nep-mon New Economics Papers
on Monetary Economics
Issue of 2017‒05‒07
twenty-two papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. The aggregate and country-speci c e ectiveness of ECB policy: evidence from an external instruments (VAR) approach By Lucas Hafemann; Peter Tillmann
  2. Federal Reserve Private Information and the Stock Market By Lakdawala, Aeimit; Schaffer, Matthew
  3. Decomposing the Effects of Monetary Policy Using an External Instruments SVAR By Lakdawala, Aeimit
  4. Doing away with cash? The welfare costs of abolishing cash By Rösl, Gerhard; Seitz, Franz; Tödter, Karl-Heinz
  5. Monetary Policy, Bounded Rationality, and Incomplete Markets By Emmanuel Farhi; Iván Werning
  6. Monetary policy and the punch bowl - The case for quantitative policy and wage growth targeting. By Thomas I. Palley
  7. Federal Reserve Credibility and the Term Structure of Interest Rates By Lakdawala, Aeimit; Wu, Shu
  8. Central Bank Communication: Managing Expectations through the Monetary Dialogue By Ansgar Belke
  9. Is monetary policy less effective when interest rates are persistently low? By Claudio Borio; Boris Hofmann
  10. Monetary Policy at Work: Security and Credit Application Registers Evidence By Peydró, José Luis; Polo, Andrea; Sette, Enrico
  11. Output gap, monetary policy trade-offs and financial frictions By Francesco Furlanetto; Paolo Gelain; Marzie Taheri Sanjani
  12. The New Keynesian Cross: Understanding Monetary Policy with Hand-to-Mouth Households By Bilbiie, Florin Ovidiu
  13. Fiscal foundations of inflation: Imperfect knowledge By Stefano Eusepi; Bruce Preston
  14. Monetary policy at work: Security and credit application registers evidence By José-Luis Peydró; Andrea Polo; Sette Enrico
  15. Output Composition of Monetary Policy Transmission in Pakistan By Kamal, Asmma
  16. A Tractable Model of Monetary Exchange with Ex-Post Heterogeneity By Rocheteau, Guillaume; Weill, Pierre-Olivier; Wong, Russell
  17. Exploring the Nexus Between Inflation and Globalization Under Inflation Targeting Through the Lens of New Zealand’s Experience By Kabukcuoglu, Ayse; Martinez-Garcia, Enrique; Soytas, Mehmet A.
  18. The effects of US monetary policy shocks: Applying external instrument identification to a dynamic factor model By Kerssenfischer, Mark
  19. If the Fed sneezes, who catches a cold? By Dedola, Luca; Rivolta, Giulia; Stracca, Livio
  20. Endogenous Real Risk-Free Rate, the Central Bank, and Stock Market By Ilomaki Jukka; Laurila Hannu
  21. Reading between the Lines: Using Media to Improve German Inflation Forecasts By Benjamin Beckers; Konstantin A. Kholodilin; Dirk Ulbricht
  22. The Euro from a business perspective By Dilger, Alexander

  1. By: Lucas Hafemann (Justus-Liebig-University Giessen); Peter Tillmann (Justus-Liebig-University Giessen)
    Abstract: This paper studies the transmission of ECB monetary policy, both at the aggregate euro area and the country level. We estimate a VAR model for the euro area in which monetary policy shocks are identified using an external instrument that refl ects policy surprises. For that purpose we use the change in German bunds at meeting days of the Governing Council. The identified monetary policy shock is then put into country-specific local projections in order to derive country-specific impulse responses. We find that (i) the transmission is very heterogeneous, both across channels and across countries, (ii) policy is transmitted through spreads, yields and the exchange rate, but less through banks and the stock market, and (iii) the strength of the transmission depends on structural characteristics of member countries, among them are current account balanced, debt to GDP levels, and the strength of banking systems.
    Keywords: Euro area, VAR, external instrument, local projections, monetary transmission
    JEL: E52 E32 E44
    Date: 2017
  2. By: Lakdawala, Aeimit; Schaffer, Matthew
    Abstract: We study the response of stock prices to monetary policy, distinguishing the effects of exogenous policy actions from ``Delphic" actions that reveal the Federal Reserve's macroeconomic forecasts. To decompose composite monetary policy surprises into these separate components, we exploit differences in central bank and private sector forecasts to construct a measure of Federal Reserve private information. Contractionary monetary policy shocks of either type cause a fall in stock prices with exogenous shocks having a larger negative effect. However there is an important asymmetry; when FOMC meetings are unscheduled or when the fed funds rate reverses direction, stock prices actually rise in response to a contractionary Delphic shock.
