nep-mon New Economics Papers
on Monetary Economics
Issue of 2016‒11‒20
twenty-two papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Trust in the Central Bank and Inflation Expectations By Dimitris Christelis; Dimitris Georgarakos; Tullio Jappelli; Maarten van Rooij
  2. The optimal conduct of central bank asset purchases By Darracq Pariès, Matthieu; Kühl, Michael
  3. "Financial Stability and Secure Currency in a Modern Context" By Jan Kregel
  5. The Perils of Nominal Targets By Armenter, Roc
  6. Monetary Policy Tradeoffs Between Financial Stability and Price Stability By Shukayev, Malik; Ueberfeldt, Alexander
  7. Speaking to the people? Money, trust, and central bank legitimacy in the age of quantitative easing By Braun, Benjamin
  8. Does the Fed's unconventional monetary policy weaken the link between the financial and the real sector? By Yimin Xu; Jakob de Haan
  9. The Determinants of the Benchmark Interest Rates in China: A Discrete Choice Model Approach By Hyeongwoo Kim; Wen Shi
  10. Liquidity, insolvency and the state By Ehnts, Dirk H.
  11. Understanding Inflation as a Joint Monetary-Fiscal Phenomenon By Campbell Leith
  13. What Do Latin American Inflation Targeters Care About? A Comparative Bayesian Estimation of Central Bank Preferences By Stephen McKnight; Alexander Mihailov; Antonio Pompa Rangel
  14. Replacing or supplementing the euro in member states whose currency is the euro By Siekmann, Helmut
  15. Housing and the Redistributive Effects of Monetary Policy By Michael Reiter; Philipp Hergovich
  16. Reserve Requirements, Liquidity Risk, and Bank Lending Behavior By Koray Alper; Mahir Binici; Selva Demiralp; Hakan Kara; Pınar Ozlu
  17. Forecast combination for euro area inflation: a cure in times of crisis? By Hubrich, Kirstin; Skudelny, Frauke
  18. Appropriate Exchange Rate Regime for economic structure of Pakistan By Ali, Faran; Mamoon, Dawood; Tahir, Naveed
  19. HOW DO FIRMS FORM THEIR EXPECTATIONS? NEW SURVEY EVIDENCE By Yuriy Gorodnichenko; Saten Kumar; Olivier Coibion
  20. Equilibrium Yield Curves and the Interest Rate Lower Bound By Taisuke Nakata; Hiroatsu Tanaka
  21. How the interbank market becomes systemically dangerous: an agent-based network model of financial distress propagation By Matteo Serri; Guido Caldarelli; Giulio Cimini
  22. Interest rate pass-through in Poland since the global financial crisis By Mariusz Kapuściński; Ewa Stanisławska

  1. By: Dimitris Christelis (University of Naples Federico II, CSEF, CFS and CEPAR); Dimitris Georgarakos (European Central Bank, CFS and University of Leicester); Tullio Jappelli (Università di Napoli Federico II, CSEF and CEPR); Maarten van Rooij (De Nederlandsche Bank and Netspar)
    Abstract: Using micro data from the 2015 Dutch CentERpanel, we examine whether trust in the European Central Bank (ECB) influences individuals’ expectations and uncertainty about future inflation, and also whether it anchors inflation expectations. We find that higher trust in the ECB lowers inflation expectations on average, and significantly reduces uncertainty about future inflation. Moreover, results from quantile regressions suggest that trusting the ECB increases (lowers) inflation expectations when the latter are below (above) the ECB’s inflation target. These findings hold after controlling for people’s knowledge about the objectives of the ECB. In addition, higher trust in the ECB raises expectations about GDP growth. The findings suggest that a central bank can influence the economy through people’s expectations, even in times when conventional monetary policy tools likely have weak effects.
