nep-mon New Economics Papers
on Monetary Economics
Issue of 2016‒05‒08
twenty-one papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. What to Aim for? The Choice of an Inflation Objective When Openness Matters By Richard T. Froyen; Alfred V Guender
  2. Crisis, contagion and international policy spillovers under foreign ownership of banks By Michal Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
  3. Exchange rate pass-through in emerging countries: Do the inflation environment, monetary policy regime and institutional quality matter? By Antonia Lopez-Villavicencio; Valérie Mignon
  4. Implementing monetary policy post-crisis: What have we learned? What do we need to know? remarks at a workshop organized by Columbia University SIPA and the Federal Reserve Bank of New York, May 2016 By Potter, Simon M.
  5. “The Distributive Effects of Conventional and Unconventional Monetary Policies” By Karen Davtyan
  6. Quantitative Easing: An Underappreciated Success By Joseph E. Gagnon
  7. A Time Series Model of Interest Rates With the Effective Lower Bound By Johannsen, Benjamin K.; Mertens, Elmar
  8. A macroprudential stable funding requirement and monetary policy in a small open economy By Punnoose Jacob; Anella Munro
  9. Turnover Liquidity and the Transmission of Monetary Policy By Lagos, Ricardo; Zhang, Shengxing
  10. Common faith or parting ways? A time varying parameters factor analysis of euro-area inflation By Delle Monache,; Ivan Petrella; Fabrizio Venditti
  11. Optimal Monetary Policy, Exchange Rate Misalignments and Incomplete Financial Markets By Senay, Ozge; Sutherland, Alan
  12. The limits of central bank forward guidance under learning By Cole, Stephen
  13. On the impact of dollar movements on oil currencies By Gabriel Gomes
  14. Strengthening the role of local currencies in EU candidate and potential candidate countries By Windischbauer, Ulrich
  15. Exchange Rate Pass-Through in the Euro Area By Rajmund Mirdala
  16. The Macroeconomic Risks of Undesirably Low Inflation By Arias, Jonas E.; Erceg, Christopher J.; Trabandt, Mathias
  17. Unsurprising Shocks: Information, Premia, and the Monetary Transmission By Silvia Miranda-Agrippino
  18. The Real Exchange Rate in Open-Economy Taylor Rules: A Re-Assessment By Richard T. Froyen; Alfred V Guender
  19. Financial supervision to fight fiscal dominance? The gold standard in Greece and South-East Europe between economic and political objectives and fiscal reality, 1841-1939 By Matthias Morys
  20. Lost in translation? ECB's monetary impulses and financial intermediaries' responses By Beck, Günter Wilfried; Kotz, Hans-Helmut; Zabelina, Natalia
  21. Effectiveness of Monetary Policy: Evidence from Turkey By Avci, S. Burcu; Yucel, Eray

  1. By: Richard T. Froyen; Alfred V Guender (University of Canterbury)
    Abstract: Inflation targeting countries generally define the inflation objective in terms of the consumer price index. Studies in the academic literature, however, reach conflicting conclusions concerning which measure of inflation a central bank should target in a small open economy. This paper examines the properties of domestic, CPI, and real-exchange- rate-adjusted (REX) inflation targeting. In one class of open economy New Keynesian models there is an isomorphism between optimal policy in an open versus closed economy. In the type of model we consider, where the real exchange rate appears in the Phillips curve, this isomorphism breaks down; openness matters. REX inflation targeting restores the isomorphism but this may not be desirable. Instead, under domestic and CPI inflation targeting the exchange rate channel can be exploited to enhance the effects of monetary policy. Our results indicate that CPI inflation targeting delivers price stability across the three inflation objectives and will be desirable to a central bank with a high aversion to inflation instability. CPI inflation targeting also does a better job of stabilizing the real exchange rate and interest rate which is an advantage from the standpoint of financial stability. REX inflation targeting does well in achieving output stability and has an advantage if demand shocks are predominant. In general, the choice of the inflation objective affects the trade-offs between policy goals and thus policy choices and outcomes.
