nep-mon New Economics Papers
on Monetary Economics
Issue of 2017‒08‒27
thirty-two papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Rethinking the Power of Forward Guidance: Lessons from Japan By Mark Gertler
  2. Central Bank Digital Currency and the Future of Monetary Policy By Michael D. Bordo; Andrew T. Levin
  3. Optimal Simple Rule for Monetary Policy and Macroprudential Policy in a Financial Accelerator Model By Hyunduk Suh
  4. Trade union inflation expectations and the second-round effect By Leshoro, Temitope L A
  5. International inflation spillovers - the role of different shocks By Gregor Bäurle; Matthias Gubler; Diego R. Känzig
  6. Openness and the Effects of Monetary Policy in Africa By Ekpo, Akpan H.; Effiong, Ekpeno L.
  7. Monetary Policy and the Redistribution Channel By Adrien Auclert
  8. International financial integration, crises, and monetary policy: evidence from the euro area interbank crises By Abbassi, Puriya; Brauning, Falk; Fecht, Falko; Peydro, Jose Luis
  9. Exchange Market Pressure: Evidences from ASEAN Inflation Targeting Countries By Abdul Aziz, Muhammad; Widodo, Tri
  10. Money, banking and financial markets By David Andolfatto; Aleksander Berentsen; Fernando M. Martin
  11. Capital Controls and Foreign Currency Denomination By Guangling Liu; Fernando Garcia-Barragan
  12. Monetary Normalizations and Consumer Credit: Evidence from Fed Liftoff and Online Lending By Xin Zhang; Christoph Bertsch; Isaiah Hull
  13. The Interest of Being Eligible By J-s.Mésonnier; C. O’Donnell; O.Toutain
  14. Structural analysis with mixed frequencies: monetary policy, uncertainty and gross capital flows By Bacchiocchi, Emanuele Author-X-Name-Firs Emanuele; Bastianin, Andrea Author-X-Name-Firs Andrea; Missale, Alessandro Author-X-Name-Firs Alessandro; Rossi, Eduardo
  15. Fiscal and Monetary Policy in a New Keynesian Model with Tobin’s Q Investment Theory Features By Giannoulakis, Stylianos
  16. Liquidity in the Repo Market By Lucas Marc Fuhrer
  17. The Unemployment Effect of Central Bank Transparency By Christoph S. Weber
  18. Monetary Policy and Asset Valuation By Francesco Bianchi
  19. Monetary policy, stock market and sectoral comovement By Pierre Guérin; Danilo Leiva-Leon
  20. Cross-Border Bank Flows and Monetary Policy: Implications for Canada By Ricardo Correa; Teodora Paligorova; Horacio Sapriza; Andrei Zlate
  21. Trilemma, Dilemma and Global Players By Samuel Ligonnière
  22. The effectiveness of unconventional monetary policy on risk aversion and uncertainty By Leonidas S. Rompolis
  23. Forecasting exchange rates: The time-varying relationship between exchange rates and Taylor rule fundamentals By Haskamp, Ulrich
  24. Fixed on Flexible Rethinking Exchange Rate Regimes after the Great Recession By Giancarlo Corsetti; Keith Kuester; Gernot J. Müller
  25. Cost of Inflation in Inventory Theoretical Models By Roberto Robatto; Francesco Lippi; Fernando Alvarez
  26. Step away from the zero lower bound: Small open economies in a world of secular stagnation By Giancarlo Corsetti; Eleonora Mavroeidi; Gregory Thwaites; Martin Wolf
  27. Learning to Live in a Liquidity Trap By Jasmina Arifovic; Stephanie Schmitt-Grohé; Martín Uribe
  28. The impact of Basel III on money creation: A synthetic analysis By Xiong, Wanting; Wang, Yougui
  29. Oil Price Pass-Through into Core Inflation By Cristina Conflitti; Matteo Luciani
  30. Quantum Barro--Gordon Game in Monetary Economics By Ali Hussein Samadi; Afshin Montakhab; Hussein Marzban; Sakine Owjimehr
  31. MAPI: Model for Analysis and Projection of Inflation in France By L. De Charsonville; F. Ferrière; C. Jardet
  32. On Interest Rate Policy and Asset Bubbles By Gadi Barlevy; Douglas Gale; Franklin Allen

  1. By: Mark Gertler
    Abstract: In the spring of 2013 the Bank of Japan introduced a state-of-the-art monetary policy which included among other things inflation targeting and aggressive use of forward guidance. In contrast to the predictions of conventional macroeconomic theory, these policies have had only very limited success in reflating the economy. I argue that the disconnect between the Japanese experience and existing theory can be traced to the forward guidance puzzle (FGP). As recent literature suggests, the essence of the FGP is that existing models predict implausibly strong effects of expected future interest rate changes on the economy,.with the strength of the effect increasing with the expected horizon of the interest rate change. Accordingly, in this lecture I sketch a model meant to capture the challenge of reflation in Japan. As in recent literature I attempt to mute the power of forward guidance by stepping outside of rational expectations. In particular I introduce a hybrid adaptive/rational expectations belief mechanism. Most relevant to the Japanese experience is that individuals have adaptive expectations about trend inflation, which is consistent with the evidence. As Kuroda (2016) emphasizes, for an economy without a history of inflation being anchored by a target, individuals need direct evidence that the central bank is capable of moving inflation to target.
