nep-mon New Economics Papers
on Monetary Economics
Issue of 2016‒11‒06
24 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Quantitative Easing and Liquidity in the Japanese Government Bond Market By Kentaro Iwatsubo; Tomoki Taishi
  2. Optimal policy rules at home, crisis and quantitative easing abroad By McNelis, Paul D.
  3. Lithuania in the Euro Area: Monetary Transmission and Macroprudential Policies By Margarita Rubio; Mariarosaria Comunale
  4. Why Has Inflation Been So Unresponsive to Economic Activity in Recent Years? By Robert G. Murphy
  5. Monetary Policy Cooperation and Coordination: An Historical Perspective on the Importance of Rules By Michael Bordo; Catherine R. Schenk
  6. Forward Guidance without Common Knowledge By George-Marios Angeletos; Chen Lian
  7. Layoff risk, the welfare cost of business cycles, and monetary policy By Yuta Takahashi; Lawrence Schmidt; Konstantin Milbradt; Ian Dew-Becker; David Berger
  8. Structural factors, unemployment and monetary policy: the useful role of the natural rate of interest By Francesco Furlanetto; Paolo Gelain
  9. Implications of Shadow Bank Regulation for Monetary Policy at the Zero Lower Bound By Falk Mazelis; ;
  10. Log-linear Approximation versus an Exact Solution at the ZLB in the New Keynesian Model By Gauti B. Eggertsson; Sanjay R. Singh
  11. Currency Unions and Regional Trade Agreements: EMU and EU Effects on Trade By Glick, Reuven
  12. Optimal Central Bank Communication By Mirko Wiederholt
  13. Monetary Policy, Credit Markets and Banking Regulation By Daniel Sanches; Todd Keister
  14. Liquidity and Credit Risks in the UK’s Financial Crisis: How ‘Quantitative Easing’ changed the relationship By Woon K. Wong; Iris Biefang-Frisancho Mariscal; Wanru Yao; Peter Howells
  15. Emerging Market Capital Flows and U.S. Monetary Policy By John Clark; Nathan Converse; Brahima Coulibaly; Steven B. Kamin
  16. Policy Responses to Commodity Price Fluctuations By Javier G. Gómez-Pineda
  17. Measuring the Effects of Federal Reserve Forward Guidance and Asset Purchases on Financial Markets By Eric Swanson
  18. Co-movement of Exchange Rates with Interest Rate Differential, Risk Premium and FED Policy in “Fragile Economies” By M. Utku Ozmen; Erdal Yilmaz
  19. Optimal Monetary Policy when Information is Market-Generated By Isabella Blengini; Kenza Benhima
  20. Forecasting Chilean Inflation with the Hybrid New Keynesian Phillips Curve: Globalisation, Combination, and Accuracy By Carlos Medel
  21. The E-Monetary Theory By Duong Ngotran
  22. Monetary Policy Tradeoffs Between Financial Stability and Price Stability By Malik Shukayev; Alexander Ueberfeldt
  23. Optimal Monetary Policy in Behavioral New Keynesian Model By Lahcen, BOUNADER
  24. The Expansionary Lower Bound: Currency Mismatches and Monetary Spillovers By Damiano Sandri; Paolo Cavallino

  1. By: Kentaro Iwatsubo (Professor, Graduate School of Economics, Kobe University (E-mail:; Tomoki Taishi (Manager, Market Operations, Osaka Exchange, Inc. (E-mail:
    Abstract: The gQuantitative and Qualitative Monetary Easing h enacted immediately after the inauguration of Bank of Japan Governor Kuroda brought violent fluctuations in the prices of government bonds and deteriorated market liquidity. Does a central bank fs government bond purchasing policy generally reduce market liquidity? Do conditions exist that can prevent this decrease? This study analyzes how the Bank of Japan fs purchasing policy changes influenced market liquidity. The results reveal that three specific policy changes contributed significantly to improving market liquidity: 1) increased purchasing frequency; 2) a decrease in the purchase amount per transaction; and 3) reduced variability in the purchase amounts. These policy changes facilitated investors f purchase schedule expectations and helped reduce market uncertainty. The evidence supports the theory that the effect of government bond purchasing policy on market liquidity depends on the market fs informational environment.
