nep-mon New Economics Papers
on Monetary Economics
Issue of 2018‒01‒01
23 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Combining Monetary Policy and Prudential Regulation: An Agent-Based Modeling Approach By Michel Alexandre; Gilberto Tadeu Lima
  2. Capital and liquidity buffers and the resilience of the banking system in the euro area By Budnik, Katarzyna; Bochmann, Paul
  3. Can the Adoption of the Euro in Croatia Reduce the Cost of Borrowing? By Davor Kunovac; Nina Pavić
  4. An Overview of Inflation-Targeting Frameworks: Institutional Arrangements, Decision-making, & the Communication of Monetary Policy By Alberto Naudon; Andrés Pérez
  5. Central bank financial strength and inflation: an empirical reassessment considering the key role of the fiscal support By Julien Pinter
  6. On the Singular Control of Exchange Rates By Giorgio Ferrari; Tiziano Vargiolu
  7. A BVAR Model for Forecasting of Czech Inflation By Frantisek Brazdik; Michal Franta
  8. Optimal Monetary Policy and Fiscal Policy Interaction in a non-Ricardian Economy By Massimiliano Rigon; Francesco Zanetti
  9. Central Bank Optimism as a Policy Tool: Evidence from the Bank of England By Tola Adesina
  10. The Macroeconomic Determinants of the Pass-Through from the Market Interest Rate to the Bank Lending Rate in Mozambique By Machava, Agostinho
  11. How do the EM Central Bank talk? A Big Data approach to the Central Bank of Turkey By Joaquin Iglesias; Alvaro Ortiz; Tomasa Rodrigo
  12. Asymmetric effects of monetary policy in regional housing markets By Knut Are Aastveit; André K. Anundsen
  13. Drivers of price inertia: survey evidence By Nataliya Karlova; Irina Bogacheva; Elena Puzanova
  14. Triffin: dilemma or myth? By Michael Bordo; Robert N McCauley
  15. Teaching Modern Macroeconomics in the Mundell-Fleming Language: The IS-MR-UIP-AD-AS Mode By Waldo Mendoza
  16. Stigma and the Discount Window By Mark A. Carlson; Jonathan D. Rose
  17. Working Paper – WP/17/03- Order flow and rand/dollar exchange rate dynamics By Aadila Hoosain; Alta Joubert; Alain Kabundi
  18. Optimal Inflation with Corporate Taxation and Financial Constraints By Daria Finocchiaro; Giovanni Lombardo; Caterina Mendicino; Philippe Weil
  19. Current account dynamics and the real exchange rate: Disentangling the evidence By Matthieu Bussiere; Aikaterini Karadimitropoulou; Miguel A. Leon-Ledesma
  20. Capital inflows, crisis and recovery in small open economies By Hamid Raza; Gylfi Zoega; Stephen Kinsella
  21. A Macroeconomic Model with Financial Panics By Gertler, Mark; Kiyotaki, Nobuhiro; Prestipino, Andrea
  22. Is inflation default? The role of information in debt crises By Marco Bassetto; Carlo Galli
  23. The Effectiveness of Monetary and Fiscal Policy Shocks on U.S. Inequality: The Role of Uncertainty By Goodness C. Aye; Matthew W. Clance; Rangan Gupta

  1. By: Michel Alexandre; Gilberto Tadeu Lima
    Abstract: This paper explores the interaction between monetary policy and prudential regulation in an agent-based modeling framework. Firms borrow funds from the banking system in an economy regulated by a central bank. The central bank carries out monetary policy, by setting the interest rate, and prudential regulation, by establishing the banking capital requirement. Different combinations of interest rate rule and capital requirement rule are evaluated with respect to both macroeconomic and financial stability. Several relevant policy implications were drawn. First, the efficacy of a given capital requirement rule or interest rate rule depends on the specification of the rule of the other type it is combined with. More precisely, less aggressive interest rate rules perform better when the range of variation of the capital requirement is narrower. Second, interest rate smoothing is more effective than the other interest rate rules assessed, as it outperforms those other rules with respect to financial stability and macroeconomic stability. Third, there is no tradeoff between financial and macroeconomic stability associated with a variation of either the capital requirement or the smoothing interest rate parameter. Finally, our results reinforce the cautionary finding of other studies regarding how output can be ravaged by a low inflation targeting.