    JEL: E52 E58
    Date: 2017–08
  2. By: Michael D. Bordo; Andrew T. Levin
    Abstract: We consider how a central bank digital currency (CBDC) could transform all aspects of the monetary system and facilitate the systematic and transparent conduct of monetary policy. In particular, we find that CBDC can serve as a practically costless medium of exchange, secure store of value, and stable unit of account. To achieve these criteria, CBDC would be account-based and interest-bearing, and the monetary policy framework would foster true price stability.
    JEL: B12 B13 B22 E42 E52 E58 E63
    Date: 2017–08
  3. By: Hyunduk Suh (Inha University)
    Abstract: This paper examines an optimal simple rule for monetary policy and macroprudential policy in a New Keynesian DSGE model with a Bernanke et al. (1999) financial accelerator mechanism. Macroprudential policy is given by countercyclical bank capital regulation or loan-to-value (LTV) ratio regulation. Macroprudential policy can mitigate the inefficiencies arising from financial friction, by reducing the uncertainty related with the solvency risk. It is optimal to separate monetary policy from macroprudential concern and use only macroprudential policy for credit stabilization. Using monetary policy for credit stabilization is sub-optimal because of its tradeoff with inflation stability.
    Keywords: Macroprudential policy, monetary policy, countercyclical bank capital regulation, loan-to-value (LTV) ratio regulation, optimal simple rule
    JEL: E44 E52 E59
    Date: 2017–08
  4. By: Leshoro, Temitope L A
    Abstract: Inflation expectation is believed to be critical in the formation of prices and wages; hence the South African Reserve Bank (SARB) reacts to any first-round effect of inflation by tightening the monetary policy in order to avoid the second-round effect. But how important are the inflation expectations of the trade unions in leading the inflation rate? Using quarterly data and Toda-Yamamoto causality technique, this study investigates whether inflation rate is led by inflation expectations and/or vice versa, using three different measures of inflation expectations of trade union representatives. The study also investigates the importance of the exchange rate in leading or lagging inflation rate. The inflation expectations of trade union representatives were chosen because of the way in which this sector, through the trade union federation COSATU (Congress of South African Trade Unions), has antagonised the inflation targeting framework adopted by SARB. The results obtained showed that inflation and the exchange rate have bi-directional causality, while uni-directional causality exists from inflation rate to inflation expectations. The study therefore concluded that a possible second-round effect of inflation cannot be experienced from the changes in inflation expectations of the trade unions, while providing possible policy recommendations. While many studies have observed inflation expectations in different ways, to our knowledge, no study has been conducted with regard to the cause and effect of inflation expectations of trade unions, in particular, on inflation rate using Toda-Yamamoto causality technique for South Africa.
