nep-mon New Economics Papers
on Monetary Economics
Issue of 2018‒07‒30
33 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. The "uncovered inflation rate parity" condition in a monetary union By Nicola Acocella; Parolo Pasimeni
  2. Shadow Banks and the Risk-Taking Channel of Monetary Policy Transmission in the Euro Area By Arina Wischnewsky; Matthias Neuenkirch
  3. Payments, credit and asset prices By Monika Piazzesi; Martin Schneider
  4. A new theory of optimal inflation By Reich, Jens
  5. A shadow rate without a lower bound constraint By De Rezende, Rafael B.; Ristiniemi, Annukka
  6. Positive Trend Inflation and Determinacy in a Medium-Sized New Keynesian Model By Jonas E. Arias; Guido Ascari; Nicola Branzoli; Efrem Castelnuovo
  7. Monetary Policy and Macroprudential Policy: Different and Separate? By Svensson, Lars E O
  8. Requiem for the Interest-Rate Controls in China By Sun, Rongrong
  9. Trade and Currency Weapons By Agnes Benassy-Quere; Matthieu Bussière; Pauline Wibaux
  10. Making sense of a crank case: monetary diversity in Argentina (1999–2003) By Gómez, Georgina M.; Dini, Paolo
  11. Assessing the Impact of Demand Shocks on the US Term Premium By Russell Barnett; Konrad Zmitrowicz
  12. Optimal Monetary Policy in the Presence of Food Price Subsidies By William Ginn; Marc Pourroy
  13. Monetary Policy Announcements and Market Interest Rates’ Response: Evidence from China By Sun, Rongrong
  14. The Fragility of Emerging Currencies Since the 2000s: a Minskyan Analysis By Raquel Ramos
  15. Should Central Banks Prick Asset Price Bubbles? An Analysis Based on a Financial Accelerator Model with an Agent-Based Financial Market By Alexey Vasilenko
  16. Long and Plosser Meet Bewley and Lucas By Dong, Feng; Wen, Yi
  17. Rules-Based Monetary Policy and the Threat of Indeterminacy when Trend Inflation is Low By Hashmat Khan; Louis Phaneuf; Jean Gardy Victor
  18. Monetary policy and household inequality By Ampudia, Miguel; Georgarakos, Dimitris; Slacalek, Jiri; Tristiani, Oreste; Vermeulen, Philip; Violante, Giovanni L.
  19. The impact of monetary policy on household borrowing - a high-frequency IV identification By Sandström, Maria
  20. Risk management-driven policy rate gap By Giovanni Caggiano; Efrem Castelnuovo; Gabriela Nodari
  22. Optimal Trend Inflation By Klaus Adam; Henning Weber
  23. Monetary Policy Analysis when Planning Horizons are Finite By Michael Woodford
  24. Can We Identify the Fed's Preferences? By Jean-Bernard Chatelain; Kirsten Ralf
  25. Conditional exchange rate pass-through: evidence from Sweden By Corbo, Vesna; Di Casola, Paola
  26. On "rusting" money: Silvio Gesell's Schwundgeld reconsidered By Rehme, Günther
  27. The Purchasing Power Parity Puzzle: An Update By Weshah Razzak
  28. The global factor in neutral policy rates: Some implications for exchange rates, monetary policy, and policy coordination By Richard Clarida
  29. Did Foreign Exchange Holding Influence Growth Performance During The Global Financial Crisis? By Jean-Pierre Allegret; Audrey Allegret
  30. Monetary Policy, External Instruments and Heteroskedasticity By Maximilian Podstawski; Thore Schlaak; Malte Rieth
  31. The Rise and Fall of the Natural Interest Rate By Fiorentini, Gabriele; Galesi, Alessandro; Pérez-Quirós, Gabriel; Sentana, Enrique
  32. Simulating the Macroeconomic Effects of Unconventional Monetary Policies By Hess Chung; Cynthia L. Doniger; Cristina Fuentes-Albero; Bernd Schlusche; Wei Zheng
  33. Whose “pound of flesh”? Egyptian sterling balances, 1939-1958 By Ricardo de Menezes Barboza

  1. By: Nicola Acocella; Parolo Pasimeni
    Abstract: The uncovered interest rate parity condition lies at the heart of the "impossible trinity", stating that the three objectives of fixed exchange rates, free capital flows, and independent monetary policy cannot be pursued simultaneously. We argue that although monetary unification does indeed eliminate the tension between exchange rates and nominal interest rates, it does not solve the problem of the intrinsic instability of the system. By eliminating the intra-area exchange rates (with a single currency) and interest rate differentials (with a single common policy rate set by the common central bank), the problem of instability is simply transferred to inflation rate differentials, what we call the (impossibility of the) "uncovered inflation rate parity condition" in a monetary union. The analysis of the actual divergences and imbalances in the EMU, then, suggests that failure to respect the "uncovered inflation rate parity condition" in a monetary union may lead to increasing economic and political tensions. Thus we conclude with the application of the Rodrik's political trilemma to the EMU, which epitomises the existential challenges that the EU faces nowadays.