    Keywords: CPI, Domestic, REX Inflation Targeting, Openness, Inflation-Output Trade-off
    JEL: E3 E5 F3
    Date: 2016–03–08
  2. By: Michal Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
    Abstract: This paper checks how international spillovers of shocks and policies are modified when banks are foreign owned. To this end we build a two-country macroeconomic model with banking sectors that are owned by residents of one (big and foreign) country. Consistently with empirical findings, in our model foreign ownership of banks amplifies spillovers from foreign shocks. It also strenghtens the international transmission of monetary and macroprudential policies. We next use the model to replicate the financial crisis in the euro area and show how, by preventing bank capital out ow in 2009, the Polish regulatory authorities managed to reduce its contagion to Poland. We also find that under foreign bank ownership such policy is strongly prefered to a recapitalization of domestic banks.
    Keywords: foreign-owned banks, monetary and macroprudential policy, international spillovers, DSGE models with banking
    JEL: E32 E44 E58
    Date: 2016–03
  3. By: Antonia Lopez-Villavicencio; Valérie Mignon
    Abstract: In this paper, we estimate the exchange rate pass-through (ERPT) to consumer prices and assess its dynamics for a sample of 15 emerging countries over the 1994-2015 period. To this end, we augment the traditional bivariate relationship between the nominal effective exchange rate and inflation by accounting for the inflation environment, monetary policy regime, as well as domestic institutional factors. We show that both the level and volatility of inflation matter in the sense that declining ERPT is evidenced with more stable and anti-inflationary environment. Monetary policy also plays a key role since adopting an inflation target-especially de jure-leads to a significant reduction in ERPT for most countries. Adopting exchange rate targeting regime matters as well, contributing to a diminishing ERPT. Finally, we find evidence that transparency of monetary policy decisions clearly reduces ERPT, while this is not the case for central bank independence.
    Keywords: exchange rate pass-through; inflation; emerging countries; monetary policy.
    JEL: E31 E52 F31
    Date: 2016
  4. By: Potter, Simon M. (Federal Reserve Bank of New York)
    Abstract: Workshop organized by Columbia University School of International Affairs and the Federal Reserve Bank of New York, May 2016.
    Keywords: monetary policy implementation framework; counterparties; the Desk; excess reserves; interest on reserves; sterilization of operations; reverse repurchase agreements (RRPs)
    Date: 2016–05–04
  5. By: Karen Davtyan (AQR Research Group-IREA. University of Barcelona)
    Abstract: The distributional effect of monetary policy is estimated in the case of the USA. In order to identify a monetary policy shock, the paper employs contemporaneous restrictions with ex-ante identified monetary policy shocks as well as log run identification. In particular, a cointegration relation has been determined among the considered variables and the vector error correction methodology has been applied for the identification of the monetary policy shock. The obtained results indicate that contractionary monetary policy decreases income inequality in the country. These results could have important implications for the design of policies to reduce income inequality by giving more weight to monetary policy.
    Keywords: Income inequality; monetary policy; cointegration; identification. JEL classification: C32; D31; E52
    Date: 2016–04
  6. By: Joseph E. Gagnon (Peterson Institute for International Economics)
    Abstract: After short-term interest rates in many advanced economies fell below 1 percent, central banks turned to quantitative easing (QE) to support economic growth. They purchased massive and unprecedented amounts of long-term bonds in an effort to reduce long-term borrowing costs. Nevertheless, recovery from the Great Recession proved disappointingly slow. Recently, some central banks have pushed short-term interest rates slightly below zero to provide an additional boost to growth. The slow recovery and the turn to negative rates have raised questions about the benefits of QE bond purchases and whether their effectiveness has reached a limit. Gagnon reviews the outpouring of research on QE and its effects and finds overwhelming evidence that QE does ease financial conditions and supports economic growth. The channels are similar to those of conventional monetary policy. QE can be especially powerful during times of financial stress, but it has a significant effect in normal times with no observed diminishing returns. Rarely, if ever, have economists studying a specific question reached such a widely held consensus so quickly. But this consensus has yet to spread more broadly within the economics profession or the wider world.