    Keywords: Exchange rate, Inflation, Inflation expectations, Toda-Yamamoto causality, Trade union
    Date: 2017–08
  5. By: Gregor Bäurle; Matthias Gubler; Diego R. Känzig
    Abstract: We analyze how the transmission of international inflation spillovers depends on the nature of the underlying shocks that drive inflation abroad. We find evidence for substantial heterogeneity in the magnitude of spillovers to domestic inflation related to the fundamental source of international price fluctuations and the corresponding monetary policy reactions. Indeed, it turns out that the relative conduct of monetary policy varies depending on the source of these price fluctuations, and so does the role of the exchange rate as a shock absorber. We show this by looking at international inflation spillovers to Switzerland through the lenses of a Bayesian structural dynamic factor model relating a large set of disaggregated prices to key macroeconomic factors. Being a small open economy with an independent monetary policy, Switzerland is a particularly suitable subject for studying the role of monetary policy in the transmission of foreign shocks. However, our results more broadly indicate that inflation spillovers need to be analyzed in a framework allowing for different transmission channels.
    Keywords: international spillovers, inflation, monetary policy, Bayesian factor model, sign restrictions
    JEL: C11 C32 E31 E52
    Date: 2017
  6. By: Ekpo, Akpan H.; Effiong, Ekpeno L.
    Abstract: This paper investigates the relationship between a country's openness to trade and the effects of monetary policy on output growth and inflation in Africa. Theory suggest that monetary policy effectiveness is influenced by the degree of openness to international trade. We apply standard panel data techniques to annual data from the period 1990-2015 for a panel of 37 African countries, and find a strong significant relationship between openness and monetary policy effectiveness in Africa. The empirical results indicate that the effects of monetary policy on output growth and inflation increases and decreases respectively with higher levels of trade openness. Therefore, monetary authorities should place emphasis on the level of openness when designing their choice of optimal monetary policy.
    Keywords: Openness; Monetary Policy; Africa.
    JEL: C33 E52 F41 O55
    Date: 2017–08
  7. By: Adrien Auclert (Stanford Institute for Economic Policy Research)
    Abstract: This paper evaluates the role of redistribution in the transmission mechanism of monetary policy to consumption. Three channels affect aggregate spending when winners and losers have different marginal propensities to consume: an earnings heterogeneity channel from unequal income gains, a Fisher channel from unexpected inflation, and an interest rate exposure channel from real interest rate changes. Sufficient statistics from Italian and U.S. data suggest that all three channels are likely to amplify the effects of monetary policy. A standard incomplete markets model can deliver the empirical magnitudes if assets have plausibly high durations but a counterfactual degree of inflation indexation.
    Date: 2017–06
  8. By: Abbassi, Puriya (Deutsche Bundesbank); Brauning, Falk (Federal Reserve Bank of Boston); Fecht, Falko (Frankfurt School of Finance & Management); Peydro, Jose Luis (Universitat Pompeu Fabra)
    Abstract: We analyze how financial crises affect international financial integration, exploiting euro area proprietary interbank data, crisis and monetary policy shocks, and variation in loan terms to the same borrower on the same day by domestic versus foreign lenders. Crisis shocks reduce the supply of crossborder liquidity, with stronger volume effects than pricing effects, thereby impairing international financial integration. On the extensive margin, there is flight to home — but this is independent of quality. On the intensive margin, however, GIPS-headquartered debtor banks suffer in the Lehman crisis, but effects are stronger in the sovereign-debt crisis, especially for riskier banks. Nonstandard monetary policy improves interbank liquidity, but without fostering strong cross-border financial reintegration.
    Keywords: financial integration; financial crises; cross-border lending; monetary policy; euro area sovereign crisis; liquidity
    JEL: E58 F30 G01 G21 G28
    Date: 2017–07–01
  9. By: Abdul Aziz, Muhammad; Widodo, Tri
    Abstract: Monetary model of Exchange Market Pressure (EMP) is one of the best-known measures to determine size of intervention, which is needed to attain any favored exchange rate target. This study intends to examine the relationship between EMP and its determinant in ASEAN inflation targeting countries during 2006Q1-2016Q4. Monetary model of Exchange Market Pressure is employed. The results show that all variables are corresponding with the theory implies, except change in real income for Indonesia and Thailand, and change in world prices for Philippines. Thus, additional pressure by financial crisis is only found in Indonesian rupiah and Thai baht exchange rates. This study also proves that independent variables, which are used, can attempt favorable prediction of the value of EMP, especially during financial crisis. In the context controlling EMP, this study finds that these countries prefer to hold their currency exchange rate level by managing domestic credit and interest rate.
