nep-mon New Economics Papers
on Monetary Economics
Issue of 2016‒07‒09
twenty-six papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Inflation expectations and low inflation in New Zealand By Özer Karagedikli; Dr John McDermott
  3. Financial factors and monetary policy: Determinacy and learnability of equilibrium By Paul Kitney
  5. The Nature of Money in Modern Economy – Implications and Consequences By Al-Jarhi, Mabid
  6. Monetary policy and economic growth in Kenya:The role of money supply and interest rates By Nyorekwa, Enock Twinoburyo; Odhiambo, Nicholas Manya
  7. "From Antigrowth Bias to Quantitative Easing: The ECB's Belated Conversion?" By Jorg Bibow
  8. How Successful Are Banking Sector Reforms in Emerging Market Economies? Evidence from Impact of Monetary Policy on Levels and Structures of Firm Debt in India By Bhaumik, Sumon K.; Kutan, Ali M.; Majumdar, Sudipa
  9. Opportunities and risks associated with the advent of digital currency in the Caribbean By Bissessar, Shiva
  10. Monetary Policy with 100 Percent Reserve Banking: An Exploration By Prescott, Edward C.; Wessel, Ryan
  11. A shadow rate model with time-varying lower bound of interest rates By Kortela, Tomi
  12. Credit, Money and Asset Equilibria with Indivisible Goods By Han Han; Benoit Julien; Asgerdur Petursdottir; Liang Wang
  13. Measuring the natural rate of interest: International trends and determinants By Holston, Kathryn; Laubach, Thomas; Williams, John C.
  14. Assessing the economic value of probabilistic forecasts in the presence of an inflation target By Chris McDonald; Craig Thamotheram; Shaun P. Vahey; Elizabeth C. Wakerly
  15. The Effect of Monetary Policy on Housing Tenure Choice as an Explanation for the Price Puzzle By Dias, Daniel A.; Duarte, Joao B.
  16. Forward Guidance and Macroeconomic Outcomes Since the Financial Crisis By Campbell, Jeffrey R.; Fisher, Jonas D. M.; Justiniano, Alejandro; Melosi, Leonardo
  17. Search-based endogenous asset liquidity and the macroeconomy By Cui, Wei; Radde, Sören
  18. De facto exchange-rate regimes in Central and Eastern European Countries By Simón Sosvilla Rivero; Maria del Carmen Ramos Herrera
  19. Did the Founding of the Federal Reserve Affect the Vulnerability of the Interbank System to Systemic Risk? By Carlson, Mark A.; Wheelock, David C.
  20. Bill Of Exchange - A Modern And Efficient Instrument Of Payment Within The Commercial Relations By Mihai, Gabriel
  21. The Effectiveness of Monetary Policy in South Africa under Inflation Targeting: Evidence from a Time-Varying Factor-Augmented Vector Autoregressive Model By Goodness C. Aye; Mehmet Balcilar; Rangan Gupta
  22. Monetary Versus Macroprudential Policies: Causal Impacts of Interest Rates and Credit Controls in the Era of the UK Radcliffe Report By Aikman, David; Bush, Oliver; Taylor, Alan M.
  23. A Demand Theory of the Price Level By Hagedorn, Marcus
  24. Optimal Monetary Policy in an Open Emerging Market Economy By Iyer, Tara
  25. Euro currency risk and the geography of debt flows to peripheral European monetary union members By Ersal-Kiziler,Eylem; Nguyen,Ha Minh
  26. The effectiveness of the European Central Bank’s Asset Purchase Programme By Maria Demertzis; Guntram B. Wolff

  1. By: Özer Karagedikli; Dr John McDermott (Reserve Bank of New Zealand)
    Abstract: This paper finds that the changing behaviour of inflation expectations can explain much of the unusually low inflation in New Zealand. Across several empirical specifications of the Phillips curve, we observe that inflation expectations have become more backward-looking. We also find that the speed of adjustment in inflation expectations, proxied by the spread between short- and longer-term inflation expectations, can explain the unusually low inflation.
