nep-mon New Economics Papers
on Monetary Economics
Issue of 2017‒07‒30
thirty-one papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. The optimal conduct of central bank asset purchases By Darracq-Pariès, Matthieu; Kühl, Michael
  2. Uncovering covered interest parity: the role of bank regulation and monetary policy By Brauning, Falk; Puria, Kovid
  3. Monetary policy and global banking By Brauning, Falk; Ivashina, Victoria
  4. The Death of Cash? Not So Fast: Demand for U.S. Currency at Home and Abroad, 1990-2016 By Judson, Ruth
  5. Asset Bubbles and Monetary Policy By Pengfei Wang; Jianjun Miao; Feng Dong
  6. Pricing behaviour and the role of trade openness in the transmission of monetary shocks By Laura Povoledo
  7. Good Policies or Good Luck? New Insights on Globalization and the International Monetary Policy Transmission Mechanism By Martinez-Garcia, Enrique
  8. Monetary and macroprudential policy with foreign currency loans By Michał Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
  9. Monetary Policy, Target Inflation and the Great Moderation: An Empirical Investigation By Qazi Haque
  10. Financial Development and Monetary Policy: Loan Applications, Rates, and Real Effects By Abuka, Charles; Alinda, Ronnie; Minoiu, Camelia; Peydró, José Luis; Presbitero, Andrea
  11. Should Inflation Measures Used by Central Banks Incorporate House Prices? The Czech Approach By Mojmir Hampl; Tomas Havranek
  12. (Un)expected Monetary Policy Shocks and Term Premia By Martin Kliem; Alexander Meyer-Gohde
  13. The Optimal Degree of Monetary-Discretion in a New Keynesian Model with Private Information By Waki, Yuichiro; Dennis, Richard; Fujiwara, Ippei
  14. Fintech: Is This Time Different? A Framework for Assessing Risks and Opportunities for Central Banks By Meyer Aaron; Francisco Rivadeneyra; Samantha Sohal
  15. Regional Heterogeneity and Monetary Policy By Joseph Vavra; Erik Hurst; Andreas Fuster; Martin Beraja
  16. Monetary Conservatism, Default Risk, and Political Frictions By Joost Roettger
  17. The Capital Structure of Nations By Bolton, Patrick; Huang, Haizhou
  18. The Dire Effects of the Lack of Monetary and Fiscal Coordination By Francesco Bianchi; Leonardo Melosi
  19. Limiting the Use of Cash for Big Purchases: Assessing the Case for Uniform Cash Thresholds By Sands, Peter; Weisman, Benjamin; Campbell, Haylea; Keatinge, Tom
  20. Asset Bubbles and Foreign Interest Rate Shocks By Pengfei Wang; Jing Zhou; Jianjun Miao
  21. Monetary Rules in a Two-Sector Endogenous Growth Model with Cash-in-Advance Constraint By Daria ONORI; Francesco MAGRIS; Antoine LE RICHE
  22. Decline management: the case of cash. Policy response in the Netherlands and the Nordic countries By Scholten, Bram
  23. Optimal Trend Inflation By Adam, Klaus; Weber, Henning
  24. Inflation Convergence In East African Countries By Dridi, Jemma; Nguyen, Anh D. M.
  25. Adoption of a New Payment Method: Theory and Experimental Evidence By Jasmina Arifovic; John Duffy; Janet Hua Jiang
  26. What Remains of Milton Friedman's Monetarism? By Hetzel, Robert L.
  27. Choice of payment instrument for low-value transactions in Japan By Fujiki, Hiroshi; Tanaka, Migiwa
  28. Addressing the limitations of forecasting banknote demand By Miller, Callum
  29. Moving towards "Cashlessness" in an emerging economy: A case study of latest policy steps in India By Dasgupta, Manjira
  30. Assessing recent increases in cash demand By Jobst, Clemens; Stix, Helmut
  31. Analysing Cross-Currency Basis Spreads By Jaroslav Baran; Jiří Witzany

  1. By: Darracq-Pariès, Matthieu; Kühl, Michael
    Abstract: We analyse the effects of central bank government bond purchases in an estimated DSGE model for the euro area. In the model, central bank asset purchases are relevant in so far as agency costs distort banks' asset allocation between loans and bonds, and households face transaction costs when trading government bonds. Such frictions in the banking sector induce inefficient time-variation in the term premia and allow for a credit channel of central bank government bond purchases. Considering ad hoc asset purchase programmes like the one implemented by the ECB, we show that their macroeconomic multipliers get stronger when the lower bound on the policy rate becomes binding and when the purchasing path is fully communicated and anticipated by the agents. From a more normative standpoint, interest rate policy and asset purchases feature strong strategic complementarities during both normal and crisis times. In an environment when nominal interest rates reach their effective lower bound, optimal monetary policy is to keep the policy rate low for a longer period in time and to engage in asset purchases. Our results also point to a clear sequencing of the exit strategy, first stopping the asset purchases and later raising the policy rate. In terms of macroeconomic stabilisation, optimal asset purchase strategies deliver sizeable benefits and have the potential to largely offset the costs of the lower bound on the policy rate.