    Keywords: Monetary Policy, Quantitative Easing, Liquidity, Government Bond
    JEL: G14
    Date: 2016–10
  2. By: McNelis, Paul D.
    Abstract: This paper examines the international transmission of financial shocks which originate in, and are partially offset by, quantitative easing in a large financially-stressed country. Using a two-country model, we evaluate the adjustment in the non-stressed home country, following recurring negative shocks to productivity and banking-sector balance-sheet/terminal wealth ratios. We first examine the application of QE policies in the stressed foreign country. Coupling quantitative easing with crisis events abroad magnifies the financial instability transmitted to the rest of the world. Our results show that the non-stressed home country can make effective use of tax-rate rules for consumption, or taxes to stabilize financial-sector net worth in times of prolonged crisis abroad.
    Keywords: quantitative easing, financial frictions, unconventional monetary policy
    JEL: E44 E58 F38 F41
    Date: 2016–10–26
  3. By: Margarita Rubio (University of Nottingham); Mariarosaria Comunale (Bank of Lithuania)
    Abstract: In this paper, we develop a two-country monetary union new Keynesian general equilibrium model with housing and collateral constraints, to be calibrated for Lithuania and the rest of the euro area. Within this setting, and following the recent entrance of Lithuania in the EMU, the aim of this paper is twofold. First, we study how shocks are transmitted differently in the two regions, considering the recent common monetary policy. Then, we analyze how macroprudential policies should be conducted in Lithuania, in the context of the EMU. As a macroprudential tool, we propose a decentralized Taylor-type rule for the LTV which responds to national deviations in output and house prices. We find that, given the housing market features in Lithuania, common shocks are transmitted more strongly in this country than in the rest of the euro area. In terms of macroprudential policies, results show that the optimal policy in Lithuania with respect to the euro area may have a different intensity and that it delivers substantial benefits in terms of financial stability.
    Keywords: Macroprudential policy, housing market, LTV, monetary union, financial stability
    JEL: E32 F44 F36
    Date: 2016–10–27
  4. By: Robert G. Murphy (Boston College)
    Abstract: Standard Phillips curve models relating price inflation to measures of slack in the economy suggest that the United States should have experienced an episode of deflation during the Great Recession and the subsequent sluggish recovery. But although inflation reached very low levels, prices continued to rise rather than fall. More recently, many observers have argued that inflation should have increased as the unemployment rate declined and labor markets tightened, but inflation has remained below the Federal Reserve’s policy target. This paper confirms that the slope of the Phillips curve has decreased over recent decades and is very close to zero today. I modify the Phillips curve to allow its slope to vary continuously through time drawing on theories of price-setting behavior when prices are costly to adjust and when information is costly to obtain. I find that adapting the Phillips curve to allow for time-variation in its slope helps explain inflation before, during, and after the Great Recession.
    Keywords: Inflation, Phillips curve, Great Recession
    JEL: E30 E31
    Date: 2016–04–30
  5. By: Michael Bordo; Catherine R. Schenk
    Abstract: This paper was prepared for the conference "International†Monetary Stability: Past, Present, and Future, held at the Hoover Institution at Stanford University on May 5, 2016.
    Date: 2016–05
  6. By: George-Marios Angeletos; Chen Lian
    Abstract: Forward guidance relies on shifting expectations of income and inflation. These expectations matter through general-equilibrium mechanisms, including two known as the deflationary spiral and the income multiplier. Recasting these expectations and these mechanisms in terms of higher-order beliefs reveals how the predictions of the New-Keynesian model—and some of its anomalies—hinge of the combination of a strong equilibrium concept with strong informational assumptions. Relaxing these assumptions anchors the expectations and attenuates the mechanisms. This attenuation increases with the horizon at which forward guidance operates, as well as with the degree of price flexibility. We thus lessen, not only the forward-guidance puzzle, but also the paradox of flexibility. We also operationalize the notion that policy makers may find it hard to shift expectations of income and inflation even if they can easily shift expectations of policy.