    Keywords: Inflation expectations, Inflation uncertainty, Anchoring, Trust in the ECB, Subjective Expectations
    JEL: D12 D81 E03 E40 E58
    Date: 2016–11–14
  2. By: Darracq Pariès, Matthieu; Kühl, Michael
    Abstract: We analyse the effects of central bank government bond purchases in an estimated DSGE model for the euro area. In the model, central bank asset purchases are relevant in so far as agency costs distort banks asset allocation between loans and bonds, and households face transaction costs when trading government bonds. Such frictions in the banking sector induce inefficient time-variation in the term premia and open up for a credit channel of central bank government bond purchases. Considering first ad hoc asset purchase programmes like the one implemented by the ECB, we show that their macroeconomic multipliers are stronger as the lower bound on the policy rate becomes binding and when the purchasing path is fully communicated and anticipated by economic agents. From a more normative standpoint, interest rate policy and asset purchases feature strong strategic complementarities during both normal and crisis times. In a lower bound environment, optimal policy conduct features long lower bound periods and activist asset purchase policy. Our results also point to a clear sequencing of the exit strategy, stopping first the asset purchases and later on, lifting off the policy rate. In terms of macroeconomic stabilisation, optimal asset purchase strategies bring sizeable benefits and have the potential to largely offset the costs of the lower bound on the policy rate. JEL Classification: C61, E52, G11
    Keywords: banking, DSGE, portfolio optimisation, quantitative easing
    Date: 2016–11
  3. By: Jan Kregel
    Abstract: Against the background of modern-day monetary proposals, ranging from a return to the gold standard to the wholesale abolition of currency, this paper seeks to draw implications from David Ricardo's "Proposals for an Economical and Secure Currency" for plans to reform the operation of central banks and extraordinary monetary policy. Although 200 years old, the "Ingot plan," proposed during a period in which gold convertibility was suspended, appears to be applicable to modern monetary conditions and suggests possible avenues of reform.
    Keywords: David Ricardo; Monetary Systems; Ingot Plan; Gold Standard
    JEL: B12 E42 N10
    Date: 2016–11
  4. By: Fujita, Shigeru (Federal Reserve Bank of Philadelphia); Fujiwara, Ippei (Keio University and Australian National University)
    Abstract: This paper explores a causal link between aging of the labor force and declining trends in the real interest rate and inflation in Japan. We develop a New Keynesian search/matching model that features heterogeneities in age and firm-specific skills. Using the model, we examine the long-run implications of the sharp drop in labor force entry in the 1970s. We show that the changes in the demographic structure induce significant low-frequency movements in per-capita consumption growth and the real interest rate. They also lead to similar movements in the inflation rate when the monetary policy follows the standard Taylor rule, failing to recognize the timevarying nature of the natural rate of interest. The model suggests that aging of the labor force accounts for roughly 40% of the declines in the real interest rate observed between the 1980s and 2000s in Japan.
    Keywords: aging; natural rate; deflation; Japan
    JEL: E24 E31 E52
    Date: 2016–11–07
  5. By: Armenter, Roc (Federal Reserve Bank of Philadelphia)
    Abstract: A monetary authority can be committed to pursuing an inflation, price-level, or nominal-GDP target yet systematically fail to achieve the prescribed goal. Con- strained by the zero lower bound on the policy rate, the monetary authority is unable to implement its objectives when private-sector expectations stray far enough from the target. Low-inflation expectations become self-fulfilling, resulting in an additional Markov equilibrium in which the monetary authority falls short of the nominal target, average output is below its efficient level, and the policy rate is typically low. Introducing a stabilization goal for long-term nominal rates can implement a unique Markov equilibrium without fully compromising stabilization policy.