    Keywords: Zero Lower Bound,Optimal Monetary Policy,Banking,Quantitative Easing,DSGE
    JEL: C61 E52 G11
    Date: 2017
  2. By: Brauning, Falk (Federal Reserve Bank of Boston); Puria, Kovid (Federal Reserve Bank of Boston)
    Abstract: We analyze the factors underlying the recent deviations from covered interest parity. We show that these deviations can be explained by tighter post-crisis bank capital regulations that made the provision of foreign exchange swaps more costly. Moreover, the recent monetary policy and related interest rate divergence between the United States and other major foreign countries has led to a surge in demand for swapping low interest rate currencies into the U.S. dollar. Given the higher bank balance sheet costs resulting from these regulatory changes, the increased demand for U.S. dollars in the swap market could not be supplied at a constant price, thereby amplifying violations of covered interest parity. Furthermore, we show that dollar swap line agreements existing between the Federal Reserve and foreign central banks mitigate pressure in the swap market. However, the current conditions that govern the provision of dollar funding through foreign central banks are not favorable enough to reduce deviations from covered interest parity to zero.
    Keywords: covered interest parity; banking; monetary policy
    JEL: E52 F31 G15 G18 G2
    Date: 2017–06–01
  3. By: Brauning, Falk (Federal Reserve Bank of Boston); Ivashina, Victoria (Harvard Business School)
    Abstract: Global banks use their global balance sheets to respond to local monetary policy. However, sources and uses of funds are often denominated in different currencies. This leads to a foreign exchange (FX) exposure that banks need to hedge. If cross‐currency flows are large, the hedging cost increases, diminishing the return on lending in foreign currency. We show that, in response to domestic monetary policy easing, global banks increase their foreign reserves in currency areas with the highest interest rate, while decreasing lending in these markets. We also find an increase in FX hedging activity and its rising cost, as manifested in violations of covered interest rate parity.
    Keywords: global banks; monetary policy transmission; cross‐border lending
    JEL: E44 E52 F36 G15 G21 G28
    Date: 2016–12–23
  4. By: Judson, Ruth
    Abstract: It would seem that physical currency should be fading out as the world of payments is increasingly electronic, with new technologies emerging at a rapid pace, and as governments look to restrictions on large-denomination notes as a way to reduce crime and tax evasion. Nonetheless, demand for U.S. dollar banknotes continues to grow, and consistently increases at times of crisis both within and outside the United States because it remains a desirable store of value and medium of exchange in times and places where local currency or bank deposits are inferior. After allowing for the effect of crises, demand for U.S. banknotes appears to be driven by the same factors as demand for other types of money, with no discernible downward trend. In this work, I review developments in demand for U.S. currency since the collapse of Lehman Brothers in late 2008 with a focus on some new questions. First, what are the factors driving demand for lower denominations, especially $20s, which are the most commonly used in domestic transactions? To what extent can the recent strength in demand be attributed to the long spell of very low interest rates? Finally, for the larger denominations, I revisit the question of international demand: I present the raw data available for measuring international banknote flows and presents updates on indirect methods of estimating the stock of currency held abroad. These methods continue to indicate that a large share of U.S. currency is held abroad, especially in the $100 denomination. As shown in an earlier paper, once a country or region begins using dollars, subsequent crises result in additional inflows: the dominant sources of international demand over the past two decades are the countries and regions that were known to be heavy dollar users in the early to mid-1990s. While international demand for U.S. currency eased during the early 2000s as financial conditions improved, the abrupt return to strong international demand that began nearly a decade ago with the collapse of Lehman Brothers in 2008 has shown only limited signs of slowing. In contrast, the growth rate of demand for smaller denominations is slowing, perhaps indicating the first signs of declining domestic cash demand.