    Date: 2016–06
  2. By: Elisabetta Montanaro (Ragnar Nurkse School of Innovation and Governance, Tallinn University of Technology)
    Abstract: The post-crisis political and theoretical developments have produced a profound reappraisal of central banks’ mandate in achieving and maintaining financial stability. This evolution has had important consequences for the institutional architecture of financial supervision and for the role assigned to central banks within it. The paper aims to analyse the rationale of this evolution and to what extent it has characterised the reforms introduced by EU countries after the crisis. The empirical analysis confirms the wider mandate for financial stability given to EU central banks, mainly in those countries whose structural vulnerabilities arise from high degree of financialisation. The reforms associated to this process always result from political choices: in this respect, the different path towards the new architecture, which has characterised the UK and Germany can be taken as the two most interesting cases. They show the complex interactions between political pressure, resistance and ambitions of the various existing authorities, and the country’s heritage, which characterise every stage of institutional reform, especially where significant supervisory failures have been found.
    Keywords: models of financial supervision; twin-peaks; central banks; financial reforms; Bank of England; Bundesbank; EU countries
    JEL: E58 G01 G28
    Date: 2016–01–30
  3. By: Paul Kitney
    Abstract: This paper contributes to the debate whether central banks should respond to asset prices, credit spreads and other financial factors in setting monetary policy, by evaluating determinacy and expectational stability of equilibria under various monetary policy rules. With adaptive learning, beliefs constitute an additional set of state variables, which may require more than a response to inflation, that has traditionally been argued in the literature as sufficient to achieve central bank objectives under rational expectations. Furthermore, financial frictions are introduced by extending the determinacy and adaptive learning methodology embodied in Bullard and Mitra (2002) and Bullard and Mitra (2007), beyond the New Keynesian modelling framework by incorporating a Financial Accelerator (Bernanke, Gertler and Gilchrist 1999). A key result is that monetary policy rules responding to lagged asset prices and credit volume have less desirable determinacy and learnability characteristics than responding to current asset prices and credit spreads. This conclusion dovetails with recent research such as Gilchrist and Zakrajsek (2011) and Gilchrist and Zakrajsek (2012), who show that signals derived from credit spreads contain information which help explain business cycle fluctuations and demonstrate that a credit spread augmented monetary policy rule dampens cycle variability. Another result is that the conclusions in both Bullard and Mitra (2002) and Bullard and Mitra (2007) are robust to a New Keynesian model with financial frictions.
    Keywords: DSGE, financial frictions, learning, determinacy, e-stability, expectations, asset prices, credit spreads, financial factors, monetary policy, Taylor rule
    JEL: E43 E44 E50 E52 E58
    Date: 2016–07
  4. By: Mario Tonveronachi (Ragnar Nurkse School of Innovation and Governance, Tallinn University of Technology)
    Abstract: Europe is at a critical crossroads for the evolution of its overall political and institutional design. Its founding goal, the creation of the internal single market, is consistent neither with the existing setup, nor with the direction recently impressed to that evolution. The inconsistency between the fiscal, monetary and financial regulatory framework and the construction of the single market cannot be solved by reforming the EU treaties simply because there is no agreement on the new design. Following Minsky’s analysis, we single out the weaknesses and fragilities of that framework when the heterogeneous reality of the EU is taken into account. While constraints on fiscal and monetary reforms derive from the existing treaties, for financial regulation they come from mixing the international approach, which makes financial stability dependent on the financial morphology freely determined by financial markets, with the belief that the EU integration will come from the operation of private interests. We show that the current approach to financial regulation fails on both regards. Complying with the existing EU treaties, we propose a reform of ECB operations that would create the single financial market, at least for the euro area, and allow a reform of the existing fiscal rules capable of converting the current deflationary stance into a reflationary one. To complete the strengthening of the systemic cushions of safety, following the Minskyan approach a radical reform of financial regulation is presented that would combine higher financial resilience with finance more closely serving national economies. The three reforms would critically contribute to the consistency of the euro area design and make its membership attractive for the non-euro EU countries that currently strongly oppose entering into it, at least for those that do not want to go on playing the inshore-offshore game.