    JEL: C72 D82 E03 E32 E43 E52 E58
    Date: 2016–10
  7. By: Yuta Takahashi (Northwestern University); Lawrence Schmidt (University of Chicago); Konstantin Milbradt (Norwestern University); Ian Dew-Becker (Northwestern University); David Berger (Northwestern University)
    Abstract: The single strongest predictor of changes in the Fed Funds rate in the period 1982--2007 was the level of the layoff rate (initial unemployment claims divided by total employment). This fact is puzzling from the perspective of standard monetary models because they typically imply that the welfare gains of stabilizing employment fluctuations are small. We argue that these welfare costs are small because standard models do not capture the fact that when people lose their jobs, they tend to experience large, permanent, and largely uninsurable income losses. We augment a standard New Keynesian model with a labor market featuring endogenous countercyclical layoffs by firms that are associated with permanent reductions in human capital. In our benchmark calibration, welfare may be increased by 4 percent of lifetime consumption when the central bank's policy rule responds to the layoff rate. This provides a quantitative rationale for the Federal Reserve's dual mandate.
    Date: 2016
  8. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Paolo Gelain (Norges Bank (Central Bank of Norway))
    Abstract: We study the role of monetary policy in response to variations in unemployment due to structural factors, modeled as exogenous changes in matching efficiency and in the size of the labor force. We fi?nd that monetary policy should play a role in such a scenario. Both negative shocks to the matching efficiency and negative shocks to the labor force increase infl?ation, thus calling for an increase in the interest rate when policy is conducted following Taylor-type rules. However, the natural rate of interest declines in response to both shocks. The optimal Ramsey policy prescribes small deviations from price stability and lowers the interest rate, thus tracking the natural rate of interest in response to both shocks. Structural factors in the labor market may have contributed to the recent decline in the natural rate of interest in the US.
    Keywords: Optimal Monetary Policy, Taylor Rules, Natural Rate of Interest, Natural Rate of Unemployment, Labor Force Shocks
    JEL: E32
    Date: 2016–10–27
  9. By: Falk Mazelis; ;
    Abstract: Counter to the credit channel of monetary transmission, monetary policy tightening induces a rise in lending by two di erent types of non-bank nancial institutions (NBFI): shadow banks and investment funds. A monetary DSGE model is able to replicate the empirical facts when augmented with interme- diaries that allow for regulatory arbitrage on the one hand, and household portfolio rebalancing on the other. Therefore NBFI reduce the e ectiveness of the bank lending channel, which posits a decrease in bank lending following monetary tightening. Given the pending regulation of the nancial system, I study how regulation of the shadow banking sector may a ect the monetary transmission mechanism, especially during a zero lower bound (ZLB) episode. I nd that bringing shadow banks back onto the balance sheets of commercial banks is bene cial for consumption smoothing. Alternatively, regulating them like investment funds results in a milder recession during, and a quicker escape from, the ZLB. This is because a large demand shock that moves the economy to the ZLB acts in a similar way to a monetary tightening due to the inability to lower the policy rate to the unconstrained level. Consequently, the bank lending channel becomes operational and its e ectiveness can be reduced via less reliance on deposit funding.
    JEL: E32 E44 E52 G11
    Date: 2016–10
  10. By: Gauti B. Eggertsson; Sanjay R. Singh
    Abstract: How accurate is a log-linear approximation of the New Keynesian model when the nominal interest rate is bounded by zero? This paper compares the solution of the exact non-linear model to the log-linear approximation. It finds that the difference is modest. This applies even for extreme events in numerical experiments that replicate the U.S. Great Depression. The exact non-linear model makes the same predictions as the log-linear approximation for key policy questions such as the size and sign of government spending and tax multipliers. It also replicates well known paradoxes like the paradox of toil and the paradox of price flexibility. The paper also reconciles different findings reported in the literature using Calvo versus Rotemberg pricing.