    Keywords: Monetary Policy Shocks, Stock Prices, Federal Reserve Private Information
    JEL: E44 E5 G14
    Date: 2016–12–13
  3. By: Lakdawala, Aeimit
    Abstract: We study the effects of monetary policy on economic activity separately identifying the effects of a conventional change in the fed funds rate from the policy of forward guidance. We use a structural VAR identified using external instruments from futures market data. The response of output to a fed funds rate shock is found to be consistent with typical monetary VAR analyses. However, the effect of a forward guidance shock that increases long-term interest rates has an expansionary effect on output. This counterintuitive response is shown to be tied to the asymmetric information between the Federal Reserve and the public.
    Keywords: Monetary policy, Forward Guidance, Identification with External Instruments
    JEL: E31 E32 E43 E52 E58
    Date: 2016–11
  4. By: Rösl, Gerhard; Seitz, Franz; Tödter, Karl-Heinz
    Abstract: To broaden the scope of monetary policy, cash abolishment is often suggested as a means of breaking through the zero lower bound. However, practically nothing is said about the welfare costs of such a proposal. Rösl, Seitz and Tödter argue that the welfare costs of bypassing the zero lower bound can be analyzed analytically and empirically by assuming negative interest rates on cash holdings. They gauge the welfare effects of abolishing cash, both, for the euro area and for Germany. Their findings suggest that the welfare losses of negative interest rates incurred by money holders are large, notably if implemented in the current low interest rate environment. Imposing a negative interest rate of 3 percentage points on cash holdings and reducing the interest on all assets included in M3 creates a deadweight loss of € 62bn for the euro area and of €18bn for Germany. Therefore, the authors argue that cash abolishment or negative interest rates on cash to break through the zero lower bound at any price can hardly be a meaningful policy goal.
    Keywords: zero lower bound,cash abolishment,negative interest rates,welfare loss,compensated variation,deadweight loss
    JEL: E41 E21 E58 I3
    Date: 2017
  5. By: Emmanuel Farhi; Iván Werning
    Abstract: This paper extends the benchmark New-Keynesian model with a representative agent and rational expectations by introducing two key frictions: (1) agent heterogeneity with incomplete markets, uninsurable idiosyncratic risk, and occasionally-binding borrowing constraints; and (2) bounded rationality in the form of level-k thinking. Compared to the benchmark model, we show that the interaction of these two frictions leads to a powerful mitigation of the effects of monetary policy, which is much more pronounced at long horizons, and offers a potential rationalization of the “forward guidance puzzle”. Each of these frictions, in isolation, would lead to no or much smaller departures from the benchmark model. We conclude that the interaction of bounded rationality and market frictions improves the ability of the model to account for the effects of monetary policy.
    JEL: E03 E1 E4 E52
    Date: 2017–03
  6. By: Thomas I. Palley
    Abstract: Federal Reserve Chairman William McChesney Martin famously declared that the Federal Reserve "is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up." This paper uses the punch bowl metaphor to analyze how the Federal Reserve can improve monetary policy so as to deliver shared prosperity with greater financial stability. The problem is the party starts earlier on Wall Street than Main Street, so the Fed may remove the punchbowl before the party reaches Main Street. Ensuring Main Street attends the party requires a new recipe for the punch, new serving rules, and a new punch master. Additionally, there is a deeper problem that current neoliberal growth model has the economy addicted to monetary punch. Resolving that requires a cure that goes beyond the punch bowl.
    Date: 2017
  7. By: Lakdawala, Aeimit; Wu, Shu
    Abstract: In this paper we show how the degree of central bank credibility influences the level, slope and curvature of the term structure of interest rates. In an estimated structural model, we find that historical yield curve data are best matched by the Federal Reserve conducting policy in a loose commitment framework, rather than the commonly used discretion and full commitment assumptions. The structural impulse responses indicate that the past history of realized shocks play a crucial role in determining the dynamic effects of monetary policy on the yield curve. Finally, the regime-switching framework allows us to estimate likely re-optimization episodes which are found to impact the middle of the yield curve more than the short and long end.
