nep-mon New Economics Papers
on Monetary Economics
Issue of 2017‒03‒05
39 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Low inflation and monetary policy in the euro area By Conti, Antonio M.; Neri, Stefano; Nobili, Andrea
  2. Exit strategies for monetary policy By Aleksander Berentsen; Sébastien Kraenzlin; Benjamin Müller
  3. The Operation and Demise of the Bretton Woods System; 1958 to 1971 By Michael D. Bordo
  4. Unconventional monetary policy and the anchoring of inflation expectations By Ciccarelli, Matteo; García, Juan Angel; Montes-Galdón, Carlos
  5. Forecasting euro area inflation using targeted predictors: is money coming back? By Falagiarda, Matteo; Sousa, João
  6. Exchange rate pass-through in the euro area By Comunale, Mariarosaria; Kunovac, Davor
  7. Did Monetary Policy Matter? Narrative Evidence from the Classical Gold Standard By Lennard, Jason
  8. Trust, but verify. De-anchoring of inflation expectations under learning and heterogeneity By Busetti, Fabio; Delle Monache, Davide; Gerali, Andrea; Locarno, Alberto
  9. Central bank sentiment and policy expectations By Hubert, Paul; Labondance, Fabien
  10. Gradualism and Liquidity Traps By Schmidt, Sebastian; Nakata, Taisuke
  11. Inflation Anchoring in the Euro Area By Speck, Christian
  12. Unconventional Monetary Policy, Fiscal Side Effects and Euro Area (Im)balances By Hachula, Michael; Rieth, Malte; Piffer, Michele
  13. Below the zero lower bound: a shadow-rate term structure model for the euro area By Lemke, Wolfgang; Vladu, Andreea Liliana
  14. Monetary policy surprises over time By Marcello Pericoli; Giovanni Veronese
  15. Tail co-movement in inflation expectations as an indicator of anchoring By Natoli, Filippo; Sigalotti, Laura
  16. The impact of constrained monetary policy on fiscal multipliers on output and inflation By Bletzinger, Tilman; Lalik, Magdalena
  17. Aftershocks of Monetary Unification: Hysteresis with a Financial Twist By Tamim Bayoumi; Barry Eichengreen
  18. Financial frictions and robust monetary policy in the models of New Keynesian framework By Ekaterina Pirozhkova
  19. The long-term distribution of expected inflation in the euro area: what has changed since the great recession? By Dovern, Jonas; Kenny, Geoff
  20. The Inherent Benefit of Monetary Unions By Groll, Dominik; Monacelli, Tommaso
  21. International Financial Market Integration, Asset Compositions, and the Falling Exchange Rate Pass-Through By Enders, Zeno; Buzaushina, Almira; Hoffmann, Mathias
  22. The Exchange Rate Pass-Through to CPI and its components in Oil-Exporting CIS Countries By Vugar Rahimov; Nigar Jafarova; Fuad Ganbarov
  23. The Mist of Central Bank Balance Sheets By Otaviano Canuto; Matheus Cavallari
  24. Interbank Credit and the Money Manufacturing Process. A Systemic Perspective on Financial Stability By Yuri Biondi; Feng Zhou
  25. Budget-neutral fiscal rules targeting inflation differentials By Brede, Maren
  26. An exchange market pressure measure for cross-country analysis. By Patnaik, Ila; Felman, Joshua; Shah, Ajay
  27. Unconventional Monetary and Exchange Rate Policies By Joseph E. Gagnon; Tamim Bayoumi; Juan M. Londono; Christian Saborowski; Horacio Sapriza
  28. Bank loan components, uncertainty and monetary transmission mechanism By Ekaterina Pirozhkova
  29. Forecasting Inflation in Vietnam with Univariate and Vector Autoregressive Models By Tran Thanh Hoa
  30. Rigid relations: External adjustment under the Gold Standard (1880-1913) By Ward, Felix; Chen, Yao
  31. A new indicator of inflation expectations anchoring By Natoli, Filippo; Sigalotti, Laura
  32. Missing disinflation and missing inflation: the puzzles that aren't By Bobeica, Elena; Jarociński, Marek
  33. Optimal Fiscal Substitutes For The Exchange Rate In A Monetary Union By Kaufmann, Christoph
  34. Exchange Rate Movements and Fundamentals: Impact of Oil Prices and China¡¯s Growth By Shuo Cao; Hongyi Chen
  35. Demographics and inflation By Bobeica, Elena; Nickel, Christiane; Lis, Eliza; Sun, Yiqiao
  36. Modeling euro area bond yields using a time-varying factor model By Adam, Tomáš; Lo Duca, Marco
  37. The European dimension: Consequences for European monetary policy By De Grauwe, Paul
  38. Is Deflation Costly After All? Evidence from Noisy Historical Data By Daniel Kaufmann
  39. Will US inflation awake from the dead? The role of slack and non-linearities in the Phillips curve By Albuquerque, Bruno; Baumann, Ursel

  1. By: Conti, Antonio M.; Neri, Stefano; Nobili, Andrea