    Keywords: Monetary Union, interest rate, exchange rate, inflation differentials, political trilemma
    JEL: E42 F33 F41 F42
    Date: 2018
  2. By: Arina Wischnewsky; Matthias Neuenkirch
    Abstract: In this paper, we provide evidence for a risk-taking channel of monetary policy transmission in the euro area that works through an increase in shadow banks’ total asset growth and their risk assets ratio. Our dataset covers the period 2003Q1 - 2017Q3 and includes, in addition to the standard variables for real GDP growth, inflation, and the monetary policy stance, the aforementioned two indicators for the shadow banking sector. Based on vector autoregressive models for the euro area as a whole, we find for conventional monetary policy shocks that a portfolio reallocation effect towards riskier assets is more pronounced, whereas for unconventional monetary policy shocks we detect stronger evidence for a general expansion of assets. Country-specific estimations confirm these findings for most of the euro area countries, but also reveal some heterogeneity in the shadow banks’ reaction.
    Keywords: European Central Bank, macroprudential policy, monetary policy transmission, risk-taking channel, shadow banks, vector autoregression
    JEL: E44 E52 E58 G11 G23 G28
    Date: 2018
  3. By: Monika Piazzesi; Martin Schneider
    Abstract: This paper studies a modern monetary economy: trade in both goods and securities relies on money provided by intermediaries. While money is valued for its liquidity, its creation requires costly leverage. In ation, security prices and the transmission of monetary policy then depend on the institutional details of the payment system. The price of a security is higher if it helps back inside money, and lower if more inside money is used to trade it. In ation can be low in security market busts if bank portfolios suffer, but also in booms if trading absorbs more money. The government has multiple policy tools: in addition to the return on outside money, it affects the mix of securities used to back inside money.
    Keywords: payments, monetary policy, liquidity trap, liquidity, asset prices, collateral premium, leverage, leverage costs, convenience yield, banking, scarce reserves, abundant reserves
    JEL: E00 E13 E41 E42 E43 E44 E51 E52 E58 G1 G12 G21
    Date: 2018–07
  4. By: Reich, Jens
    Abstract: Central banks like the Bank of England or the Bundesbank have highlighted recently that the supply of currency is achieved not by means of printing and spending but by means of credit. This clarification raises further issues. This article addresses the issue of seigniorage and optimal inflation. So far approaches to seigniorage and optimal inflation are still based on the assumption of a currency which is printed and spend by a central authority. From this perspective central banks’ inflation targets and optimal inflation targets are at odds with those suggested by economic theory. The so-called Friedman-rule, the common core of optimal inflation theory, determines optimal inflation via the (opportunity) cost of producing currency. This basic approach is amended by “external effects”, e.g. the impact of monetary non-neutrality or wage rigidities and so on. However, even under consideration of external effects there remains a significant gap between actual inflation targets and optimal rates as suggested by theory. The supply by means of credit, however, involves “costs of production” which do not appear in Friedman’s case: losses from borrower defaults. Incorporating expected losses into economic theory contributes significantly in aligning central banks’ optima with economic theory and provides a new theory of seigniorage for a credit currency.
    Keywords: Optimal inflation, seigniorage, monetary policy, central banking.
