nep-mon New Economics Papers
on Monetary Economics
Issue of 2016‒05‒28
forty papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. New Zealand's experience with changing its inflation target and the impact on inflation expectations By Michelle Lewis; Dr John McDermott
  2. Money Demand in India By Basutkar, Tirupati
  3. How to escape a liquidity trap with interest rate rules By Duarte, Fernando M.
  4. Assessment of Macroprudential Policy in a Dual Banking Sector By Zulkhibri, Muhamed; Naiya, Ismaeel
  5. Large Depreciations: Recent Experience in Historical Perspective By José De Gregorio
  6. Challenges for Central Banks´ Macro Models By Lindé, Jesper; Smets, Frank; Wouters, Rafael
  7. East Asian Economies and Financial Globalization In the Post-Crisis World By Joshua Aizenman; Hiro Ito
  8. Too-Big-to-Fail before the Fed By Gorton, Gary; Tallman, Ellis W.
  9. Policy implications of learning from more accurate Central Bank Forecasts By Paul Hubert
  10. Financial De-Dollarization; A Global Perspective and the Peruvian Experience By Luis Catão; Marco Terrones
  11. Money demand in the Arab Republic of Egypt : a vector equilibrium correction model By Rostom,Ahmed Mohamed Tawfick
  12. Regional Financial Integration in East Asia against the Backdrop of Recent European Experiences By Ulrich Volz
  13. Foreign Exchange Intervention under Policy Uncertainty By Gustavo Adler; Ruy Lama; Juan Pablo Medina Guzman
  14. Targeting Constant Money Growth at the Zero Lower Bound By Michael T. Belongia; Peter N. Ireland
  15. (Money), Interest and Prices: Patinkin and Woodford : a speech at "A Conference in Honor of Michael Woodford’s Contributions to Economics" cosponsored by the Federal Reserve Bank of New York, Columbia University Program for Economic Research, and Columbia University Department of Economics, New York, New York, May 19, 2016. By Fischer, Stanley
  16. Cointegration and Causality among the Onshore and Offshore Markets for China's Currency By Owyong, David; Wong, Wing-Keung; Horowitz, Ira
  17. From bond yield to macroeconomic instability: The effect of negative interest rates By Maria Cristina Recchioni; Gabriele Tedeschi
  18. Accounting in central banks By Bholat, David; Darbyshire, Robin
  19. Do markets learn to rationally expect US interest rates? evidence from survey data By Georges Prat; Remzi Uctum
  20. The Real Effects of Capital Requirements and Monetary Policy: Evidence from the United Kingdom By De Marco, Filippo; Wieladek, Tomasz
  21. The Role and Limitations of Monetary Policy / Neel Kashkari, President...Minneapolis, MN...May 9, 2016 By Kashkari, Neel
  22. Nonlinearities, Smoothing and Countercyclical Monetary Policy By Jackson, Laura E.; Owyang, Michael T.; Soques, Daniel
  23. Monetary Policy, Bank Bailouts and the Sovereign-Bank Risk Nexus in the Euro Area By Marcel Fratzscher, DIW Berlin, Humboldt-University Berlin and CEPR; Malte Rieth, DIW Berlin
  24. From the “Great Inflation” to the “Great Moderation” in Peru: A Time Varying Structural Vector Autoregressions Analysis By Castillo, Paul; Montoya, Jimena; Quineche, Ricardo
  25. Cost channel, interest rate pass-through and optimal monetary policy under zero lower bound By Siddhartha Chattopadhyay; Taniya Ghosh
  26. Reverse speculative attacks: A comment By Alberto Martin
  27. Monetary policy and volatility in the sterling money market By Osborne, Matthew
  28. Review on Determinants of Capital Flight By Liew, Siew-Ling
  29. VAR meets DSGE; Uncovering the Monetary Transmission Mechanism in Low-Income Countries By Bin Grace Li; Stephen A. O'Connell; Christopher Adam; Andrew Berg; Peter Montiel
  30. Effective Macroprudential Policy; Cross-Sector Substitution from Price and Quantity Measures By Janko Cizel; Jon Frost; Aerdt G. F. J. Houben; Peter Wierts
  31. The Role of Money in Explaining Business Cycles for a Developing Economy: The Case of Pakistan By Shahzad Ahmad; Farooq Pasha; Muhammad Rehman
  32. Money and Velocity During Financial Crises: From the Great Depression to the Great Recession By Richard G. Anderson; Michael Bordo; John V. Duca
  33. On Monetary Policy, Unemployment, and Economic Growth By Rosas-Martinez, Victor H.
  34. The Great Escape? A Quantitative Evaluation of the Fed’s Liquidity Facilities By Marco Del Negro; Gauti Eggertsson; Andrea Ferrero; Nobuhiro Kiyotaki
  35. Recent Inflation Developments and Challenges for Research and Monetary Policymaking : The 47th Konstanz Seminar on Monetary Theory and Monetary Policy, Insel Reichenau, Germany 5-12-2016 By Mester, Loretta J.