    Keywords: EU, Euro Area, ECB, fiscal rules, monetary policy, financial regulation
    JEL: E58 E61 G18 F02 F45 G18
    Date: 2016–01–30
  5. By: Al-Jarhi, Mabid
    Abstract: Reforming the contemporary monetary and financial system has come under the limelight with the onset of the last international financial crisis. Zarlenga and Poteat focus on the elimination of credit money and the return of the exclusive right of issuing money to the government as a key to reforming the system. In this comment, I argue that they are right, but reform should be wider and more comprehensive. My arguments are inspired by Al-Jarhi’s model of an Islamic monetary system (1981)
    Keywords: money, definition of money, monetary reform, Chicago Plan, Islamic economics, monetary policy, interest rate, seigniorage, Friedman's rule, information asymmetry, classical loan contract, Islamic finance
    JEL: E0 E19 E40 E42 E50 E52
    Date: 2016–05–10
  6. By: Nyorekwa, Enock Twinoburyo; Odhiambo, Nicholas Manya
    Abstract: Using the autoregressive distributed lag (ARDL) bounds testing approach; this paper examines the short-run and long-run impact of monetary policy on economic growth in Kenya for the period 1973 to 2013. The paper uses both the broad money supply and the 3-month Treasury bill rate as proxies of monetary policy. Both short-run and long-run empirical results support monetary policy neutrality, implying that monetary policy has no effect on economic growth ??? both in the short run and in the long run. This could be due to the fact that the increasing fiscal deficits funded domestically in Kenya could have weakened the transmission of monetary policy actions into the real economy. The study recommends that policies aimed at improving the institutional and regulatory environment for the financial sector and monetary policy conduct should be pursued in Kenya. There is also a need for improvement in policy coordination, particularly monetary and fiscal policies.
    Keywords: Kenya,Money supply,intrerest rates and economic growth
    Date: 2016–06
  7. By: Jorg Bibow
    Abstract: This paper investigates the European Central Bank's (ECB) monetary policies. It identifies an antigrowth bias in the bank's monetary policy approach: the ECB is quick to hike, but slow to ease. Similarly, while other players and institutional deficiencies share responsibility for the euro's failure, the bank has generally done "too little, too late" with regard to managing the euro crisis, preventing protracted stagnation, and containing deflation threats. The bank remains attached to the euro area's official competitive wage-repression strategy, which is in conflict with the ECB's price stability mandate and undermines its more recent, unconventional monetary policy initiatives designed to restore price stability. The ECB needs a "Euro Treasury" partner to overcome the euro regime's most serious flaw: the divorce between central bank and treasury institutions.
    Keywords: Central Banking; Monetary Policy; Euro Crisis; Lender of Last Resort; Euro Treasury
    JEL: E30 E42 E52 E58 E61 E65
    Date: 2016–06
  8. By: Bhaumik, Sumon K. (University of Sheffield); Kutan, Ali M. (Southern Illinois University Edwardsville); Majumdar, Sudipa (Middlesex University, Dubai)
    Abstract: Many emerging markets have undertaken significant financial sector reforms especially in their banking sectors that have been quite critical for both financial development and real economic activity. In this paper, we investigate the success of banking reforms in India where significant banking reforms have been introduced since 1990s. Using the argument that well-functioning credit markets would reflect a bank channel for monetary policy at work, we test whether a change in monetary policy has predictable impact on borrowing behaviour of several types of firms, including business group affiliated, unaffiliated private firms, state-owned firms and foreign firms. The empirical results suggest that unaffiliated private firms have the most vulnerable to monetary policy stance during tight policy regimes. We also find that during tight monetary policy regimes, smaller firms are much more affected by monetary policy than large firms. In an easy money regime, monetary policy and the associated change in interest rate does not affect change in bank credit, change in total debt and the proportion of bank credit in total debt for any of the firms. We discuss the policy implications of the findings.
    Keywords: banking reforms, monetary policy, credit markets, bank debt, debt structure
    JEL: E52 G21 G28 G32 O16
    Date: 2016–06
  9. By: Bissessar, Shiva
    Abstract: This report examines the usage of digital currency technology in the Caribbean subregion with a view to drawing attention to the opportunities and risks associated with this new phenomenon. It discusses the broader context of an emerging activity at the global level and considers how this technology could address subregional deficiencies in the electronic payment infrastructure. The report also discusses mobile money solutions, and the relationship of that technology to digital currency.
