nep-mon New Economics Papers
on Monetary Economics
Issue of 2017‒02‒12
eighteen papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Did the FED REact to Asset Price Bubbles? By Dennis Wesselbaum; Marc-Andre Luik
  2. Policy effectiveness is limited by a flat Phillips curve, stabilization as practiced in Europe and the US By David Kiefer
  3. Global impact of US and euro area unconventional monetary policies: a comparison By Qianying Chen; Marco Lombardi; Alex Ross; Feng Zhu
  4. A Model of Secular Stagnation: Theory and Quantitative Evaluation By Gauti B. Eggertsson; Neil R. Mehrotra; Jacob A. Robbins
  5. The credit channel during times of financial stress: A time varying VAR analysis By Dany, Geraldine
  6. External Monetary Shocks to Central and Eastern European Countries By Pierre LESUISSE
  7. Inflation expectation uncertainty, inflation and the output gap By Fuest, Angela; Schmidt, Torsten
  8. Quantitative easing, changes in global liquidity and financial instability By Esteban Ramon Perez Caldentey
  9. Demonetization and Its Impact on Employment in India By Pawan Kumar
  10. Large and state-dependent effects of quasi-random monetary experiments By Jordà, Òscar; Schularick, Moritz; Taylor, Alan M.
  11. Abolishing privately created money would increase GDP. By Musgrave, Ralph S.
  12. Cheap Talk in a New Keynesian Model By Dennis Wesselbaum
  13. Yields on sovereign debt, fragmentation and monetary policy transmission in the euro area: A GVAR approach By Victor Echevarria Icaza; Simón Sosvilla-Rivero
  14. Intermediation Markups and Monetary Policy Passthrough By Semyon Malamud; Andreas Schrimpf
  15. Liquidity Traps and Monetary Policy: Managing a Credit Crunch By Buera, Francisco J.; Nicolini, Juan Pablo
  16. Uncertainty and Monetary Policy in the US: A Journey into Non-Linear Territory By Giovanni Pellegrino
  17. The political economy of exchange rate stability during the gold standard. The case of Spain, 1874-1914 By Nogues-Marco, Pilar; Martínez-Ruiz, Elena
  18. Monetary Policy and Inequality when Aggregate Demand depends on Liquidity By Bilbiie, Florin Ovidiu; Ragot, Xavier

  1. By: Dennis Wesselbaum (Department of Economics, University of Otago, New Zealand); Marc-Andre Luik (Helmut-Schmidt University)
    Abstract: This paper investigates whether the U. S. Federal Reserve responds to asset price bubbles or not. We estimate a DSGE model featuring a financial accelerator and a process for asset price bubbles. We find evidence for a fairly strong reaction to bubbles. However, a counterfactual analysis shows that output is lower if the central banks reacts to the asset price bubble. Finally, we estimate an asymmetric version in which the central bank only reacts to positive price deviations. This version generates the best statistical fit. Including the bubble reduces the negative effects of the recent financial crisis but the symmetric response would have generated an earlier and stronger recovery.
    Keywords: Bayesian Methods, Bubbles, Monetary Policy.
    JEL: C11 E32 E44 E62
    Date: 2016–02
  2. By: David Kiefer
    Abstract: A standard model of activist macroeconomic policy derives a monetary reaction rule by assuming that governments have performance objectives, but are constrained by an augmented Phillips curve. In addition to monetary policy, governments apply a variety of instruments to influence inflation and output, including fiscal policy, bailouts and foreign exchange policy, but effectiveness is limited by Phillips curve flatness. Solving the Phillips curve and reaction rule for a reduced form, we study this theory with a panel of countries. A textbook version of the activist model leads to disappointing results; the activist model fits the data only slightly better than a flat-Phillipscurve benchmark. The econometric results are enhanced by accounting for autocorrelated shocks. Although results are mixed, our interpretation favors inertial inflation expectations over rational ones. An extension of this approach suggests that US policy is more effective than that of European governments, finding that the US Phillips curve is more than twice as steep.