    Keywords: Agent-based modeling; monetary policy; financial stability; prudential Regulation.
    JEL: E52 G18 C63
    Date: 2017–12–15
  2. By: Budnik, Katarzyna; Bochmann, Paul
    Abstract: How do capital and liquidity buffers affect the evolution of bank loans in periods of financial and economic distress? To answer this question we study the responses of 219 individual banks to aggregate demand, standard and unconventional monetary policy shocks in the euro area between 2007 and 2015. Banks’ responses are derived from a factor-augmented VAR, which relates macroeconomic aggregates to individual bank balance sheet items and interest rates. We find that banks with high capital and liquidity buffers show a more muted response in their lending to adverse real economy shocks. Capital and liquidity buffers also affect bank responses to monetary policy shocks. High bank capitalisation reduces the degree to which banks increase the average duration of loans to the non-financial corporate sector, while high bank liquidity strengthens the positive response to policy easing of both longand short-term loans to the non-financial corporate sector. The latter findings substantiate the relevance of interactions between prudential controls and monetary policy. JEL Classification: E51, E52, G21
    Keywords: capital requirements, liquidity requirements, macroprudential policy, monetary policy
    Date: 2017–12
  3. By: Davor Kunovac (The Croatian National Bank, Croatia); Nina Pavić (The Croatian National Bank, Croatia)
    Abstract: The paper analyses the impact of euro adoption on the reduction of borrowing costs of EU member states. The results of the analysis point to the existence of a "euro premium" – after controlling for the dynamics in the macroeconomic fundamentals of particular countries and the market sentiment, member states of the monetary union have, on average, lower borrowing costs and higher credit ratings than other EU member states. In order to draw attention to the significance that the results could have for bank interest rates in Croatia in the event of euro adoption, a simple VAR model is used to demonstrate that there is a statistically significant transmission of the changes in government borrowing costs to interest rates on bank loans.
    Keywords: euro, borrowing costs, CDS premium, credit rating, Croatia
    JEL: E42
    Date: 2017–11
  4. By: Alberto Naudon; Andrés Pérez
    Abstract: The main objective of this study is to contribute to the public understanding of the inflationtargeting (IT) framework currently being implemented in several leading central banks. We do so by discussing differences in the institutional set up, the decision-making process, and the communication of monetary policy. We analyze these aspects from a conceptual perspective and review them in practice by referring to a set of eleven “small, open” OECD economies as well as four major central banks of the world (Bank of England, Bank of Japan, European Central Bank, & the Federal Reserve). We pay specific attention to recent changes along the multiple dimensions that have, on balance, aimed at further strengthening the IT framework.
    Date: 2017–12
  5. By: Julien Pinter (Centre d'Economie de la Sorbonne & Amsterdam University)
    Abstract: This paper re-examines whether weak central bank finances affect inflation by scrutinizing the key rationale for such a relationship: that the absence of Treasury support makes central bank finances relevant for price stability. Specifically, I ask whether central banks which are not likely to enjoy fiscal support when needed experience higher inflation as their inflation as their financial situation deteriorates. I find this to be true among a large sample of 82 countries between 1998 and 2008. De facto potential fiscal support appears relevant, while de jure fiscal support, which I survey analyzing 82 central bank laws, does not appear to matter. No link is found in a general context. The results bring forward an explanation for the conflicting results of the previous empirical studies, which neglected this key component
    Keywords: Central bank financial strength; Central bank capital; Central bank balance sheet; Inflation; Fiscal space; Central bank law
    JEL: E58 E52 E42 E63
    Date: 2017–10
  6. By: Giorgio Ferrari; Tiziano Vargiolu
    Abstract: Consider the problem of a central bank that wants to manage the exchange rate between its domestic currency and a foreign one. The central bank can purchase and sell the foreign currency, and each intervention on the exchange market leads to a proportional cost whose instantaneous marginal value depends on the current level of the exchange rate. The central bank aims at minimizing the total expected costs of interventions on the exchange market, plus a total expected holding cost. We formulate this problem as an infinite time-horizon stochastic control problem with controls that have paths which are locally of bounded variation. The exchange rate evolves as a general linearly controlled one-dimensional diffusion, and the two nondecreasing processes giving the minimal decomposition of a bounded-variation control model the cumulative amount of foreign currency that has been purchased and sold by the central bank. We provide a complete solution to this problem by finding the explicit expression of the value function and a complete characterization of the optimal control. At each instant of time, the optimally controlled exchange rate is kept within a band whose size is endogenously determined as part of the solution to the problem. We also study the expected exit time from the band, and the sensitivity of the width of the band with respect to the model's parameters in the case when the exchange rate evolves (in absence of any intervention) as an Ornstein-Uhlenbeck process, and the marginal costs of controls are constant. The techniques employed in the paper are those of the theory of singular stochastic control and of one-dimensional diffusions.