    Keywords: currency,banknotes,dollarization,crisis
    JEL: C82 E4 E49
    Date: 2017
  5. By: Pengfei Wang (Hong Kong University of Science and Tech); Jianjun Miao (Boston University); Feng Dong (Shanghai Jiao Tong University)
    Abstract: We provide an infinite-horizon model of rational asset bubbles in a Dynamic New Keynesian framework. Entrepreneurs are heterogeneous in investment efficiency and face credit constraints. They can trade land as an asset, which also serves as collateral to borrow from banks with reserve requirements. Land commands a liquidity premium and a land bubble can emerge. Monetary policy can affect the condition for the existence of a bubble, its steady-state size, and its dynamics including the initial size. The `leaning against the wind' interest rate policy will reduce the bubble volatility, but it may come at the cost of raising the inflation volatility. Whether monetary policy should respond to asset bubbles depends on the particular interest rate rule adopted by the central bank and on the exogenous shocks hitting the economy.
    Date: 2017
  6. By: Laura Povoledo (University of the West of England, Bristol)
    Abstract: External demand is considered to be one of the channels of transmission of monetary policy to aggregate demand. If external demand matters in the monetary transmission, then the response of output to monetary shocks must be more pronounced in the sectors that are more open to trade and exposed to foreign competition. However, the empirical evidence is not conclusive. Using a New Keynesian open economy model, I show that the role of trade openness in the transmission of monetary shocks can be reversed completely by the degree of exchange-rate pass-through into import prices. If the pass-through is complete, traded output increases more than nontraded output after a positive monetary shock, if the pass-through is zero, traded output increases less. The lack of conclusive evidence on the role of external demand in the transmission of monetary shocks may also be explained by sectoral heterogeneity in price rigidity: if prices are more rigid in the nontraded sector, then it is not possible to find a positive correlation between the response of output to monetary shocks and the degree of openness, regardless of the degree of exchange rate pass-through.
    Keywords: Monetary transmission; External demand channel; Exchange rate pass-through;
    JEL: E52 F41
    Date: 2016–01–09
  7. By: Martinez-Garcia, Enrique (Federal Reserve Bank of Dallas)
    Abstract: The open-economy dimension is central to the discussion of the trade-offs that monetary policy faces in an increasingly integrated world. I investigate the monetary policy transmission mechanism in a two-country workhorse New Keynesian model where policy is set according to Taylor (1993) rules. I find that a common monetary policy isolates the effects of trade openness on the cross-country dispersion, and that the establishment of a currency union as a means of deepening economic integration may lead to indeterminacy. I argue that the common (coordinated) monetary policy equilibrium is the relevant benchmark for policy analysis showing that in that case open economies tend to experience lower macro volatility, a flatter Phillips curve, and more accentuated trade-offs between inflation and slack. Moreover, I show that the trade elasticity often magnifies the effects of trade integration (globalization) beyond what conventional measures of trade openness would imply. I also discuss how other features such as the impact of a stronger anti-inflation bias, technological diffusion across countries, and the sensitivity of labor supply to real wages influence the quantitative effects of policy and openness in this context. Finally, I conclude that the theoretical predictions of the workhorse open-economy New Keynesian model are largely consistent with the stylized facts of the globalization era started in the 1960s and the Great Moderation period that followed.
    JEL: C11 C13 F41
    Date: 2017–07–01
  8. By: Michał Brzoza-Brzezina (Narodowy Bank Polski; Warsaw School Economics); Marcin Kolasa (Narodowy Bank Polski; Warsaw School Economics); Krzysztof Makarski (Narodowy Bank Polski; Warsaw School Economics; Group for Research in Applied Economics (GRAPE))
    Abstract: In a number of countries a substantial proportion of mortgage loans is denominated in foreign currency. In this paper we demonstrate how their presence affects economic policy and agents' welfare. To this end we construct a small open economy model with financial frictions, where housing loans can be denominated in domestic or foreign currency. The model is calibrated for Poland - a typical small open economy with a large share of foreign currency loans (FCL). We show that the presence of FCLs negatively affects the transmission of monetary policy and deteriorates the output-inflation volatility trade-off it faces. The trade-off can be improved with macroprudential policy but the outcomes are still worse than under this same policy mix applied to an economy with domestic currency debt. We also demonstrate that a high share of FCLs is harmful for social welfare, even if financial stability considerations are not taken into account. Finally, we show that regulatory policies that discriminate against FCLs may have a negative impact on economic activity and discuss the redistributive consequences of forced currency conversion of household debt.