  36. Aspects of Stickiness in Understanding Inflation By Kim, Minseong
  37. Credit, Securitization and Monetary Policy; Watch Out for Unintended Consequences By Andrea Pescatori; Juan Sole
  38. Financing Channel and Monetary Policy: Evidence from Islamic Banking in Indonesia By Zulkhibri, Muhamed; Sukmana, Raditya
  39. Optimal Inflation Rate in a Life-Cycle Economy By Takemasa Oda
  40. Let’s talk about the weather: the impact of climate change on central banks By Batten,, Sandra; Sowerbutts, Rhiannon; Tanaka, Misa

  1. By: Michelle Lewis; Dr John McDermott (Reserve Bank of New Zealand)
    Abstract: We document the experience of the Reserve Bank of New Zealand in changing its inflation target, particularly the effects on inflation expectations. Firstly, the Reserve Bank of New Zealand's DSGE model is used to highlight expectation-formation in the transmission following a change in the inflation target. Secondly, a Nelson-Siegel model is used to combine a number of inflation expectation surveys into a continuous curve where expectations can be plotted as a function of the forecast horizon. Using estimates of long-run inflation expectations derived from the Nelson-Siegel model, we find that numerical changes in the inflation target result in an immediate change in inflation expectations.
    Date: 2016–07
  2. By: Basutkar, Tirupati
    Abstract: There exist many approaches, both at theoretical and empirical levels, to compute money demand function. This paper attempts to derive a money demand function for Indian economy over the period 2004-2014.
    Keywords: Money Demand Function, Narrow Money, Broad Money, Indian Economy
    JEL: E52 E58
    Date: 2016–04
  3. By: Duarte, Fernando M. (Federal Reserve Bank of New York)
    Abstract: I give necessary and sufficient conditions under which interest-rate feedback rules eliminate aggregate instability by inducing a globally unique optimal equilibrium in a canonical New Keynesian economy with a binding zero lower bound. I consider a central bank that initially keeps interest rates pegged at zero for a length of time that depends on the state of the economy and then switches to a standard Taylor rule. There are two crucial principles to achieving global uniqueness. In response to deepening deflationary expectations, the central bank must, first, sufficiently extend the initial period of zero interest rates and, afterward, follow a Taylor rule that does not obey the Taylor principle. I obtain all results assuming a passive or Ricardian fiscal policy stance, so that it is monetary policy alone that eliminates undesired equilibria. The interest rate rules that I consider do not require central banks to undergo any significant institutional change and do not rely on the Neo-Fisherian mechanism of inducing an increase in inflation by first increasing interest rates.
    Keywords: zero lower bound (ZLB); liquidity trap; New Keynesian model; indeterminacy; monetary policy; Taylor rule; Taylor principle; interest rate rule; forward guidance
    JEL: E43 E52 E58
    Date: 2016–05–01
  4. By: Zulkhibri, Muhamed (The Islamic Research and Teaching Institute (IRTI)); Naiya, Ismaeel (Islamic Development Bank (IDB))
    Abstract: The paper synthesizes the growing literature on macroprudential policy in particular countries with a dual banking system. In a dual banking system, both conventional and Islamic financial institutions operate side-by-side, but specific laws and regulations have been introduced for the Islamic financial institutions. Based on the analysis there is no “one size fits all”; different models might be effective depending on the country specifics. The choice among the different macroprudential models is mostly influenced by traditions, current institutional frameworks for other policies and political economy considerations. Furthermore, there is no differentiation on macroprudential policy framework between conventional and Islamic financial institutions has been practiced by the authorities with dual banking system. The reason is to avoid regulatory arbitrage between these two financial institutions and the fact that Islamic financial institution is still largely based on mark-up or profit margin techniques in its operation
    Keywords: Macroprudential; Islamic Finance; Regulation; Systemic Risks
    JEL: G20 G21 G28
    Date: 2016–05–01
  5. By: José De Gregorio (Peterson Institute for International Economics)
    Abstract: Data for a large sample of countries dating back to the early 1970s reveal that the large depreciations against the dollar that are occurring in many countries are not unprecedented in magnitude or duration. The pass-through to inflation from exchange rate depreciation has been slightly more muted than in previous occasions, but it is not out of line with experience since the mid-1990s. The current account adjustment has been more limited than in the past, possibly suggesting that the period of weak currencies may be prolonged.
    Keywords: Current account adjustment, depreciation, exchange rate pass-through, inflation
    JEL: E31 F31 F32 F41
    Date: 2016–05
  6. By: Lindé, Jesper (Research Department, Central Bank of Sweden); Smets, Frank (ECB, KU Leuven and CEPR); Wouters, Rafael (National Bank of Belgium and CEPR)
    Abstract: In this paper we discuss a number of challenges for structural macroeconomic models in the light of the Great Recession and its aftermath. It shows that a benchmark DSGE model that shares many features with models currently used by central banks and large international institutions has difficulty explaining both the depth and the slow recovery of the Great Recession. In order to better account for these observations, the paper analyses three extensions of the benchmark model. First, we estimate the model allowing explicitly for the zero lower bound constraint on nominal interest rates. Second, we introduce time-variation in the volatility of the exogenous disturbances to account for the non-Gaussian nature of some of the shocks. Third and finally, we extend the model with a financial accelerator and allow for time-variation in the endogenous propagation of financial shocks. All three extensions require that we go beyond the linear Gaussian assumptions that are standard in most policy models. We conclude that these extensions go some way in accounting for features of the Great Recession and its aftermath, but they do not suffice to address some of the major policy challenges associated with the use of non-standard monetary policy and macroprudential policies.