    Date: 2017–12
  7. By: Frantisek Brazdik; Michal Franta
    Abstract: Bayesian vector autoregressions (BVAR) have turned out to be useful for medium-term macroeconomic forecasting. Several features of the Czech economy strengthen the rationale for using this approach. These include in particular the short time series available and uncertainty about long-run trends. We compare forecasts based on a small-scale mean-adjusted BVAR with the official forecasts published by the Czech National Bank (CNB) over the period 2008q3-2016q4. The comparison demonstrates that the BVAR approach can provide more precise inflation forecasts over the monetary policy horizon. For other macroeconomic variables, the CNB forecasts either outperform or are comparable with the forecasts based on the BVAR model.
    Keywords: BVAR, forecast evaluation, inflation targeting, real-time forecasting
    JEL: E37 E52
    Date: 2017–11
  8. By: Massimiliano Rigon (Bank of Italy); Francesco Zanetti (University of Oxford)
    Abstract: This paper studies optimal discretionary monetary policy and its interaction with fiscal policy in a New Keynesian model with fi?nitely-lived consumers and government debt. Optimal discretionary monetary policy involves debt stabilization to reduce consumption dispersion across cohorts of consumers. The welfare relevance of debt stabilization is proportional to the debt-to-output ratio and inversely related to the household?s probability of survival that affects the household?s propensity to consume out ?financial wealth. Debt stabilization bias implies that discretionary optimal policy is suboptimal compared with the infl?ation targeting rule that fully stabilizes the output gap and the in?flation rate while leaving debt to freely fl?uctuate in response to demand shocks.
    Keywords: Optimal monetary policy, ?fiscal and monetary policy interaction.
    JEL: E52 E63
    Date: 2017–12
  9. By: Tola Adesina (Birkbeck, University of London)
    Abstract: We evaluate the tone of optimism in the Bank of England’s Monetary Policy Committee (MPC) communication using computerised textual analysis and then explore the impacts of optimism shocks on key macroeconomic variables. We show that innovations in optimism impact key macroeconomic variables in the same way that a contractionary monetary policy would. We find that increasing optimism shocks in MPC communication leads to rising inflation, falling output, declining stock market returns and a rise in the Pound value. We further find evidence that optimism shocks reduce credit availability, the money supply, retail sales as well as earnings. Finally, government bond yields also tend to rise in response to optimism shocks.
    Keywords: Central Bank Communication, Monetary Policy, Optimism.
    JEL: E52 E58
    Date: 2017–11
  10. By: Machava, Agostinho (Department of Economics, Umeå University)
    Abstract: This paper employs a linear regression with interaction terms, impulse response functions, and analysis of multiplier effects to identify the macroeconomic determinants of the market-to-bank interest rate pass-through in Mozambique. This paper also looks at how these macroeconomic fundamentals affect the interest rate pass-through mechanism. The study finds incomplete market-to-bank interest rate pass-through and shows that it takes approximately five months for the money market rate to be fully transmitted to the bank lending rate. There is evidence indicating the existence of asymmetry in the interest rate transmission mechanism, and the empirical findings also highlight that GDP growth and inflation are the most important macroeconomic variables influencing the degree of the interest rate pass-through in both the short and long run.
    Keywords: Mozambique; cointegration; interaction terms; asymmetry; interest rate pass-through; money market rate; bank lending rate
    JEL: E43 E44 G21
    Date: 2017–12–18
  11. By: Joaquin Iglesias; Alvaro Ortiz; Tomasa Rodrigo
    Abstract: We apply the natural language processing or computational linguistics (NLP) to the analysis of the communication policy (i.e statements and minutes) of the Central Bank of Turkey (CBRT). While previous literature has focused on Developed countries, we extend the NLP analysis to the Central Banks of the Emerging Markets using the Dynamic Topic Modelling approach.