    Keywords: foreign currency loans, monetary policy, macroprudential policy, DSGE models
    JEL: E32 E44 E58
    Date: 2017
  9. By: Qazi Haque (School of Economics, University of Adelaide)
    Abstract: This paper compares the empirical fit of a Taylor rule featuring constant versus time-varying inflation target by estimating a Generalized New Keynesian model under positive trend inflation while allowing for indeterminacy. The estimation is conducted over two different periods covering the Great Inflation and the Great Moderation. We find that the rule embedding time variation in target inflation turns out to be empirically superior and determinacy prevails in both sample periods. Counterfactual simulations point toward both `good policy' and `good luck' as drivers of the Great Moderation. We find that better monetary policy, both in terms of a more active response to inflation gap and a more anchored inflation target, has resulted in the decline in inflation gap volatility and predictability. In contrast, the reduction in output growth variability is mainly explained by reduced volatility of technology shocks.
    Keywords: Monetary policy; Great Inflation; Great Moderation; Equilibrium Indeterminacy; Generalized New Keynesian Phillips curve; Taylor rules; Time-varying inflation target; Good policy; Good luck; Sequential Monte Carlo
    JEL: C11 C52 C62 E31 E32 E52 E58
    Date: 2017–07
  10. By: Abuka, Charles; Alinda, Ronnie; Minoiu, Camelia; Peydró, José Luis; Presbitero, Andrea
    Abstract: The finance-growth literature argues that institutional constraints in developing countries impede financial intermediation and monetary policy transmission. Recent studies using aggregate data document a weak bank lending channel. For identification, we instead exploit Uganda's super- visory credit register, with loan applications and rates, and unanticipated variation in monetary policy. A monetary tightening strongly reduces credit supply - increasing loan application rejections and tightening volume and rates - especially for banks with more leverage and sovereign debt exposure (even within the same borrower-period). There are spillovers on inflation and eco- nomic activity, especially in more financially-developed areas, including on commercial building, trade, and social unrest.
    Keywords: Bank credit; bank lending channel; developing countries; Financial Development; monetary policy; Real effects
    JEL: E42 E44 E52 E58 G21 G28
    Date: 2017–07
  11. By: Mojmir Hampl (Czech National Bank); Tomas Havranek (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic; Czech National Bank)
    Abstract: In this paper we describe the Czech National Bank’s approach to incorporating macroprudential considerations into monetary policy decision making: the use of a broader inflation measure that gives substantial weight to house prices and is considered along with headline CPI inflation. We argue that, in terms of theory, the broader inflation gauge is at least as suitable for measuring the value of money as headline CPI inflation is, but we also acknowledge practical problems that arise from the use of the broader index.
    Keywords: Consumer price index, financial stability, house prices, macroprudential policy, monetary policy, owner-occupied housing
    JEL: E31 E44 E50 R30
    Date: 2017–07
  12. By: Martin Kliem; Alexander Meyer-Gohde
    Abstract: We analyze an estimated stochastic general equilibrium model that replicates key macroeconomic and financial stylized facts during the Great Moderation of 1983-2007. Our model predicts a sizeable and volatile nominal term premium - comparable to recent reduced-form empirical estimates - with real risk two times more important than in ation risk for the average nominal term premia. The model enables us to address salient questions about the effects of monetary policy on the term structure of interest rates. We nd that monetary policy shocks can have differing effects on risk premia. Actions by the monetary authority with a persistent effect on households' expectations have substantial effects on nominal and real risk premia. Our model rationalizes many of the opposing ndings on the effects of monetary policy on term premia in the empirical literature.
    Keywords: DSGE model, Bayesian estimation, Term structure, Monetary policy
    JEL: E13 E31 E43 E44 E52
    Date: 2017–07
  13. By: Waki, Yuichiro (University of Queensland); Dennis, Richard (University of Glasgow); Fujiwara, Ippei (Keio University)
    Abstract: This paper considers the optimal degree of monetary-discretion when the central bank conducts policy based on its private information about the state of the economy and is unable to commit. Society seeks to maximize social welfare by imposing restrictions on the central bank's actions over time, and the central bank takes these restrictions and the New Keynesian Phillips curve as constraints. By solving a dynamic mechanism design problem we find that it is optimal to grant “constrained discretion” to the central bank by imposing both upper and lower bounds on permissible inflation, and that these bounds should be set in a historydependent way. The optimal degree of discretion varies over time with the severity of the timeinconsistency problem, and, although no discretion is optimal when the time-inconsistency problem is very severe, it is a transient phenomenon and some discretion is granted eventually.