    Date: 2016–01
  10. By: Prescott, Edward C. (Federal Reserve Bank of Minneapolis); Wessel, Ryan (Arizona State University)
    Abstract: We explore monetary policy in a world without fractional reserve banking. In our world, banks are purely transaction institutions. Money is a form of government debt that bears interest, which can be negative as well as positive. Services of money are a factor of production. We show that the national accounts must be revised in this world. Using our baseline economy, we determine a balanced growth path for a set of money interest rate policy regimes. Besides this interest rate, the only policy variable that differs across regimes is the labor income tax rate. Within this set of policy regimes, there is a balanced growth welfare-maximizing regime. We show that Friedman monetary satiation without deflation is possible in this world. We also examine a set of inflation rate targeting regimes. Here, the only other policy variable that differs across regimes is the inflation rate.
    Keywords: 100 percent reserve banking; Money in production function; Interest rate targeting; Inflation rate targeting; Friedman monetary satiation
    JEL: E00 E40 E50 E60
    Date: 2016–06–22
  11. By: Kortela, Tomi
    Abstract: Typically a constant – or zero – lower bound for interest rates is applied in shadow rate term structure models. However, euro area yield curve data suggest that a time-varying lower bound might be appropriate for the euro area. I show that this indeed is the case, i.e. a shadow rate model with time-varying lower bound outperforms the constant lower bound model in euro area data. I argue that the time-variation in the lower bound is related to the deposit facility rate and, thus, to monetary policy. This time-variation in the lower bound gives a new channel via which monetary policy may affect the yield curve in a shadow rate model. I show that the intensity of this channel depends on how tightly the lower bound restricts the yield curve, and I argue that this channel has recently become important for the euro area.
    Keywords: term structure models, shadow rates, policy liftoff, monetary policy, zero lower bound
    JEL: E43 E44 E52
    Date: 2016–06–22
  12. By: Han Han (School of Economics Peking University); Benoit Julien (UNSW Australia); Asgerdur Petursdottir (University of Bath); Liang Wang (University of Hawaii Manoa)
    Abstract: We study the trade of indivisible goods using credit, divisible money and divisible assets in a frictional market. We show how indivisibility matters for equilibria. Bargaining generates a price that is not linked to nominal interest rates, dividend value of the asset, or the number of active buyers. To reestablish this connection, we consider price posting with competitive search. We provide conditions under which stationary equilibrium exists. With bargaining, we find that for negative dividend value on the asset, multiple equilibria occur. Otherwise, in all possible combinations of liquidity and price mechanisms the equilibrium is unique or generically unique.
    Keywords: Nash Bargaining; Competitive Search; Indivisibility; Multiplicity; Uniqueness
    JEL: D51 E40
  13. By: Holston, Kathryn (Board of Governors of the Federal Reserve System); Laubach, Thomas (Board of Governors of the Federal Reserve System); Williams, John C. (Federal Reserve Bank of San Francisco)
    Abstract: U.S. estimates of the natural rate of interest—the real short-term interest rate that would prevail absent transitory disturbances—have declined dramatically since the start of the global financial crisis. For example, estimates using the Laubach-Williams (2003) model indicate the natural rate in the United States fell to close to zero during the crisis and has remained there through the end of 2015. Explanations for this decline include shifts in demographics, a slowdown in trend productivity growth, and global factors affecting real interest rates. This paper applies the Laubach-Williams methodology to the United States and three other advanced economies—Canada, the Euro Area, and the United Kingdom. We find that large declines in trend GDP growth and natural rates of interest have occurred over the past 25 years in all four economies. These country-by-country estimates are found to display a substantial amount of comovement over time, suggesting an important role for global factors in shaping trend growth and natural rates of interest.