    JEL: E30 E50 E60
    Date: 2016–10
  11. By: Glick, Reuven (Federal Reserve Bank of San Francisco)
    Abstract: The effects of the European Economic and Monetary Union (EMU) and European Union (EU) on trade are separately estimated using an empirical gravity model. Employing a panel approach with both time-varying country and dyadic fixed effects on a large span of data (across both countries and time), it is found that EMU and EU each significantly boosted exports. EMU expanded European trade by 40% for the original members, while the EU increased trade by almost 70%. Newer members have experienced even higher trade as a result of joining the EU, but more time is necessary to see the effects of their joining EMU.
    JEL: F15 F33
    Date: 2016–10–28
  12. By: Mirko Wiederholt (Goethe University Frankfurt)
    Abstract: Communication has become an increasingly important aspect of monetary policy. This paper studies optimal central bank communication in a monetary DSGE model. The basic model setup resembles a New Keynesian model, but private-sector agents have limited attention and optimally allocate attention. Households and decision-makers in firms choose the attention devoted to fundamentals and announcements by the central bank. I characterize the optimal communication strategy by the central bank.
    Date: 2016
  13. By: Daniel Sanches (Federal Reserve Bank of Philadelphia); Todd Keister (Rutgers University)
    Abstract: We study a model in which both money and private credit instruments can potentially be used as media of exchange to overcome trading frictions in decentralized markets. Entrepreneurs in our model have access to productive projects, but face credit constraints due to limited pledgeability of their returns. If credit claims cannot circulate, the optimal monetary policy is the Friedman rule, which leads to efficient patterns of exchange, but the equilibrium level of investment is inefficiently low. When credit claims do circulate, monetary policy affects the liquidity premium on private credit and thereby influences the cost of borrowing and the level of investment. The Friedman rule is no longer optimal; we show that the optimal policy instead strikes a balance between easing borrowing constraints for entrepreneurs and promoting efficient exchange. We relate our result to the traditional bank lending channel of monetary policy and derive implications for optimal banking regulation.
    Date: 2016
  14. By: Woon K. Wong (Cardiff Business School); Iris Biefang-Frisancho Mariscal; Wanru Yao; Peter Howells
    Abstract: This paper investigates the relationship between credit and liquidity risk components in the UK interbank spread during the recent financial crisis and sheds light on the transmission mechanism of the quantitative easing (QE) carried out by the Bank of England on short term interest rates. Specifically, we find that prior to the Bank’s intervention counterparty risk was a major factor in the widening of the spread and also caused a rise in liquidity risk. However, this relationship was reversed during the period when QE was implemented. Using the accumulated value of asset purchases as a proxy for the central bank’s liquidity provisions, we provide evidence that the QE operations were successful in reducing liquidity premia and ultimately, and indirectly, credit risk. We also find evidence that suggests liquidity schemes provided by other central banks and international market sentiment contributed to the reduction of interbank spread.
    Keywords: Migration; Fiscal Decentralisation; Tax Revenue
    JEL: R23 J61 H11 H22 H71 H72 H77
    Date: 2016–09
  15. By: John Clark; Nathan Converse; Brahima Coulibaly; Steven B. Kamin
    Abstract: Accordingly, in this note we analyze the drivers of EME capital flows, focusing in particular on the role of U.S. monetary policy and other potential factors in the decline in capital flows to EMEs since 2010.