    JEL: E52 E61
    Date: 2017–07–01
  14. By: Meyer Aaron; Francisco Rivadeneyra; Samantha Sohal
    Abstract: We investigate the risks and opportunities to the mandates of central banks arising from fintech developments. Fintech may affect the different areas of responsibility of central banks—mainly monetary policy and financial stability—by changing money demand and by changing the industrial organization of the financial system. We present a competitive strategy framework to help evaluate the likelihood of these changes.
    Keywords: Central bank research, Digital Currencies, Financial Institutions, Payment clearing and settlement systems
    JEL: G1 G2 L1 E42
    Date: 2017
  15. By: Joseph Vavra (University of Chicago); Erik Hurst (University of Chicago); Andreas Fuster (Federal Reserve Bank of New York); Martin Beraja (MIT and Princeton University)
    Abstract: We argue that the time-varying regional distribution of housing equity shapes the aggregate consequences of monetary policy through its influence on mortgage refinancing. Using detailed loan-level data, we begin by showing that: (i) the refinancing response to interest rate cuts is strongly affected by regional differences in housing equity, and (ii) both regional differences in refinancing and overall refinancing vary over time with changes in the regional distribution of house price growth and unemployment. Then, we build a heterogeneous household model of refinancing in order to derive aggregate implications of monetary policy from our regional evidence. We find that the 2008 equity distribution made spending in depressed regions less responsive to interest rate cuts, thus dampening aggregate stimulus and increasing regional consumption inequality, whereas the opposite occurred in some earlier recessions. Taken together, our results strongly suggest that monetary policy makers should track the regional distribution of equity over time.
    Date: 2017
  16. By: Joost Roettger (University of Cologne)
    Abstract: This paper studies the consequences of delegating monetary policy to an inflation conservative central banker as in Rogoff (1985) for an emerging economy that faces three frictions which might undermine the success of such a policy reform: (i) incomplete financial markets, (ii) risk of default and (iii) political distortions. To do so, a quantitative sovereign default model is developed in which monetary and fiscal policies are set by two different authorities that both cannot commit to future policies. Inflation conservatism tends to result in lower and more stable inflation as well as a higher average debt burden, more frequent default events and more volatile fiscal policy. Whether the economy benefits from the appointment of a conservative central banker depends on the degree of inflation conservatism, the amount of political distortions and the volatility of fiscal shocks.
    Date: 2017
  17. By: Bolton, Patrick; Huang, Haizhou
    Abstract: When a nation can finance its investments via foreign-currency denominated debt or domestic-currency claims, what is the optimal capital structure of the nation? Building on the functions of fiat money as both medium of exchange, and store of value like corporate equity, our model connects monetary economics, fiscal theory and international finance under a unified corporate finance perspective. With frictionless capital markets both a Modigliani-Miller theorem for nations and the classical quantity theory of money hold. With capital market frictions, a nation's optimal capital structure trades off inflation dilution costs and expected default costs on foreign-currency debt. Our framing focuses on the process by which new money claims enter the economy and the potential wealth redistribution costs of inflation.
    Date: 2017–07
  18. By: Francesco Bianchi; Leonardo Melosi
    Abstract: What happens if the government's willingness to stabilize a large stock of debt is waning, while the central bank is adamant about preventing a rise in inflation? The large fiscal imbalance brings about inflationary pressures, triggering a monetary tightening, further debt accumulation, and additional inflationary pressure. Thus, the economy will go through a spiral of higher inflation, output contraction, and further debt accumulation. A coordinated commitment to inflate away the portion of debt resulting from a large recession leads to better macroeconomic outcomes by separating the issue of long-run fiscal sustainability from the need for short-run fiscal stabilization. This strategy can also be used to rule out episodes in which the central bank becomes constrained by the zero lower bound.