    Keywords: stabilization policy, inflation targets, expectations JEL Classification: E61, E63
    Date: 2016
  3. By: Qianying Chen; Marco Lombardi; Alex Ross; Feng Zhu
    Abstract: The paper analyses and compares the domestic and cross-border effects of US and euro area unconventional monetary policy measures on 24 major advanced and emerging economies, based on an estimated global vector error-correction model (GVECM). Unconventional monetary policies are measured using shadow interest rates developed by Lombardi and Zhu (2014). Monetary policy shocks are identified using sign restrictions. The GVECM impulse responses suggest that US unconventional monetary policy generally has stronger domestic and cross-border impacts than euro area non-standard measures. Its spillovers to other economies are estimated to be more sizeable and persistent, especially in terms of output growth and inflation. There is evidence of diverse responses in the emerging economies in terms of exchange rate pressures, credit growth as well as monetary policy. In addition, the strength of cross-border transmission channels to the emerging economies appears to differ for US and euro area policies.
    Keywords: unconventional monetary policy; quantitative easing; shadow interest rate; spillover; global vector error correction model (GVECM)
    Date: 2017–01
  4. By: Gauti B. Eggertsson; Neil R. Mehrotra; Jacob A. Robbins
    Abstract: This paper formalizes and quantifies the secular stagnation hypothesis, defined as a persistently low or negative natural rate of interest leading to a chronically binding zero lower bound (ZLB). Output-inflation dynamics and policy prescriptions are fundamentally different than in the standard New Keynesian framework. Using a 56-period quantitative lifecycle model, a standard calibration to US data delivers a natural rate ranging from -1% to -2%, implying an elevated risk of ZLB episodes for the foreseeable future. We decompose the contribution of demographic and technological factors to the decline in interest rates since 1970 and quantify changes required to restore higher rates.
    JEL: E31 E32 E5 E52 E58 E6 E62
    Date: 2017–01
  5. By: Dany, Geraldine
    Abstract: This paper investigates in the contribution of financial stress to gdp and price developments as well as in the strength of the credit channel, as part of the monetary policy transmission mechanism, especially in times of high financial stress. Therefore, a TVP VAR with stochastic volatility is estimated and a structural financial stress shock, a monetary policy shock and a productivity shock are identified by using sign restrictions. Moreover, the imposed identification relies on a monetary DSGE model with financial frictions in the form of moral hazard with bankers running away with a faction of the assets they manage. As the estimation sample spans from 1984Q1 to 2012Q4 the implied impulse responses of the model are verified by re-simulating the model over a wide range of parameter calibrations as to account for a decline of inflation persistence and changing monetary policy as well as changes in the risk-adjusted premium and leverage ratio of the financial intermediaries over time. It is shown that structural financial stress as well as monetary policy shock are drivers of real economic activity and prices. Especially during the recent financial crisis and also in the course of the dot-com crisis financial stress has had negative impacts on gdp and prices whereas monetary policy was able to counteract declines of gdp but was not able to offset deflationary developments. The contributions to the risk-adjusted financing premium show that the credit channel in deed has been of increased importance during times of high financial stress. Thus, the paper provides evidence for the implications of recently developed DSGE models with financial frictions in the banking sector.
    JEL: E44 E52 C11
    Date: 2016
  6. By: Pierre LESUISSE
    Abstract: Few countries are part of the European Union but on the verge of the Euro-zone. This study aims at identifying the amplitude of the direct ECB monetary policy impact, i.e. the so-called international monetary spillovers, in Central and Eastern European countries (CEECs). The use of a panel-VAR method allows to deal with the small time span and endogeneity. We found that CEECs tend to significantly converge in monetary terms to the ECB standards. The direct impact on real variables remains relatively weak but contrary to the literature, is significant and in line with expectations. A persistent negative adjustment of GDP gives a quick glimpse of a robust reaction against monetary shock when the focus is made on the post-economic crisis period. The exchange rate regime plays a small but significant role in terms of magnitude. This increased interdependence is the result of macroeconomic reforms implemented during the last 25 years.