    Date: 2016–04
  7. By: Johannsen, Benjamin K.; Mertens, Elmar
    Abstract: Modeling interest rates over samples that include the Great Recession requires taking stock of the effective lower bound (ELB) on nominal interest rates. We propose a flexible time– series approach which includes a “shadow rate”—a notional rate that is less than the ELB during the period in which the bound is binding—without imposing no–arbitrage assumptions. The approach allows us to estimate the behavior of trend real rates as well as expected future interest rates in recent years.
    Keywords: Bayesian Econometrics ; Effective Lower Bound ; Shadow Rate ; State-Space Model ; Term Structure of Interest Rates
    JEL: C32 C34 C53 E43 E47
    Date: 2016–04–04
  8. By: Punnoose Jacob; Anella Munro
    Abstract: The Basel III net stable funding requirement, scheduled for adoption in 2018, requires banks to use a minimum share of long-term wholesale funding and deposits to fund their assets. A similar regulation has been in place in New Zealand since 2010. This paper introduces the stable funding requirement (SFR) into a DSGE model featuring a banking sector with richly-specified liabilities, and estimates the model for New Zealand. We then evaluate the implications of an SFR for monetary policy trade-offs. Altering the steadystate SFR does not materially affect the transmission of most structural shocks to the real economy and hence has little effect on the optimised monetary policy rules. However, a higher steady-state SFR level amplifies the effects of bank funding shocks, adding to macroeconomic volatility and worsening monetary policy trade-offs conditional on these shocks. We find that this volatility can be moderated if optimal monetary or prudential policy responds to credit growth.
    Keywords: DSGE models, prudential policy, monetary policy, small open economy, sticky interest rates, banks, wholesale funding
    JEL: E31 E32 E44 F41
    Date: 2016–05
  9. By: Lagos, Ricardo (Federal Reserve Bank of Minneapolis); Zhang, Shengxing (London School of Economics)
    Abstract: We provide empirical evidence of a novel liquidity-based transmission mechanism through which monetary policy influences asset markets, develop a model of this mechanism, and assess the ability of the quantitative theory to match the evidence.
    Keywords: Asset prices; Liquidity; Monetary policy; Monetary transmission
    JEL: D83 E52 G12
    Date: 2016–05–03
  10. By: Delle Monache, (Bank of Italy); Ivan Petrella (Department of Economics, Mathematics & Statistics, Birkbeck; Bank of England); Fabrizio Venditti (Bank of Italy)
    Abstract: We analyze the interaction among the common and country specific components for the inflation rates in twelve euro area countries through a factor model with time varying parameters. The variation of the model parameters is driven by the score of the predictive likelihood, so that, conditionally on past data, the model is Gaussian and the likelihood function can be evaluated using the Kalman filter. The empirical analysis uncovers significant variation over time in the model parameters. We find that, over an extended time period, inflation persistence has fallen over time and the importance of common shocks has increased relatively to the idiosyncratic disturbances. According to the model, the fall in inflation observed since the sovereign debt crisis, is broadly a common phenomenon, since no significant cross country inflation differentials have emerged. Stressed countries, however, have been hit by unusually large shocks.
    Keywords: inflation, time-varying parameters, score driven models, state space models, dynamics factor models.
    JEL: E31 C22 C51 C53
    Date: 2015–07
  11. By: Senay, Ozge; Sutherland, Alan
    Abstract: Recent literature on monetary policy shows that, when international financial trade is restricted to a single non-contingent bond, there are significant trade-offs that prevent optimal policy from simultaneously closing all internal and external welfare gaps. Optimal policy therefore deviates from inflation targeting in order to offset real exchange rate misalignments. These simple models are, however, not good representations of modern financial markets. This paper develops a more realistic two-country model of incomplete markets, where there is international trade in nominal bonds denominated in the currencies of the two countries and equity claims on profit streams in the two countries. The analysis shows that the welfare benefits of optimal policy relative to inflation targeting are quantitatively smaller than found in simpler models of financial incompleteness. It is nevertheless found that optimal policy implies quantitatively significant stabilisation of the real exchange rate gap and trade balance gap compared to inflation targeting.