    Keywords: Exchange Market Pressure, Exchange Rate, Intervention, Inflation Targeting, Financial Crisis
    JEL: F31 F33 F35
    Date: 2017–08–20
  10. By: David Andolfatto; Aleksander Berentsen; Fernando M. Martin
    Abstract: The fact that money, banking, and financial markets interact in important ways seems self-evident. The theoretical nature of this interaction, however, has not been fully explored. To this end, we integrate the Diamond (1997) model of banking and financial markets with the Lagos and Wright (2005) dynamic model of monetary exchange – a union that bears a framework in which fractional reserve banks emerge in equilibrium, where bank assets are funded with liabilities made demandable for government money, where the terms of bank deposit contracts are constrained by the liquidity insurance available in financial markets, where banks are subject to runs, and where a central bank has a meaningful role to play, both in terms of inflation policy and as a lender of last resort. The model provides a rationale for nominal deposit contracts combined with a central bank lender-of-last-resort facility to promote efficient liquidity insurance and a panic-free banking system.
    Keywords: Money, banking, financial markets, monetary policy
    JEL: E50 E60 D53 D02 G21
    Date: 2017–08
  11. By: Guangling Liu (University of Stellenbosch); Fernando Garcia-Barragan
    Abstract: This paper studies the effectiveness of capital controls with foreign currency denomination on business cycle fluctuations and the implications for welfare. To do this, we develop a general equilibrium model with financial frictions and banking, in which assets and liabilities are denominated in both domestic and foreign currencies. We propose a non-pecuniary, capital-control policy that limits the gap between foreign-currency denominated loans and deposits to the amount of foreign funds that bankers can borrow from the international credit market. We show that capital controls have a significant impact on the dynamics of assets and liabilities that are denominated in foreign currency. The non-pecuniary capital controls help to stabilize the financial sector, thereby reducing the negative spillovers to the real economy. A more restrictive capital-control policy significantly weakens the welfare effect of the foreign monetary policy and exchange rate shocks.
    Date: 2017
  12. By: Xin Zhang (Sveriges Riksbank); Christoph Bertsch (Sveriges Riksbank); Isaiah Hull (Sveriges Riksbank)
    Abstract: On December 16th of 2015, the Fed initiated "liftoff," raising the federal funds rate range by 25 basis points and initiating a significant step in the monetary normalization process. We use a unique panel dataset of 640,000 loan-hour observations to measure the impact of liftoff on interest rates, demand, and supply in the online primary market for uncollateralized consumer credit. We find that the average interest rate dropped by 16.9-22.9 basis points. This holds for a number of window sizes, including 3 days, 7 days, and 14 days around liftoff, and is robust to the inclusion of a broad set of loan-level controls and fixed effects. We also find that the interest rate declined more for borrowers with subprime characteristics, leading to a 16% reduction in the spread. We reject a number of candidate explanations for these results, including a change in borrower composition, a collapse in demand, and a shift in risk appetite. Our findings are consistent with an investor-perceived reduction in default probabilities; and suggest that liftoff may have provided a strong, positive signal ab out the future solvency of borrowers.
    Date: 2017
  13. By: J-s.Mésonnier; C. O’Donnell; O.Toutain
    Abstract: Major central banks often accept pooled individual corporate loans as collateral in their refinancing operations with credit institutions. Such ``eligible'' loans to firms therefore provide a liquidity advantage to the banks that originate them. Banks may in turn pass on this advantage to the borrowers in the form of a reduced liquidity risk premium: the eligibility discount. We exploit a temporary surprise extension of the Eurosystem's universe of eligible collateral to mediumquality corporate loans, the Additional Credit Claims (ACC) program of February 2012, to assess the eligibility discount to corporate loans spreads in France. We find that becoming eligible to the Eurosystem's collateral framework translates into a reduction in rates by 7bp for new loans issued to ACC-firms, controlling for loan-, firm- and bank-level characteristics. In line with the opportunity-cost view of collateral choice, we also find evidence that this collateral channel of monetary policy is only active for banks which ex ante pledged more credit claims as part of their collateral with the Eurosystem.
    Keywords: monetary policy, collateral framework, eligibility discount, Eurosystem.