    Abstract: Inflation in the euro area has been falling since mid-2013, turned negative at the end of 2014 and remained below target thereafter. This paper employs a Bayesian VAR to quantify the contribution of a set of structural shocks, identified by means of sign restrictions, to inflation and economic activity. Shocks to oil supply do not tell the full story about the disinflation that started in 2013, as both aggregate demand and monetary policy shocks also played an important role. The lower bound to policy rates turned the European Central Bank (ECB) conventional monetary policy de facto contractionary. A country analysis confirms that the negative effects of oil supply and monetary policy shocks on inflation was widespread, albeit with different intensity across countries. The ECB unconventional measures since 2014 contributed to raising inflation and economic activity in all the countries. All in all, our analysis confirms the appropriateness of the ECB asset purchase programme. JEL Classification: C32, E31, E32, E52
    Keywords: Bayesian methods, inflation, monetary policy, oil supply, VAR models
    Date: 2017–01
  2. By: Aleksander Berentsen; Sébastien Kraenzlin; Benjamin Müller
    Abstract: In response to the financial crisis of 2007/08, all major central banks decreased interest rates to historically low levels and created large excess reserves. Central bankers currently discuss how to raise interest rates in such an environment. The term "exit strategy" refers to the various policies that allow central banks to achieve this objective. Exit instruments such as paying interest on reserves, term deposits, central bank bills and reverse repos are evaluated with respect to the central bank's ability to control the money market interest rate and their impact on money market trading activity, welfare, inflation and taxes. Each instrument is investigated under two polar coordination regimes: monetary dominance and fiscal dominance.
    Keywords: Exit strategies, money market, repo, monetary policy, interest rates
    JEL: E40 E50 D83
    Date: 2016–12
  3. By: Michael D. Bordo
    Abstract: This chapter revisits the history of the origins, operation and demise of the Bretton Woods International Monetary System. The Bretton Woods system was created by the !944 Articles of Agreement to design a new international monetary order for the post war at a global conference organized by the US Treasury at the Mount Washington Hotel in Bretton Woods ,New Hampshire at the height of World War II. The Articles represented a compromise between the American plan of Harry Dexter White and the British plan of John Maynard Keynes. The compromise created an adjustable peg system based on the US dollar convertible into gold at $35 per ounce along with capital controls. It was designed to combine the advantages of fixed exchange rates of the pre World War I gold standard with some flexibility to handle large real shocks. The compromise gave members both exchange rate stability and the independence for their monetary authorities to maintain full employment. It took over a decade for the fully current account convertible system to get started. The system only lasted for 12 years from 1959 to 1971 but it did deliver remarkable economic performance. The BWS evolved into a gold dollar standard which depended on the US monetary authorities following sound low inflation policies. As the System evolved it faced the same severe fundamental problems as in the interwar gold exchange standard of: adjustment, confidence and liquidity. The adjustment problem meant that member countries with balance of payments deficits, in the face of nominal rigidities, ran the gauntlet between currency crises and recessions. Surplus countries had to sterilize dollar inflows to prevent inflation. The U.S. as center country faced the Triffin dilemma. With the growth of trade and income member countries held more and more dollars instead of scarce gold as reserves generated by a growing US balance of payments deficit. As outstanding dollar liabilities grew relative to the US monetary gold stock confidence in the dollar would wane raising the likelihood of a run on Fort Knox.This led to the possibility that the US would follow tight financial policies to reduce the deficit thereby starving the rest of the world of needed liquidity leading to global deflation and depression as occurred in the 1930s. Enormous efforts by the US, the G10 and international institutions were devoted to solving this problem. As it turned out, after 1965 the key problem facing the global economy was inflation, not deflation, reflecting expansionary Federal Reserve policies to finance the Vietnam war and the Great Inflation. US inflation was exported through the balance of payments to the surplus countries of Europe and Japan leading them in 1971 to begin converting their outstanding dollar holdings into gold. In reaction President Richard Nixon closed the US gold window ending the BWS.