    Keywords: Working Paper , Central Banks , Digital economy , Economic Analysis , Emerging Economies , Turkey
    JEL: E52 E58
    Date: 2017–12
  12. By: Knut Are Aastveit (Norges Bank (Central Bank of Norway)); André K. Anundsen (Norges Bank (Central Bank of Norway))
    Abstract: The responsiveness of house prices to monetary policy shocks depends both on the nature of the shock – expansionary versus contractionary – and on city-specific housing supply elasticities. We test and find supporting evidence for the hypothesis that expansionary monetary policy shocks have a larger impact on house prices when supply elasticities are low on 263 US metropolitan areas. We also test whether contractionary shocks are orthogonal to supply elasticities, as implied by downward rigidity of housing supply, and find supporting evidence. A final theoretical conjecture is that contractionary shocks should have a greater impact on house prices than expansionary shocks, as long as supply is not perfectly inelastic. For areas with high housing supply elasticity, our results are in line with this conjecture. However, for areas with an inelastic housing supply, we find that expansionary shocks have a greater impact on house prices than contractionary shocks. We provide evidence that this is related to a momentum effect that is more pronounced when house prices are increasing than when they are falling.
    Keywords: House prices, Heterogeneity, Monetary policy, Non-linearity, Supply elasticities
    JEL: E32 E43 E52 R21 R31
    Date: 2017–12–19
  13. By: Nataliya Karlova (Bank of Russia, Russian Federation); Irina Bogacheva (Bank of Russia, Russian Federation); Elena Puzanova (Bank of Russia, Russian Federation)
    Abstract: Inflation inertia hinders the process of slowing down inflation to meet the target level and thus lowers the effectiveness of monetary policy. Widespread methods of assessing the observed inflation inertia using different models can’t clear up important aspects, such as between-industry analysis based on firm-specific characteristics and, consequently, the speed of response to external shocks in different sectors. The paper investigates the pricing behaviour of firms on the basis of a survey of companies’ conducted by the Bank of Russia. According to the results the main drivers of inflation (price) inertia (or delayed and prolonged response of inflation to shocks) in Russia are backwardlooking (or adaptive) expectations of economic agents, inflexible pricing policy, and wage indexation based on past inflation level. It is important for central banks to understand these processes in order to implement and maintain the effective monetary policy.
    Keywords: price inertia, price-setting behaviour of companies, inflation expectations, Inflexible pricing policy, survey of companies, Russia
    Date: 2017–11
  14. By: Michael Bordo; Robert N McCauley
    Abstract: Triffin gained enormous influence by reviving the interwar story that gold scarcity threatened deflation. In particular, he held that central banks needed to accumulate claims on the United States to back money growth. But the claims would eventually surpass the US gold stock and then central banks would inevitably stage a run on it. He feared that the resulting high US interest rates would cause global deflation. However, we show that the US gold position after WWII was no worse than the UK position in 1900. Yet it took WWI to break sterling's gold link. And better and feasible US policies could have kept Bretton Woods going. This history serves as a backdrop to our critical review of two later extensions of Triffin. One holds that the dollar's reserve role required US current account deficits. This current account Triffin is popular, but anachronistic, and flawed in logic and fact. Nevertheless, it pops up in debates over the euro's and the renminbi's reserve roles. A fiscal Triffin holds that global demand for safe assets will either remain dangerously unsatisfied, or force excessive US fiscal debt. Less flawed, this story posits implausibly inflexible demand for and supply of safe assets. Thus, these stories do not convince in their own terms. Moreover, each lacks Triffin's clear cross-over point from a stable system to an unstable one. Triffin's seeming predictive success leads economists to wrap his brand around dissimilar stories. Yet Triffin's dilemma in its most general form correctly points to the conflicts and difficulties that arise when a national currency plays a role as an international public good.
