    Keywords: currency crises, strategic uncertainty, global games, time inconsistency
    Date: 2016–03
  17. By: Tomasz Łyziak
    Abstract: To what extent financial crisis whose sharp face begun in 2008 and low inflation environment that started in 2013 affect inflation expectations in Poland? Have inflation expectations of the private sector become more forward-looking? Is monetary policy still able to influence expectations as compared with the pre-crisis period? Those are the main questions addressed in this paper. To answer them we analyse survey-based measures of inflation expectations of consumers, enterprises and financial sector analysts. Estimation of simple and extended hybrid models of inflation expectations combined with verification of orthogonality of expectational errors with respect to available information leads us to the conclusion that since 2008 inflation expectations of enterprises and financial sector analysts have become more forward-looking, better exploiting available information and more sensitive to interest rate changes and developments in the real economy. At the same time formation of consumer inflation expectations has not been affected significantly.
    Keywords: Inflation expectations, survey, Poland.
    JEL: D84 E31
    Date: 2016
  18. By: Kohei Hasui (Kobe University.); Tomohiro Sugo (European Central Bank); Yuki Teranishi (Keio University)
    Abstract: This paper investigates history dependent easing known as a conventional wis- dom of optimal monetary policy in a liquidity trap. We show that, in an economy where the rate of inflation exhibits intrinsic persistence, monetary tightening is earlier as inflation becomes more persistent. This property is referred as early tightening and in the case of a higher degree of inflation persistence, a central bank implements front-loaded tightening so that it terminates the zero interest rate policy even before the natural rate of interest turns positive. As a prominent feature in a liquidity trap, a forward guidance of smoothing the change in inflation rates contributes to an early termination of the zero interest rate policy.
    Keywords: liquidity trap; optimal monetary policy; inflation persistence; early tightening; forward guidance
    JEL: E31 E52 E58 E61
    Date: 2016–02
  19. By: Nikhil Patel
    Abstract: This paper models the interaction between international trade finance and monetary policy in open economies and shows that trade finance affects the propagation mechanism of all macroeconomic shocks that are identified to be drivers of business cycles in advanced economies. The model is estimated with Bayesian techniques using output, price and bilateral trade data from the US and the Eurozone. The estimation exercise shows that trade finance conditions, which in turn are driven by US interest rates, are critical in explaining economic fluctuations. Quantitatively, trade finance has a larger impact on spillover effects of shocks to foreign countries, implying that incorporation of trade finance is particularly important when modeling small open economies.
    Keywords: trade finance, monetary policy, DSGE
    Date: 2016–01
  20. By: Hernán Rincón-Castro (Banco de la República de Colombia); Norberto Rodríguez-Niño (Banco de la República de Colombia)
    Abstract: Determining the exchange rate pass-through on inflation is a necessity for central banks as well as for firms and households. This is an apparently easy and intuitive task, but it faces high complexity and uncertainty. This paper examines the short and long-term impact of an exchange rate shock on inflation along the distribution chain in the presence of endogeneity, nonlinearity and asymmetry. The econometric model is a smooth transition autoregressive vector estimated by Bayesian methods. This incorporates a model of pricing and the endogenous nature of the exchange rate pass-through (PT). The paper uses monthly data from Colombia for the period 2002 to 2015. The main findings are that PT is incomplete, endogenous and then changes over time, nonlinear and asymmetric in the short and long terms to the state of the economy (i.e., PT is nonlinear state-dependent) and to exchange rate shocks. Findings showed that historically the accumulated PT on inflation of import prices rises from 20% in the first month of the exchange rate shock to a maximum of around 66% in the first year. The equivalent figures on the inflation of producer goods go from 13% to 52%; on the inflation of imported consumer goods from 6% to 48%, and on the CPI inflation from 4% to 30%. At four years, the respective figures for accumulated PT are 98%, 84%, 94% and 80%, but uncertainty about these estimates increases rapidly over time. Classification JEL:F31, E31, E52, C51, C52
    Keywords: Exchange rate pass-through, pricing along the distribution chain, endogeneity, nonlinearity, asymmetry, logistic smooth transition VAR (LST-VAR), Bayesian approach
    Date: 2016–03
  21. By: Waqas Ahmed (State Bank of Pakistan); Sajawal Khan (State Bank of Pakistan); Muhammad Rehman (State Bank of Pakistan)
    Abstract: We analyze optimality of pro-cyclical monetary policy in the presence of informal sector and firm level constraint. Our findings suggest that in case of export demand shock pro-cyclical monetary policy suits only when shock is severe and domestic firms have high leverage ratio. However, the conventional monetary policy helps cushioning the loss in output when the size of informal sector is significantly large. Furthermore, fixing exchange rate is better policy option if objective is to keep domestic employment or consumption from falling (when negative shock hits the economy). We cannot find any disproportionate impact of monetary policy on informal sector. This may be due to static nature of the model and it might be possible that dynamics of responses of the two sectors to shocks differ significantly.