    Date: 2016–10–18
  16. By: Javier G. Gómez-Pineda (Banco de la República de Colombia)
    Abstract: The world economy has recently been hit by commodity price fluctuations, with first round effects on noncore inflation and second round effects on core inflation. The policy response to commodity price fluctuations depends on the first and second round effects as well as on the strength of the central bank reaction to noncore inflation. The impulse responses and the historical error decomposition exercises show that the second round effects have followed two cycles, the first one before and after Lehman crisis; the second one, that started in 2010, exerted particularly strong downward pressure on interest rates during 2015-2016. The results are obtained with a global model of the largest five systemic economies plus one non systemic economy. In the model, latent variables are obtained with the multivariate Kalman filter and parameters are estimated with Bayesian methods. Classification JEL: E58; E37; E43; Q43
    Keywords: Commodity prices; Oil price shocks; Second round effects; Inflation
    Date: 2016–10
  17. By: Eric Swanson (University of California Irvine)
    Abstract: I adapt the methods of Gurkaynak, Sack, and Swanson (2005) to estimate two dimensions of monetary policy during the 2009–2015 zero lower bound period in the U.S. I show that, after a suitable rotation, these two dimensions can be interpreted as “forward guidance†and “large-scale asset purchases†(LSAPs). I estimate the sizes of the forward guidance and LSAP components of each FOMC announcement between January 2009 and October 2015, and show that those estimates correspond closely to identifiable features of major FOMC announcements over that period. Forward guidance has relatively small effects on the longest-maturity Treasury yields and essentially no effect on corporate bond yields, while LSAPs have large effects on those yields but essentially no effect on short-term Treasuries. Both types of policies have significant effects on medium-term Treasury yields, stock prices, and exchange rates. However, these effects do not seem to be very persistent.
    Date: 2016
  18. By: M. Utku Ozmen; Erdal Yilmaz
    Abstract: In this study, we use the wavelet coherency analysis in order to investigate the relationship between the exchange rate changes and its major financial determinants for selected emerging economies. Our analysis shows that the changes in exchange rate are correlated with interest rate differentials, risk premium, the FED’s monetary policy implementation and its policy uncertainty. Our findings reveal that the co-movement between the exchange rate changes and its financial determinants substantially changes across frequencies and over time: it becomes stronger/weaker or disappears completely at times. Also, although grouped together as “fragile economies”, the co-movement patterns of the exchange rate with major determinants vary to a large extent across these countries. Finally, the strongest co-movement of exchange rate changes is with the risk premium in all countries.
    Keywords: Exchange rate, FED policy, Uncertainty, Country risk, Fragile economies, Wavelet coherency
    JEL: E43 F31 F41
    Date: 2016
  19. By: Isabella Blengini (Ecole hôtelière de Lausanne); Kenza Benhima (University of Lausanne (HEC))
    Abstract: In this paper we study how the endogenous nature of the signals ob- served by the private sector affects optimal monetary policy. Agents learn from sources of information that are not market-determined, such as news, but also from variables that are endogenously determined on the markets, such as prices or production. In that case, how can the central optimally condition its monetary instrument on its information? When signals re- ceived by private agents are purely exogenous, it is optimal for the central bank to directly steer the economy towards the efficient allocation. This can be achieved through a price stabilization objective. In this case the public does not need to infer the state of the economy and the central bank is in charge of all the action. When information is endogenous, the policy of the central bank is aimed at maximizing the information content of the market-determined variables that agents use as sources of information. This is achieved by exacerbating the natural response of prices to shocks. This result holds independently of the possibility of the central bank to directly communicate its information through public announcements.