    JEL: N10
    Date: 2017–02
  4. By: Ciccarelli, Matteo; García, Juan Angel; Montes-Galdón, Carlos
    Abstract: The effects of the unconventional monetary policy (UMP) measures undertaken by the U.S. Federal Reserve (and other major central banks) remain a crucial topic for research. This paper investigates their effects on the anchoring of long-term inflation expectations, a key dimension of UMP that has been largely overlooked. Our analysis provides two key insights. First, the anchoring of inflation expectations deteriorated significantly since late 2008. Second, the expansion of the Fed’s balance sheet contributed decisively to prevent and gradually reverse that de-anchoring during the Great Recession. Using a SVAR framework extended to incorporate policy news, we show that accounting for the predictable path of the balance sheet following the Fed’s asset purchase announcements is fundamental to properly assess the effects of UMP. JEL Classification: E43, E44, C52, C55
    Keywords: inflation expectations, news shocks, unconventional monetary policy
    Date: 2017–01
  5. By: Falagiarda, Matteo; Sousa, João
    Abstract: This paper sheds new light on the information content of monetary and credit aggregates for future price developments in the euro area. Overall, we find strong variation in the information content of these variables over time. We show that monetary and credit aggregates are very often selected among the top predictors of inflation, with their predictive power relative to other predictors generally improving in the post-2012 period. An out-of-sample forecasting exercise indicates that, when monetary and credit aggregates are loaded directly in the forecasting equation, the additional gains over the benchmark model are generally high and significant across horizons and HICP components only in the most recent period. When the forecasts are computed using factor-augmented regressions based on the best predictors, we confirm the importance of monetary and credit variables in forecasting inflation, even if their information content is diluted in a much broader pool of variables. JEL Classification: C53, E37, E41, E51, E58
    Keywords: diffusion index, forecasting, inflation, money, targeted predictors
    Date: 2017–02
  6. By: Comunale, Mariarosaria; Kunovac, Davor
    Abstract: In this paper we analyse the exchange rate pass-through (ERPT) in the euro area as a whole and for four euro area members - Germany, France, Italy and Spain. For that purpose we use Bayesian VARs with identi?cation based on a combination of zero and sign restrictions. Our results emphasize that pass-through in the euro area is not constant over time - it may depend on a composition of economic shocks governing the exchange rate. Regarding the relative importance of individual shocks, it seems that pass-through is the strongest when the exchange rate movement is triggered by (relative) monetary policy shocks and the exchange rate shocks. Our shock-dependent measure of ERPT points to a large but volatile pass-through to import prices and overall very small pass-through to consumer in?ation in the euro area. JEL Classification: E31, F3, F41
    Keywords: Bayesian vector autoregression, consumer prices, exchange rate pass-through, import prices, inflation
    Date: 2017–01
  7. By: Lennard, Jason (Department of Economic History, Lund University)
    Abstract: This paper investigates the causal effect of monetary policy on economic activity in the United Kingdom between 1890 and 1913. Based on the Romer and Romer (2004) narrative identification approach, I find that following a one percentage point monetary tightening, unemployment rose by 0.8 percentage points, while inflation fell by 2.7 percentage points. In addition, monetary policy shocks accounted for more than a quarter of macroeconomic volatility.
    Keywords: business cycles; gold standard; monetary policy; narrative identification
    JEL: E31 E32 E52 E58 N13
    Date: 2017–02–28
  8. By: Busetti, Fabio; Delle Monache, Davide; Gerali, Andrea; Locarno, Alberto
    Abstract: The paper studies how a prolonged period of subdued price developments may induce a de-anchoring of inflation expectations from the central bank's objective. This is shown within a framework where agents form expectations using adaptive learning, choosing among a set of alternative forecasting models. The analysis is accompanied by empirical evidence on the properties of inflation expectations in the euro area. Our results also suggest that monetary policy may lose effectiveness if delayed too much, as expectations are allowed to drift away from target for too long. JEL Classification: E31, E37, E58, D83
    Keywords: DSGE, expectations de-anchoring, inflation, learning
    Date: 2017–01
  9. By: Hubert, Paul (OFCE - SCiences Po.); Labondance, Fabien (Université de Bourgogne Franche-Comté — CRESE, OFCE — Sciences Po)
    Abstract: We explore empirically the theoretical prediction that optimism or pessimism have aggregate effects, in the context of monetary policy. First, we quantify the tone conveyed by FOMC policymakers in their statements using computational linguistics. Second, we identify sentiment as the unpredictable component of tone, orthogonal to fundamentals, expectations, monetary shocks and investors’ sentiment. Third, we estimate the impact of FOMC sentiment on the term structure of private interest rate expectations using a high-frequency methodology and an ARCH model. Optimistic FOMC sentiment increases policy expectations primarily at the one-year maturity. We also find that sentiment affects inflation and industrial production beyond monetary shocks.
    Keywords: Animal spirits; optimism; confidence; FOMC; interest rate expectations; central bank communication; ECB; aggregate effects
    JEL: E43 E52 E58
    Date: 2017–02–17
  10. By: Schmidt, Sebastian; Nakata, Taisuke
    Abstract: Modifying the mandate of a discretionary central bank to include an interest-rate smoothing objective increases the welfare of an economy where large contractionary shocks occasionally force the central bank to lower the policy rate to its effective lower bound. The central bank with an interest-rate smoothing objective credibly keeps the policy rate low for longer than the discretionary central bank with the standard mandate does, as in optimal commitment policy. Through expectations, the temporary overheating of the economy associated with such low-for-long interest rate policy mitigates the declines in inflation and output when the lower bound constraint is binding. In a calibrated model, we find that the introduction of an interest-rate smoothing objective can reduce the welfare costs associated with the lower bound constraint by more than half.
    JEL: E52 E61 E58
    Date: 2016
  11. By: Speck, Christian
    Abstract: Did the decline in inflation rates from 2012 to 2015 and the low levels of market-based inflation expectations lead to de-anchored inflation dynamics in the euro area? This paper is the first time-varying event study to investigate the reaction of inflation-linked swap (ILS) rates - a market-based measure of inflation expectations - to macroeconomic surprises in the euro area. Compared to the pre-crisis period, surprises have a much stronger effect on spot ILS rates during the crisis. Medium-term forward ILS rates remain insensitive to news most of the time, which implies inflation anchoring. Only short periods of sensitivity on the part of medium-term forward ILS rates are identified at times of low inflation or recession. The sensitivity is lower over more distant forecast horizons such that medium-term sensitivity represents an inflation adjustment process and provides no evidence for a de-anchoring of inflation expectations or a loss of credibility for the Eurosystem's policy target.