    Keywords: Term Structure, Commitment, Regime-Switching Bayesian Estimation, Optimal Monetary Policy, DSGE models
    JEL: E52 G12
    Date: 2017–01
  8. By: Ansgar Belke
    Abstract: Successfully managing a course back to normality (“exit”) will depend crucially on the central banks’ ability to communicate effectively a credible strategy for an orderly exit from such kind of policies. In this context, clear, deliberate, coordinated messages that are anchored in the central banks’ mandate are of essence. We focus upon transparency and “forward guidance” as potential tools to stimulate the economy in the Euro Area. We then deliver details on whether and how the effectiveness of central bank’s policies can be improved through more transparency and “forward guidance”. We do so by highlighting marked differences in the Fed’s and the ECB’s interpretation of “forward guidance”. In order to highlight the key issues of central bank communication and the management of expectations referring to a practical institutional example, we also comment on the role the Monetary Dialogue in the context of an evolving monetary policy. Communication is finally described as a policy option in terms of minimising risk in the context of exit from unconventional monetary policies and of the signalling channel which refers to what the public learns from announcements of unconventional monetary policy operations such as Quantitative Easing.
    Keywords: central bank communication, European Central Bank, forward guidance, monetary dialogue, transparency
    JEL: E52 E58 G14
    Date: 2017–04
  9. By: Claudio Borio; Boris Hofmann
    Abstract: Is monetary policy less effective in boosting aggregate demand and output during periods of persistently low interest rates? This paper reviews the reasons why this might be the case and the corresponding empirical evidence. Transmission could be weaker for two main reasons: (i) headwinds, which would typically arise in the wake of balance sheet recessions, when interest rates are low; and (ii) inherent non-linearities, which would kick in when interest rates are persistently low and would dampen their impact on spending. Our review of the evidence suggests that headwinds during the recovery from balance-sheet recessions tend to reduce monetary policy effectiveness. At the same time, there is also evidence of inherent non-linearities. That said, disentangling the two types of effect is very hard, not least given the limited extant work on this issue. In addition, there appears to be an independent role for nominal rates in the transmission process, regardless of the level of real (inflation-adjusted) rates.
    Keywords: monetary policy, low interest rates, balance-sheet recession, monetary transmission
    Date: 2017–04
  10. By: Peydró, José Luis; Polo, Andrea; Sette, Enrico
    Abstract: The potency of the bank lending channel of monetary policy may be limited if banks rebalance their portfolios towards securities, e.g. to pursue risk-shifting or liquidity hoarding. To test for the bank lending and risk-taking (reach-for-yield) channels, we therefore analyze banks' securities trading, in addition to credit supply, in turn allowing us to also study the empirical relevance of key financial frictions. For identification, since the creation of the euro, we exploit the security and credit application registers owned by the central bank of Italy. In crisis times, we find that, with softer monetary policy, less capitalized banks prefer buying securities rather than increasing credit supply (not due to lack of good loan applications), thereby impacting firm-level real outcomes. Moreover, more - not less - capitalized banks reach-for-yield, which is inconsistent with the risk-shifting hypothesis. Results suggest that the main drivers at work are access to liquidity and risk-bearing capacity, and not regulatory capital arbitrage. Finally, in pre-crisis times, when financial frictions are limited, less capitalized banks do not expand securities holdings over credit supply.
    Keywords: bank capital; loan applications; monetary policy; reach-for-yield; regulatory arbitrage; securities; Sovereign debt
    JEL: E51 E52 E58 G01 G21
    Date: 2017–04
  11. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Paolo Gelain (Norges Bank (Central Bank of Norway)); Marzie Taheri Sanjani (International Monetary Fund)
    Abstract: This paper investigates how the presence of financial frictions and financial shocks changes the definition and the estimated dynamics of the output gap in a New Keynesian model. Financial shocks absorb explanatory power from efficient labor supply shocks, thus changing radically the dynamics of the economy's efficient frontier. Despite their large impact on the output gap, financial factors affect the monetary policy trade-offs only to some extent. Nominal stabilization can be achieved at the cost of limited (but non-negligible) fluctuations in real economic activity. Finally, we discuss an alternative measure of the output gap (in deviation from the optimal equilibrium) that is a better measure of imbalances in the economy than the conventional output gap.
    Keywords: Financial frictions; output gap; monetary policyClassification-JEL: E32, C51, C52Note:
    Date: 2017–04–27
  12. By: Bilbiie, Florin Ovidiu
    Abstract: The "New Keynesian Cross" proposed here describes aggregate demand through a planned expenditure PE curve and captures analytically a key mechanism and decomposition in heterogeneous-agent New Keynesian (HANK) models à la Kaplan, Moll and Violante, 2015. In response to monetary policy, PE's shift is the direct effect (intertemporal substitution), while its slope (marginal propensity to consume) is the share of the indirect effect in total. The total and indirect effects are increasing with the share of hand-to-mouth agents when these are employed, but decreasing when unemployed; the same holds for forward guidance. Despite this, the optimal duration of forward guidance is not much affected, for when its power increases so does its welfare cost.