    Keywords: Monetary integration, External shocks, Panel VAR.
    JEL: F42 E52 C23
    Date: 2017–02
  7. By: Fuest, Angela; Schmidt, Torsten
    Abstract: Uncertainty about the future path of inflation affects consumption, saving and investment decisions as well as wage negotiations and price setting of firms. These decisions are based on inflation expectations which are a key determinant of inflation in the New Keynesian Phillips Curve. In this paper we therefore explicitly analyse the relationship between inflation expectations, the inflation rate and the output gap and the variance of these variables as uncertainty measures by using a VAR-GARCH-inmean model. Our main finding is that inflation expectation uncertainty is positively related to expected inflation and to the inflation rate.
    Keywords: inflation expectations,inflation uncertainty,VAR-GARCH-M models
    JEL: C22 E31 E32
    Date: 2017
  8. By: Esteban Ramon Perez Caldentey (Universidad de Santiago de Chile (CL))
    Abstract: This paper argues that Quantitative Easing (QE) led to significant changes in the global financial system, which, are not conducive to greater financial stability. Through a policy of reserve accumulation, QE disconnected base money from the money supply and deposits from loans. Jointly with the deleveraging process of global banks, QE contributed to restrain the supply of bank credit growth throughout the world. Also global banks continued to expand their trading on the basis of opaque instruments such as derivatives. Moreover, by altering the relative profitability of investing in different assets, QE exerted a positive effect on the performance of the international bond market. This not only spilled into emerging market economies expanding the debt of both the financial sector and the non-financial corporate sector but also has reinforced the role of the asset management industry in financial markets. Due to its concentration and interconnectedness, illiquidity, and pro-cyclicality the asset management industry poses important risks to financial stability.
    Keywords: Quantitative easing, financial system, global banks, asset management industry
    JEL: E12 E42 E44 E51
    Date: 2017–02
  9. By: Pawan Kumar
    Abstract: On November 08, the sudden announcement to demonetization the high denomination currency notes sent tremors all across the country. Given the timing, and socioeconomic and political repercussions of the decision, many termed it a financial emergency. Given high proportion of these notes in circulation, over 86 percent, it led to most economic activities, particularly employment, affected in a big way. Political parties, however, seemed divided on the issue, i.e. those in favor of the decision feel it will help to curb the galloping size of black money, fake currency, cross boarder terrorism, etc. In sharp contrast, the others believe it is a purely misleading, decision, based on no or poor understanding of black economy, and hence is only politically motivated in wake of the assembly elections due in a couple of states.
    Date: 2017–02
  10. By: Jordà, Òscar; Schularick, Moritz; Taylor, Alan M.
    Abstract: Fixing the exchange rate constrains monetary policy. Along with unfettered cross-border capital flows, the trilemma implies that arbitrage, not the central bank, determines how interest rates fluctuate. The annals of international finance thus provide quasi-natural experiments with which to measure how macroeconomic outcomes respond to policy rates. Based on historical data since 1870, we estimate the local average treatment effect (LATE) of monetary policy interventions and examine its implications for the population ATE with a trilemma instrument. Using a novel control function approach we evaluate the robustness of our findings to possible spillovers via alternative channels. Our results prove to be robust. We find that the effects of monetary policy are much larger than previously estimated, and that these effects are state-dependent.
    Keywords: fixed exchange rates; instru- mental variables; interest rates; local average treatment effect; local projections; monetary experiments; trilemma
