nep-mon New Economics Papers
on Monetary Economics
Issue of 2016‒08‒07
thirty-one papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Russia’s Monetary Policy in 2015 By Bozhechkova Alexandra; Trunin Pavel; Kiyutsevskaya Anna
  2. Do Fed forecast errors matter? By Pao-Lin Tien; Tara M. Sinclair; Edward N. Gamber
  3. The stability of money demand in the long-run: Italy 1861–2011 By Vittorio Daniele; Pasquale Foresti; Oreste Napolitano
  4. Cost Channel, Interest Rate Pass-Through and Optimal Policy under Zero Lower Bound By Chattopadhyay, Siddhartha; Ghosh, Taniya
  5. International Trade Fluctuations and Monetary Policy By Ana Maria Santacreu; Fernando Leibovici
  6. Starting from a Blank Page? Semantic Similarity in Central Bank Communication and Market Volatility By Michael Ehrmann; Jonathan Talmi
  7. Bank Lending Channel of Transmission of Monetary Policy: Does the Financial Structure of Banks Matter? By Jose E. Gomez-Gonzalez; Ali M. Kutan; Jair N. Ojeda-Joya; María Camila Ortiz
  8. Exchange Rate Pass-Through in a Small Open Economy: A Structural VAR Approach By Tunc, Cengiz; Kılınç, Mustafa
  9. The Role of Central Banks in Promoting Financial Stability: An International Perspective By Rose Cunningham; Christian Friedrich
  10. Do heterogeneous expectations constitute a challenge for policy interaction? By Gasteiger, Emanuel
  11. Liquidity Management and Central Bank Strength: Bank of England Operations Reloaded, 1889-1910 By Stefano Ugolini
  12. Relationships in the interbank market By Chiu, Jonathan; Monnet, Cyril
  13. Central bank and asymmetric preferences: An application of sieve estimators to the U.S. and Brazil By de Sá, Rodrigo; Savino Portugal, Marcelo
  14. The Inherent Benefit of Monetary Unions By Groll, Dominik; Monacelli, Tommaso
  15. The signalling content of asset prices for inflation: Implications for Quantitative Easing By Leo de Haan; Jan Willem van den End
  16. Output Comovement and Inflation Dynamics in a Two-Sector Model with Durable Goods: The Role of Sticky Information and Heterogeneous Factor Markets By Tomiyuki Kitamura; Tamon Takamura
  17. Structural transformation, services deepening, and the transmission of monetary policy By Alessandro Galesi; Omar Rachedi
  18. Monetary Policy and Sovereign Debt Vulnerability By Carlos Thomas; Galo Nuño
  19. Liquidity Traps and Monetary Policy: Managing a Credit Crunch By Juan Pablo Nicolini
  20. Fan chart – a tool for NBP’s monetary policy making By Paweł Pońsko; Bartosz Rybaczyk
  21. Danger to the Old Lady of Threadneedle Street? The Bank Restriction Act and the regime shift to paper money, 1797-1821 By Patrick K. O’Brien; Nuno Palma
  22. The Palmer Rule and the convertibility of bank notes in Spain By Yolanda Blasco-Martel
  23. Firms' Inflation Expectations and Wage-setting Behaviors By Sohei Kaihatsu; Noriyuki Shiraki
  24. Is Inflation Default? The Role of Information in Debt Crises By Carlo Galli; Marco Bassetto
  25. The enigmatic dollar-euro exchange rate and the world's biggest forex market - performance, causes, consequences By Jan Priewe
  26. How Central Banks End Crises By Guillermo Ordonez; Gary Gorton
  27. Assessing the appropriateness of zero and negative interest rate regimes: recent developments and comparative analyses By Ojo, Marianne; Newton, Sarah
  28. On the essentiality of E-money By Chiu, Jonathan; Wong, Tsz-Nga
  29. Exchange Rate Targeting in the Presence of Foreign Debt Obligations By James Staveley-O'Carroll; Olena M. Staveley-O'Carroll
  30. Why ZLB Economics and Negative Interest Rate Policy (NIRP) are wrong By Thomas I. Palley
  31. Dollarization, liquidity and performance: Evidence from Turkish banking By Caglayan, Mustafa; Talavera, Oleksandr

  1. By: Bozhechkova Alexandra (Gaidar Institute for Economic Policy); Trunin Pavel (Gaidar Institute for Economic Policy); Kiyutsevskaya Anna (Gaidar Institute for Economic Policy)
    Abstract: In 2015, the Bank of Russia faced global challenges while implementing measures as part of its monetary policy. The economic situation in 2015 was marked by the following: Western sanctions and Russia’s countersanctions remained in effect, prices of Russia’s key export commodities continued to fall, economic agents’ expectations for high inflation remained intact. The sweeping depreciation of the Russian ruble in late 2014/early 2015 resulted in an inflation shock which kept the year-end inflation at high level: the Consumer Price Index (CPI) stood at 12.9% at the 2015 year-end, much higher than the 2017 mid-term target level (4%) set forth in the central bank’s Guidelines for the Single State Monetary Policy for 2015–2017. In its official 2015 forecast, Russia’s Ministry of Economic Development predicted inflation will not move beyond 6.3% in late 2014/early 2015, and Russia’s central bank expected it to stay at 8.2–8.7% under the baseline scenario and 9.3–9.8% under the risk scenario. At the same time, the Bank of Russia cut its key rate gradually from 17% in January down to 11% in December 2015 as inflation slowed down over the course of the year.