    Keywords: Informal sector, credit constraint, exchange rate and monetary policy
    JEL: F0 F4 O17 O23 E52
  22. By: Honkapohja, Seppo
    Abstract: ​Many central banks have lowered their interest rates close to zero in response to the crisis since 2008. In standard monetary models the zero lower bound (ZLB) constraint implies the existence of a second steady state in addition to the inflation-targeting steady state. Large scale asset purchases (APP) have been used as a tool for easing of monetary policy in the ZLB regime. I provide a theoretical discussion of these issues using a stylized general equilibrium model in a global nonlinear setting. I also review briefly the empirical literature about effects of APP’s.
    Keywords: adaptive learning, monetary policy, inflation targeting, zero interest rate lower bound
    JEL: E63 E52 E58
    Date: 2015–08–20
  23. By: Sánchez-Fung, José R.
    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: E52 D31
    Date: 2015–05–13
  24. By: Crowley, Patrick M.; Hudgins, David
    Abstract: This paper first applies the MODWT (Maximal Overlap Discrete Wavelet Transform) to Euro Area quarterly GDP data from 1995 – 2014 to obtain the underlying cyclical structure of the GDP components. We then design optimal fiscal and monetary policy within a large state-space LQ-tracking wavelet decomposition model. Our study builds a MATLAB program that simulates optimal policy thrusts at each frequency range where: (1) both fiscal and monetary policy are emphasized, (2) only fiscal policy is relatively active, and (3) when only monetary policy is relatively active. The results show that the monetary authorities should utilize a strategy that influences the short-term market interest rate to undulate based on the cyclical wavelet decomposition in order to compute the optimal timing and levels for the aggregate interest rate adjustments. We also find that modest emphasis on active interest rate movements can alleviate much of the volatility in optimal government spending, while rendering similarly favorable levels of aggregate consumption and investment. This research is the first to construct joint fiscal and monetary policies in an applied optimal control model based on the short and long cyclical lag structures obtained from wavelet analysis.
    Keywords: discrete wavelet analysis, euro area, fiscal policy, LQ tracking, monetary policy, optimal control
    JEL: C49 C61 C63 C88 E52 E61
    Date: 2015–08–12
  25. By: Hetzel, Robert L. (Federal Reserve Bank of Richmond); Richardson, Gary (Federal Reserve Bank of Richmond)
    Abstract: The United States Congress created the Federal Reserve System in 1913. The System consists of the Federal Reserve Board in Washington, D.C.; 12 Federal Reserve Banks; and thousands of member commercial banks. This entry describes the evolution of the System and of monetary policy from its foundation through 2013.
    Date: 2016–01–15
  26. By: Fujisaki, Seiya
    Abstract: We analyze aggregate stability of a monetary economy with an interest-rate control type of monetary policy and endogenous consumption tax rate under balanced-budget rule, in terms of equilibrium determinacy. We find the effect of the response to income in monetary policy on macroeconomic stability depends on whether the consumption tax rate is adequately high.