    JEL: D83 E31 E52 E62 E63
    Date: 2017–07
  19. By: Sands, Peter; Weisman, Benjamin; Campbell, Haylea; Keatinge, Tom
    Abstract: For all the hype about electronic payment systems, cash remains by far the world’s most popular mechanism. However, over the past year we have seen an intensification of the discussion about the role of cash in society. Cash has great advantages: it is familiar, simple to use and ubiquitously accepted. However, cash also has downsides. Because cash transactions leave no record, cash plays a critical role in money laundering, tax evasion and terrorist financing. This debate generates strong feelings, to the extent that it is sometimes depicted as a “war on cash”. Some decry moves to curtail cash usage as an unwarranted encroachment on individual liberty and a manifestation of an over-reaching state. Others see physical cash as a costly remnant of a pre-digital age that we should get rid of as soon as is feasible. Yet it is also possible to hold a position between these extremes: acknowledging the continued value of cash in modern society, whilst seeking ways to curb its misuse. In 2016 we witnessed a number of policy initiatives aimed at curbing the illicit use of cash. For example, the ECB decided to stop issuing the €500 note due to concerns about its role in illicit finance. India implemented a radical “demonetisation” strategy, abolishing the 500 and 1000 rupee notes in an effort to tackle the scourge of “black money”. Various governments promoted innovative digital payments systems to replace cash, accelerate financial inclusion and reduce benefit fraud...
    Date: 2017
  20. By: Pengfei Wang (Hong Kong University of Science and Tech); Jing Zhou (Fudan University); Jianjun Miao (Boston University)
    Abstract: We provide an inï¬ nite-horizon general equilibrium model of a small open economy with both domestic and international ï¬ nancial market frictions. Firms face credit constraints and use a bubble asset (land) as collateral to borrow. A land bubble can provide liquidity and relax credit constraints. Low foreign interest rates are conducive to bubble formation. A rise in foreign interest rate can cause the collapse of the asset bubble, which in turn causes an equilibrium regime shift and a sudden stop. Asset bubbles provide an important ampliï¬ cation mechanism.
    Date: 2017
  21. By: Daria ONORI; Francesco MAGRIS; Antoine LE RICHE
    Date: 2017
  22. By: Scholten, Bram
    Abstract: The Netherlands and the Nordic countries are faced with a rapid decline in the use of cash. Sooner or later, they will be confronted with the question whether cash remains necessary as well-functioning means of payment for POS transactions. This paper focuses on how this issue is addressed in the Netherlands and the Nordics, based on answers to a detailed questionnaire submitted to the central banks of these countries, covering the three main elements of the well-functioning of cash: paying in cash, drawing cash from, and lodging cash in one’s bank account. All central banks seem to believe that at least for the foreseeable future, cash remains needed as well-functioning means of payment. Leaving legal issues aside, main arguments are that for part of the population, use of electronic payment instruments is not, or not always, possible or desirable. In addition, cash functions as fall back in case of temporary breakdowns in the functioning of, or trust in, the electronic payment system. In Norway and the Netherlands, this view seems shared by the government and society at large. As far as Denmark, Finland and Sweden are concerned, a broad consensus and a general policy to ‘manage’ the decline of cash have not or not yet materialized. Once authorities and society at large are convinced that cash remains needed as well-functioning means of payment, it has to be determined whether, and if so which, specific action is required to keep cash well-functioning as means of payment. In this respect, unlike the market approach (at least so far) favored in Sweden, Norway and the Netherlands adopted a pro-active approach, with the idea that it is easier to prevent unwelcome developments than to correct them once they have occurred. In the Netherlands, agreement has been reached on a cooperative approach.
    Keywords: cash,cashless society,legal tender
    Date: 2017
  23. By: Adam, Klaus; Weber, Henning
    Abstract: We present a sticky-price model incorporating heterogeneous firms and systematic firm-level productivity trends. Aggregating the model in closed form, we show that it delivers radically different predictions for the optimal inflation rate than canonical sticky price models featuring homogenous firms: (1) the optimal steady-state inflation rate generically differs from zero and (2) inflation optimally responds to productivity disturbances. Using micro data from the US Census Bureau to estimate the inflation-relevant productivity trends at the firm level, we find that the optimal US inflation rate is positive. It was slightly above 2 percent in the year 1986, but continuously declined thereafter, reaching about 1 percent in the year 2013.
    Keywords: Firm Heterogeneity; optimal inflation
    JEL: E31 E32 E52
    Date: 2017–07
  24. By: Dridi, Jemma; Nguyen, Anh D. M.
    Abstract: The paper investigates inflation convergence in five East African Countries: Burundi, Kenya, Rwanda, Tanzania, and Uganda, as they aspire to form a monetary union by 2024 under the umbrella of the East African Community. Based on various panel unit root tests, we find that inflation rates in these countries have been converging. An explanation for the convergence is also provided from the perspective of a Global Vector Autoregressive (GVAR) model, which attributes this convergence to a similarity in terms of the nature of shocks affecting EAC countries as well as the role of foreign factors as drivers of inflation given that inflation has been low and less volatile in industrial and emerging countries since the early 1990s.