    Keywords: Monetary policy; DSGE; and VAR models; Regime-Switching; Zero Lower Bound; Financial Frictions; Great Recession; Macroprudential policy; Open economy
    JEL: E52 E58
    Date: 2016–05–01
  7. By: Joshua Aizenman; Hiro Ito
    Abstract: This paper assesses the East Asian Economies’ openness to cross-border capital flows and exchange rate arrangements in the past decades, with the main focus on emerging market economies. Using Mundell’s trilemma indexes, we note that the convergence of the three policy goals in East Asia toward a “middle ground” pre-dates the convergence of these indices in other regions. Another more recent development involves the high level of international reserve (IR) holdings–a feature that is known as the most distinct characteristic of Asian EMEs. Financial globalization made asset prices and interest rates in Asian EMEs more vulnerable to global movements of capital, and to the monetary policy of the center country, the United-States. The U.S. presence in trade ties with Asian economies has been declining over the last two decades, whereas China’s has been on a rising trend. Yet, the share of trade among Asian economies with the dollar zone economies has been quite stable. China has been recently making efforts to “internationalize” its currency, the yuan (RMB). Hence, if China succeeds in its internationalization efforts and creates the RMB zone, the dynamics between the U.S. and Asia will most likely change. Recently, Chinese authorities have become more interventionist because of the slowdown of the economy and financial markets. For now, the Asian region’s international finance continues to be dollar-centric.
    JEL: F31 F36 F41 O24
    Date: 2016–05
  8. By: Gorton, Gary (Yale School of Management); Tallman, Ellis W. (Federal Reserve Bank of Cleveland)
    Abstract: “Too-big-to-fail” is consistent with policies followed by private bank clearing houses during financial crises in the U.S. National Banking Era prior to the existence of the Federal Reserve System. Private bank clearing houses provided emergency lending to member banks during financial crises. This behavior strongly suggests that “too-big-to-fail” is not the problem causing modern crises. Rather, it is a reasonable response to the threat posed to large banks by the vulnerability of short-term debt to runs.
    Keywords: Financial crisis; bank runs; banking panic; clearing house; bank-specific information; currency premium;
    JEL: E02 E32 E42 E52 E58
    Date: 2016–05–06
  9. By: Paul Hubert (OFCE)
    Abstract: How might central bank communication of its internal forecasts assist the conduct of monetary policy? The literature has shown that heterogeneous expectations may have destabilizing effects on aggregate dynamics. This paper analyzes through adaptive learning the policy implications of central bank influence of private forecasts stemming from more accurate central bank forecasts. In this case, the central bank must only respect the Taylor principle to ensure macroeconomic stability, in contrast to the situation where private agents are learning from less accurate central bank forecasts.
    Keywords: Adaptive Learning; Taylor Principle; Monetary Policy
    JEL: E5 D8
    Date: 2015–03
  10. By: Luis Catão; Marco Terrones
    Abstract: We re-appraise the cross-country evidence on the dollarization of financial systems in emerging market economies. Amidst striking heterogeneity of patterns across regions, we identify a broad global trend towards financial sector de-dollarization from the early 2000s to the eve of the global financial crisis of 2008–09. Since then, de-dollarization has broadly stalled or even reversed in many economies. Yet a few of them have continued to de-dollarize. This suggests that domestic factors are also important and interact with global factors. To gain insight into such an interaction, we examine the experience of Peru since the early 1990s and find that low global interest rates, low global risk-aversion, and high commodity prices have fostered de-dollarization. Domestic macro-prudential measures that raise the relative cost of domestic dollar loans and the introduction and adherence to inflation targeting have also been key.
    Keywords: Dollarization;Peru;Financial sector;Currency substitution;Emerging markets;Macroprudential Policy;Regression analysis;Dollarization, Currrency Substitution, Monetary Policy, Emerging Markets.
    Date: 2016–04–26
  11. By: Rostom,Ahmed Mohamed Tawfick
    Abstract: Money demand is critical for defining monetary policy options and is not driven necessarily by developed country standards of transaction demand, speculation motive, and opportunity costs grounded by fully functioning financial markets. However, market imperfections in less developed economies can also play a critical role in the dynamics of demand for money. This paper estimates a vector equilibrium correction model to investigate the nature of short-term and long-term interactions for money demand in the Arab Republic of Egypt. The paper concludes that real money demand in Egypt during (1958-2013) is stable and can be considered confidently by monetary authorities to adjust for long-term growth in the real economy. The rate of devaluation of the official exchange rate and inflation have a serious effect on the public's trust in the national currency in the long term. Money is not neutral for long-term portfolio decisions, because of the increase in real income in the economy that couples with an uptrend in monetization as the ratio of money stock over output also uptrends. The paper also provides quantitative evidence that the devaluation within the parallel market is negatively related to the change in demand for real money balances in the short term. Economic agents hold more domestic currency if the official exchange rate slides, and arbitrage opportunities are sought in the parallel market.