    JEL: E31 E51 E52 E58
    Date: 2017–11–01
  5. By: De Rezende, Rafael B. (Monetary Policy Department, Central Bank of Sweden); Ristiniemi, Annukka (Financial Stability Department, Central Bank of Sweden)
    Abstract: We propose a shadow rate that measures the expansionary (contractionary) interest rate effects of unconventional monetary policies that are present when the lower bound is not binding. Using daily yield curve data we estimate shadow rates for the US, Sweden, the euro-area and the UK, and find that they fall (rise) when market participants expect monetary policy to become more expansionary (contractionary), and price this information into the yield curve. This ability of the shadow rate to track the stance of monetary policy is identified on announcements of policy rate cuts (hikes), balance sheet expansions (contractions) and forward guidance, with shadow rates responding timely, and in line with government bond yields. We show two applications for our shadow rate. First, we decompose shadow rate responses to monetary policy announcements into conventional and unconventional monetary policy surprises, and assess the pass-through of each type of policy to exchange rates. We find that exchange rates respond more to conventional than to unconventional monetary policy. Lastly, a counterfactual experiment in a DSGE model suggests that inflation in Sweden would have been around 0.47 percentage points lower had the Riksbank not used unconventional monetary policy since February 2015.
    Keywords: unconventional monetary policy; monetary policy stance; term structure of interest rates; short-rate expectations; term premium
    JEL: E43 E44 E52 E58
    Date: 2018–06–01
  6. By: Jonas E. Arias; Guido Ascari; Nicola Branzoli; Efrem Castelnuovo
    Abstract: This paper studies the challenge that increasing the inflation target poses to equilibrium determinacy in a medium-sized New Keynesian model without indexation fitted to the Great Moderation era. For moderate targets of the inflation rate, such as 2 or 4 percent, the probability of determinacy is near one conditional on the monetary policy rule of the estimated model. However, this probability drops significantly conditional on model-free estimates of the monetary policy rule based on real-time data. The difference is driven by the larger response of the federal funds rate to the output gap associated with the latter estimates.
    Keywords: trend inflation, determinacy, monetary policy
    JEL: E52 E30 C22
    Date: 2018
  7. By: Svensson, Lars E O
    Abstract: The paper discusses how monetary and macroprudential policies can be distinguished, how appropriate goals for the two policies can be determined, whether the policies are best conducted separately or coordinately and by the same or different authorities, and how they can be coordinated when desired. The institutional frameworks in Canada, Sweden, and the UK are briefly compared. The Swedish example of monetary policy strongly "leaning against the wind" and the subsequent policy turnaround is summarized, as well as what estimates have been found of the costs and benefits of leaning against the wind.
    Keywords: Financial crises; Financial Stability; leaning against the wind
    JEL: E44 E52 E58 G01 G28
    Date: 2018–07
  8. By: Sun, Rongrong
    Abstract: This paper reviews the retail interest-rate-control deregulation in China over the 1993-2015 period and provides a preliminary assessment of the PBC's replacement monetary framework. I show that the interest-rate controls triggered the development of deposit substitutes that banks used to circumvent the restrictions, which in turn drove deposits out of commercial banks.This gave rise to concerns about deterioration of bank profits and build-up of financial frangibility, which have pushed up the PBC's deregulation acceleration over the post-2012 period. I quantify the distortionary effects of these controls: disintermediation, a rising shadow banking system and financial repression. Despite the official lift-off of the controls, the retail interest rates are still subject to the PBC’s window guidance and other pricing mechanism guidance. The interest-rate corridor does not function well in confining money market rates. This suggests that the PBC adopt a target money market rate system.
    Keywords: interest-rate control, deregulation, China, financial repression, interest-rate corridor
    JEL: E52 E58
    Date: 2018–06
  9. By: Agnes Benassy-Quere; Matthieu Bussière; Pauline Wibaux
    Abstract: The debate on trade wars and currency wars has re-emerged since the Great recession of 2009. We study the two forms of non-cooperative policies within a single framework. First, we compare the elasticity of trade flows to import tariffs and to the real exchange rate, based on product level data for 110 countries over the 1989-2013 period. We find that a 1 percent depreciation of the importer’s currency reduces imports by around 0.5 percent in current dollar, whereas an increase in import tariffs by 1 percentage point reduces imports by around 1.4 percent. Hence the two instruments are not equivalent. Second, we build a stylized short-term macroeconomic model where the government aims at internal and external balance. We find that, in this setting, monetary policy is more stabilizing for the economy than trade policy, except when the internal transmission channel of monetary policy is muted (at the zero-lower bound). One implication is that, in normal times, a country will more likely react to a trade “aggression” through monetary easing rather than through a tariff increase. The result is reversed at the ZLB.