    Keywords: inflation targeting; zero lower bound; Markov equilibria
    JEL: E52 E58
    Date: 2016–11–10
  6. By: Shukayev, Malik (University of Alberta, Department of Economics); Ueberfeldt, Alexander (Bank of Canada)
    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: Fire sales externality; short-term bank funding; business cycles; financial crisis
    JEL: D62 E32 E44 G01
    Date: 2016–11–11
  7. By: Braun, Benjamin
    Abstract: Financial upheaval and unconventional monetary policies have made money a salient political issue. This provides a rare opportunity to study the under-appreciated role of monetary trust in the politics of central bank legitimacy which, for the first time in decades, appears fragile. While research on central bank communication with "the markets" abounds, little is known about if and how central bankers speak to "the people." A closer look at the issue immediately reveals a paradox: while a central bank's legitimacy hinges on it being perceived as acting in line with the dominant folk theory of money, this theory accords poorly with how money actually works. How central banks cope with this ambiguity depends on the monetary situation. Using the Bundesbank and the European Central Bank as examples, this paper shows that under inflationary macro-economic conditions, central bankers willingly nourished the folk-theoretical notion of money as a quantity under the direct control of the central bank. By contrast, the Bank of England's recent refutation of the folk theory of money suggests that deflationary pressures and rapid monetary expansion have fundamentally altered the politics of monetary trust and central bank legitimacy.
    Abstract: Die durch die Finanzkrise und die unkonventionellen Maßnahmen der Zentralbanken bewirkte Politisierung des Geldes erlaubt einen seltenen Einblick in den Zusammenhang zwischen Geldvertrauen und Zentralbanklegitimität. Die Kommunikation von Zentralbanken mit der breiten Öffentlichkeit - im Gegensatz zur gut erforschten Kommunikation mit Finanzmärkten bisher weitgehend vernachlässigt - sieht sich mit einem Dilemma konfrontiert. Einerseits hängt die Legitimität der Zentralbank davon ab, ob ihr Handeln den Maximen entspricht, die sich aus der in der Öffentlichkeit vorherrschenden Theorie des Geldes ableiten. Andererseits weicht diese Theorie in wichtigen Punkten von der tatsächlichen Funktionsweise des Geldsystems ab. Wie Zentralbanken mit diesem Dilemma umgehen, hängt von der allgemeinen geldpolitischen Situation ab. Anhand der Beispiele der Deutschen Bundesbank und der Europäischen Zentralbank wird argumentiert, dass Zentralbanker unter inflationären Bedingungen die Öffentlichkeit gerne in dem Glauben lassen, die Geldmenge sei vollständig von der Zentralbank kontrolliert. Die außergewöhnliche Initiative der Bank of England, die Öffentlichkeit von der Irrtümlichkeit dieser Vorstellung zu überzeugen, zeigt hingegen, dass deflationärer Druck und rapide geldpolitische Expansion das diskursive Verhältnis zwischen Geldvertrauen und Zentralbanklegitimität grundlegend verändert haben.
    Date: 2016
  8. By: Yimin Xu; Jakob de Haan
    Abstract: After the global financial crisis, several central banks introduced unconventional monetary policies, such as QE. If QE increases asset prices, but does not boost the real economy to the same extent, the relationship between the financial and the real sector will weaken. This study investigates this issue for the US using the predictive power of the credit spread for future employment growth as measure for the strength of the real-financial link in a moving-window framework. Our results suggest that the real-financial link is lower during bubbles and recessions. We also find that the relationship weakened after the Fed introduced QE.
    Keywords: Financial-real Linkages; unconventional monetary policies; QE; Federal Reserve
    JEL: E22 G31 G32 D92
    Date: 2016–11
  9. By: Hyeongwoo Kim; Wen Shi
    Abstract: This paper empirically investigates the determinants of the two key benchmark interest rates in China using an array of constrained ordered probit models for quarterly frequency data from 1987 to 2013. Specifically, we estimate the behavioral equation of the People's Bank of China that models its decision-making process for revisions of the benchmark deposit rate and the lending rate. Our findings imply that the PBC's policy decisions are better understood as responses to changes in inflation and money growth, while output gaps and the exchange rate play negligible roles. We also implement in-sample fit analyses and out-of-sample forecast exercises. Our empirical findings show robust and reasonably good performances of our models in understanding dynamics of these benchmark interest rates.