    Keywords: Currencies and Exchange Rates,Debt Markets,Economic Theory&Research,Emerging Markets,Fiscal&Monetary Policy
    Date: 2016–05–18
  12. By: Ulrich Volz (Department of Economics, SOAS, University of London, UK)
    Abstract: This paper discusses recent trends in regional financial integration in East Asia and current efforts of the Association of Southeast Asian Nations (ASEAN) member countries to foster regional financial integration against the backdrop of three decades of experience with financial integration in Europe. It reviews the two major crisis episodes of the recent European financial history to illustrate the risks associated with comprehensive capital account liberalisation and financial integration without commensurate supervisory structures. The paper highlights the importance of targeted macroprudential policies and the development of an adequate region-wide regulatory and supervisory framework to reduce the risks associated with regional ñ and hence international ñ financial integration.
    Keywords: Regional financial integration, East Asia, financial stability
    JEL: E44 F36
  13. By: Gustavo Adler; Ruy Lama; Juan Pablo Medina Guzman
    Abstract: We study the use of foreign exchange (FX) intervention as an additional policy instrument in an environment with learning, where agents infer the central bank policy rules from its policy actions. Under full information, a central bank focused on stabilizing output and inflation can achieve better outcomes by using FX intervention as an additional policy tool. Under policy uncertainty, where agents perceive that monetary policy may also have exchange rate stabilization goals, the use of FX intervention entails a trade-off, reducing output volatility while increasing inflation volatility. While having an additional policy tool is always beneficial, we find that the optimal magnitude of intervention is higher in monetary policy regimes with lower uncertainty. These results indicate that the benefits of using FX intervention as an additional stabilization tool are greater in regimes where monetary policy is credibly focused on output and inflation stabilization.
    Keywords: Foreign exchange;Central banks and their policies;Foreign Exchange Intervention, Monetary Policy, Learning, inflation, central bank, exchange, currency, Open Economy Macroeconomics,
    Date: 2016–03–17
  14. By: Michael T. Belongia (University of Mississippi); Peter N. Ireland (Boston College)
    Abstract: Unconventional policy actions, including quantitative easing and forward guidance, taken by the Federal Reserve during and since the financial crisis and Great Recession of 2007-2009, have been widely interpreted as attempts to influence long-term interest rates after the federal funds rate hit its zero lower bound. Alternatively, similar actions could have been directed at stabilizing the growth rate of a monetary aggregate, so as to maintain a more consistent level of policy accommodation in the face of severe disruptions to the financial sector and the economy at large. This paper bridges the gap between these two views, by developing a structural vector autoregression that uses information contained in both interest rates and a Divisia monetary aggregate to infer the stance of Federal Reserve policy and to gauge its effects on aggregate output and prices. Counterfactual simulations from the SVAR suggest that targeting money growth at the zero lower bound would not only have been feasible, but would also have supported a stronger and more rapid economic recovery since 2010.
    Keywords: Constant money growth rate rules, Divisia monetary aggregates, Quantitative easing, Structural vector autoregressions, Zero lower bound
    JEL: E31 E32 E37 E41 E43 E47 E51 E52 E65
    Date: 2016–05–25
  15. By: Fischer, Stanley (Board of Governors of the Federal Reserve System (U.S.))
    Date: 2016–05–19
  16. By: Owyong, David; Wong, Wing-Keung; Horowitz, Ira
    Abstract: China has taken steps to develop offshore markets for renminbi trading and to liberalize exchange-rate determination in its onshore market. We examine the interaction between onshore and offshore markets with attention to how the interaction has been affected by widening of the onshore trading band first in April 2012 and further in March 2014. Ties between the onshore and offshore markets were closest before the first band widening and steadily loosened thereafter. We further study the cointegration and lead-lag effects between offshore and onshore spot and forward markets and show that there is a long-term equilibrium relationship between any pair of them. Our results suggest stronger causality running from the spot onshore rate to the spot offshore rate than vice versa. Between the spot and forward markets, there is evidence of bidirectional linear and nonlinear causality, which implies foreign impulses have had an influence on the domestic market.
    Keywords: RMB; onshore and offshore markets; spot and forward markets; liberalization; cointegration
    JEL: F31 G12
    Date: 2015–10–11
  17. By: Maria Cristina Recchioni (Department of Managment, Università Politecnica delle Marche, Ancona, Italy); Gabriele Tedeschi (Department of Economics, Universidad Jaume I, Castellón, Spain)
    Abstract: We present a hybrid Heston model with a local stochastic volatility to describe government bond yield dynamics. The model is analytically tractable and, therefore, can be efficiently estimated using the maximum likelihood approach. Twofold is the model contribution. First, it captures changes in the yield volatility and predict future yield values of Germany, French, Italy and Spain. The result is an early-warning indicator which anticipates phases of instability characterizing the time series investigated. Then, the model describes convergence/divergence phenomena among European government bond yields and explores the countries' reactions to a common monetary policy described through the EONIA interbank rate.