    JEL: C21 G21 E43 E52
    Date: 2017
  14. By: Bacchiocchi, Emanuele Author-X-Name-Firs Emanuele (University of Milan, Department of Economics, Management and Quantitative Method); Bastianin, Andrea Author-X-Name-Firs Andrea (University of Milan, Department of Economics, Management and Quantitative Method); Missale, Alessandro Author-X-Name-Firs Alessandro (University of Milan, Department of Economics, Management and Quantitative Method); Rossi, Eduardo (European Commission – JRC)
    Abstract: In this paper we study how monetary policy, economic uncertainty and economic policy uncertainty impact on the dynamics of gross capital inflows in the US. Particular attention is paid to the mixed frequency-nature of the economic time series involved in the analysis. A MIDAS-SVAR model is presented and estimated over the period 1988-2013. While no relation is found when using standard quarterly data, exploiting the variability present in the series within the quarter shows that the effect of a monetary policy shock is greater the longer the time lag between the month of the shock and the end of the quarter. In general, the effects of economic and policy uncertainty on US capital inflows are negative and significant. Finally, the effect of the three shocks is different when distinguishing between financial and bank capital in ows from one side, and FDI from the other.
    Keywords: Gross capital inflows; monetary policy; economic and policy uncertainty; mixed frequency variables
    JEL: C32 E52
    Date: 2016–12
  15. By: Giannoulakis, Stylianos
    Abstract: The purpose of this article is to carefully lay out the internal monetary and fiscal transmission mechanisms in the context of a New Keynesian model, with a particular focus on the role of capital - the most vital ingredient in the transition from the basic framework to the medium - scale DSGE models. The key concept of this paper is the form of the monetary policy: we assume a two-channel monetary policy, i.e. it is conducted through a rule for money supply and a Taylor-type rule for interest rates, in order to keep up with the ECB and Fed’s policies. We also adopt a simple fiscal policy rule for public consumption to examine the interactions between fiscal and monetary policy. Finally, in order to capture the crisis effects we introduce exogenous shocks to both monetary and fiscal policy rules.
    Keywords: Transmission Mechanisms; New Keynesian Model; Tobin’s Q; Two-Channel Monetary Policy
    JEL: E37 E52 E62 E63
    Date: 2017–05–04
  16. By: Lucas Marc Fuhrer
    Abstract: This paper examines liquidity in the Swiss franc repurchase (repo) market and assesses its determinants using a proprietary dataset ranging from 2006 to 2016. I find that repo market liquidity has a distinct intraday pattern, with low liquidity in early and late trading hours. Moreover, repo market liquidity is negatively affected by stress in the global financial system and the end of the minimum reserve requirement period if central bank reserves are scarce. Furthermore, I show that with excess central bank reserves in the financial system, quoted volumes in the interbank market get imbalanced towards more cash provider relative to cash taker quotes and the trading volume declines. By estimating liquidity in an interbank repo market and explaining its drivers, this paper contributes to the ongoing debate on repo market functioning.
    Keywords: Repo market, liquidity, central bank reserves, Switzerland.
    JEL: G01 G12 G21
    Date: 2017
  17. By: Christoph S. Weber
    Abstract: Most central banks around the world have increased their transparency in the recent past. The greater openness of central bankers manifests itself in the publication of the central banks’ own macroeconomic forecasts or the disclosure of minutes and voting records of central bank committees. The intention of this policy is to build credibility and achieve better economic outcomes. The question is whether higher transparency comes at some cost, i.e. higher unemployment or higher unemployment variability. Firstly, the article shows in a theoretical model that opaqueness regarding the central bank’s preferences does not necessarily lead to lower unemployment. Secondly, the paper analyses the main theoretical results of other authors, namely that transparency leads to higher wages, higher unemployment, and higher unemployment volatility. The results of the estimations show that there is no evidence that central bank transparency leads to higher wages. We can also reject the hypothesis that transparency induces higher unemployment. In fact, the analyses show that central bank transparency can reduce the detrimental effect that central bank independence has on employment. Furthermore, the estimations confirm that central bank transparency does not lead to higher unemployment volatility but can reduce it in most cases.