    Keywords: Inflation, Global VAR (GVAR), Panel Unit Root Tests, Spillovers, East African Community.
    JEL: C32 C33 E31 F40
    Date: 2017–07
  25. By: Jasmina Arifovic; John Duffy; Janet Hua Jiang
    Abstract: We model the introduction of a new payment method, e.g., e-money, that competes with an existing payment method, e.g., cash. The new payment method involves relatively lower per-transaction costs for both buyers and sellers, but sellers must pay a fixed fee to accept the new payment method. As a result of the network effects, our model admits two symmetric pure strategy Nash equilibria. In one equilibrium, the new payment method is not adopted and all transactions continue to be carried out using the existing payment method. In the other equilibrium, the new payment method is adopted and completely replaces the existing payment method. The equilibrium involving only the new payment method is socially optimal as it minimizes total transaction costs. Using this model, we study the question of equilibrium selection by conducting a laboratory experiment. We find that, depending on the fixed fee charged for the adoption of the new payment method and on the choices made by participants on both sides of the market, either equilibrium can be selected. More precisely, a lower fixed fee for sellers favors very quick adoption of the new payment method by all participants, while for a sufficiently high fee, sellers gradually learn to refuse to accept the new payment method and transactions are largely conducted using the existing payment method. We also find that an evolutionary learning model captures the dynamics of the experimental data well.
    Keywords: Central bank research, Digital Currencies
    JEL: E41 C35 C83 C92
    Date: 2017
  26. By: Hetzel, Robert L. (Federal Reserve Bank of Richmond)
    Abstract: From the early 1960s until the early 1970s with the emergence of rational expectations, under the rubric of monetarism, Milton Friedman defined macroeconomic debate. Although the Keynesian consensus that he challenged has disappeared, the current academic literature makes little reference to monetarist ideas. What happened to them? The argument here is that those ideas remain relevant but require translation into terms expressible in modern macroeconomic models and in the monetary policies of central banks, neither of which contain any obvious references to money. Moreover, the Friedman and Schwartz methodology for identifying shocks retains relevance.
    Keywords: monetary policy; Milton Friedman
    JEL: B22
    Date: 2017–07–21
  27. By: Fujiki, Hiroshi; Tanaka, Migiwa
    Abstract: In this paper, we examine the determinants of the choice of payment instrument for low-value day-to-day transactions. Using Japanese household data from 2007 to 2014, we find that three payment instruments, namely, cash, electronic money, and credit cards, comprise the major payment choices for transactions with values less than 1,000 yen (about 8.7 euros). We also find that high-income, financially sophisticated households in urban areas tend to use both electronic money and cash. Further, family households choosing electronic money and cash do not have higher cash holdings compared with family households exclusively choosing cash, holding all other variables constant. We obtain weak evidence that single-person households choosing electronic money and cash have higher cash holdings compared with single-person households exclusively choosing cash, holding all other variables constant.
    Keywords: cash demand,electronic money
    JEL: E41
    Date: 2017
  28. By: Miller, Callum
    Abstract: Central banks need to forecast banknote demand. It determines the number of notes they need printed and the future distribution network required. Yet forecasting demand is an inherently complex problem - banknotes are anonymous bearer instruments and so many of the sources of demand are difficult to research. This paper sets out a framework for identifying and assessing drivers likely to influence banknote demand. It presents, for the first time, the findings from an econometric model, looking at the past relationship between demand for Bank of England notes and a range of economic variables and cash industry statistics, to help forecast future demand. But this approach has its limitations. There will be determinants of demand not included in the model. Furthermore, what is to say that past relationships will hold into the future? Perhaps we are now approaching a point of inflection - a paradigm shift in the demand for cash that causes the pre-existing relationships to break down. To account for this, central banks must continue to research cash demand, its current and future drivers, and how significant they might be going forward. They must look for leading indicators that suggest a break with the past, and attempt to understand how, and when, the impact of technological change may significantly change the trajectory of cash use. This paper will set out a structure for capturing all of this information and using it to make judgements on the future of cash. Whilst it might improve central bank’s forecasting capability, and thus the basis for policy decisions, it will not eliminate all uncertainty. Therefore, central banks must retain flexibility, and ensure the wider cash industry does as well. There is a future for cash but we must constantly be alert to events that might change what that future looks like.