    Keywords: Stochastic volatility model, Kolmogorov backward equation, maximum likelihood function, government bond yield forecasting
    JEL: C13 C32 G12 G17 E58
    Date: 2016
  18. By: Bholat, David (Bank of England); Darbyshire, Robin
    Abstract: This paper examines the important but not often discussed issue of accounting in central banks. It highlights the distinguishing factors that make the financial statements of central banks unique relative to those produced by other bodies. We begin by explaining why central banks produce financial statements. We then discuss a variety of specific topics in central bank accounting. In terms of balance sheet items, we discuss banknotes, shareholders’ equity, gold, foreign exchange and financial instruments. Our discussion of the income statement then centres on profit recognition and distribution.
    Keywords: Central bank accounting; central bank balance sheet; seigniorage; central bank capital;
    JEL: E58 G20 H83 M40 M41 M48
    Date: 2016–05–20
  19. By: Georges Prat; Remzi Uctum
    Abstract: Using Consensus Economics survey data on the US 3-month bill rate and the 10 years Treasury bonds expectations for the 3- and 12-month horizons over the period November 1989 – May 2015, this article aims at testing whether a group of rational forecasters coexists with or emerges over time beside a group of forecasters employing the traditional limited information-based rules that are the extrapolative, the adaptive, the regressive and the forward-market premium rules. We estimate the time-varying weights associated with the two groups using the Kalman filter methodology and find that the aggregate expectations fail to exhibit a learning process towards rationality both for short term and long term interest rates. While long term interest rate expectations appear to be explained only by limited information rules at any time, in the case of the short term interest rate a group of rational agents seems to have operated in the market over the whole period with a small but almost constant weight simultaneously with limited information-based forecasters. Overall, for both short and long term interest rates, our results strongly suggest that experts’ forecasts are essentially based on a combination of the four traditional processes. This is consistent with the economically rational expectations theory which suggests that information costs and agents’ aversion to misestimating future interest rates determine the optimal amounts of information on which they base their expectations.
    Keywords: expectation formation, interest rates, dynamic heterogeneity, survey data.
    JEL: D84 F31 G14
    Date: 2016
  20. By: De Marco, Filippo; Wieladek, Tomasz
    Abstract: We study the effects of bank-specific capital requirements on Small and Medium Enterprises (SMEs) in the UK from 1998 to 2006. Following a 1% increase in capital requirements, SMEs' asset growth contracts by 6.9% in the first year of a new bank-firm relationship, but the effect declines over time. We also compare the effects of capital requirements to those of monetary policy. Monetary policy only affects firms with higher credit risk and those borrowing from small banks, whereas capital requirements affect both. Capital requirement changes, instead, do not affect firms with alternative sources of finance, but monetary policy shocks do.
    Keywords: Capital requirements; Firm-level real effects; prudential and monetary policy.; relationship lending; SMEs
    JEL: E51 G21 G28
    Date: 2016–05
  21. By: Kashkari, Neel (Federal Reserve Bank of Minneapolis)
    Date: 2016–05–09
  22. By: Jackson, Laura E. (Bentley University); Owyang, Michael T. (Federal Reserve Bank of St. Louis); Soques, Daniel (University of North Carolina, Wilmington.)
    Abstract: Empirical analysis of the Fed’s monetary policy behavior suggests that the Fed smooths interest rates— that is, the Fed moves the federal funds rate target in several small steps instead of one large step with the same magnitude. We evaluate the effect of countercyclical policy by estimating a Vector Autoregression (VAR) with regime switching. Because the size of the policy shock is important in our model, we can evaluate the effect of smoothing the interest rate on the path of macro variables. Our model also allows for variation in transition probabilities across regimes, depending on the level of output growth. Thus, changes in the stance of monetary policy affect the macroeconomic variables in a nonlinear way, both directly and indirectly through the state of the economy. We also incorporate a factor summarizing overall sentiment into the VAR to determine if sentiment changes substantially around turning points and whether they are indeed important to understanding the effects of policy.
    Keywords: Time-varying transition probabilities; Markov-switching; monetary policy
    JEL: C24 E32
    Date: 2016–05–11
  23. By: Marcel Fratzscher, DIW Berlin, Humboldt-University Berlin and CEPR; Malte Rieth, DIW Berlin
    Abstract: The paper analyses the empirical relationship between bank risk and sovereign credit risk in the euro area. Using structural VAR with daily financial markets data for 2003-13, the analysis confirms twoway causality between shocks to sovereign risk and bank risk, with the former being overall more important in explaining bank risk, than vice versa. The paper focuses specifically on the impact of non-standard monetary policy measures by the European Central Bank and on the effects of bank bailout policies by national governments. Testing specific hypotheses formulated in the literature, we find that bank bailout policies have reduced credit risk in the banking sector, but partly at the expense of raising the credit risk of sovereigns. By contrast, monetary policy was in most, but not all cases effective in lowering credit risk among both sovereigns and banks. Finally, we find spillover effects in particular from sovereigns in the euro area periphery to the core countries.