    JEL: C24 E43 E52 O40
    Date: 2016–06–20
  14. By: Chris McDonald; Craig Thamotheram; Shaun P. Vahey; Elizabeth C. Wakerly (Reserve Bank of New Zealand)
    Abstract: We consider the fundamental issue of what makes a 'good' probability forecast for a central bank operating within an inflation targeting framework. We provide two examples in which the candidate forecasts comfortably outperform those from benchmark specifications by conventional statistical metrics such as root mean squared prediction errors and average logarithmic scores. Our assessment of economic significance uses an explicit loss function that relates economic value to a forecast communication problem for an inflation targeting central bank. We analyse the Bank of England's forecasts for inflation during the period in which the central bank operated within a strict inflation targeting framework in our first example. In our second example, we consider forecasts for inflation in New Zealand generated from vector autoregressions, when the central bank operated within a flexible inflation targeting framework. In both cases, the economic significance of the performance differential exhibits sensitivity to the parameters of the loss function and, for some values, the differentials are economically negligible.
    Date: 2016–06
  15. By: Dias, Daniel A.; Duarte, Joao B.
    Abstract: In this paper we provide an alternative explanation for the price puzzle (Sims 1992) based on the effect of monetary policy on housing tenure choice and the weight of the shelter component in overall CPI. In the presence of nominal or financial frictions, when interest rates increase, the real cost of owning a house increases, and this increase may make some people prefer to rent instead of buying. This change in consumption behavior increases the price of rents relative to other goods. Starting in 1983, homeownership costs are based on a measure of implied owner equivalent rent, which is calculated using observed house rents. This change implies that, directly and indirectly, prices in the rental market almost entirely command the shelter component of CPI, which weighs around 30% in the overall index. When we take these two pieces into account and use CPI net of shelter services as a measure of inflation, we obtain impulse responses of prices to a monetary contraction shock more in line with what is predicted by theory. In addition, our results also suggest that inflation is much less persistent than what is implied by analyses using a measure of inflation that includes shelter services. Our results pass a long list of robustness check exercises and compare well against other explanations of the price puzzle.
    Keywords: Price puzzle ; Housing tenure choice ; Monetary policy ; SVAR
    JEL: E31 E43 R21
    Date: 2016–06
  16. By: Campbell, Jeffrey R. (Federal Reserve Bank of Chicago); Fisher, Jonas D. M. (Federal Reserve Bank of Chicago); Justiniano, Alejandro (Federal Reserve Bank of Chicago); Melosi, Leonardo (Federal Reserve Bank of Chicago)
    Abstract: This paper studies the effects of FOMC forward guidance. We begin by using high frequency identification and direct measures of FOMC private information to show that puzzling responses of private sector forecasts to movements in federal funds futures rates on FOMC announcement days can be attributed entirely to Delphic forward guidance. However a large fraction of futures rates' variability on announcement days remains unexplained, leaving open the possibility that the FOMC has successfully communicated Odyssean guidance. We then examine whether the FOMC used Odyssean guidance to improve macroeconomic outcomes since the financial crisis. To this end we use an estimated medium-scale New Keynesian model to perform a counterfactual experiment for the period 2009q1−2014q4, in which we assume the FOMC did not employ any Odyssean guidance and instead followed its reaction function from before the crisis as closely as possible while respecting the effective lower bound. We find that a purely rule-based policy would have delivered better outcomes in the years immediately following the crisis than FOMC forward guidance did in practice. However starting toward the end of 2011, after the Fed's introduction of “calendar-based” communications, the FOMC's Odyssean guidance appears to have boosted real activity and moved inflation closer to target. We show that our results do not reflect Del Negro, Giannoni, and Patterson (2015)’s forward guidance puzzle.
    Keywords: Monetary policy; Business cycles; Great Recession; Counterfactual policy analysis
    JEL: E00 E50 E52
    Date: 2016–06–13
  17. By: Cui, Wei; Radde, Sören
    Abstract: We endogenize asset liquidity in a dynamic general equilibrium model with search frictions on asset markets. In the model, asset liquidity is tantamount to the ease of issuance and resaleability of private financial claims, which is driven by investors' participation on the search market. Limited market liquidity of private claims creates a role for liquid assets, such as government bonds or at money, to ease financing constraints. We show that endogenising liquidity is essential to generate positive comovement between asset (re)saleability and asset prices. When the capacity of the asset market to channel funds to entrepreneurs deteriorates, investment falls while the hedging value of liquid assets increases, driving up liquidity premia. Our model, thus, demonstrates that shocks to the cost of financial intermediation can be an important source of flight-to-liquidity dynamics and macroeconomic fluctuations, matching key business cycle characteristics of the U.S. economy. JEL Classification: E22, E44, G11
    Keywords: asset search markets, endogenous asset liquidity, financial shocks, financing constraints, liquidity premium
    Date: 2016–06
  18. By: Simón Sosvilla Rivero (Departamento de Economía Cuantitativa, Facultad de Ciencias Económicas y Empresariales, Universidad Complutense de Madrid.); Maria del Carmen Ramos Herrera (Departamento de Economía Cuantitativa, Facultad de Ciencias Económicas y Empresariales, Universidad Complutense de Madrid.)