    Keywords: Country portfolios; Financial market structure; Optimal monetary policy
    JEL: E52 E58 F41
    Date: 2016–03
  12. By: Cole, Stephen
    Abstract: Central bank forward guidance emerged as a pertinent tool for monetary policymakers since the Great Recession. Nevertheless, the effects of forward guidance remain unclear. This paper investigates the effectiveness of forward guidance while relaxing two standard macroeconomic assumptions: rational expectations and frictionless financial markets. Agents forecast future macroeconomic variables via either the rational expectations hypothesis or a more plausible theory of expectations formation called adaptive learning. A standard Dynamic Stochastic General Equilibrium (DSGE) model is extended to include the financial accelerator mechanism. The results show that the addition of financial frictions amplifies the differences between rational expectations and adaptive learning to forward guidance. The macroeconomic variables are overall more responsive to forward guidance under rational expectations than under adaptive learning. During a period of economic crisis (e.g. a recession), output under rational expectations displays more favorable responses to forward guidance than under adaptive learning. These differences are exacerbated when compared to a similar analysis without financial frictions. Thus, monetary policymakers should consider the way in which expectations and credit frictions are modeled when examining the effects of forward guidance.
    Keywords: Forward Guidance, Monetary Policy, Adaptive Learning, Expectations, Financial Frictions
    JEL: D84 E30 E44 E50 E52 E58 E60
    Date: 2016–03–22
  13. By: Gabriel Gomes
    Abstract: This paper investigates to which extent dollar real exchange rate fluctuations explain the unexpected divergent movement between the real exchange rate of oil exporting countries and the price of oil in certain periods. Estimating a panel cointegrating model for 11 OPEC and 5 major oil exporting countries over the 1980-2014 period, we find evidence to support they have oil currencies in the long term. In fact, a 10% increase in the price of oil leads to a 2.1% appreciation of their real exchange rate. To analyse how swings on the dollar exchange rate affect the co-movement between the two variables in the short run, we rely on a non-linear approach and estimate a panel smooth transition regression model. Results show that, in the short term, oil currencies move in concert with the price of oil only if the dollar appreciation is lower than 2.6%. After the dollar appreciates beyond this threshold, the real exchange rate of oil exporting economies is rather negatively affected by the price of oil.
    Keywords: Oil Price;Oil Currencies;Non-linearities
    JEL: C33 F31 Q43
    Date: 2016–05
  14. By: Windischbauer, Ulrich
    Abstract: This paper deals with the phenomenon of high levels of unofficial euroisation in countries preparing for EU membership (Albania, Bosnia and Herzegovina, the former Yugoslav Republic of Macedonia, Serbia and Turkey). The challenges stemming from unofficial euroisation are particularly relevant for central banks as high degrees of euroisation reduce the effectiveness of monetary policy and create risks to financial stability. Unofficial euroisation in these countries is fuelled by legacies of inflation and macroeconomic imbalances, close economic and financial linkages with the euro area, as well as the perspective of EU membership. While euroisation (or, more generally, dollarisation) is typically a sticky phenomenon that is difficult to reverse, entrenched as it is in the behaviour and mind-set of economic agents, the paper finds - based also on the experience of countries outside the region - that there is a set of policies under the competence of domestic authorities which are conducive to strengthening the use of domestic currencies, even though efforts to bring down dollarisation or euroisation rates typically take a long time to show results. In this context, macroeconomic stabilisation is a necessary but not sufficient condition. It needs to be flanked by targeted prudential and regulatory measures, as well as efforts to develop local currency capital markets. Authorities in EU candidate and potential candidate countries have already engaged in such endeavours and euroisation rates have gone down to some extent in recent years, though at different levels and at an uneven pace. Nevertheless, further efforts are needed, while acknowledging that some specific factors like the strong presence of euro area headquartered banks in these countries as well as their EU accession perspective are conducive to euroisation. JEL Classification: E42, E52, E58, F31, F41, G28
    Keywords: bank regulation, capital markets, currency, dollarisation, euroisation, financial stability, monetary policy, prudential policy, South-East Europe
    Date: 2016–04
  15. By: Rajmund Mirdala
    Abstract: Time-varying exchange rate pass-through effects to domestic prices under fixed euro exchange rate perspective represent one of the most challenging implications of the common currency. The problem is even more crucial when examining crisis related redistributive effects associated with relative price changes. The degree of the exchange rate pass-through to domestic prices reveals its role as the external price shocks absorber especially in the situation when the leading path of exchange rates is less vulnerable to the changes in the foreign prices. Adjustments in domestic prices followed by exchange rate shifts induced by sudden external price shocks are associated with changes in the relative competitiveness among member countries of the currency area. In the paper we examine exchange rate pass-through to domestic prices in the Euro Area member countries to examine crucial implications of the nominal exchange rate rigidity. Our results indicate that absorption capabilities of nominal effective exchange rates clearly differ in individual countries. As a result, an increased exposure of domestic prices to the external price shocks in some countries represents a substantial trade-off of the nominal exchange rate stability.