    JEL: E44 E31 G14
    Date: 2016
  12. By: Hachula, Michael; Rieth, Malte; Piffer, Michele
    Abstract: We study the effects and transmission channels of non-standard monetary policy in the euro area using structural vector autoregressions, identified with an external instrument. The instrument is the common component of unexpected variations in euro area sovereign yields vis-à-vis Germany for different maturities on policy announcement days. We find that expansionary monetary surprises are effective in stimulating economic activity, prices and inflation expectations. Shock transmission functions through public and private interest rates, asset prices and credit conditions. The policy innovations, however, also lead to a rise in primary public expenditures, a divergence of relative prices within the union and a widening of internal trade balances.
    JEL: E52 E58 E63
    Date: 2016
  13. By: Lemke, Wolfgang; Vladu, Andreea Liliana
    Abstract: We propose a shadow-rate term structure model for the euro area yield curve from 1999 to mid-2015, when bond yields had turned negative at various maturities. Yields in the model are constrained by a lower bound, but - as a special feature of our specification - the bound is allowed to change over time. We estimate that it has first ranged marginally above zero, but has decreased to -11 bps in September 2014. We derive the impact of a changing lower bound on the yield curve and interpret the impact of the September 2014 ECB rate cut from this perspective. Our model matches survey forecasts of short rates and the decline in yield volatility during the low-rate period better than a benchmark affine model. We estimate that since mid-2012 the horizon when short rates are expected to exceed 25 bps again has ranged between 18 and 62 months. JEL Classification: C32, E43, E52
    Keywords: lower bound, monetary policy expectations, nonlinear state space model, term structure of interest rates
    Date: 2017–01
  14. By: Marcello Pericoli (Bank of Italy); Giovanni Veronese (Bank of Italy)
    Abstract: We document how the impact of monetary surprises in the euro area and the US on financial markets has changed since 1999. We use a definition of monetary policy surprises that singles out movements in the long end of the yield curve, rather than those that change nearby futures on the central bank reference rates. By focusing only on this component of monetary policy our results are more comparable over time. We find a hump-shaped response of the yield curve to monetary policy surprises, both in the pre-crisis period and since 2013. During the crisis years, Fed path-surprises, largely through their effect on term premia, account for the impact on interest rates, which is found to be increasing in tenor. In the euro area, the path-surprises reflect shifts in sovereign spreads and have a large impact on the entire constellation of interest rates, exchange rates and equity markets.
    Keywords: monetary policy surprises, unconventional monetary policy
    JEL: E44 E52 F31 G14
    Date: 2017–02
  15. By: Natoli, Filippo; Sigalotti, Laura
    Abstract: We analyze the degree of anchoring of inflation expectations in the euro area during the post-crisis period, with a focus on the time span from 2014 onwards when long-term beliefs have substantially drifted away from the policy target. Using a new estimation technique, we look at tail co-movements between short- and long-term distributions of inflation expectations, estimated from daily quotes of inflation derivatives. We find that, during 2014, average correlations between short- and long-term inflation expectations rose sharply; moreover, negative tail events impacting short-term beliefs have been increasingly channeled to long-term views, triggering both downward revisions in expectations and upward changes in uncertainty. Overall, our results signal a risk of downside de-anchoring of long-term inflation expectations. JEL Classification: C14, C58, E31, E44, G13
    Keywords: anchoring, inflation expectations, inflation swaps, inflations options, option-implied density, tail co-movement
    Date: 2017–01
  16. By: Bletzinger, Tilman; Lalik, Magdalena
    Abstract: This paper uses two established DSGE models (QUEST III and Smets-Wouters) to assess the impact of fiscal spending cuts on output and, in particular, also on inflation in the euro area under alternative settings for monetary policy. We compare four different settings of constrained monetary policy, taking into account alternative agents’ expectations about future monetary policy. We illustrate that those expectations are even more important for the size of the fiscal multipliers than the difference between exogenously versus endogenously modelled constraints. We confirm the well-known finding that fiscal multipliers exhibit an over-proportional reaction when monetary policy is constrained. The novelty of our results is that this over-proportionality is stronger for the fiscal multiplier on inflation than on output. We relate this finding to the structural parameters of the models by means of a Global Sensitivity Analysis. JEL Classification: E31, E43, E52, E62, E63
    Keywords: constrained monetary policy, fiscal multipliers, zero lower bound
    Date: 2017–02
  17. By: Tamim Bayoumi; Barry Eichengreen
    Abstract: Once upon a time, in the 1990s, it was widely agreed that neither Europe nor the United States was an optimum currency area, although moderating this concern was the finding that it was possible to distinguish a regional core and periphery (Bayoumi and Eichengreen, 1993). Revisiting these issues, we find that the United States is remains closer to an optimum currency area than the Euro Area. More intriguingly, the Euro Area shows striking changes in correlations and responses which we interpret as reflecting hysteresis with a financial twist, in which the financial system causes aggregate supply and demand shocks to reinforce each other. An implication is that if the Euro Area wishes to avoid financial booms and busts it will need vigorous, coordinated regulation of its banking and financial systems by a single supervisor—that monetary union without banking union will be prone to economic and financial instability.