    Keywords: Central Bank Transparency, Unemployment, Determinants of Unemployment Rates
    JEL: E24 E42 E58
    Date: 2017–08
  18. By: Francesco Bianchi (Duke University)
    Abstract: This paper presents evidence of infrequent shifts, or “breaks,” in the mean of the consumption-wealth variable cay that are strongly associated with fluctuations in the long-run expected value of the Federal Reserve's primary policy rate, with low policy rates associated with high asset valuations, and vice versa. By contrast, there is no evidence that infrequent shifts to high asset valuations and low policy rates are associated with higher expected economic growth or lower economic uncertainty; indeed the opposite is true. Additional evidence supports an equity market "reaching for yield" channel, wherein low interest rate regimes coincide with low risk premia.
    Date: 2017
  19. By: Pierre Guérin (OECD); Danilo Leiva-Leon (Banco de España)
    Abstract: This paper evaluates the role that sectoral comovement plays in the propagation of monetary policy shocks on the stock market. In doing so, we introduce a factor-augmented vector autoregressive model with heterogeneous regime-switching factor loadings, denoted as MS2-FAVAR, that allows us to jointly assess (i) potential changes in the degree of comovement between each sector-specific stock return and the aggregate stock market as well as (ii) the propagation of monetary policy shocks taking into account such changes in comovement. We find that the efects of monetary policy shocks on stock returns are substantially amplied when industries experience a stronger degree of comovement, suggesting that a more interconnected stock market is more prone to the propagation of monetary policy shocks. The MS2-FAVAR model is also well-suited to perform a network analysis to characterize linkages in large datasets.
    Keywords: stock market, monetary policy, markov-switching, factor model, network analysis
    JEL: E44 C32 G12
    Date: 2017–08
  20. By: Ricardo Correa; Teodora Paligorova; Horacio Sapriza; Andrei Zlate
    Abstract: Using the Bank for International Settlements (BIS) Locational Banking Statistics data on bilateral bank claims from 1995 to 2014, we analyze the impact of monetary policy on cross-border bank flows. We find that monetary policy in a source country is an important determinant of cross-border bank flows. In addition, we find evidence in favor of a cross-border portfolio channel that works in parallel with the traditional bank lending channel. As tighter monetary conditions in source countries erode the net worth and collateral values of domestic borrowers, banks reallocate credit away from relatively risky domestic borrowers toward safer foreign counterparties. The cross-border reallocation of credit is more pronounced for source countries with weaker financial sectors that are likely more risk averse. Also, the reallocation is directed toward borrowers in advanced economies, or those in economies with investment-grade sovereign rating. In particular, source countries with tighter monetary policy increase cross-border credit to Canada. Our study highlights the spillovers of domestic monetary policy on foreign credit, which enhances the understanding of the international monetary transmission mechanism through global banks.
    Keywords: Financial Institutions, Monetary Policy
    JEL: F34 F36 G01
    Date: 2017
  21. By: Samuel Ligonnière
    Abstract: This paper investigates the debate between the Mundellian trilemma and the dilemma. It focuses on the active role of the exchange rate regime. Overall, the global financial cycle magnifies the binding effect of financial openness on monetary policy autonomy, thus at the same time sharply reducing the effectiveness of the floating exchange rate regime to isolate the domestic economy against financial pressures. We provide empirical evidence that the trilemma does not morph into a dilemma. Furthermore, the sensitivity to the global financial cycle depends less on the fluctuations of these financial forces than on the presence of global investors and global banks.
    Keywords: Trilemma;Dilemma;Exchange-Rate Regime;Global Financial Cycle;Global Players
    JEL: E52 F32 F33
    Date: 2017–08
  22. By: Leonidas S. Rompolis (Athens University of Economics and Business)
    Abstract: This paper examines the impact of unconventional monetary policy of ECB measured by its balance sheet expansion on euro area equity market uncertainty and investors risk aversion within a structural VAR framework. An expansionary balance sheet shock decreases both risk aversion and uncertainty at least in the medium-run. A negative shock on policy rates has also a negative impact on risk aversion and uncertainty. These results are generally robust to different specifications of the VAR model, estimation procedures and identification schemes. Conversely, periods of high uncertainty are followed by a looser conventional monetary policy. The effect of uncertainty on ECB’s total assets and of risk aversion on conventional or unconventional monetary policy is not always statistically significant.