    JEL: E01 E30 E32 E44 E47 E51 F33 F42 F44
    Date: 2017–01
  11. By: Musgrave, Ralph S.
    Abstract: In an economy where privately created money is banned, i.e. where the only form of money is state issued money, there is no obvious reason why interest rates would not settle down to some sort of genuine free market level. On the assumption normally made in economics, namely that GDP is maximised where market forces prevail unless market failure can be demonstrated, and given that there is no obvious reason to suspect market failure under the latter ban, that means that GDP is maximised where privately issued money is banned. One reason for thinking a state money only system (SMO) is more of a genuine free market than the existing system is that in free markets, producers normally bear the full costs of production and pass those costs on to customers. However, under the existing bank system, private banks can obtain money for free (administration costs apart) because those banks can effectively print money. Other corporations do not have that privilege. I.e. under SMO, banks and non-bank corporations are on an equal footing. It might seem odd to claim that SMO is closer to a free market than the alternatives, given that free markets are normally associated with scenarios where the private sector dominates, or (same thing), associated with the state playing little or no role. However the latter generalisation does not apply to money. A hint as to why is contained in the well-known phrase “money is a creature of the state”. That is, governments inevitably play an important role when it comes to a country’s currency, thus the only question is: what should that role be? While interest rates are higher and debts are lower under SMO, any deflationary effect of those higher rates is easily countered by creating and spending more base money and/or cutting taxes. If SMO in fact maximises GDP, and that system is implemented, states (or more specifically central banks’) ability to adjust interest rates is curtailed. Given that it is widely accepted that interest rate adjustments are a good way of adjusting demand, that might appear to be a weakness in the argument here. In fact there are glaring flaws in artificial interest rate adjustments. Thus the latter apparent weakness is not a weakness at all.
    Keywords: Money; banks; full reserve; free market; base money.
    JEL: E4 E41 E5 H62
    Date: 2017–02–05
  12. By: Dennis Wesselbaum (Department of Economics, University of Otago, New Zealand)
    Abstract: This paper shows that the stance of fiscal policy does have significant impact on the conduct of monetary policy in the United States. Further, we document that the implied fiscal-monetary policy interactions are subject to regime instability, using a Markov-switching model. Then, we develop a microfoundation of regime switches using a cheap talk game between central bank and government. As a case study, we simulate the effects of regime switches within an otherwise standard New Keynesian model using the cheap talk game in the state-space of our model.
    Keywords: Markov-switching, Monetary and Fiscal Policy Interactions, Policy Coordination Games, Sequential Games
    JEL: C32 C7 E5 E6
    Date: 2016–02
  13. By: Victor Echevarria Icaza (Universidad Complutense de Madrid Departamento de Fundamentos del Análisis Económico II (Economía Cuantitativa)); Simón Sosvilla-Rivero (Department of Quantitative Economics, Universidad Complutense de Madrid)
    Abstract: The divergence in sovereign yields has been presented as a reason for the lack of traction of monetary policy. We use a GVAR framework to assess the transmission of monetary policy in the period 2005-2016. We identify sovereign yield divergence as a key mechanism by which the leverage channel of monetary policy worked. Unconventional monetary policy was successful in mitigating this effect. When exploring the channels through which yields may affect the heterogeneous transmission of monetary policy, we find that the reaction of bank leverage depended substantially on where the sovereign yield originated, thus providing a mechanism that explains this heterogeneity. Second, large spillover effects meant that yield divergence decreased the traction of monetary policy even in anchor countries. Third, the heterogeneity in the transmission mechanism can be in part attributed to contagion from euro area wide sovereign stress. Fiscal credibility, therefore, may be an appropriate tool to enhance the output effect of monetary policy. Given the importance of spillovers, this credibility may be achieved by changes in the institutional make-up and policies in the euro area
    Keywords: monetary policy, spillovers, euro area crisis
    JEL: E52 E63 F45 H63
    Date: 2017–01
  14. By: Semyon Malamud (Ecole Polytechnique Fédérale de Lausanne, Swiss Finance Institute, and Centre for Economic Policy Research (CEPR)); Andreas Schrimpf (Bank for International Settlements (BIS))
    Abstract: We introduce intermediation frictions into the classical monetary model with fully flexible prices. Trade in financial assets happens through intermediaries who bargain over a full set of state contingent claims with their customers. Monetary policy is redistributive and affects intermediaries' ability to extract rents; this opens up a new channel for transmission of monetary shocks into rates in the wider economy, which may be labelled the markup channel of monetary policy. Passthrough efficiency depends crucially on the anticipated sensitivity of future monetary policy to future stock market returns (the "Central Bank Put"). The strength of this put determines the room for maneuver of monetary policy: when it is strong, monetary policy is destabilizing and may lead to market tantrums where deteriorating risk premia, illiquidity and markups mutually reinforce each other; when the put is too strong, passthrough becomes fully inefficient and a surprise easing even begets a rise in real rates.