    JEL: F0 F3 F41
    Date: 2017–02
  18. By: Ekaterina Pirozhkova (Birkbeck, University of London)
    Abstract: In this paper I study how financial frictions affect robustness of monetary policy in DSGE models in the case of model uncertainty. The types of frictions I consider are financial accelerator and collateral constraints. Modeling monetary policy in terms of optimal interest rate rules, I find that welfare-maximizing policies for the models with financial frictions are robust to model uncertainty. Policy rule optimal for the basic New Keynesian model is not robust. Thereby I show that when there is uncertainty about what type of frictions is at work, a policymaker exposes economy to risks of significant welfare losses by using a reference model without frictions as economy representation. Using fault tolerance approach I find that modified policy rule optimal for the basic New Keynesian model is robust when it allows to respond to fluctuations in output.
    Keywords: optimal monetary policy rules, financial frictions, DSGE models, robustness.
    JEL: E32 E37 E44 E52
    Date: 2017–02
  19. By: Dovern, Jonas; Kenny, Geoff
    Abstract: This paper analyses the distribution of long-term inflation expectations in the euro area using individual density forecasts from the ECB Survey of Professional Forecasters. We exploit the panel dimension in this dataset to examine whether this distribution became less stable following the Great Recession, subsequent sovereign debt crisis and period when the lower bound on nominal interest rates became binding. Our results suggest that the distribution did change along several dimensions. We document a small downward shift in mean long-run expectations toward the end of our sample although they remain aligned with the ECB definition of price stability. More notably, however, we identify a trend toward a more uncertain and negatively skewed distribution with higher tail risk. Another main finding is that key features of the distribution are influenced by macroeconomic news, including the ex post historical track record of the central bank. JEL Classification: E31, E58
    Keywords: density forecasts, ECB, euro area, inflation expectations
    Date: 2017–01
  20. 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 efficiency in the adjustment of the terms of trade in order to improve on its ability to manage private sector's expectations. Thus, fixed exchange rate-induced inertia in the terms of trade is a cost under commitment, whereas it is a benefit under discretion, for it acts like a commitment device.
    JEL: F33 F41 E52
    Date: 2016
  21. By: Enders, Zeno; Buzaushina, Almira; Hoffmann, Mathias
    Abstract: This paper provides an explanation for the observed decline of the exchange rate pass-through into import prices by modeling the effects of financial market integration on the optimal choice of the pricing currency in the context of rigid nominal goods prices. Contrary to previous literature, we take the interdependence of this choice with the optimal portfolio choice of internationally traded financial assets explicitly into account. In particular, price setters move towards more localcurrency pricing and portfolios include more foreign debt assets following increased financial integration. Both predictions are in line with novel empirical evidence.
    JEL: F41 F36 F31
    Date: 2016
  22. By: Vugar Rahimov (Central Bank of the Republic of Azerbaijan); Nigar Jafarova (Central Bank of the Republic of Azerbaijan); Fuad Ganbarov (Azerbaijan National Academy of Sciences, Institute of Economics)
    Abstract: In this study, we explore the pass-through of exchange rate fluctuations to domestic CPI and its components for Azerbaijan, Kazakhstan and Russia. Using the data of 2003:Q1-2016:Q2, we estimate a VAR model and find significant but incomplete pass-through in all sample countries. The accumulated pass-through to aggregate CPI within one year is 28 percent for both Azerbaijan and Kazakhstan; however the equivalent figure for Russia is 32 percent. According to our empirical findings the largest pass-through (ERPT) is observed in the non-food CPI in Azerbaijan and Kazakhstan, whereas in Russia the food prices demonstrate the greatest ERPT. Since the ERPT is an essential ingredient of price developments in sample countries, it should be assessed precisely and taken into account in monetary policy decisions and inflation forecasting.
    Keywords: Exchange rate pass-through, VAR model, disaggregated CPI, oil exporting countries
    JEL: F31 E31 E52 C51 C52
    Date: 2017–02
  23. By: Otaviano Canuto; Matheus Cavallari
    Abstract: Central banks of large advanced and many emerging market economies have recently gone through a period of extraordinary expansion of balance sheets and are all now possibly facing a transition to less abnormal times. However, the fact that one group is comprised by global reserve issuers and the other by bystanders receiving impacts of the former’s policies carries substantively different implications. Furthermore, using Brazil and the U.S. as examples, we also illustrate how the relationships between central bank and public sector balance sheets have acquired higher levels of complexity, risks and opacity.