    Keywords: Unconventional monetary policy; euro area; risk aversion; uncertainty
    JEL: C32 E44 E52 G12
    Date: 2017–07
  23. By: Haskamp, Ulrich
    Abstract: There is empirical evidence for a time-varying relationship between exchange rates and fundamentals. Such a relationship with time-varying coefficients can be estimated by a Kalman filter model. A Kalman filter estimates the coefficients recursively depending on the prediction error of the examined model. Using a Taylor rule based exchange rate model, which in the literature was found to have promising forecasting abilities, it is possible to further improve the performance if the utilization of information from the prediction error is restricted. This is necessary as classic exchange rate models do not perform badly solely because they neglect the time-varying relationship, but also due to missing explanatory information. So, if the Kalman filter uses the entire information from the prediction error, it would overestimate the need for coefficient adjustment. With this calibration of the Kalman filter model the short-term out-ofsample forecasting accuracy can be enhanced for 10 out of 12 exchange rates.
    Keywords: exchange rates,forecasting,Kalman filter,state space models
    JEL: C53 F31 F37
    Date: 2017
  24. By: Giancarlo Corsetti (University of Cambridge; Centre for Macroeconomics (CFM); Centre for Economic Policy Research); Keith Kuester (University of Bonn; Centre for Economic Policy Research); Gernot J. Müller (University of Tübingen; Centre for Economic Policy Research)
    Abstract: The zero lower bound problem during the Great Recession has exposed the limits of monetary autonomy, prompting a re-evaluation of the relative benefits of currency pegs and monetary unions (see e.g. Cook and Devereux, 2016). We revisit this issue from the perspective of a small open economy. While a peg can be beneficial when the recession originates domestically, we show that a oat dominates in the face of deflationary demand shocks abroad. When the rest of the world is in a liquidity trap, the domestic currency depreciates in nominal and real terms even in the absence of domestic monetary stimulus (if domestic rates are also at the zero lower bound)|enhancing the country's competitiveness and insulating to some extent the domestic economy from foreign deflationary pressure.
    Keywords: External shock, Great Recession, Exchange rate, Zero lower bound, Exchange rate peg, Currency union, Fiscal Multiplier, Benign coincidence
    JEL: F41 F42 E31
    Date: 2017–07
  25. By: Roberto Robatto (University of Wisconsin-Madison); Francesco Lippi (Einaudi Institute (EIEF)); Fernando Alvarez (University of Chicago)
    Abstract: We show that the area under the long-run demand curve for money measures the welfare cost of inflation for a very large class of inventory theoretical models of money demand. The class of inventory models considered has a general stochastic structure of the net cash expenditures as well as of the fixed/variable cost of withdrawing and depositing money. Thus, our framework includes a large number of models that have been studied in the literature as special cases. The most important feature that is responsible for our result is the fact that private agents fully internalize all the costs and benefits associated with managing their inventory of money. As a result, the social costs and benefits of holding money, which are related to the welfare cost of inflation, are equal to the private costs and benefits of holding money, which are in turn captured by the area under the money demand curve.
    Date: 2017
  26. By: Giancarlo Corsetti (University of Cambridge; Centre for Macroeconomics (CFM); Centre for Economic Policy Research); Eleonora Mavroeidi (Bank of England); Gregory Thwaites (Bank of England; Centre for Macroeconomics (CFM)); Martin Wolf (University of Bonn)
    Abstract: We study how small open economies can escape from deflation and unemployment in a situation where the world economy is permanently depressed. Building on the framework of Eggertsson et al. (2016), we show that the transition to full employment and at-target in ation requires real and nominal depreciation of the exchange rate. However, because of adverse income and valuation effects from real depreciation, the escape can be beggar thy self, raising employment but actually lowering welfare. We show that as long as the economy remains financially open, domestic asset supply policies or reducing the effective lower bound on policy rates may be ineffective or even counterproductive. However, closing domestic capital markets does not necessarily enhance the monetary authorities' ability to rescue the economy from stagnation.
    Keywords: Monetary policy, Zero lower bound, deflation, depreciation, Beggar-thy-neighbour, Capital controls
    JEL: F41 E62
    Date: 2017–05
  27. By: Jasmina Arifovic; Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: The Taylor rule in combination with the zero lower bound on nominal rates has been shown to create an unintended liquidity-trap equilibrium. The relevance of this equilibrium has been challenged on the basis that it is not stable under least-square learning. In this paper, we show that the liquidity-trap equilibrium is stable under social learning. The learning mechanism we employ includes three realistic elements: mutation, crossover, and tournaments. We show that agents can learn to have pessimistic sentiments about the central bank's ability to generate price growth, giving rise to a stochastically stable environment characterized by deflation and stagnation.