    Keywords: exchange rate pass-through, inflation, Euro Area, VAR, impulse-response function
    JEL: C32 E31 F41
    Date: 2016–04
  16. By: Arias, Jonas E.; Erceg, Christopher J.; Trabandt, Mathias
    Abstract: This paper investigates the macroeconomic risks associated with undesirably low inflation using a medium-sized New Keynesian model. We consider different causes of persistently low inflation, including a downward shift in long-run inflation expectations, a fall in nominal wage growth, and a favorable supply-side shock. We show that the macroeconomic effects of persistently low inflation depend crucially on its underlying cause, as well as on the extent to which monetary policy is constrained by the zero lower bound. Finally, we discuss policy options to mitigate these effects.
    Keywords: Inflation Expectations ; Wages ; Productivity ; Disin ation ; Monetary Policy ; Liquidity Trap ; DSGE Model
    JEL: E52 E58
    Date: 2016–04–12
  17. By: Silvia Miranda-Agrippino (Bank of England; Centre for Macroeconomics (CFM))
    Abstract: The use of narrow time frames to measure monetary policy surprises using interest rate futures is potentially not sufficient to guarantee their exogeneity as proxies for monetary policy shocks. Raw monetary “surprises" are, in fact, predictable. These findings are interpreted as suggesting that time-varying risk premia and news shocks are likely to be captured in the measurement. The resulting violation of the identifying assumptions in Proxy SVARs induces non-trivial distortions in the estimation of the contemporaneous transmission coefficients: consequences for the estimation of structural IRFs can be dramatic, both qualitatively and quantitatively. This paper analyses the informational content of monetary surprises and proposes a new method to construct futures-based external instruments that conditions on both central banks' and market participants' information sets. Identification of monetary policy shocks via the orthogonal proxies is shown to retrieve contemporaneous transmission coefficients that are in line with macroeconomic theory even in small, potentially informationally insufficient VARs.
    Keywords: Monetary Surprises, Identification with External Instruments, Monetary Policy, Expectations, Information Asymmetries, Event Study, Proxy SVAR
    JEL: C36 E44 E52 G14
    Date: 2016–04
  18. By: Richard T. Froyen; Alfred V Guender (University of Canterbury)
    Abstract: This paper re-examines the merits of including an exchange rate response in Taylor-type interest rate rules for small open economies. Taylor (2001) and Taylor and Williams (2011) express what has been the conventional view: inclusion of the real exchange rate will either add little or might negatively affect the rule’s performance. We argue that developments in the theory of optimal monetary policy for open economies taken together with increased instability in world financial markets warrant a re-examination of the issue. Examining three flexible inflation targeting strategies, we find that a small weight on real exchange rate stability in the loss function is sufficient to improve the performance of Taylor-type rules relative to optimal policy. Gains are substantial for domestic and REX inflation targets because a small weight on real exchange rate fluctuations inhibits the aggressive use of the policy instrument under optimal policy. As real exchange rate stability is a built-in feature of a CPI inflation objective, the gains under a CPI inflation target are considerably lower. A central bank that values real exchange rate stability and follows a Taylor-type rule should respond to the real exchange rate. Doing so reduces relative losses irrespective of the specification of the inflation objective. Only a complete disregard for exchange rate stability bears out the view that there is no substantive role for the real exchange rate in Taylor-type rules.