    Keywords: Central Banks, Brazil, United States, Balance Sheets, Finance, Debt, Inflation, Public Sector
    Date: 2017–02
  24. By: Yuri Biondi; Feng Zhou
    Abstract: Interbank lending and borrowing occur when financial institutions seek to settle and refinance their mutual positions over time and circumstances. This interactive process involves money creation at the aggregate level. Coordination mismatch on interbank credit may trigger systemic crises. This happened when, since summer 2007, interbank credit coordination did not longer work smoothly across financial institutions, eventually requiring exceptional monetary policies by central banks, and guarantee and bailout interventions by governments. Our article develops an interacting heterogeneous agents-based model of interbank credit coordination under minimal institutions. First, we explore the link between interbank credit coordination and the money generation process. Contrary to received understanding, interbank credit has the capacity to make the monetary system unbound. Second, we develop simulation analysis on imperfect interbank credit coordination, studying impact of interbank dynamics on financial stability and resilience at individual and aggregate levels. Systemically destabilizing forces prove to be related to the working of the banking system over time, especially interbank coordination conditions and circumstances.
    Date: 2017–02
  25. By: Brede, Maren
    Abstract: In light of persistent inflation dispersion and high debt levels in the EMU, this paper investigates the desirability of budget-neutral fiscal policy rules that respond to the domestic inflation differential. The paper employs a two-country DSGE model of a monetary union with traded and non-traded goods. When consumption or labour income taxes respond to the domestic inflation differential while lump-sum taxes balance the budget, a national fiscal authority is able to reduce welfare costs of business cycle fluctuations by 1-4%. When lump-sum taxes are absent, hybrid rules using only distortionary taxes can reduce welfare costs by 6-10% under demand and supply disturbances. Gains in welfare stem from higher mean consumption due to lower price dispersion when the fiscal authority actively compresses the domestic inflation differential and thus domestic inflation.
    JEL: E62 F41 F45
    Date: 2016
  26. By: Patnaik, Ila (National Institute of Public Finance and Policy); Felman, Joshua (IMF); Shah, Ajay (National Institute of Public Finance and Policy)
    Abstract: EMP measures in the existing literature are oriented towards applications in crisis dating and prediction. We propose a modified EMP measure where cross-country comparisons are possible. This is the sum of the observed change in the exchange rate with an estimated counterfactual of the magnitude of the change in the exchange rate associated with the observed currency intervention. We construct a multi-country dataset for EMP in each month. This opens up many new research possibilities.
    Keywords: Exchange rate regime ; capital flows ; currency wars ; monetary policy ; Exchange market pressure ; Statistical system
    JEL: E52 F31 F32
    Date: 2017–02
  27. By: Joseph E. Gagnon; Tamim Bayoumi; Juan M. Londono; Christian Saborowski; Horacio Sapriza
    Abstract: This paper explores the direct effects and spillovers of unconventional monetary and exchange rate policies. We find that official purchases of foreign assets have a large positive effect on a country's current account that diminishes considerably as capital mobility rises. There is an important additional effect through the lagged stock of official assets. Official purchases of domestic assets, or quantitative easing (QE), appear to have no significant effect on a country's current account when capital mobility is high, but there is a modest positive impact when capital mobility is low. The effects of purchases of foreign assets spill over to other countries in proportion to their degree of international financial integration. We also find that increases in US bond yields are associated with increases in foreign bond yields and in stock prices, as well as with depreciations of foreign currencies, but that all of these effects are smaller on days of US unconventional monetary policy announcements. We develop a theoretical model that is broadly consistent with our empirical results and that highlights the potential usefulness of domestic unconventional policies as responses to the effects of foreign policies of a similar type.
    Keywords: Current account balance ; Unconventional monetary policy ; Foreign exchange intervention ; Quantitative easing
    JEL: F36 F42
    Date: 2017–02
  28. By: Ekaterina Pirozhkova (Birkbeck, University of London)
    Abstract: We study the dynamic characteristics of bank loan components and seek to resolve the puzzle raised by den Haan et al. (2007) that commercial and industrial loans increase following monetary contraction. By estimating a set of structural vector autoregression models on US data for 1954-2015, we demonstrate that when risk and balance sheet factors are controlled for, business loans decrease after monetary tightening, what is consistent with bank-lending channel of monetary policy transmission mechanism. This result is robust to VAR specification and to the measure of uncertainty employed. We distinguish between volatility measures of uncertainty and measures of uncertainty as vagueness/”unknownness” of economic outlook and show that business loans go down following uncertainty shock only after the latter uncertainty measure is used. We demonstrate that controlling for risk factors is critical for explaining the dynamic properties of business loans, as variance of business loans is driven by innovations to uncertainty and credit risk to the greater extent than by innovations to macroeconomic variables.
    Keywords: uncertainty, bank loans, vector autoregression.