    Keywords: Russian economy, monetary policy, money market, exchange rate, INFLATION, BALANCE OF PAYMENTS
    JEL: E31 E43 E44 E51 E52 E58
    Date: 2016
  2. By: Pao-Lin Tien; Tara M. Sinclair; Edward N. Gamber
    Abstract: There is a large literature evaluating the forecasts of the Federal Reserve by testing their rationality and measuring the size of their forecast errors. There is also a substantial literature and debate on the impact of the Fed’s monetary policy on the economy. We know little, however about the impact of the Fed’s forecast errors on economic outcomes. This paper constructs a measure of a forecast error shock for the Federal Reserve based on the assumption that the Fed follows a forward-looking Taylor rule. Given the effort the Fed puts towards producing forecasts that do not have an endogenous error component, we treat the Fed’s forecast errors as a shock, analogous to a monetary policy shock. Our shock, however, is different in that it is completely unintended by the monetary authority rather than simply unanticipated by the public. We follow Romer and Romer (2004) and investigate the effect of the forecast error shock on output and price movements. Our results suggest that although the absolute magnitude of the forecast error shock is large, the impact of the shock on the macroeconomy is quite small. This finding is robust across a range of different specifications. The maximum impact suggests a decline of less than 0.3 percent of real GDP and less than 0.4 percent of GDP deflator in response to a 100 basis point contractionary forecast error shock.
    Keywords: Federal Reserve, Taylor rule, forecast evaluation, monetary policy shocks
    JEL: E32 E31 E52 E58
    Date: 2016–07
  3. By: Vittorio Daniele; Pasquale Foresti; Oreste Napolitano
    Abstract: Money demand stability is a crucial issue for monetary policy efficacy, and it is particularly endangered when substantial changes occur in the monetary system. By implementing the ARDL technique, this study intends to estimate the impact of money demand determinants in Italy over a long period (1861–2011) and to investigate the stability of the estimated relations. We show that instability cannot be excluded when a standard money demand function is estimated, irrespectively of the use of M1 or M2. Then, we argue that the reason for possible instability resides in the omission of relevant variables, as we show that a fully stable demand for narrow money (M1) can be obtained from an augmented money demand function involving real exchange rate and its volatility as additional explanatory variables. These results also allow us to argue that narrower monetary aggregates should be employed in order to obtain a stable estimated relation.
    Keywords: Italy; money demand stability; monetary aggregates; exchange rate; ARDL
    JEL: C22 E41 E52
    Date: 2016–04–26
  4. By: Chattopadhyay, Siddhartha; Ghosh, Taniya
    Abstract: This paper analyzes optimal monetary policy under zero lower bound in the presence of cost channel. Cost channel introduces trade-off between output and inflation when economy is out of ZLB. As a result, exit time both under discretion and commitment is endogenous in the presence of cost channel. We also find that commitment outperforms discretion by promising future boom and inflation and a T-only policy closely replicates commitment both under presence and absence of cost channel. Moreover, the exit date (from ZLB) under discretion, commitment and T-only policy rises with the magnitude of demand shock given the degree of interest rate pass-through irrespective if the cost channel is present. We also show that, while exit date both under discretion and T-only policy rises with the degree of interest rate pass-through/credit market imperfection, it falls under commitment given demand shock.