    JEL: E52 G10 E60
    Date: 2015–09
  24. By: Castillo, Paul (Banco Central de Reserva del Perú); Montoya, Jimena (Banco Central de Reserva del Perú); Quineche, Ricardo (Banco Central de Reserva del Perú)
    Abstract: Over the last 30 years, the Peruvian economy has shown a dramatic decrease in the volatility of its macroeconomic aggregates. Following Primiceri (2005), Benati (2008) and Galí and Gambetti (2009), a Bayesian structural vector autoregression with time-varying parameters and variance covariance matrix of the innovations is used to analyse the underlying causes of Peruvian "Great Moderation". The Peruvian economy is modelled using real GDP growth, inflation and the rate of growth of M1 (money base). Our main results show: (1) Monetary policy has contributed significantly to the "Great Moderation" by reducing the volatility of its non-systematic component and by changing its reaction function to demand and supply shocks; (2) Structural reforms also contributed to reduce the responsiveness of GDP and inflation to demand and supply shocks; (3) During the period of high volatility, supply and policy shocks were the most important determinants of macroeconomic instability.
    Keywords: time varying coe¢ cients, multivariate stochastic volatility, Gibbs sampling, systematic monetary policy, monetary policy shocks, identi cation
    JEL: C15 C22 E23 E24 E31 E32 E47 E52 E58
    Date: 2016–04
  25. By: Siddhartha Chattopadhyay (Indian Institute of Technology, Kharagpur); Taniya Ghosh (Indira Gandhi Institute of Development Research)
    Abstract: Cost channel introduces trade-off between inflation rate and output gap. Unlike the canonical New Keynesian DSGE model, optimal monetary policy cannot set both inflation rate and output gap simultaneously to zero under a demand shock. Using a perfect foresight New Keynesian model with cost channel, this paper analyzes the optimal discretionary monetary policy under Zero Lower Bound (ZLB) for varying degree of interest rate pass-through. We find (i) exit date from ZLB becomes endogenous due to the trade-off between output gap and inflation introduced by the cost channel; (ii) presence of cost channel delays the exit from ZLB compared to models without cost channel; and (iii) exit date rises monotonically with the magnitude of demand shock and degree of interest rate pass-through.
    Keywords: New-Keynesian Model, Inflation Target, Liquidity Trap
    JEL: E63 E52 E58
    Date: 2016–05
  26. By: Alberto Martin
    Abstract: Introduction: Imagine the case of a Central Bank that wants to peg its currency to the Euro at some predetermined exchange rate. Imagine moreover that, at this exchange rate, there is an excess demand of domestic currency by foreigners. Conventional wisdom suggests that there is no problem whatsoever for the Central Bank to achieve its objective: all it needs to do is to expand the supply of domestic currency to accommodate whatever demand there is at the chosen exchange rate. In the process of doing so, the Central Bank will expand both its assets, i.e., foreign reserves, and its liabilities, i.e., domestic currency. Since the Central Bank can issue as much domestic currency as it desires, there is in principle no limit to the size of this policy intervention. In this interesting paper, Amador, Bianchi, Bocola and Perri (henceforth ABBP) propose a model that illustrates the limits to this conventional wisdom.
    Date: 2016–04
  27. By: Osborne, Matthew (Bank of England)
    Abstract: Money market volatility may disrupt the transmission mechanism of monetary policy as well as increase uncertainty for market participants. This paper assesses the impact of reforms to the Bank of England’s operating framework over the last two decades. These reforms have been successful in reducing overnight volatility. A new framework in 2006 which introduced reserves averaging and voluntary reserve targets was associated with lower volatility of overnight rates. Further reductions in volatility were associated with interim reforms and communications prior to the launch of this new framework. The injection of excess reserves under the floor system introduced in 2009 has been associated with a further reduction in volatility. Despite these encouraging findings, further analysis shows that the volatility of overnight rates had little effect on the volatility of longer-term rates except in the pre-2006 ‘zero reserves’ period and no effect at all on three-month Libor rates, which are the key benchmark for many derivatives and bank loans. Since longer-term rates are more important than overnight rates for the transmission of monetary policy to the real economy, the results provide limited support for prioritising the reduction of volatility in the design of central banks’ operating frameworks. The results also suggest that additional communication regarding likely future monetary policy decisions is associated with lower volatility of term rates.
    Keywords: Money market; monetary policy; interest rates; Bank of England
    JEL: E43 E44 E52 E58 G21
    Date: 2016–04–08
  28. By: Liew, Siew-Ling
    Abstract: Capital flight is the shift of one investment to another in search of greater prospect or increased returns. Capital flight is sometimes stimulated by a nation’s unfavorable conditions where the country may be undergoing high inflation or political turmoil. However, it is most commonly seen at times of currency instability. Most of the time, the outflows are large enough to affect a country’s entire financial system. Simply to say, such phenomenon is bad for the home country as it deters the economy. This is especially true for developing countries whereby the nation’s financial status is often not strong enough to sustain huge amount of capital flight.