    JEL: E40
    Date: 2017–02
  29. By: Tran Thanh Hoa (The State Bank of Vietnam)
    Abstract: In this paper, I apply univariate and vector autoregressive (VAR) models to forecast inflation in Vietnam. To investigate the forecasting performance of the models, two naïve benchmark models (one is a variant of a random walk and the other is an autoregressive model) are first built based on Atkeson-Ohanian (2001), Gosselin-Tkacz (2001) and the specific properties of inflation in Vietnam. Then, I compute the pseudo out-of-sample root mean square error (RMSE) as a measure of forecast accuracy for the candidate models and benchmarks, using rolling window and expanding window forecasting evaluation strategies. The process is applied to both monthly and quarterly data from Vietnam for the period from 2000 through the first half of 2015. I also apply the forecast-encompassing Diebold-Mariano test to support choosing statistically better forecasting models from among the different candidates. I find that VAR_m2 is the best monthly model to forecast inflation in Vietnam, whereas AR(6) is the best of the quarterly forecasting models, although it provides a statistically insignificantly better forecast than the benchmark BM2_q.
    Keywords: Inflation, Forecast, Univariate Models, Vector Autoregressive Models, Forecast Accuracy
    JEL: C22 C32 C51 C53 E31 E37
    Date: 2017–02
  30. By: Ward, Felix; Chen, Yao
    Abstract: External adjustments during the classical gold standard – a fixed exchange rate regime – were associated with few, if any, output costs. This paper analyzes the relative importance of flexible prices, migration and mildly countercyclical monetary policy for this relatively smooth adjustment experience. For this purpose we build and estimate a structural model of the classical gold standard. We find that the sustainability of the gold standard as a fixed exchange rate regime was primarily a consequence of flexible prices. Pre-1914 price flexibility is furthermore largely explicable by large pre-1914 primary sector shares. The paper proceeds in a historical comparative fashion by relating the gold standard experience to that of another fixed-exchange rate regime – today’s eurozone.
    JEL: N10 F20 E50
    Date: 2016
  31. By: Natoli, Filippo; Sigalotti, Laura
    Abstract: We compare the degree of anchoring of inflation expectations in the euro area, the United States and the United Kingdom, focusing on the post-crisis period. First of all, we estimate a set of measures of average and tail correlation using inflation swaps and options, following Natoli and Sigalotti (2016). To quantify the degree of anchoring, we also propose a new indicator based on the results of a logistic regression, measuring the odds that strong negative shocks to short-term expectations are channelled to large declines in long-term expectations. The results reveal, for the euro area, an increase in the de-anchoring risk during the last quarter of 2014; while showing a significant reduction after the peak, our de-anchoring indicator remains high and volatile in 2015 and 2016. Expectations in the US and UK are instead found to be firmly anchored. JEL Classification: C14, C58, E31, E44, G13
    Keywords: anchoring, inflation expectations, inflation options, inflation swaps, option-implied density, tail co-movement
    Date: 2017–01
  32. By: Bobeica, Elena; Jarociński, Marek
    Abstract: In the immediate wake of the Great Recession we didn't see the disinflation that most models predicted and, subsequently, we didn't see the inflation they predicted. We show that these puzzles disappear in a Vector Autoregressive model that properly accounts for domestic and global factors. Such a model reveals, among others, that domestic factors explain much of the inflation dynamics in the 2012-2014 euro area missing inflation episode. Consequently, economists and models that excessively focused on the global nature of inflation were liable to miss the contribution of deflationary domestic shocks during this episode. JEL Classification: E31, E32, F44
    Keywords: Bayesian vector autoregression, conditional forecast, inflation dynamics, international transmission of shocks, Phillips curve, shock identification
    Date: 2017–01
  33. By: Kaufmann, Christoph
    Abstract: This paper studies Ramsey-optimal monetary and fiscal policy in a New Keynesian 2-country open economy framework, which is used to assess how far fiscal policy can substitute for the role of nominal exchange rates within a monetary union. Giving up exchange rate flexibility can result in high welfare costs, which depend significantly on whether firms set prices in producer or in local currency. By using only one tax instrument per country and robust to changes in the calibration, the welfare costs can be reduced by 86% in case of producer currency pricing and by 68% in case of local currency pricing. Optimal policy in a monetary union can be described as a fiscal devaluation: if a nominal devaluation of the domestic currency is optimal under flexible exchange rates, optimal fiscal policy in a monetary union is a relative increase of the domestic VAT.
    JEL: F41 F45 E63
    Date: 2016
  34. By: Shuo Cao (Shenzhen Stock Exchange); Hongyi Chen (Hong Kong Institute for Monetary Research)
    Abstract: This paper identifies five factors that can capture 95% of the variance across 39 US dollar exchange rates based on the principal component method. A time-varying parameter factor-augmented vector autoregressive (TVP-FAVAR) model is used to analyze the determinants of movements in these exchange rates, revealing that impact of global oil prices and China¡¯s growth has increased significantly since 2008. In particular, shocks to these two fundamentals drive the movements of both commodity and non-commodity currencies recently. The impact of monetary policy shocks on the currency pairs is comparatively small.