    Keywords: Monetary Policy; People's Bank of China; Ordered Probit Model; Deposit Rate; Lending Rate; In-Sample Fit; Out-of-Sample Forecast
    JEL: E52 E58
    Date: 2016–11
  10. By: Ehnts, Dirk H.
    Abstract: The importance of liquidity and insolvency for nation states and banks has been highlighted by current economic woes in the eurozone and elsewhere. The concepts are grounded in monetary theory, which determine the way they are interpreted. Connected to the discussion of autometallism and Chartalism in the early 20th century, monetary economists of today have come full circle. Discussing some modern authors, it is argued that the concepts of liquidity and insolvency are connected. However, if the central bank functions as lender of last resort the link is cut. Also, fiscal policy has the potential to remove problems of illiquidity and insolvency in the financial system. Illiquidity and insolvency are signals of stress in the real economy. Their oppression through central bank policy might lead to the (wrong) perception that all is well in the economy.
    Keywords: monetary policy,fiscal policy,balance sheets,autometallism,Chartalism
    JEL: E5 E6 G21
    Date: 2016
  11. By: Campbell Leith (University of Glasgow)
    Abstract: We develop the fiscal theory of the price level in a range of models using both ad hoc policy rules and jointly optimal monetary and fiscal policies. The article is prepared for the Handbook of Macroeconomics, volume 2 (John B. Taylor and Harald Uhlig, editors, Elsevier Press).
    Keywords: inflation, fiscal policy, fiscal theory of the price level, Monetary Policy, Debt Management
    Date: 2016
  12. By: Ion PARTACHI (Academia de Studii Economice, Chișinău, Republica Moldova,); Vitalie MOTELICA (Academia de Studii Economice, Chișinău, Republica Moldova,)
    Abstract: Implementing effective inflation targeting strategy requires the knowledge of all the factors that are responsible for the inflationary process. The consumer price index includes sub-components, such as trend or seasonality that makes it difficult to analyze the inflationary pressures for the monetary policy decision making. The annual inflation indicator eliminates these deficiencies to a certain extent. However, in the decision making process and for communication purposes, monthly inflation is used as well which, first must be seasonally adjusted to provide information relevant for monetary policy. In this study we addressed the seasonality issues for both CPI, and for the main sub-components of this indicator in Moldova to track the sources responsible for seasonal fluctuations. The study established that the seasonal factor has moderate positive values in the first 4 months of the year, then in the summer months it becomes negative. During the fall and in December, the seasonal factor is back in positive territory. Furthermore, the largest impact on seasonal fluctuations is determined by the seasonal factor of food prices.
    Keywords: Seasonal factors, CPI inflation, monetary policy, inflation targeting strategy
    Date: 2016–11
  13. By: Stephen McKnight (Centro de Estudios Económicos, El Colegio de México); Alexander Mihailov (Department of Economics, University of Reading); Antonio Pompa Rangel (
    Abstract: This paper uses Bayesian estimation techniques to uncover the central bank preferences of the big five Latin American inflation targeting countries: Brazil, Chile, Colombia, Mexico, and Peru. The target weights of each central bank's loss function are estimated using a medium-scale small open economy New Keynesian model with incomplete international asset markets and imperfect exchange-rate pass-through. Our results suggest that all central banks in the region place a high priority on stabilizing inflation and interest rate smoothing. While stabilizing the real exchange rate is a concern for all countries except Brazil, only Mexico is found to assign considerable weight to reducing real exchange rate fluctuations. Overall, Brazil, Colombia, and Peru show evidence of implementing a strict inflation targeting policy, whereas Chile and Mexico follow a more flexible policy by placing a sizeable weight to output gap stabilization. Finally, the posterior distributions for the central bank preference parameters are found to be strikingly different under complete asset markets. This highlights the sensitivity of Bayesian estimation, particularly when uncovering central bank preferences, to alternative international asset market structures.