    Keywords: Literature review,capital flight, economic growth
    JEL: F0
    Date: 2016–04–02
  29. By: Bin Grace Li; Stephen A. O'Connell; Christopher Adam; Andrew Berg; Peter Montiel
    Abstract: VAR methods suggest that the monetary transmission mechanism may be weak and unreliable in low-income countries (LICs). But are structural VARs identified via short-run restrictions capable of detecting a transmission mechanism when one exists, under research conditions typical of these countries? Using small DSGEs as data-generating processes, we assess the impact on VAR-based inference of short data samples, measurement error, high-frequency supply shocks, and other features of the LIC environment. The impact of these features on finite-sample bias appears to be relatively modest when identification is valid—a strong caveat, especially in LICs. However, many of these features undermine the precision of estimated impulse responses to monetary policy shocks, and cumulatively they suggest that “insignificant†results can be expected even when the underlying transmission mechanism is strong.
    Keywords: Monetary transmission mechanism;Low-income developing countries;Variables (Mathematics);Vector autoregression;General equilibrium models;Monetary Transmission Mechanism; Monetary Policy; Low Income Countries; Vector Autoregression Methods; Monte Carlo Methods
    Date: 2016–04–11
  30. By: Janko Cizel; Jon Frost; Aerdt G. F. J. Houben; Peter Wierts
    Abstract: Macroprudential policy is increasingly being implemented worldwide. Its effectiveness in influencing bank credit and its substitution effects beyond banking have been a key subject of discussion. Our empirical analysis confirms the expected effects of macroprudential policies on bank credit, both for advanced economies and emerging market economies. Yet we also find evidence of substitution effects towards nonbank credit, especially in advanced economies, reducing the policies’ effect on total credit. Quantity restrictions are particularly potent in constraining bank credit but also cause the strongest substitution effects. Policy implications indicate a need to extend macroprudential policy beyond banking, especially in advanced economies.
    Date: 2016–04–21
  31. By: Shahzad Ahmad (State Bank of Pakistan); Farooq Pasha (State Bank of Pakistan); Muhammad Rehman (State Bank of Pakistan)
    Abstract: This paper theoretically evaluates the role of money and monetary policy in propagating business cycle fluctuations of Pakistan’s economy. We introduce the role of money via money in utility (MIU) and cash in advance constraint (CIA) in simple closed economy DSGE models and analyze monetary policy through a money growth rule as well as Taylor type interest rate rule. We establish the theoretical and empirical linkages between nominal and real variables of Pakistan’s economy for post financial liberalization era. We find that the cash base economy models under money growth rule matches the data relatively better compared to cashless economy with Taylor rule.
    Keywords: General Equilibrium Models, Modeling and Simulations, Monetary Policy
    JEL: D58 E27 E52
    Date: 2016–04
  32. By: Richard G. Anderson; Michael Bordo; John V. Duca
    Abstract: This study offers a single, consistent model that tracks the velocity of broad money (M2) since 1929, including the Great Depression, the global financial crisis, and the Great Recession. The model emphasizes the roles of changes in uncertainty and risk premia, financial innovation, and major banking regulations. Our findings suggest an enhanced role of a broad, liquid money aggregate as a policy guide during crises and their unwinding. Following crises, policymakers face the challenge of not only unwinding their balance sheet so as to prevent excess reserves from fueling a surge in M2, but also countering a fall in the demand for money as risk premia return to normal amid velocity shifts stemming from relevant financial reforms.
    Keywords: money demand, financial crises, monetary policy, liquidity, financial innovation
    JEL: E41 E50 G11
    Date: 2016–05
  33. By: Rosas-Martinez, Victor H.
    Abstract: Recognizing the possible relation between investments, economic growth and unemployment, and how there is not an established impact of an unlikely productive project failure on the secondly mentioned variables, we address such relation and asses theoretically the effect of different instruments of monetary policy on the mentioned macroeconomic indicators. To do this we modify two models of economic growth by considering the role of entrepreneurs, risk takers, and a monetary authority which is the average agent of the economy that is assumed to be aware of how the inflation can damage equally the individuals' life style, independently of their particular levels of income, finding that the impact of the monetary instruments depends on the behavior of the population.
    Keywords: Monetary Authority; Endogenous expansive policy; Inflation; Unemployment; Economic Growth
    JEL: E2 E5 O3 O4
    Date: 2016–01–19
  34. By: Marco Del Negro; Gauti Eggertsson; Andrea Ferrero; Nobuhiro Kiyotaki
    Abstract: We introduce liquidity frictions into an otherwise standard DSGE model with nominal and real rigidities and ask: Can a shock to the liquidity of private paper lead to a collapse in short-term nominal interest rates and a recession like the one associated with the 2008 U.S. financial crisis? Once the nominal interest rate reaches the zero bound, what are the effects of interventions in which the government provides liquidity in exchange for illiquid private paper? We find that the effects of the liquidity shock can be large, and show some numerical examples in which the liquidity facilities prevented a repeat of the Great Depression in 2008-2009.