    Keywords: Triffin dilemma, foreign exchange reserves, gold, US current account, safe assets, world's banker
    JEL: F32 F33 F34 F41 H63
    Date: 2017–12
  15. By: Waldo Mendoza (Departamento de Economía de la Pontificia Universidad Católica del Perú)
    Abstract: The traditional open aggregate demand and aggregate supply model backed by the Mundell-Fleming model, together with the supply curve that relates the price level to the output gap, should be abandoned in undergraduate Macroeconomics teaching. First, because economies do not return automatically to equilibrium; second, modern central banks set the interest rate, not the amount of money; and third, the main variable of interest is inflation, not price level. The New Keynesian models taught in intermediate macroeconomics have raised these questions, and had been expected to replace the traditional model. However, they lack its appeal and simplicity. At present, the Mundell-Fleming model, on the verge of turning 60, remains a fundamental part of undergraduate-level macroeconomics textbooks. In this article we present an alternative, the IS-MR-UIP-AD-AS, a simple New Keynesian model and a form of the Mundell-Fleming with inflation targeting that determines the equilibrium values ​​of production, inflation, the real interest rate, and the real exchange rate. The model is as simple as the traditional one in that it replicates the general equilibrium scheme, it contains a reasonable measure of mathematics and graphical treatment, and it has a simple connection between predictions and facts; but it is also useful in analyzing the main questions of interest. In addition, and more importantly, the device is as flexible as the traditional one, so it can be extended to deal with more complex matters.The main objective is that this model replace the traditional Mundell-Fleming in the teaching of macroeconomics at the undergraduate level. JEL Classification-JEL: E32 , E52 , E58
    Keywords: Teaching macroeconomics, Inflation Targeting Scheme, Mundell-Fleming Model, Open-Economy New Keynesian Model, monetary policy rule
    Date: 2017
  16. By: Mark A. Carlson; Jonathan D. Rose
    Abstract: One of the primary roles of central banks like the Federal Reserve is to provide liquidity to the financial system, particularly during periods of stress. The discount window is a critical tool for providing that liquidity. In this note, we discuss several topics related to stigma in depth and describe how concerns about stigma have influenced changes in Federal Reserve discount window policies.
    Date: 2017–12–19
  17. By: Aadila Hoosain; Alta Joubert; Alain Kabundi
    Abstract: This paper uses the microstructure approach for the South African foreign exchange market to determine the impact of order flow on the rand/US dollar exchange rate over the short and long term. A hybrid model which combines microeconomic and macroeconomic fundamental determinants of the exchange rate has been adopted. The analysis uses monthly series from January 2004 to December 2016 and finds that order flow explains movements in the exchange rate, both in the short and in the long term. The speed of adjustment from short-term deviations is relatively slow. The results based on the rolling-window estimation of the long-run model provide evidence of a changing relationship between order flow and the exchange rate. Consistent with the literature, the results show that the rand/dollar exchange rate reacts to fundamental variables only in the long term. Unlike Meese and Rogoff (1983), who postulate that the best way to estimate the exchange rate over the short term is with a random walk model, the current study shows that the microstructure approach can be exploited to explain short-term dynamics in the exchange rate.
    Date: 2017–12–20
  18. By: Daria Finocchiaro; Giovanni Lombardo; Caterina Mendicino; Philippe Weil
    Abstract: How does inflation affect the investment decisions of financially constrained firms in the presence of corporate taxation? Inflation interacts with corporate taxation via the deductibility of i) capital expenditures and ii) interest payments on debt. Through the first channel, inflation increases firms’ taxable profits and further distorts their investment decisions. Through the second, expected inflation affects the effective real interest rate and stimulates investment. When debt is collateralized, the second effect dominates. Therefore, present a tax-advantage to debt financing, positive long-run inflation enhances welfare by mitigating or even eliminating the investment distortion.
    Keywords: optimal monetary policy; Friedman rule; credit frictions; tax benefits of debt
    JEL: E31 E43 E44 E52 G32
    Date: 2017–12
  19. By: Matthieu Bussiere (Banque de France); Aikaterini Karadimitropoulou (University of East Anglia); Miguel A. Leon-Ledesma (University of Kent)
    Abstract: We study the main shocks driving current account fluctuations for the G6 economies. Our theoretical framework features a standard two-goods inter-temporal model, which is specifically designed to uncover the role of permanent and temporary output shocks and the relation between the real exchange rate and the current account. We build a SVAR model including the world real interest rate, net output, the real exchange rate, and the current account and identify four structural shocks. Our results suggest four main conclusions: i) there is substantial support for the two-good intertemporal model with time-varying interest rate, since both external supply and preference shocks account for an important proportion of current account fluctuations; ii) temporary domestic shocks account for a large proportion of current account fluctuations, but the excess response of the current account is less pronounced than in previous studies; iii) our results alleviate the previous puzzle in the literature that a shock that explains little about net output changes can explain a large proportion of current account changes; iv) the nature of the shock matters to shape the relationship between the current account and the real exchange rate, which explains why is it difficult to understand the role of the real exchange rate for current account fluctuations.