    Date: 2016
  20. By: Carlos Medel
    Abstract: This article analyses the multihorizon predictive power of the Hybrid New Keynesian Phillips Curve (HNKPC) covering the period from 2000.1 to 2014.12, for the Chilean economy. A distinctive feature of this article is the use of a Global Vector Autoregression (GVAR) specification of the HNKPC to enforce an open economy version. Another feature is the use of direct measures of inflation expectations—Consensus Forecasts—differing from a fully-founded rational expectations model. The HNKPC point forecasts are evaluated using the Mean Squared Forecast Error (MSFE) statistic and statistically compared with several benchmarks, including combined forecasts. The results indicate that there is evidence supporting the existence of the HNKPC for the Chilean economy, and robust to alternative specifications. In predictive terms, the results show that in a sample previous to the global financial crisis, the evidence is mixed between atheoretical benchmarks and the HNKPC by itself or participating in a combined prediction. However, when the evaluation sample is extended to include a more volatile inflation period, the results suggest that the HNKPC (and combined with the random walk) delivers the most accurate forecasts at horizons comprised within a year. In the long-run the HNKPC deliver accurate results, but not enough to outperform the candidate statistical models.
    Date: 2016–10
  21. By: Duong Ngotran
    Abstract: Using the Smolyak grid, we solve a DSGE model where there are two types of money: reserves (e-money that banks deposit at the central bank) and zero maturity deposits (e-money that is issued by banks). Transactions between bankers are settled by reserves, while other ones are settled by zero maturity deposits. Our model, featuring only one housing demand shock, can match some key facts in the Great Recession: (i) the investment falls sharply, (ii) the excess reserves skyrocket but the money multiplier plummets, (iii) the household debt declines, (iv) the long duration of the interbank rate at the lower bound - the interest rate paid on reserves, (v) the sharp deflation then back to inflation immediately after the central bank conducts quantitative easing. Due to the maturity mismatch between deposits and loans, we find that the large scale asset purchase program is very effective in the short run but creates deflation and lower outputs in the long run. After a period of time since conducting quantitative easing, a recommended policy is to slowly raise the interest rate paid on reserves even if the central bank does not see the inflation signal.
    JEL: E4 E5
    Date: 2016–10–29
  22. By: Malik Shukayev; Alexander Ueberfeldt
    Abstract: We analyze the impact of interest rate policy on financial stability in an environment where banks can experience runs on their short-term liabilities, forcing them to sell assets at fire-sale prices. Price adjustment frictions and a state-dependent risk of financial crisis create the possibility of a policy tradeoff between price stability and financial stability. Focusing on Taylor rules with monetary policy possibly reacting to banks’ short-term liabilities, we find that the optimized policy uses the extra tool to support investment at the expense of higher inflation and output volatility.
    Keywords: Financial stability, Monetary policy framework, Transmission of monetary policy
    JEL: E44 D62 G01 E32
    Date: 2016
  23. By: Lahcen, BOUNADER
    Abstract: This paper conducts the first assessment of the optimal monetary policy in the case of behavioral New Keynesian model proposed by Gabaix (2016). Consistent with the previous studies, I find that monetary policy under commitment continues to be important for optimal policy, but the optimal policy is found to be more history-dependent than in the traditional New Keynesian model. Importantly, I find that monetary policy under discretion may be optimal under some constraints on the parameters of the model which seems to correspond better to the reality of the conduct of monetary policy in central banks of developing, emerging and transitional economies. This finding is considered as filling the gap that always has been between the practice and the theory of the optimal monetary policy.
    Keywords: Optimal Monetary Policy, Behavioral New Keynesian Model
    JEL: D84 E52
    Date: 2016–08–26
  24. By: Damiano Sandri (International Monetary Fund); Paolo Cavallino (International Monetary Fund)
    Abstract: We develop a tractable model of monetary policy in emerging markets featuring currency mismatches and occasionally binding collateral constraints. We show that, if currency mismatches are severe, monetary policy is constrained in its ability to support output, even under flexible exchange rates. We characterize the existence of a strictly positive \expansionary lower bound" (ELB) on interest rates below which further monetary easing has contractionary effects. The ELB is affected by foreign monetary conditions that can in turn constrain domestic monetary policy. In particular, a US monetary tightening raises the ELB and can have recessionary consequences for emerging markets. As a result, a need for policy coordination arises. When the ELB is binding, social efficiency requires accepting some overheating in the US to reduce the contractionary effects on emerging markets.
    Date: 2016

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