    Keywords: Monetary Policy, Stock Returns, Intermediation, Market Frictions
    JEL: G12 E52 E40 E44
  15. By: Buera, Francisco J. (Federal Reserve Bank of Chicago); Nicolini, Juan Pablo (Federal Reserve Bank of Minneapolis)
    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 in the United States. The model can be used to study the effects of the credit-crunch on the main macroeconomic variables and the impact of alternative policies. The policy implications regarding forward guidance are in contrast with the prevalent view in most central banks, based on the New Keynesian explanation of the liquidity trap.
    Keywords: Liquidity trap; Credit crunch; Collateral constraints; Monetary policy; Ricardian equivalence
    JEL: E44 E52 E58 E63
    Date: 2017–02–02
  16. By: Giovanni Pellegrino (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne; and Department of Economics, University of Verona)
    Abstract: This paper estimates a non-linear Interacted VAR model to assess whether the real effects of monetary policy shocks are milder during times of high uncertainty. In a novel way, uncertainty, i.e., the conditioning indicator discriminating “high†and “low†uncertainty states, is modeled endogenously in the VAR and is found to reduce after an expansionary shock. Generalized Impulse Response Functions à la Koop, Pesaran and Potter (1996) suggest that monetary policy shocks are significantly less powerful during uncertain times, with the peak reactions of a battery of real variables being about two-thirds milder than those during tranquil times. Among the theoretical explanations proposed by the literature, real option effects and precautionary savings appear the ones supported by our results.
    Keywords: Monetary policy shocks, Non-Linear Structural Vector Auto-Regressions, Interacted VAR, Generalized Impulse Response Functions, uncertainty
    JEL: C32 E32 E52
    Date: 2017–02
  17. By: Nogues-Marco, Pilar; Martínez-Ruiz, Elena
    Abstract: This article contributes to the literature on the commitment to gold during the classical period of the gold standard. We use the case of Spain to analyse how national institutional design determined adherence to gold in peripheral countries, and argue that institutional design was the result of negotiation between the government and the central bank. We construct indicators of the relative bargaining power of the two actors to assess their respective influence in determining adherence to gold. Our results show that a powerful government facilitated adherence to the gold standard, but an independent central bank hindered it, especially if confronted by an unstable political authority. Central banks were private institutions whose objective was profit maximization, not monetary stability. Strongly independent private central banks operating in politically very weak countries avoided the responsibility of defending the national currency, even in a stable macroeconomic situation. In peripheral countries, therefore, adherence (or not) to gold was determined by the institutional design in which the monetary system operated.
    Keywords: Gold Standard, Political Economy, Central Bank Independence, Institutional Design, Monetary Stability, Spain
    JEL: E02 E42 E58 F33 N13
    Date: 2017
  18. By: Bilbiie, Florin Ovidiu; Ragot, Xavier
    Abstract: Monetary policy design changes a great deal when inequality matters. In our New Keynesian model, aggregate demand depends on liquidity as heterogeneous consumers hold money in face of uninsurable risk and participate infrequently in financial markets. Endogenous fluctuations in precautionary liquidity challenge central bank's aggregate demand management: the Taylor coefficients required for determinacy are in the double digits, for moderate market incompleteness. Responding to inequality or liquidity can restore conventional wisdom. A novel tradeoff for Ramsey-optimal monetary policy arises between inequality and standard---inflation and output---stabilization objectives. Price stability has significant welfare costs that are inequality-related: inflation volatility hinders volatility of constrained agents' consumption.
    Keywords: determinacy; heterogenous agents; incomplete markets; inequality; interest rate rules; limited participation; liquidity constraints; money; optimal (Ramsey) monetary policy; Taylor principle
    JEL: D14 D31 E21 E3 E4 E5
    Date: 2017–01

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