    Keywords: current account, real exchange rate, two-good intertemporal model, SVAR
    JEL: F32 F41
    Date: 2017–11
  20. By: Hamid Raza (Aalborg University, Denmark); Gylfi Zoega (University of Iceland; Birkbeck, University of London); Stephen Kinsella (Kemmy Business School, University of Limerick, Ireland)
    Abstract: We compare two small open economics, Iceland and Ireland, that experienced a capital inflow through their banking systems in the period preceding the 2008 financial crises but differ in their currency arrangements. Both countries have mostly recovered from their respective crises, but the differences in the way their economies adjusted are interesting. The evidence suggests that changes in the real exchange rate served as the adjusting mechanism for Iceland’s current account while in Ireland domestic demand compression served as the main adjustment mechanism. We also explore the adjustment to the crisis in three other Eurozone economies and find that they were similar to the one in Ireland.
    Keywords: sudden stop, real exchange rates, demand compression.
    JEL: F32
    Date: 2017–11
  21. By: Gertler, Mark; Kiyotaki, Nobuhiro; Prestipino, Andrea
    Abstract: This paper incorporates banks and banking panics within a conventional macroeconomic framework to analyze the dynamics of a financial crisis of the kind recently experienced. We are particularly interested in characterizing the sudden and discrete nature of the banking panics as well as the circumstances that makes an economy vulnerable to such panics in some instances but not in others. Having a conventional macroeconomic model allows us to study the channels by which the crisis affects real activity and the effects of policies in containing crises.
    Keywords: Bank Runs; Financial Crisis; New Keynesian DSGE
    JEL: E23 E32 E44 G01 G21 G33
    Date: 2017–12–15
  22. By: Marco Bassetto (Institute for Fiscal Studies and Federal Reserve Bank of Chicago); Carlo Galli (Institute for Fiscal Studies and University College London)
    Abstract: We consider a two-period Bayesian trading game where in each period informed agents decide whether to buy an asset ("government debt") after observing an idiosyncratic signal about the prospects of default. While second-period buyers only need to forecast default, first-period buyers pass the asset to the new agents in the secondary market, and thus need to form beliefs about the price that will prevail at that stage. We provide conditions such that coarser information in the hands of second-period agents makes the price of debt more resilient to bad shocks not only in the last period, but in the first one as well. We use this model to study the consequences of issuing debt denominated in domestic vs. foreign currency: we interpret the former as subject to inflation risk and the latter as subject to default risk, with inflation driven by the information of a less-sophisticated group of agents endowed with less precise information, and default by the information of sophisticated bond traders. Our results can be used to account for the behavior of debt prices across countries following the 2008 nancial crisis, and also provide a theory of "original sin."
    Date: 2017–05–02
  23. By: Goodness C. Aye (Department of Economics, University of Pretoria, Pretoria, South Africa); Matthew W. Clance; Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, South Africa)
    Abstract: The study examines the effect of monetary and fiscal policy on inequality conditioned on low and high uncertainty. We use U.S. quarterly time series data on different measures of income, labour earnings, consumption and total expenditure inequality as well as economic uncertainty. Our analysis is based on the impulse responses from the local projection methods that enable us to recover a smoothed average of the underlying impulse response functions. The results show that both contractionary monetary and fiscal policies increase inequality, and in the presence of relatively higher levels of uncertainty, the effectiveness of both policies is weakened. Thus, pointing to the need for policy-makers to be aware of the level of uncertainty while conducting of economic policies in the U.S.
    Keywords: Inequality, Monetary and Fiscal Policies, Uncertainty
    JEL: C22 E24 E40 E62
    Date: 2017–12

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