    Date: 2017–02
  35. By: Bobeica, Elena; Nickel, Christiane; Lis, Eliza; Sun, Yiqiao
    Abstract: Most euro area countries have entered an unprecedented ageing process: life expectancy continues to rise and fertility rates have declined, while retirement age in the last twenty to thirty years hardly increased. This implies an ever smaller fraction of the working age population in total population, leading to changes in consumption and saving behaviours and having an important impact on the macroeconomy. In this paper we focus on the relationship between demographic change and inflation. We find that based on a cointegrated VAR model there is a positive long-run relationship between inflation and the growth rate of working-age population as a share in total population in the euro area countries as a whole, but also in the US and Germany. We also find that this relation is mitigated by the effect of monetary policy, which we account for by including the short-term interest rate in our analysis. One caveat of the analysis could be that the empirical relationship as found does not sufficiently take into account changes in policy settings following the high inflation experiences in the 1970s. Our findings support the view that demographic trends are among the forces that shape the economic environment in which monetary policy operates. This is particularly relevant for countries, like many in Europe, that face an ageing process. JEL Classification: E31, J11, C22
    Keywords: cointegration, demographic change, inflation
    Date: 2017–01
  36. By: Adam, Tomáš; Lo Duca, Marco
    Abstract: In this paper, we study the dynamics and drivers of sovereign bond yields in euro area countries using a factor model with time-varying loading coefficients and stochastic volatility, which allows for capturing changes in the pricing mechanism of bond yields. Our key contribution is exploring both the global and the local dimensions of bond yield determinants in individual euro area countries using a time-varying model. Using the reduced form results, we show decoupling of periphery euro area bond yields from the core countries yields following the financial crisis and the scope of their subsequent re-integration. In addition, by means of the structural analysis based on identification via sign restrictions, we present time varying impulse responses of bond yields to EA and US monetary policy shocks and to confidence shocks. JEL Classification: C11, G01, E58
    Keywords: bayesian estimation, bond yield, factor model, sovereign debt crisis, stochastic volatility
    Date: 2017–02
  37. By: De Grauwe, Paul
    Abstract: [Introduction] The Eurozone creates a number of new challenges in policy-making in Europe. These challenges exist both for the monetary and the fiscal authorities. In this workpackage we aim at providing novel insights in the nature of these challenges using new approaches in modelling the macro economy. These new approaches highlight the importance of multiple equilibria, herd behaviour and animal spirits (market sentiments). The first challenge is for the monetary authorities to understand the nature of the transmission of monetary policies. We analyse this transmission process using a behavioural macroeconomic model in which animal spirits play a major role. We contrast this transmission process in a bank based with a market based financial model. As the Eurozone is mainly based on bank finance the comparison with a market based financial model will allow us to identify what is special in the monetary transmission process in the Eurozone. The second challenge has to do with crisis management. During financial crises panic and fear is likely to take over, creating a potential for self-fulfilling liquidity crises. These can push countries into a bad equilibrium that forces them into imposing excessive austerity thereby reinforcing deflationary dynamics. We provide evidence that these forces have been at work during the sovereign debt crisis of 2010-12. The third challenge relates to the governance of the Eurozone. It is clear that the Eurozone has not yet achieved a governance structure that will guarantee its long run survival. In a third contribution we use empirical evidence about the nature of economic shocks in the Eurozone to analyse how the Eurozone should be redesigned so as to become sustainable in the long run.
    Date: 2016
  38. By: Daniel Kaufmann (KOF Swiss Economic Institute, ETH Zurich, Switzerland)
    Abstract: I study the link between real activity and deflation, taking into account measurement problems in 19th century CPI data. Replications based on modern data show that measurement problems spuriously increase the volatility of inflation as well as the number of deflationary episodes, and they lower inflation persistence. As a consequence, estimates of the link between real activity and deflation may be attenuated because of the errors-in-variables problem. I find that real activity was on average substantially lower during 19th century deflations in the US, after controlling for measurement error using an IV-regression approach. Moreover, the average short-fall in real activity was not significantly different compared to the Great Depression. Using well-measured data for a panel of 17 industrialized economies shows that milder deflations were associated with a lower output gap. But, the association with GDP growth is not statistically significant.
    Keywords: Deflation, Real activity, Measurement error, Monetary history, IV
    Date: 2016–11
  39. By: Albuquerque, Bruno; Baumann, Ursel
    Abstract: The response of US inflation to the high levels of spare capacity during the Great Recession of 2007-09 was rather muted. At the same time, it has been argued that the short-term unemployment gap has a more prominent role in determining inflation, and either the closing of this gap or non-linearities in the Phillips curve could lead to a sudden pick-up in inflation. We revisit these issues by estimating Phillips curves over 1992Q1 to 2015Q1. Our main findings suggest that a Phillips curve model that takes into account inflation persistence, inflation expectations, supply shocks and labour market slack as determinants explains rather well the behaviour of inflation after the Great Recession, with little evidence of a "missing deflation puzzle". More important than the choice of the slack measure is the consideration of time-variation in the slope. In fact, we find that Phillips curve models with time-varying slope coefficients are able to outperform significantly the constant-slope model as well as other non-linear models over 2008Q1-2015Q1. JEL Classification: E31, E37, E58
    Keywords: inflation dynamics, labour market slack, Phillips curve
    Date: 2017–01

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