    Abstract: This paper attempts to identify implicit exchange rate regimes for currencies of new European Union (EU) countries vis-à-vis the euro. To that end, we apply three sequential procedures that consider the dynamics of exchange rates to data covering the period from 1999:01 to 2012:12. Our results would suggest that implicit bands have existed in many sub-periods for almost all currencies under study. This paper provides new empirical evidence that strengthens the hypothesis of that the implemented policies differ from those announced by the monetary authorities, identifying the existence of de facto fixed monetary systems along large number of sub-periods for different currencies.
    Keywords: Exchange-rate regimes; Implicit fluctuation bands; Exchange rates.
    Date: 2015
  19. By: Carlson, Mark A. (Bank for International Settlements and Board of Governors of the Federal Reserve System); Wheelock, David C. (Federal Reserve Bank of St. Louis)
    Abstract: As a result of legal restrictions on branch banking, an extensive interbank system developed in the United States during the 19th century to facilitate interregional payments and flows of liquidity and credit. Vast sums moved through the interbank system to meet seasonal and other demands, but the system also transmitted shocks during banking panics. The Federal Reserve was established in 1914 to reduce reliance on the interbank market and correct other defects that caused banking system instability. Drawing on recent theoretical work on interbank networks, we examine how the Fed’s establishment affected the system’s resilience to solvency and liquidity shocks and whether these shocks might have been contagious. We find that the interbank system became more resilient to solvency shocks but less resilient to liquidity shocks as banks sharply reduced their liquidity after the Fed’s founding. The industry’s response illustrates how the introduction of a lender of last resort can alter private behavior in a way that increases the likelihood that the lender will be needed.
    Keywords: Federal Reserve System; contagion; systemic risk; seasonal liquidity demand; interbank networks; banking panics; National Banking system
    JEL: E42 E44 E58 G21 N11 N12 N21 N22
    Date: 2016–06–14
  20. By: Mihai, Gabriel
    Abstract: The mechanism of payment and compensation is an important component of the monetary system and financial infrastructure of the economy, ensuring the cash flow and the transfer of monetary assets. Due to the development of the trade and the economic modernization the payment in scriptural money (currency account) was imposed in the internal and international transactions, the circuit of payment instruments and credit (bills of exchange, checks, promissory notes) amplified and, recently, the electronic payment became functional by using bank cards and computerization of settlement systems, which have contributed to ensuring payment in real time, reducing the risks and costs of funds transfer.
    Keywords: instruments of payment, monetary assets, bill of exchange, international commerce, fiduciary currency, transaction settlement
    JEL: F33 G23 K22
    Date: 2016–05–15
  21. By: Goodness C. Aye (Department of Economics, University of Pretoria); Mehmet Balcilar (Department of Economics, Eastern Mediterranean University and Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: This paper examines the transmission mechanism of shocks to monetary policy in South Africa using quarterly data from 1980:1 to 2012:4. We also in addition identify demand and supply shocks. Our analyses are based on a factor-augmented vector autoregression with time-varying coefficients and stochastic volatility (TVP-FAVAR), which allows us to simultaneously analyse the changing impulse responses of a set of 177 macroeconomic variables. Our results based on the impulse response functions, are consistent with economic theory as we observe no price puzzle that is often associated with the standard VAR models. We find evidence of modest time variation in the transmission of shocks. Overall, the macroeconomic variables seemed to have responded slightly more to the monetary policy shocks in the post -2000 (inflation targeting) sub-period than the pre-2000 period, albeit the differences in the effects are statistically insignificant. Demand shocks are found to have contributed more to changes in macroeconomic variables in South Africa than monetary policy and supply shocks. Our results suggest the need for a more efficient role of the monetary authority as this will both improve its credibility and greater economic stability.