    Keywords: hand-to-mouth; heterogenous agents; aggregate demand; optimal monetary policy; liquidity trap; Keynesian cross; forward guidance.
    JEL: E21 E31 E40 E44 E50 E52 E58 E60 E62
    Date: 2017–04
  13. By: Stefano Eusepi; Bruce Preston
    Abstract: This paper proposes a theory of the fiscal foundations of inflation based on imperfect knowledge and learning. Because imperfect knowledge breaks Ricardian equivalence the scale and composition of the public debt matter for inflation. High moderate-duration debt generates wealth effects on consumption demand that impairs the intertemporal substitution channel of monetary policy: aggressive monetary policy is required to anchor inflation expectations. Counterfactual experiments, in an estimated medium-scale DSGE model, reveal the US economy would have been substantially more volatile over the Great Inflation and Great Moderation periods, had average debt been consistent with levels currently observed in Italy or Japan.
    Keywords: Monetary and Fiscal Interactions, Learning Dynamics, Expectations Stabilization, Great Moderation, Great Inflation
    JEL: E32 D83 D84
    Date: 2017–05
  14. By: José-Luis Peydró; Andrea Polo; Sette Enrico
    Abstract: The potency of the bank lending channel of monetary policy may be limited if banks rebalance their portfolios towards securities, e.g. to pursue risk-shifting or liquidity hoarding. To test for the bank lending and risk-taking (reach-for-yield) channels, we therefore analyze banks’ securities trading, in addition to credit supply, in turn allowing us to also study the empirical relevance of key financial frictions. For identification, since the creation of the euro, we exploit the security and credit application registers owned by the central bank of Italy. In crisis times, we find that, with softer monetary policy, less capitalized banks prefer buying securities rather than increasing credit supply (not due to lack of good loan applications), thereby impacting firm-level real outcomes. Moreover, more – not less – capitalized banks reach-for-yield, which is inconsistent with the risk-shifting hypothesis. Results suggest that the main drivers at work are access to liquidity and risk-bearing capacity, and not regulatory capital arbitrage. Finally, in pre-crisis times, when financial frictions are limited, less capitalized banks do not expand securities holdings over credit supply.
    Keywords: monetary policy, securities, loan applications, bank capital, reach-for-yield, held to maturity, available for sale, trading book, haircuts, regulatory arbitrage, sovereign debt.
    JEL: E51 E52 E58 G01 G21
    Date: 2017–04
  15. By: Kamal, Asmma
    Abstract: This paper employs an unrestricted vector autoregressive (VAR) model, identified using a recursive Cholesky decomposition, to examine the output composition of the monetary policy transmission mechanism in Pakistan. The results indicate that a contractionary monetary policy shock leads to a relatively larger decline in private consumption compared to private investment with a significant lag. Furthermore, preliminary analysis suggests that the consumption channel plays a more important role than investment channel in contributing to the output reactions resulting from policy rate (interbank rate) shocks during the period 1995Q3 2010Q2 analysed in this study.
    Keywords: Monetary policy, output composition, consumption, investment
    JEL: E5 E52
    Date: 2016–10–20
  16. By: Rocheteau, Guillaume (University of California, Irvine); Weill, Pierre-Olivier (University of California, Los Angeles); Wong, Russell (Federal Reserve Bank of Richmond)
    Abstract: We construct a continuous-time, New-Monetarist economy with general preferences that displays an endogenous, non-degenerate distribution of money holdings. Properties of equilibria are obtained analytically and equilibria are solved in closed form in a variety of cases. We study policy as incentive-compatible transfers financed with money creation. Lump-sum transfers are welfare-enhancing when labor productivity is low, but regressive transfers achieve higher welfare when labor productivity is high. We introduce illiquid government bonds and draw implications for the existence of liquidity-trap equilibria and policy mix in terms of "helicopter drops" and open-market operations.