    Keywords: New-Keynesian Model, Cost Channel, Liquidity Trap
    JEL: E52 E58 E63
    Date: 2016–07–20
  5. By: Ana Maria Santacreu (Federal Reserve Bank of Saint Louis and); Fernando Leibovici (York University)
    Abstract: This paper studies the role of trade openness for the design of monetary policy. We extend a standard small open economy model of monetary policy to capture cyclical fluctuations of international trade flows, and parameterize it to match key features of the data. We find that accounting for trade fluctuations matters for monetary policy: when the monetary authority follows a Taylor rule, inflation and the output gap are more volatile. Moreover, we find that the volatility of these variables is significantly higher when the central bank follows the optimal policy based on a model that cannot account for international trade fluctuations.
    Date: 2016
  6. By: Michael Ehrmann; Jonathan Talmi
    Abstract: Press releases announcing and explaining monetary policy decisions play a critical role in the communication strategy of central banks. Because of their market-moving potential, it is particularly important how they are drafted. Often, central banks start from the previous statement and update the earlier text with only small changes. This way, it is straightforward to compare statements and see how the central bank’s thinking has evolved. This paper studies to what extent such similarity in central bank statements matters for the reception of their content in financial markets. Using the case of the Bank of Canada (the G7 central bank that had to rely the least on unconventional monetary policy following the global financial crisis and has therefore broadly continued standard monetary policy communications), the paper shows that press releases with larger differences in wording lead to higher volatility in financial markets, suggesting that their content is more difficult to absorb. At the same time, while press releases that are similar to the previous one generate less market volatility, once their wording is updated, volatility increases substantially.
    Keywords: Central bank research, Financial markets, Interest rates
    JEL: E43 E52 E58
    Date: 2016
  7. By: Jose E. Gomez-Gonzalez (Banco de la República de Colombia); Ali M. Kutan; Jair N. Ojeda-Joya (Banco de la República de Colombia); María Camila Ortiz
    Abstract: This paper tests the importance of the financial structure of banks in the bank lending channel of monetary policy transmission in Colombia, using an unbalanced panel of 51 banks for the period of 1996:4-2014:8. We find that an increase in the interbank rate (proxy of the intervention rate) has a response of a drop in the growth of the total loan portfolio of banks. When we breakdown by type of policy, the bank lending channel works better in times of monetary contraction, exhibiting significant reactions from banks with low levels of solvency rather than those with high solvency. In contrast, when the policy is expansionary, the high solvency banks are the only segment exhibiting the presence of the bank lending channel. We discuss the policy implications of findings. Classification JEL: E5, E52, E59, G21
    Keywords: Monetary Policy Transmission, Bank Lending Channel, Bank Financial Structure, Solvency, Heterogeneous Effects, Colombia
    Date: 2016–08
  8. By: Tunc, Cengiz; Kılınç, Mustafa
    Abstract: Pass through from the exchange rate developments to consumer prices could be an important dimension of inflationary dynamics in small open economies. In such economies, the proper identification of exchange rate pass through (ERPT) is crucial for monetary policy analysis. In this paper, we study ERPT in Turkey for the period of 2006m1-2015m6, which starts with the launch of explicit inflation-targeting regime. We first show that commonly used recursive VAR model generates unrealistic dynamics like effects of domestic variables on external variables in small open economies and as result ERPT estimate is biased. This bias comes from the unrealistic decline in energy prices in response to depreciation of currency for the given period in Turkey. We then use a structural VAR model with block exogeneity assumption. This model generates more realistic dynamics and suggests that ERPT is around 18 percent in Turkey. Overall, the analysis demonstrates the importance of using realistic model setup and checking the relationships across variables when estimating ERPT in small open economies.