    JEL: E44 E58
    Date: 2016–05
  35. By: Mester, Loretta J. (Federal Reserve Bank of Cleveland)
    Abstract: It seems clear to me that if there is one topic that would benefit from better understanding the interplay of theory and policy, it is inflation. For a monetary policymaker, price stability is the Holy Grail — price stability is the one thing that monetary policy can ensure over the longer run, and monetary policy is the only tool that can ensure price stability over the longer run. The benefits of price stability for the economy are clear.2 Stable prices mean businesses and households don’t have to spend time trying to protect the purchasing power of their money; they can make long-term plans and commitments without having to deal with the uncertainty about the value of their money. When the price level is stable, any price changes reflect changes in the supplies of certain goods or services relative to others and this information is helpful to businesses and consumers when they have to allocate their scarce resources. Price stability also promotes other goals like financial stability and confidence in the economy, thereby supporting growth and maximum employment, the other part of the Federal Reserve’s dual mandate.
    Keywords: monetary policy; inflation; prices;
    Date: 2016–05–12
  36. By: Kim, Minseong
    Abstract: This paper examines the question of how conventional understanding of inflation relates to stickiness. Several results that often go unnoticed are re-examined.
    Keywords: theory of price level; theory of inflation; stickiness; New Keynesian; uniqueness; explosive path; stability
    JEL: E12 E13 E31 E52
    Date: 2016–04–30
  37. By: Andrea Pescatori; Juan Sole
    Abstract: We show evidence that interest rate hikes slowdown loan growth but lead intermediation to migrate from banks’ balance sheets to non-banks via increased securitization activity. As such, higher interest rates have the potential for unintended consequences; raising systemic risk rather than lowering it by pushing more intermediation activity to more weakly regulated sectors. In the past, this increased securitization activity was driven primarily byb private-label securitization. On the other hand, the government sponsored entities like Freddie Mac and Fannie Mae appear to react to higher policy rates by cutting back on their securitization activity but expanding loans to the Federal Home Loan Bank system.
    Keywords: Monetary policy;United States;Interest rate increases;Credit expansion;Nonbank financial sector;Securities;Mortgages;Financial intermediaries;Monetary policy; monetary policy shocks; VAR; proxy VAR; financial intermediation; shadow banking; securitization; GSE; private-label ABS issuers.
    Date: 2016–03–23
  38. By: Zulkhibri, Muhamed (The Islamic Research and Teaching Institute (IRTI)); Sukmana, Raditya (The Islamic Research and Teaching Institute (IRTI))
    Abstract: Using Indonesia Islamic banks data from 2003 to 2014, this paper employs panel regression methodology by investigating the responses of Islamic banks to changes in financing rate and monetary policy may differ, depending on their characteristics. The results suggest that the financing rate has negative impact on Islamic bank financing, while bank-specific characteristics have positive influence on Islamic bank financing. The degree of size and capital have greater impact than liquidity on Islamic bank financing. On the other hand, changes in monetary policy is insignificant on bank financing, which implies that the transmission of monetary policy through the Islamic segment of the banking sector is weak. Furthermore, the weak impact of monetary policy on bank financing can be explained by the dramatic expansion of Islamic banks during this sample period, which contributed to substantial increase in deposit growth and high liquidity position.
    Keywords: Islamic Banks; Financing Rate; Financing Channels; Monetary Policy; Panel Regression
    JEL: E44 E52
    Date: 2016–03–01
  39. By: Takemasa Oda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: This paper investigates long-run effects of inflation and deflation in a monetary life-cycle model that incorporates both capital stock and elastic labor supply as production factors. The model also introduces the zero lower bound on the nominal interest rate. The findings of this paper are twofold. First, in contrast to a result obtained from most neoclassical monetary models with an infinitely lived representative agent, the Friedman rule is not optimal and mild inflation can be desirable in this model. The Tobin effect on capital stock is encouraged by redistribution among households and therefore dominates distortionary effects of the inflation tax on labor supply and consumption. Importantly, the optimal rate of inflation depends on how inflation tax revenues are rebated to households. Second, there is a remarkable asymmetry in terms of welfare costs between inflation and deflation. For a lower rate of inflation than the rate that makes the nominal interest rate just zero, the Tobin effect works strongly in a deflationary direction because households are willing to hold more money, thus depressing aggregate output and social welfare significantly. This result reinforces the validity of pursuing mild inflation to evade the risk of hitting the zero lower bound.
    Keywords: Friedman rule, Zero lower bound, Tobin effect, Inflation tax, Redistribution
    JEL: E31 E58 O42
    Date: 2016–04
  40. By: Batten,, Sandra (Bank of England); Sowerbutts, Rhiannon (Bank of England); Tanaka, Misa (Bank of England)
    Abstract: This paper examines the channels via which climate change and policies to mitigate it could affect a central bank’s ability to meet its monetary and financial stability objectives. We argue that two types of risks are particularly relevant for central banks. First, a weather-related natural disaster could trigger financial and macroeconomic instability if it severely damages the balance sheets of households, corporates, banks, and insurers (physical risks). Second, a sudden, unexpected tightening of carbon emission policies could lead to a disorderly re-pricing of carbon-intensive assets and a negative supply shock (transition risks). Climate-related disclosure could facilitate an orderly transition to a low-carbon economy if it helps a wide range of investors better assess their financial risk exposures.
    Keywords: Climate change; natural disasters; financial stability; monetary policy;
    JEL: E58 G21 G22 Q43 Q54
    Date: 2016–05–20

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