    Keywords: Bayesian estimation, central bank preferences, inflation targeting, Latin America, small open economies, incomplete asset markets, monetary policy
    JEL: C51 E52 F41
    Date: 2016
  14. By: Siekmann, Helmut
    Date: 2016
  15. By: Michael Reiter (Institute for Advanced Studies); Philipp Hergovich (University of Vienna)
    Abstract: We study the redistributive effects of monetary policy in the framework of a large OLG model, with endogenous housing choice, downpayment constraints, and different types of shocks. We pay special attention to the structure of debt, whether it is short-term or long-term, nominal or real. We find that monetary policy shocks have long-lasting effects on the inter-generational wealth distribution. While the debt structure only has a mild effect on aggregate statistics, it matters a lot for how different types of shocks under different monetary policy regimes affect the distribution.
    Date: 2016
  16. By: Koray Alper (Central Bank of the Republic of Turkey); Mahir Binici (Central Bank of the Republic of Turkey); Selva Demiralp (Koc University); Hakan Kara (Central Bank of the Republic of Turkey); Pınar Ozlu (Central Bank of the Republic of Turkey)
    Abstract: Although reserve requirements have been used in emerging markets to smooth credit cycles, the exact transmission mechanism remains to be explored. Using bank level data, this study looks inside the black-box to unveil the interaction of reserve requirement policy with bank lending. We identify a new channel that works through a decline in bank liquidity and loan supply due to an increase in reserve requirements. We show that “quantitative tightening” through reserve requirements affect the funding needs and the liquidity position of the banking system. The consequent changes in bank liquidity have a significant impact on the bank lending behavior.
    Keywords: Monetary transmission mechanism; liquidity channel; reserve requirements; Turkey.
    JEL: E44 E51 E52
    Date: 2016–11
  17. By: Hubrich, Kirstin; Skudelny, Frauke
    Abstract: The period of extraordinary volatility in euro area headline inflation starting in 2007 raised the question whether forecast combination methods can be used to hedge against bad forecast performance of single models during such periods and provide more robust forecasts. We investigate this issue for forecasts from a range of short-term forecasting models. Our analysis shows that there is considerable variation of the relative performance of the different models over time. To take that into account we suggest employing performance-based forecast combination methods, in particular one with more weight on the recent forecast performance. We compare such an approach with equal forecast combination that has been found to outperform more sophisticated forecast combination methods in the past, and investigate whether it can improve forecast accuracy over the single best model. The time-varying weights assign weights to the economic interpretations of the forecast stemming from different models. We also include a number of benchmark models in our analysis. The combination methods are evaluated for HICP headline inflation and HICP excluding food and energy. We investigate how forecast accuracy of the combination methods differs between pre-crisis times, the period after the global financial crisis and the full evaluation period including the global financial crisis with its extraordinary volatility in inflation. Overall, we find that forecast combination helps hedge against bad forecast performance and that performance-based weighting outperforms simple averaging. JEL Classification: C32, C52, C53, E31, E37
    Keywords: euro area inflation, forecast combinations, forecast evaluation, forecasting
    Date: 2016–10
  18. By: Ali, Faran; Mamoon, Dawood; Tahir, Naveed
    Abstract: This study empirically finds the appropriate exchange rate regime for economic structure of Pakistan. To find long run association between exchange rate regime and its determinants; ARDL bond testing approach is concern however for the estimation of short run analysis Error correction model (ECM) is applied. Time series data is used over the period from 1984 to 2012. Findings reveal that Trade openness, foreign exchange reserves, rate of inflation and financial development are important determinant while choosing appropriate exchange-rate regime for economy having features like Pakistan. On the basis of analysis, this study suggests that both extreme ends hard peg and free float are unfavorable for it. Still, lot of attention is required on this topic. Choice of regime is a difficult task in empirical analysis because few factors cannot explain actual regime.