    Keywords: Inflation, Exchange Rates, Pass-through, Turkey
    JEL: E31 E52 F31
    Date: 2016–02–02
  9. By: Rose Cunningham; Christian Friedrich
    Abstract: The 2007–09 global financial crisis has led policy-makers around the world, including central banks, to refocus their efforts to promote financial stability. As part of this process, central banks became quite active in supporting financial stability in a variety of ways, such as publicly sharing their assessments of financial system vulnerabilities and risks and helping to strengthen regulation, supervision and macroprudential measures. However, the use of monetary policy instruments for managing financial stability risks is more widely debated because central banks may face a trade-off between attaining their inflation targets in a timely manner and exacerbating financial stability risks. Recent research suggests that central banks that tend to have stronger financial stability mandates and less influence over regulatory and macroprudential tools are more likely to use monetary policy to address financial stability risks.
    Keywords: Financial stability, Financial system regulation and policies
    JEL: E5 G01 G28
    Date: 2016
  10. By: Gasteiger, Emanuel
    Abstract: Yes, indeed; at least for macroeconomic policy interaction. We examine a Neo-Classical economy and provide the conditions for policy arrangements to successfully stabilize the economy when agents have either rational or adaptive expectations. For a contemporaneous-data monetary policy rule, the monetarist solution is unique and stationary under a passive fiscal/active monetary policy regime if monetary policy appropriately incorporates expectational heterogeneity. In contrast, the active fiscal/passive monetary policy regime's fiscalist solution is prone to explosiveness due to empirically plausible expectational heterogeneity. Nevertheless, this can be a well-defined, rather orthodox equilibrium. For operational monetary policy rules, only the results for the fiscalist solution prevail. Moreover, our results are plausible from an adaptive learning viewpoint.
    Keywords: inflation,heterogeneous expectations,fiscal and monetary policy interaction
    JEL: E31 D84 E52 E62
    Date: 2016
  11. By: Stefano Ugolini (University of Toulouse (Institute of Political Studies and LEREPS))
    Abstract: Is a strong commitment to monetary stability enough to ensure credibility? The recent literature suggests it might not be if the central bank cannot perform pure interest rate policy and has to resort to balance sheet policy: the central bank’s financial strength (i.e. the long-term sustainability of its policy) is also a determinant of credibility. This paper provides historical evidence on the issue by focusing on the case of the Bank of England at the heyday of the classical gold standard. It shows that as the Bank was not perceived as having the means to fulfil all of its obligations, the efficacy of its interest rate policy was poor. Failing to reform for political economy reasons, the Bank eventually had to default on its formal convertibility mandate.
    Keywords: Central banking, institutional design, monetary policy implementation, reverse repos, term structure of interest rates, gold standard
    JEL: E42 E43 E58 N13
    Date: 2016–07–01
  12. By: Chiu, Jonathan; Monnet, Cyril
    Abstract: The market for central bank reserves is mainly over-the-counter and exhibits a core-periphery network structure. This paper develops a model of relationship lending in the unsecured interbank market. In equilibrium, a tiered lending network arises endogenously as banks choose to build relationships in order to insure against liquidity shocks and to economize on the cost to trade in the interbank market. Relationships matter for banks’ bidding strategies at the central bank auction, and introduce a relationship premium that can significantly distort the observed overnight rate. For example, it can explain some anomalies in the level of interest rates – namely, the fact that banks sometimes trade above (resp. below) the central bank’s lending (resp. deposit) rate. The model also helps understand how monetary policy affects the network structure of the interbank market and its functioning, and how the market responds dynamically to an exit from the floor system. We also use the model to discuss the potential effects of bilateral exposure limit on relationship lending.
    Keywords: Interbank market, Relationships, Networks, Monetary policy, Corridor system,
    Date: 2016
  13. By: de Sá, Rodrigo; Savino Portugal, Marcelo
    Abstract: Whether central banks place the same weights on positive and negative deviations of inflation and of the output gap from their respective targets is an interesting question regarding monetary policy. The literature has sought to address this issue using a specific asymmetric function, the so-called Linex loss function. However, is the Linex an actually asymmetric specification? In an attempt to answer this question, we applied the sieve estimation method, a fully nonparametric approach, in which the result could be any proper loss function. This way, our results could corroborate the quadratic or Linex loss functions used in the literature or suggest an entirely new function. We applied the sieve estimation method to the United States and to Brazil, an emergent country which has consistently followed an inflation targeting regime. The economy was modeled with forward-looking agents and central bank commitment. Our results indicate that the FED was more concerned with inflation rates below the target, but no asymmetry was found in the inflation–output process in the Volcker–Greenspan period. As to Brazil, we found asymmetries in output gaps from 2004 onwards, when the Brazilian Central Bank was more concerned with positive output gaps; but we did not find any statistically significant asymmetries in inflation.