    Date: 2016
  22. By: Aikman, David; Bush, Oliver; Taylor, Alan M.
    Abstract: We have entered a world of conjoined monetary and macroprudential policies. But can they function smoothly in tandem, and with what effects? Since this policy cocktail has not been seen for decades, the empirical evidence is almost non-existent. We can only fix this shortcoming in a historical laboratory. The Radcliffe Report (1959), notoriously skeptical about the efficacy of monetary policy, embodied views which led the UK to a three-decade experiment of using credit controls alongside conventional changes in the central bank interest rate. These non-price tools are similar to policies now being considered or used by macroprudential policymakers. We describe these tools, document how they were used by the authorities, and craft a new, largely hand-collected dataset to help estimate their effects. We develop a novel identification strategy, which we term Factor-Augmented Local Projection (FALP), to investigate the subtly different impacts of both monetary and macroprudential policies. Monetary policy acted on output and inflation broadly in line with consensus views today, but credit controls had markedly different effects and acted primarily to modulate bank lending.
    Keywords: credit controls; macroprudential policy; Monetary policy
    JEL: E50 G18 N14
    Date: 2016–06
  23. By: Hagedorn, Marcus
    Abstract: In this paper I show that the price level is globally unique in an incomplete market model. I base my argument on the simple idea that the price equates demand with supply in the goods market. Monetary policy works through setting nominal interest rates, e.g. an interest rate peg, while fiscal policy is committed to satisfying the present value budget constraint at all times (in contrast to the FTPL). Together, these determine the unique price level, as well as consumption and employment, jointly. In particular, the model predicts a unique equilibrium in response to a fiscal stimulus if the nominal interest is pegged, whereas there is a continuum of equilibria in the standard New Keynesian model. In contrast to the conventional view the long-run inflation rate is, in the absence of output growth, equal to the growth rate of nominal government spending, which is controlled by fiscal policy. This new theory where nominal government spending anchors aggregate demand, and therefore current and future prices, offers a different perspective on a range of important issues including the fiscal and monetary transmission mechanism, policy coordination, policies at the zero-lower bound, U.S. inflation history and recent attempts to stimulate inflation in the Euro area.
    Keywords: Fiscal policy; incomplete markets; inflation; Monetary policy; Price level
    JEL: D52 E31 E43 E52 E62 E63
    Date: 2016–06
  24. By: Iyer, Tara (University of Oxford)
    Abstract: The majority of households across emerging market economies are excluded from the financial markets and cannot smooth consumption. I analyze the implications of this for optimal monetary policy and the corresponding choice of domestic versus external nominal anchor in a small open economy framework with nominal rigidities, aggregate uncertainty and financial exclusion. I find that, if set optimally, monetary policy smooths the consumption of financially excluded agents by stabilizing their income. Even though Consumer Price Index (CPI) inflation targeting approximates optimal monetary policy when financial inclusion is high, targeting the exchange rate is appropriate if financial inclusion is limited. Nominal exchange rate stability, upon shocks that create trade-offs for monetary policy, directly stabilizes the import component of financially excluded agents’ consumption baskets, which smooths their consumption and reduces macroeconomic volatility. This study provides a counterpoint to Milton Friedman’s long-standing argument for a float.
    Keywords: Asymmetric Risk-Sharing; Fixed Exchange Rates; Financial Exclusion; Optimal Monetary Policy; Emerging Market Economies
    JEL: E24 E52 F21 F31 F43
    Date: 2016–06–20
  25. By: Ersal-Kiziler,Eylem; Nguyen,Ha Minh
    Abstract: The pattern of debt flows to peripheral European Monetary Union members seems puzzling: they are mostly indirect and channeled through the large countries of the European Monetary Union. This paper examines to what extent the introduction of the euro and the elimination of the intra-area currency risk can explain this puzzle. A three-country dynamic stochastic general equilibrium framework with endogenous portfolio choice and two currencies is developed. In the equilibrium, the core members of the European Monetary Union emerge as the main group of lenders to the peripheral European Monetary Union members. Outside lenders are pushed from the periphery debt markets because of currency risk. The model generates a pattern of debt flows consistent with the data despite the absence of any exogenous frictions or market segmentations.