    Keywords: Exchange Rate Regime,
    JEL: E5 E58
    Date: 2016–10–01
  19. By: Yuriy Gorodnichenko (University of California Berkeley); Saten Kumar (Auckland University of Technology); Olivier Coibion (UT Austin)
    Abstract: We implement a new survey of firms’ macroeconomic beliefs in New Zealand and document a number of novel stylized facts from this survey. Despite nearly twenty-five years under an inflation targeting regime, there is widespread dispersion in firms’ beliefs about both past and future macroeconomic conditions, especially inflation, with average beliefs about recent and past inflation being much higher than those of professional forecasters. Much of the dispersion in beliefs can be explained by firms’ incentives to collect and process information, i.e. rational inattention motives. Using experimental methods, we find that firms update their beliefs in a Bayesian manner when presented with new information about the economy. But few firms seem to think that inflation is most important to their business decisions and therefore they tend to devote few resources to collecting and processing information about inflation.
    Date: 2016
  20. By: Taisuke Nakata; Hiroatsu Tanaka
    Abstract: We study the term structure of default-free interest rates in a sticky-price model with an occasionally binding effective lower bound (ELB) constraint on interest rates and recursive preferences. The ELB constraint induces state-dependency in the dynamics of term premiums by affecting macroeconomic uncertainty and interest-rate sensitivity to economic activities. In a model calibrated to match key features of the aggregate economy and term structure dynamics in the U.S. above and at the ELB, we find that the ELB constraint typically lowers the absolute size of term premiums at the ELB and increases their volatility around the time of liftoff. The central bank's announcement to keep the policy rate at the ELB for longer than previously expected lowers the expected short rate path, but its effect on term premiums depends on the risk exposure of bonds to the macroeconomy; while the announcement increases term premiums if bonds are a hedge against economic downturns, it decreases them otherwise.
    Keywords: Effective Lower Bound ; Forward Guidance ; New Keynesian Model ; Recursive Preference ; Term Premiums ; Term Structure of Interest Rates ; Yield Curves
    JEL: E12 E32 E43 E44 E52 G12
    Date: 2016–10
  21. By: Matteo Serri; Guido Caldarelli; Giulio Cimini
    Abstract: Assessing the stability of economic systems is a fundamental research focus in economics, that has become increasingly interdisciplinary in the currently troubled economic situation. In particular, much attention has been devoted to the interbank lending market as an important diffusion channel for financial distress during the recent crisis. In this work we study the stability of the interbank market to exogenous shocks using an agent-based network framework. Our model encompasses several ingredients that have been recognized in the literature as pro-cyclical triggers of financial distress in the banking system: credit and liquidity shocks through bilateral exposures, liquidity hoarding due to counterparty creditworthiness deterioration, target leveraging policies and fire-sales spillovers. But we exclude the possibility of central authorities intervention. We implement this framework on a dataset of 183 European banks that were publicly traded between 2004 and 2013. We document the extreme fragility of the interbank lending market up to 2008, when a systemic crisis leads to total depletion of market equity with an increasing speed of market collapse. After the crisis instead the system is more resilient to systemic events in terms of residual market equity. However, the speed at which the crisis breaks out reaches a new maximum in 2011, and never goes back to values observed before 2007. Our analysis points to the key role of the crisis outbreak speed, which sets the maximum delay for central authorities intervention to be effective.
    Date: 2016–11
  22. By: Mariusz Kapuściński; Ewa Stanisławska
    Abstract: We analyse why loan rates in Poland have diverged from interbank interest rates since the beginning of the global financial crisis. Following Illes et al. (2015) we calculate a weighted average cost of liabilities, which might be considered as a more accurate proxy for a marginal cost of funding for banks than an interbank interest rate. Then, we investigate the interest rate pass-through on bank-level panel data using both measures. We find that an increase in the weighted average cost of liabilities, relative to interbank interest rates, explains some of the increase in credit spreads. However, deterioration of economic outlook, an increase in uncertainty and non-performing loans, as well as tightening of capital regulation have also been at play. That the cost of funding matters for loan rates has important implications for the current discussion on the potency of negative interest rates, as they rather cannot be transmitted to deposit rates, which are the main component of bank funding.
    Keywords: interest rate pass-through, monetary policy, global financial crisis, lending spreads, panel data models
    JEL: E43 E52 C23
    Date: 2016

This nep-mon issue is ©2016 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.