    Keywords: CPI, Domestic, REX Inflation Targeting, Taylor-Type Rules, Timeless Perspective, Real Exchange Rate
    JEL: E3 E5 F3
    Date: 2016–02–20
  19. By: Matthias Morys
    Abstract: We add a historical and regional dimension to the debate on the Greek debt crisis. Analysing Greece, Romania, Serbia/Yugoslavia and Bulgaria from political independence to WW II, we find surprising parallels to the present: repeated cycles of entry to and exit from monetary unions, government debt build-up and default, and financial supervision by West European countries. Gold standard membership was more short-lived than in any other part of Europe due to fiscal dominance. Granger causality tests and money growth accounting show that the prevailing pattern of fiscal dominance was only broken under international financial control, when strict conditionality scaled back the treasury’s influence; only then were central banks able to conduct a rule-bound monetary policy and stabilize their exchange-rates. The long-run record of Greece suggests that the perennial economic and political objective of monetary union membership can only be achieved if both monetary and fiscal policy is effectively delegated abroad.
    Keywords: fiscal dominance, gold standard, financial supervision, South-East Europe
    JEL: N13 N14 N23 N24 E63 F34
    Date: 2016–04
  20. By: Beck, Günter Wilfried; Kotz, Hans-Helmut; Zabelina, Natalia
    Abstract: Non-bank (-balance sheet) based financial intermediation has become considerably more important over the last couple of decades. For the U.S., this trend has been discussed ever since the mid-1990s. As a consequence, traditional monetary transmission mechanisms, mainly operating through bank balance sheets, have apparently become less relevant. This in particular applies to the bank lending channel. Concurrently, recent theoretical and empirical work uncovered a "risk-taking channel" of monetary policy. This mechanism is not confined to traditional banks but has been found to operate also across the spectrum of financial intermediaries and intermediation devices, including securitization and collateralized lending/borrowing. In addition, recent empirical evidence suggests that the increasing importance of shadow-banking activities might have given rise to a so-called "waterbed effect". This is a mediating mechanisms, dampening or counteracting typically to be expected reactions to monetary policy impulses. Employing flow-of-funds data, we can document also for the Euro Area that a trend towards non-bank (not necessarily more 'market'-based) intermediation has occurred. This is, however, a fairly recent development, substantially weaker than in the U.S. Nonetheless, analyzing the response of Euro Area bank and nonbank financial intermediaries to monetary policy impulses, we find some notable behavioral differences between mainly deposit-funded and more 'market'-based financial intermediaries. We also detect, inter alia, the existence of a (still) fairly weak, but potentially policyrelevant, "waterbed" effect.
    Keywords: non-bank financial intermediation,interest-rate channel,credit channel,risk-taking channel of monetary policy,market-based financial intermediation,monetary transmission mechanism,waterbed effect
    Date: 2016
  21. By: Avci, S. Burcu; Yucel, Eray
    Abstract: Effectiveness of monetary policy depends on the degree to which policy interest rate affects all other financial prices, including the entire term structure of interest rates, credit rates, exchange rates and asset prices. An effective monetary policy framework can be seen as a pre-condition for well-functioning financial markets. However, effectiveness of the monetary policy is not straightforward to measure and requires empirical work to understand the effects of financial infrastructure, competitiveness of financial markets as well as current economic conditions. This paper examines the effectiveness of the monetary policy in Turkey by focusing on the interest rate pass-through behavior by means of an Interacted Panel Vector Autoregressive (IPVAR) approach. The results suggest that policy rate innovations transmit fully in less than eight months. Regulatory quality of the country, competition, liquidity, and profitability of banking sector, dollarization and exchange rate flexibility, inflation, and term structure have a positive effect on interest rate pass-through. Short-term credit ratio, GDP growth, monetary growth, and capital inflows have a negative effect.
    Keywords: Interest Rate Pass-through; Deposit and Credit Channels; Policy and Market Rates; Banking Sector; Interacted Panel Vector Autoregressive Methodology
    JEL: E43 E44 E58 F41
    Date: 2016–04–20

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