    Keywords: aggregate stability, endogenous consumption tax rate, Taylor rule.
    JEL: E52 E62
    Date: 2016–03–03
  27. By: Hélène Rey
    Abstract: This lecture argues that the Global Financial Cycle is a challenge for the validity of the Mundellian trilemma. I present evidence that US monetary policy shocks are transmitted internationally and affect financial conditions even in inflation targeting economies with large financial markets. Hence flexible exchange rates are not enough to guarantee monetary autonomy in a world of large capital flows.
    JEL: F3 F33 F41
    Date: 2016–01
  28. By: Juan Manuel Julio; Norberto Rodríguez; Hector Zárate
    Abstract: In this paper we estimated a volatility model for COP/US under two different samples, one containing the information before the “discretional interventions” started, and the other using the whole sample. We use a nonparametric approach to estimate the mean and “volatility smile” return functions using daily data. For the pre-interventions sample, we found a nonlinear expected return function and, surprisingly, a non-symmetric “volatility smile”. These lack of linearity and symmetry are related to absolute returns above 1,5% and 1,0%, respectively. We also found that the “discretional interventions” did not shift the mean response function, but moved the expected returns along the line towards the required levels. In contrast, the “volatility smile” tends to increase in a non-symmetric way after accounting for “discretional interventions”. The Sep/29/2004 announcement does not seem to have had any effect on the expected conditional mean or variance functions, but the Dec/17/2004 announcement seems to be related to non-symmetric effects on the volatility smile. We concluded that the announcement of discretional intervention by the monetary authority was more efficient when time and amount were unannounced.
    Keywords: Volatility Smile, Exchange Rate Risk, Nonparametric Estimation, Central Bank Intervention.
    JEL: C14 C22 E58 F31 E44
  29. By: Shin-ichi Fukuda
    Abstract: In the post Lehman period, the interest rate of the US dollar became low on the forward contract because of“flight to quality” to the international currency. However, in the Euro crisis, that of the Sterling pound became equally low, while the other European currencies such as the Danish kroner increased its liquidity premium. By using secured rates, the following analysis examines why the Sterling pound and the Danish kroner showed asymmetric features in deviations from the covered interest parity (CIP) condition. The regression results suggest that there was a structural break in the determinants of the deviations across the European currencies in the two crises. Currency-specific money market risk was critical in explaining the deviations in the global financial crisis (GFC), while EU banks’ credit risk and market risk were useful in explaining the deviations in the Euro crisis. In particular, EU banks’ credit risk and market risk had asymmetric effect on the deviations. The asymmetry explains different features between the Sterling pound and the Danish kroner.
    JEL: F36 G12 G15
    Date: 2016–01
  30. By: Gros, Daniel
    Abstract: The Federal Reserve left rates unchanged at its closely-watched meeting on September 17th, although many had argued that the real economy data, especially on the labour market, would have justified an exit (from the zero interest policy). In this CEPS Commentary, Daniel Gros observes that no similar decision on exit is in sight in the euro area, despite the fact that some have argued that the ECB should consider further easing measures (pushing the deposit rate deeper into negative territory or increasing the size of its asset purchase programme). He asks, in fact, whether further easing measures should be even discussed at this point.