    Date: 2017
  29. By: Dasgupta, Manjira
    Abstract: On November 08, 2016, India took a decisive step towards going “cashless” by suddenly announcing withdrawal of its existing currency notes of two highest denominations, namely, the Rs. 500/= and the Rs. 1000/=. The move, announced with a suddenness that took the entire nation by surprise, had at its root the purpose of countering the threefold menaces of rampant corruption, counterfeit money and cross-border and internal terror funding. It has generated widespread controversy, the main criticism being that while the policy intent was sound, the execution plan was rather unsound. With one of the highest cash-GDP ratio in the world (close to 11%), India was revealed by RBI (Reserve Bank of India) data as having a staggering share of nearly 86% held in Rs.500/= and 1,000/= notes in the currency stock in circulation (end of FY 2014-15). The cost of “retiring” this volume of currency was therefore, going to be enormous which, as economists like former World Bank Chief Kaushik Basu (Basu 2016) emphasize, could far exceed the gains. In view of the intriguing developments overtaking the Indian economy since the date of submission of the initial abstract, problems that subsequently emerged as considerably more pressing and pertinent have been treated in greater detail in this study. Consequently, the approach and methodology has been substantially modified, although of course retaining the original motivation. With its laudable objectives of striking at the cash-corruption link, India saw, within the first four days of the announcement of demonetization, a staggering surge in bank deposits exceeding USD 52 billion, leading to high hopes of trapping unaccounted or illegal money through this route, a hope that was unfortunately to be belied. Given the enormous problem of Non-Performing Assets plaguing Indian Banks, we have also paid special attention to this potential vast source of unaccounted money in some detail. Next, an overview of India’s vast informal sector has been given, and the guidelines by Schneider and Williams (2013) and Schneider and Buehn (2008) have been used in an attempt to estimate the shadow economy in India using cointegration in a MIMIC framework. Finally, not only did India’s decision to demonetize have enormous economic or financial implications, but it also has had huge social and political ramifications that must be recognized.
    Keywords: India,Demonetization,Cashlessness,Informal Sector,Shadow Economy
    JEL: E26 E42 E58 E65 G00 O17
    Date: 2017
  30. By: Jobst, Clemens; Stix, Helmut
    Abstract: Contrary to predictions that demand for cash will decline with the increased availability and use of non-cash payment means, currency demand has increased in the Euro area and the US over the past 15 years. Against this background, this short article summarizes recent findings from Jobst and Stix (2017), who provide a discussion of trends in currency demand, and presents additional descriptive evidence. In a first step, currency demand over a longer period is analyzed for the USA, Germany and the Euro area. This is helpful for understanding and assessing recent trends. In a second step, evidence from 70 economies is analyzed for the period from 2001 to 2014. This broader perspective informs us about the development for currencies that do not circulate internationally. Our descriptive account provides several insights: (i) Recent increases for the euro and the US dollar are strong even if seen over a 100 year horizon. (ii) Over the period from 2001 to 2014 currency demand has increased in many economies. (iii) In economies where currency demand increased, the increase typically happened after the start of the economic and financial crisis of 2007/08. What are the drivers of recent increases in currency demand? Jobst and Stix (2017) estimate panel money demand models, accounting for changes in GDP, interest rates and shadow economic activities. In economies with high GDP, a substantial share of the increase cannot be explained by changes in interest rates or in the size of the shadow economy. We conjecture that the unexplained component is related to increased hoarding.
    Date: 2017
  31. By: Jaroslav Baran (European Stability Mechanism); Jiří Witzany (University of Economics, Prague)
    Abstract: This paper investigates the drivers of cross-currency basis spreads, which were historically close to zero but have widened significantly since the start of the financial crisis. Credit and liquidity risk, as well as supply and demand have often been cited as general factors driving cross-currency basis spreads, however, these spreads may widen beyond what is normally explained by such variables. We suggest market proxies for EUR/USD basis swap spread drivers and build a multiple regression and cointegration model to explain their significance during three different historical periods of basis widening. The most important drivers of the cross-currency basis spreads appear to be short- and medium-term EU financial sector credit risk indicators, and to a slightly lesser extent, short- and medium-term US financial sector credit risk indicators. Another important driver is market volatility for the short-end basis spread, and the EUR/USD exchange rate for the medium term basis spread, and to a lesser extent, the Fed/ECB balance sheet ratio.
    Keywords: Cross-currency swap, basis spread, overnight indexed swap, cointegration, arbitrage
    JEL: D53 G01 C31
    Date: 2017–07–18

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