    Keywords: Currencies and Exchange Rates,Debt Markets,Financial Intermediation,Economic Theory&Research,Emerging Markets
    Date: 2016–06–30
  26. By: Maria Demertzis; Guntram B. Wolff
    Abstract: The general macroeconomic situation and weak inflation dynamics justified quantitative easing (QE) in the euro area. Doubts have emerged about its effectiveness as inflation has remained weak. However, we do not know where inflation would have been without QE and the still large slack in the economy suggests that inflation might increase only in a few years. Two major channels through which QE operates are visible - a weaker exchange rate and lower long-term yields. Lending, investment and housing have somewhat increased. However, banks have not shed sovereign debt from their balance sheets at a significant scale. Bank profitability is squeezed by QE but we do not see a generalised financial stability risk as credit creation remains meager. Further monetary policy action is unlikely to generate strong benefits. It is important that other government action supports the ECB in achieving its goals. Executive summary For full references and footnotes, please see the PDF version of this publication. Central banks resort to quantitative easing when the normal monetary policy tool of lowering the short-term interest rate is constrained. This constraint typically arises from the zero-lower bound, ie the reluctance to cut nominal rates below zero. This can result in a real interest rate that, while negative, is still too high for an economy to quickly find its way back to full employment and equilibrium. Many indicators such as the low inflation rate, high unemployment rates, the current account surplus and high savings compared to weak investment suggest that the euro area is in such a situation. Quantitative easing attempts to address this situation through three different channels - lowering long-term interest rates to improve investment conditions and disincentivise savings (interest rate channel); purchasing relatively safe long-term assets thereby driving investors into riskier investments (portfolio rebalancing channel); and weakening the exchange rate (exchange rate channel). The main criticisms of the European Central Bank’s sovereign QE programme are that it is (i) unlawful in a monetary union without a joint treasury; (ii) ineffective and/or unnecessary; and (iii) associated with negative side effects in terms of financial stability and inequality. The design of the programme has dealt with the first criticism. This briefing focuses on the second criticism. We argue that the ECB’s QE programme is necessary given the general macroeconomic situation and the continuing weak inflation dynamics in the euro area. But the continuously weak inflation dynamics have raised doubts about its effectiveness. Assessing the effectiveness of QE is difficult without a counter-factual, but we show that QE had a strong effect on the exchange rate channel, weakening the euro-dollar exchange rate substantially. We also show that long-term interest rates fell substantially in anticipation of the programme. In relation to portfolio rebalancing, we show that banks have not shed sovereign debt from their balance sheets at a significant scale so the purchases have been from different parties. We show that investment has picked up slightly, housing markets in some countries have gained strength but credit creation is only slightly increasing. Finally, we show that the expansion of the ECB’s Public Sector Purchase Programme in March 2016 has had no visible effect on any variable. We document that QE has reduced the profitability of banks by narrowing their margins. The recent corporate QE, while lowering corporate yields, is further reducing margins for banks. We argue that further monetary policy measures are unlikely to bring strong benefits. One sensible avenue for monetary policy could be to enact the sovereign bond purchases from banks in order to reduce the exposure of banks to sovereign debt. More important, however, is government action. In particular, reducing the debt overhang, tackling banking fragilities and introducing reforms to create new business opportunities and fiscal measures in countries with fiscal space would help speed the recovery and increase inflation. 1 Introduction The decision to start quantitative easing in the euro area has been highly controversial. After a long period of deliberation, the European Central Bank decided in January 2015 on a sovereign QE programme that was implemented from March 2015 with monthly purchases of €44 billion. The amount purchased was increased in March 2016. The controversy over QE now is less about whether the ECB is empowered to use a monetary policy instrument that most central banks in advanced economies have used. It is rather about whether QE is effective as a tool to increase inflation to the target. In addition, there is increasing concern that QE and other non-conventional monetary policy measures produce unintended consequences in terms of financial instability or in terms of wealth inequality. Central banks resort to QE when the nominal short-term interest rate falls to zero.
    Date: 2016–06

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