    Keywords: Monetary policy; Central bank's preference; Asymmetric preferences; Sieve estimators
    JEL: C14 E52
    Date: 2015–12
  14. By: Groll, Dominik; Monacelli, Tommaso
    Abstract: The desirability of flexible exchange rates is a central tenet in international macroeconomics. We show that, with forward-looking staggered pricing, this result crucially depends on the monetary authority's ability to commit. Under full commitment, flexible exchange rates generally dominate a monetary union (or fixed exchange rate) regime. Under discretion, this result is overturned: a monetary union dominates flexible exchange rates. By fixing the nominal exchange rate, a benevolent monetary authority finds it welfare improving to tradeoff flexibility in the adjustment of the terms of trade in order to improve on its ability to manage the private sector's expectations. Thus, inertia in the terms of trade (induced by a fixed exchange rate) is a cost under commitment, whereas it is a benefit under discretion, for it acts like a commitment device.
    Keywords: commitment; discretion; flexible exchange rates; monetary union; nominal rigidities.; welfare losses
    JEL: E52 F33 F41
    Date: 2016–07
  15. By: Leo de Haan; Jan Willem van den End
    Abstract: We investigate the information content of financial variables as signalling devices of two abnormal inflationary regimes: (1) very low inflation or deflation, and (2) high inflation. Specifically, we determine the information content of equity and house prices, private credit volumes, and sovereign and corporate bond yields, for 11 advanced economies over the past three decades, using both the receiver operating characteristic (ROC) curve and a logit model. The outcomes show that high asset prices more often signal high inflation than low inflation/deflation. However, in some countries, high asset prices and low bond yields are a significant indicator of low inflation or deflation as well. The transmission time of financial developments to inflation can be quite long (up to 8 quarters). For monetary policy, these findings imply that stimulating asset prices through Quantitative Easing (QE) can effectively influence inflation, but that the effects are quite uncertain, both in timing and direction.
    Keywords: Quantitative Easing; Inflation; Financial markets
    JEL: E31 E44 E52
    Date: 2016–07
  16. By: Tomiyuki Kitamura; Tamon Takamura
    Abstract: In a simple two-sector New Keynesian model, sticky prices generate a counterfactual negative comovement between the output of durable and nondurable goods following a monetary policy shock. We show that heterogeneous factor markets allow any combination of strictly positive price stickiness to generate positive output comovement. Even if the prices of durable goods are flexible, adding sticky information ensures that the output of both sectors moves in the same direction. Furthermore, we find that the combination of sticky information and heterogeneous factor markets produces hump-shaped responses in both sectoral output and inflation, as observed in a vector-autoregression analysis. In contrast to backward indexation to past inflation, which is often assumed in the literature, sticky information leads to a hump-shaped response in the inflation of flexibly priced goods. Finally, the estimated information stickiness through the minimum-distance estimation method suggests that information rigidity is stronger in residential investment than nondurable goods and services.
    Keywords: Inflation and prices, Transmission of monetary policy
    JEL: E31 E32 E52
    Date: 2016
  17. By: Alessandro Galesi (Banco de España); Omar Rachedi (Banco de España)
    Abstract: Advanced economies are undergoing a structural transformation from manufacturing to services. We document that structural change comes with a process of services deepening: over time, both services and manufacturing become more intensive in service inputs. We argue that structural transformation and services deepening affect the transmission of monetary policy by increasing the relative importance of services, which have stickier prices than manufacturing. We study the implications of the U.S. sectoral reallocation with a New Keynesian model with two sectors connected by an input-output matrix, which varies endogenously over time. The rise of services dampens the responses of aggregate and sectoral inflation rates to a monetary policy shock. The changes in the responses of sectoral inflation rates are entirely driven by services deepening.