    JEL: E52
    Date: 2017–08
  28. By: Xiong, Wanting; Wang, Yougui
    Abstract: Recent evidences provoke broad rethinking of the role of banks in money creation. The authors argue that apart from the reserve requirement, prudential regulations also play important roles in constraining the money supply. Specifically, they study three Basel III regulations and theoretically analyze their standalone and collective impacts. The authors find that 1) the money multiplier under Basel III is not constant but a decreasing function of the monetary base; 2) the determinants of the bank's money creation capacity are regulation-specific; 3) the effective binding regulation and the corresponding money multiplier vary across different economic states and bank balance sheet conditions.
    Keywords: money creation,Basel III,liquidity coverage ratio,capital adequacy ratio,leverage ratio,money multiplier
    JEL: E51 G28 G18 E60
    Date: 2017
  29. By: Cristina Conflitti; Matteo Luciani
    Abstract: We estimate the oil price pass-through into consumer prices both in the US and in the euro area. In particular, we disentangle the specific effect that an oil price change might have on each disaggregate price, from the effect on all prices that an oil price change might have since it affects the whole economy. To do so, we first estimate a Dynamic Factor Model on a panel of disaggregate price indicators, and then we use VAR techniques to estimate the pass-through. Our results show that the oil price passes through core inflation only via its effect on the whole economy. This pass-through is estimated to be small, but statistically different from zero and long lasting.
    Keywords: Core inflation ; Disaggregate consumer prices ; Dynamic factor model ; Oil price ; Pass-through
    JEL: C32 E31 E32 Q43
    Date: 2017–08–17
  30. By: Ali Hussein Samadi; Afshin Montakhab; Hussein Marzban; Sakine Owjimehr
    Abstract: Classical game theory addresses decision problems in multi-agent environment where one rational agent's decision affects other agents' payoffs. Game theory has widespread application in economic, social and biological sciences. In recent years quantum versions of classical games have been proposed and studied. In this paper, we consider a quantum version of the classical Barro-Gordon game which captures the problem of time inconsistency in monetary economics. Such time inconsistency refers to the temptation of weak policy maker to implement high inflation when the public expects low inflation. The inconsistency arises when the public punishes the weak policy maker in the next cycle. We first present a quantum version of the Barro-Gordon game. Next, we show that in a particular case of the quantum game, time-consistent Nash equilibrium could be achieved when public expects low inflation, thus resolving the game.
    Date: 2017–08
  31. By: L. De Charsonville; F. Ferrière; C. Jardet
    Abstract: In this paper, we present the new model developed at Banque de France to forecast the Harmonized Index of Consumer Prices (HICP) and its components in France up to twelve quarters during the Eurosystem projection exercises. The model is a partial equilibrium model and is used for forecast purposes jointly with the macroeconomic model Mascotte. The model generates more accurate forecasts, conditional to Eurosystem common technical assumptions, than pure autoregressive models. We derive impacts of oil-price shock, exchange rate and wage shocks on headline and core HICP and find significant pass-through.
    Keywords: forecasting, inflation, time-series.
    JEL: E37 C32 E31 C53
    Date: 2017
  32. By: Gadi Barlevy (Federal Reserve Bank of Chicago); Douglas Gale (New York University); Franklin Allen (Imperial College London)
    Abstract: In a provocative paper, Gali (2014), showed that a policymaker who raises interest rates because of concerns about a bubble will paradoxically make the bubble bigger. In this paper, we argue Gali's framework abstracts from the possibility that a policymaker who raises rates might crowd out resources that would have otherwise been spent on the bubble. We show that when we modify Gali's model to allow for this possibility, interventions that lead to higher interest rates can dampen bubbles. However, even if raising rates effectively dampens bubbles, such an intervention is not Pareto improving in the modified version of Gali's model we analyze. We then show that if we modify the model so that it can generate the type of credit-driven bubbles policymakers worry about, raising rates may still be effective against bubbles, and that there may be scope for such interventions to make society better off.
    Date: 2017

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