    Keywords: money; inflation; risk sharing; liquidity traps
    JEL: E40 E50
    Date: 2017–04–20
  17. By: Kabukcuoglu, Ayse (Koç University); Martinez-Garcia, Enrique (Federal Reserve Bank of Dallas); Soytas, Mehmet A. (Özyeğin University)
    Abstract: We investigate empirically the inflation dynamics in New Zealand, a small open economy and a pioneer in inflation targeting, under various open-economy Phillips curve specifications. Our forecasting exercise suggests that open-economy Phillips curves under standard measures of global slack do not help forecast domestic inflation, possibly indicating measurement problems with global slack itself. In turn, under a stable inflation target we still find that (i) global inflation and (ii) global inflation and oil prices have information content for headline CPI and core CPI inflation over the 1997:Q3-2015:Q1 period and appear to be reliable proxies for global slack in forecasting inflation.
    JEL: C21 C23 C53 F41 F47 F62
    Date: 2017–03–01
  18. By: Kerssenfischer, Mark
    Abstract: Dynamic factor models and external instrument identification are two recent advances in the empirical macroeconomic literature. This paper combines the two approaches in order to study the effects of monetary policy shocks. I use this novel framework to re-examine the effects found by Forni and Gambetti (2010, JME) in a recursively-identified DFM. Considering the fundamental differences between the identifying assumptions, the results are overall strikingly similar. Importantly, this finding stands in stark contrast to traditional VAR models, which yield decisively different results in the two identification schemes. This highlights the importance of using extended information sets to properly identify monetary policy shocks.
    Keywords: Monetary Policy,Dynamic Factor Models,External Instrument,High-Frequency Identification
    JEL: C32 E32 E44 E52 F31
    Date: 2017
  19. By: Dedola, Luca; Rivolta, Giulia; Stracca, Livio
    Abstract: This paper studies the international spillovers of US monetary policy shocks on a number of macroeconomic and financial variables in 36 advanced and emerging economies. In most countries, a surprise US monetary tightening leads to depreciation against the dollar; industrial production and real GDP fall, unemployment rises. Inflation declines especially in advanced economies. At the same time, there is significant heterogeneity across countries in the response of asset prices, and portfolio and banking cross-border flows. However, no clear-cut systematic relation emerges between country responses and likely relevant country characteristics, such as their income level, dollar exchange rate flexibility, financial openness, trade openness vs. the US, dollar exposure in foreign assets and liabilities, and incidence of commodity exports. JEL Classification: F3, F4
    Keywords: capital mobility, exchange rate regime, identification of monetary shocks, international transmission, trilemma
    Date: 2017–05
  20. By: Ilomaki Jukka; Laurila Hannu (Faculty of Management, University of Tampere)
    Abstract: The central bank acts as a social planner, and adjusts the real risk-free rate of return to correct any mispricing in the stock market so that the emergence of positive or negative bubbles is avoided. The flip side is that if the real risk-free rate is fixed, it incorporates inefficiency into the financial market. Setting a zero bound for the risk-free rate constrains the adjustment in the case of negative bubbles, and the fixed negative risk-free rate in the market not only prevents the adjustment of possible positive bubbles but may also lead to rampant instability in the market. The paper also points out the limits of manageable control of mispricing. In addition, the analysis indicates that the central bank should intervene in the stock market even if it does not have perfect information about the bubble.
    Keywords: Real Interest Rate, Monetary Policy, Portfolio Choice
    JEL: E43 E52 G11
    Date: 2017–01
  21. By: Benjamin Beckers; Konstantin A. Kholodilin; Dirk Ulbricht
    Abstract: In this paper, we examine the predictive ability of automatic and expert-rated media sentiment indicators for German inflation. We find that sentiment indicators are competitive in providing inflation forecasts against a large set of common macroeconomic and financial predictors. Sophisticated linguistic sentiment algorithms and business cycle news rated by experts perform best and are superior to simple word-count indicators and autoregressive forecasts.
    Keywords: Inflation prediction, media sentiment indicators, news reports, real-time forecasting
    JEL: C53 E31 E37
    Date: 2017
  22. By: Dilger, Alexander
    Abstract: The euro area has several problems. Nevertheless, there is not only strong political support for it, but also most companies back the euro or at least do not complain. It is worthwhile to analyse which companies do profit from the euro and why most others do not oppose it. Exporting companies in the northern countries of the euro zone profit from the euro and the policies to save the common currency even if their countries and people suffer. Other companies, especially in the southern member countries, suffer themselves but fear a break-up of the euro area even more than its continuance. For small companies it is not worthwhile to lobby for other policies, while the companies worst affected already ceased to exist. All companies have to come to terms with the euro but should also prepare for the possible end of the euro zone. Companies in other European countries reconsider whether they really want their countries to join the euro area.
    JEL: E31 E42 F02 F45 G01 L21 M21
    Date: 2017

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