    Keywords: New Keynesian model, intermediate inputs, input-output matrix
    JEL: E31 E43 E52 O41
    Date: 2016–07
  18. By: Carlos Thomas (Banco de España); Galo Nuño (Banco de España)
    Abstract: We investigate the trade-o¤s between price stability and sovereign debt sustainability, in a small-open-economy model where the government issues nominal debt without committing not to default or inflate. Inflation allows to absorb the e¤ect of aggregate shocks on the debt ratio, which improves sovereign debt sustainability. But the government incurs an ‘inflationary bias’: it creates (costly) inflation even when default is distant. For plausible calibrations, we find that abandoning the ability to inflate debt away raises welfare, even when the economy is close to default: the benefits from eliminating the inflationary bias dominate the costs from losing inflation’s debt-stabilizing role.
    Date: 2016
  19. By: Juan Pablo Nicolini (Minneapolis Fed)
    Abstract: We study a model with heterogeneous producers that face collateral and cash in advance constraints. A tightening of the collateral constraint results in a credit-crunch generated recession that reproduces several features of the financial crisis that unraveled in 2007. The model can suitable be used to study the effects on the main macroeconomic variables and of alternative policies following the credit crunch. The policy implications are in sharp contrast with the prevalent view in most Central Banks, based on the New Keynesian explanation of the liquidity trap.
    Date: 2016
  20. By: Paweł Pońsko; Bartosz Rybaczyk
    Abstract: In this note we describe, in substantial detail, the methodology behind the construction of NBP’s fan chart. This note is meant to help the readers interpret information contained in the mid-term projection, understand the differences in the predicted uncertainty between the projection rounds, and the usefulness of the projection for the monetary policy conduct. We describe the process which leads to the final projection, the methodology of estimation of the variance of the final forecast probability distribution, the method used for quantifying asymmetry of the fan chart and the role the two-piece normal distribution plays in it. Finally, we describe the analysis of the changes in the fan charts between the projection rounds and explain how the narrative associated with the projection is consistent with its assessment of risk.
    Keywords: Projection, balance of risk, variance, probability distribution, fan chart
    JEL: E31 E37 E59
    Date: 2016
  21. By: Patrick K. O’Brien (London School of Economics); Nuno Palma (European University Institute; University of Groningen)
    Abstract: The Bank Restriction Act of 1797 made legal the Bank of England’s suspension of the convertibility of its banknotes. The current historical consensus is that it was a result of the state's need to finance the war, France’s remonetisation, a loss of confidence in the English country banks, and a run on the Bank of England’s reserves. We argue that while these factors help us understand the timing of the Restriction period, they cannot explain its success. We deploy new long-term data which leads us to a complementary explanation: the policy succeeded thanks to the reputation of the Bank of England, achieved through a century of monetary stability.
    Keywords: Bank of England, financial revolution, fiat money, money supply, monetary policy commitment, reputation, and time-consistency, regime shift, financial sector growth
    JEL: N13 N23 N43
    Date: 2016–07
  22. By: Yolanda Blasco-Martel (Universitat de Barcelona \cf0 Author-Email:
    Abstract: Research on banking systems has token as a frame of reference the English banking system. Precisely because the English banking system was early, it had opportunities to explore certain control mechanisms that favored the extension of the bill of bank. One such mechanism was known as Palmer Rule, a rule stating that a well-managed bank should keep in its cash box one third of its responsibilities. This rule allowed maintaining the convertibility of notes, giving confidence to customers and encouraging the spread paper money. In Spain it has been discussed about the convertibility of the note in the last quarter of the nineteenth century. This work includes to the discussion the Palmer rule, crucial to understanding why the ticket of the Bank of Spain ceased to be convertible de facto in the late nineteenth century, although the inconvertibility is not legally established until 1946.
    Keywords: Palmer rule, Convertibility, Banking history, Banking rules, Spain
    JEL: N14 N24 E42 E58
    Date: 2016–07
  23. By: Sohei Kaihatsu (Bank of Japan); Noriyuki Shiraki (Bank of Japan)
    Abstract: This paper aims to examine the formation mechanism of firms' inflation expectations and the relationship between those expectations and wage-setting behaviors. We conduct an empirical analysis based on microdata constructed by matching a business survey for inflation expectations and corporate financial data. Our empirical results demonstrate that firms' short-term and medium- to long-term inflation expectations have significantly increased after the Bank of Japan introduced a price stability target of two percent and quantitative and qualitative monetary easing in 2013. During this period, dispersions of distributions of inflation expectations increased temporarily and then shrank again. These changes vary across business attributes, such as the size of a firm. Therefore, differences in business attributes might result in the heterogeneous reaction of inflation expectations to monetary policy shocks. Furthermore, an empirical analysis using the data from 2004 to 2016 shows that (a) both wages and short-term inflation expectations tend to increase along with medium- to long-term inflation expectations and (b) both wages and operating profits tend to decrease when only short-term inflation expectations increase. The result implies that a balanced economic growth between prices and wages can be achieved when there is an increase in a wide range of firms' medium- to long-term inflation expectations.