    Date: 2015–09
  31. By: Turhan, Ibrahim M.; Gumus, Nihat
    Abstract: The main objective of this study is to provide additional evidence on the operation and relative importance of monetary transmission channels in Turkey. The results of the VAR analysis conducted using monthly data between January 2004 and November 2013 suggest that the traditional channels of interest rates, exchange rates, and credit do work in Turkish economy. However, the most striking finding of the study is the relative importance of exchange rate channel in the transmission of monetary policy decision into real economy. Variance decomposition analysis shows that the explained variance by real effective exchange rates is higher for all variables as compared to the variance explained by interest rates. However, interest rates seem to be still a useful tool to manage monetary policy given its role in controlling the changes in exchange rates. The granger causality analysis points into the fact that while interest rates have a role in leading the volatility of exchange rates, exchange rates have an impact on foreign debt holdings of banks and credit growth. On the other hand, foreign debt positions of banks and other sector firms together with credit growth granger causes industrial production. The study has some remarkable ramifications in terms of monetary policy design.
    Keywords: Monetary transmission mechanism, monetary policy, interest rate channel, exchange rate channel
    JEL: E52 E58 G18
    Date: 2014–05–12
  32. By: Shakhzod Ismailov (Central Bank of Uzbekistan); Makoto Kakinaka (International University of Japan); Hiroaki Miyamoto (The University of Tokyo)
    Abstract: Inflation targeting has attracted attention to researchers and policy makers since the first attempt in New Zealand in 1990. This paper discusses a country's choice of inflation targeting by examining its driving forces with the dataset of 82 countries. The empirical result shows that countries' decision of adoption of inflation targeting depends highly on their development stage. For high-income or developed countries, the significant motive of monetary authority to choose inflation targeting is the desire to keep or enhance anti-inflation credibility, and inflation targeting could be a natural option under more floats with the absence of nominal exchange rate anchor. On the other hand, low-income or developing countries with the large size of public debts are not likely to choose inflation targeting, so that fiscal fragility would discourage monetary authority to adopt restrictive monetary policy under inflation targeting.
    Keywords: inflation targeting, exchange rate arrangements, anti-inflation credibility, fiscal fragility
    Date: 2016–03
  33. By: Guay Lim (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne); Sarantis Tsiaplias (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)
    Abstract: Understanding the impact of changes in interest rates on house prices is important for managing house price bubbles and ensuring housing affordability. This paper investigates the effect of interest rates on regional house price to income measures based on a non-linear smooth transition VAR model of inter-regional house price dynamics. To minimize the impact of housing mix changes on estimated effects, we apply the model to an Australian dataset of regional hedonic house price indices that account for both changes in housing mix and quality over time. The empirical analysis provides evidence that house price to income ratios depend non-linearly on interest rates, and moreover that there is an interest rate ‘transition point’ below which a house price bubble is probable. We investigate the implications for monetary policy of stable and unstable house price regimes and propose a housing lending rate lower bound that achieves long-run house price stability in the presence of regime uncertainty. To check the generality of the result, we also apply the model to aggregate Australian and US data. Classification-C30, E43, E52, G21, R10, R31
    Keywords: House prices, interest rates, monetary policy, nonlinear VAR, housing affordability, bubbles
    Date: 2016–01
  34. By: Susanto Basu; Brent Bundick
    Abstract: At the zero lower bound, the central bank's inability to offset shocks endogenously generates volatility. In this setting, an increase in uncertainty about future shocks causes significant contractions in the economy and may lead to non-existence of an equilibrium. The form of the monetary policy rule is crucial for avoiding catastrophic outcomes. State-contingent optimal monetary and fiscal policies can attenuate this endogenous volatility by stabilizing the distribution of future outcomes. Fluctuations in uncertainty and the zero lower bound help our model match the unconditional and stochastic volatility in the recent macroeconomic data.
    JEL: E32 E52
    Date: 2015–12
  35. By: Gros, Daniel
    Abstract: For the better part of a decade, central banks have been making only limited headway in curbing powerful global deflationary forces. Since 2008, the US Federal Reserve has maintained zero interest rates, while pursuing multiple waves of unprecedented balance-sheet expansion through large-scale bond purchases. The Bank of England, the Bank of Japan and the European Central Bank have followed suit, each with its own version of so-called quantitative easing (QE). Yet inflation has not picked up appreciably anywhere.
    Date: 2016–02

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