    Keywords: firm's inflation expectation; wage-setting behavior; quantitative and qualitative monetary easing; panel VAR
    JEL: D21 D84 E31 E52
    Date: 2016–07–29
  24. By: Carlo Galli (University College London); Marco Bassetto (Federal Reserve Bank of Chicago)
    Abstract: In the aftermath of the financial crisis, countries which had control over their monetary policy, such as the United States, the United Kingdom, and Japan, were able to borrow at extremely low rates, even though they experienced very high deficit/GDP ratios (the UK) or debt/GDP ratios (Japan). In contrast, peripheral Eurozone countries with a high deficit/GDP ratio (Spain) or a high debt/GDP ratio (Italy) faced volatile interest rates. In a frictionless benchmark, default and inflation have the same economic effect. Creditors care about the real rate of return on their investment: whether they anticipate losing money to default or inflation, they will require an identical interest rate spread over risk-free bonds. We break this equivalence by introducing two classes of heterogeneously informed agents: bondholders, who decide whether to roll over their credit, and workers, who decide whether to accept currency in payment for their services. Domestic and foreign-currency borrowing are now distinguished by the identity of the marginal agent who triggers a crisis. We show conditions under which domestic-currency debt makes the economy more resilient to fiscal shocks.
    Date: 2016
  25. By: Jan Priewe
    Abstract: Foreign exchange markets are the biggest financial markets on the globe, the dollar-euro market is the biggest among them with a daily turnover of $1.3 trillion. This market is the interface of the euro bloc and the dollar bloc which use mainly one of the major currencies, comprising 45-60% and 25% of global GDP, respectively. Hence the dollar-euro exchange rate is the prime exchange rate among thousands of others. After reviewing the exchange rate performance and the dismal state of exchange rate theories, the paper analyses in the first part the following questions: what determines the large and long swings and the turning points of the exchange rate super-cycle; what is the role of "fundamentals" and what are the non-fundamental determinants of the dollar-euro exchange rate. In the second part we analyse the consequences of high volatility and frequent misalignment of the dollar-euro rate: in what way is this exchange rate relevant for the real economies, as both the majority of the euro area's and the trade of the U.S. is denominated in own currency; what are the interdependencies between the dollar-euro exchange rate and internal imbalances in the current accounts of the euro area; has the relationship between exchange rates and trade changed, due to reduced elasticities; what is the impact of dollar-euro exchange rate on international financial markets.
    Date: 2016
  26. By: Guillermo Ordonez (University of Pennsylvania); Gary Gorton (Yale School of Management)
    Abstract: To end a financial crisis, the central bank is to lend freely, against good collateral, at a high rate, according to Bagehot’s Rule. We argue that in theory and in practice there is a missing ingredient to Bagehot’s Rule: secrecy. Re-creating confidence requires that the central bank lend in secret, hiding the identities of the borrowers, to prevent information about individual collateral from being produced and to create an information externality by raising the perceived value of average collateral. Ironically, the participation of “bad†borrowers, with low quality collateral, in the central bank’s lending program is a desirable part of re-creating confidence because it creates stigma. Stigma is critical to sustain secrecy because no borrower wants to reveal his participation in the lending program, and it is limited by the central bank charging a high rate for its loans.
    Date: 2016
  27. By: Ojo, Marianne; Newton, Sarah
    Abstract: This paper explores the widely held theoretical view that zero interest rates should result in lower borrowing costs – propelling the demand for borrowing, “the theory and practice of monetary policy”, against the practical and broader acknowledgements that further negative consequences, namely bank runs - as well as the possibility of the occurrence of concerns of banks becoming more prone to the probabilities of greater unwillingness to lend, could occur. The latter negative consequence of banks’ unwillingness to lend, being considered to arise where “banks absorb the cost of negative rates themselves” such that this phenomenon “squeezes” the profit margin between their lending and deposit rates. However, as will be illustrated, different sources and authorities on the literature agree that it is still too early to draw conclusions on the impact of negative interest rates – be it in respect of i) whether it will work, ii) its wider impact and repercussions for the economy – as well as those economies where the policy has not yet been implemented (even where the policy is on the cards – namely in jurisdictions such as the United States), as well as (iii) its impact on the behavior of individuals (households) and firms. In exploring the appropriateness of its adoption – given prevailing global financial conditions and the economic environment, the paper also contributes to the extant literature from a theoretical, practical, empirical, as well as comparative jurisdictional perspective.
    Keywords: interest rates; monetary policy; central banks; market rates; lending rates
    JEL: E5 E58 E6 F3 G2 G3 K2 M4
    Date: 2016–07–28
  28. By: Chiu, Jonathan; Wong, Tsz-Nga
    Abstract: Recent years have witnessed the advances of e-money systems such as Bitcoin, PayPal and various forms of stored-value cards. This paper adopts a mechanism design approach to identify some essential features of different payment systems that implement the optimal resource allocation. We find that, compared to cash, e-money technologies allowing limited participation, limited transferability and non-zero-sum transfers can help mitigate fundamental frictions and enhance social welfare, if they satisfy conditions in terms of parameters such as trade frequency and bargaining powers. An optimally designed e-money system exhibits realistic arrangements including non-linear pricing, cross-subsidization and positive interchange fees even when the technologies incur no costs. Regulations such as a cap on interchange fees (à la the Dodd-Frank Act) can distort the optimal mechanism and reduce welfare.
    Keywords: Money, Electronic money, Mechanism design, Search and matching, Efficiency,
    Date: 2016
  29. By: James Staveley-O'Carroll (Economics Division, Babson College); Olena M. Staveley-O'Carroll (Department of Economics, College of the Holy Cross)
    Abstract: We study the impact of foreign debt on the trade-off between the three open economy objectives of a central bank - international risk sharing, the need to facilitate expenditure-switching, and the incentive to tilt international prices to lower the labor effort of domestic households - in a two-country DSGE model with incomplete asset markets and deviations from the purchasing power parity. We fi?nd that at low debt levels, a Taylor rule outperforms simple targeting rules. However, the central bank can improve welfare by up to 0.25 percent of consumption via an exchange rate peg when debt-to-GDP ratio reaches 100 percent.
    Keywords: international risk sharing, foreign debt, exchange rate policy
    JEL: E52 F32 F41
    Date: 2016–07
  30. By: Thomas I. Palley
    Abstract: NIRP is quickly becoming a consensus policy within the economics establishment. This paper argues that consensus is dangerously wrong, resting on flawed theory and flawed policy assessment. Regarding theory, NIRP draws on fallacious pre-Keynesian economic logic that asserts interest rate adjustment can ensure full employment. That pre-Keynesian logic has been augmented by ZLB economics which claims times of severe demand shortage may require negative interest rates, which policy must deliver since the market cannot. Regarding policy assessment, NIRP turns a blind eye to the possibility that negative interest rates may reduce AD, cause financial fragility, create a macroeconomics of whiplash owing to contradictions between policy today and tomorrow, promote currency wars that undermine the international economy, and foster a political economy that spawns toxic politics. Worst of all, NIRP maintains and encourages the flawed model of growth, based on debt and asset price inflation, which has already done such harm.
    Keywords: Negative interest rate policy, zero lower bound
    Date: 2016
  31. By: Caglayan, Mustafa; Talavera, Oleksandr
    Abstract: Using a panel of Turkish commercial banks, we examine credit dollarization and its impact on banks' liquidity and profitability. Our estimates suggest that banks partially passthrough foreign denominated funds to borrowers in the form of foreign denominated credit. Furthermore, banks which lend in foreign denominated currency hold less liquid assets and experience higher return on assets. The results suggest that, when the domestic currency is stable, banks in Turkey manage their liquidity aggressively to earn higher returns on foreign denominated funds.
    Keywords: Financial Dollarization, Commercial Banks, Liquidity, Performance, Pass-through
    JEL: G20 G21
    Date: 2016–07–16

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