    Keywords: tariffs, exchange rates, trade elasticities, protectionism
    JEL: F13 F14 F31
    Date: 2018
  10. By: Gómez, Georgina M.; Dini, Paolo
    Abstract: Based on empirical data, this study discusses the introduction, acceptance and circulation of two complementary currencies in Argentina that do not fit well in the main approaches to the nature of money. These two monetary circuits, provincial and community currencies, were introduced as units of account to denominate the value of debt and circulated as means of payment to overcome monetary stringency during the crisis of 1999-2003. After discussing several theories on the nature of money, we reflect on the institutional significance of currency circuits as concurrent and rather stable pairs of trade and money. We suggest that several theories of money need to be combined to account for the variety and heterogeneity of daily monetary practices in a broad spectrum of countries.
    Keywords: Ontology of money; Monetary plurality; Community currencies; Subnational currencies; Argentina
    JEL: E5 O2 Z1
    Date: 2016–09–01
  11. By: Russell Barnett; Konrad Zmitrowicz
    Abstract: During and after the Great Recession of 2008–09, conventional monetary policy in the United States and many other advanced economies was constrained by the effective lower bound (ELB) on nominal interest rates. Several central banks implemented large-scale asset purchase (LSAP) programs, more commonly known as quantitative easing or QE, to provide additional monetary stimulus. Gauging the effectiveness of LSAPs is important, since the ELB may be a constraint on conventional monetary policy more frequently in the future than it was in the past. In this paper we analyze two distinct periods where we observe exogenous demand shocks for 10-year US Treasury bonds to assess their impact on the term premium. Our results show that official sector demand factors, measured by purchases of securities by the foreign official sector and the Federal Reserve’s asset purchase program, are important drivers explaining movements in the term premium. They suggest that asset purchases (QE) can help provide additional monetary stimulus even once the policy rate has reached its ELB. Robustness tests also suggest that the estimated impact of official sector demand factors is the most robust driver of the term premium across alternative specifications, while the estimates on risk factors appear more sensitive to the choice of term premium specification. Based on external projections and authors’ assumptions, our results suggest that the US term premium will rise gradually from an average of about -20 basis points in the fourth quarter of 2016 to around +10, 32 and 60 basis points by the end of 2017, 2018 and 2019, respectively, before stabilizing around 100 basis points in the medium term.
    Keywords: Financial markets, Interest rates, Monetary policy framework, Monetary policy implementation, Transmission of monetary policy
    JEL: E E4 E43 E5 E52 E58 E6 E61 E65 G G1 G12
    Date: 2018
  12. By: William Ginn (FAU - Friedrich-Alexander Universität Erlangen-Nürnberg); Marc Pourroy (CRIEF - Centre de Recherche sur l'Intégration Economique et Financière - Université de Poitiers)
    Abstract: Food price subsidies are a prevalent means by which fiscal authorities may counteract food price volatility in middle-income countries (MIC). We develop a DSGE model for a MIC that captures this key channel of a policy induced price smoothing mechanism that is different to, yet in parallel with, the classic Calvo price stickiness approach, which can have consequential effects for monetary policy. We then use the model to address how the joint fiscal and monetary policy responds to an increase in inflation driven by a food price shock can affect welfare. We show that, in the presence of credit constrained households and households with a significant share of food expenditures , a coordinated reaction of fiscal and monetary policies via subsidized price targeting can improve aggregate welfare. Subsidies smooth prices and consumption, especially for credit constrained households, which can consequently result in an interest rate reaction less intensely with subsidized price targeting compared with headline price targeting.
    Keywords: Monetary Policy,Fiscal Policy,Food subsidies,DSGE Model,Subsidies,Commodities,Middle income countries
    Date: 2018–07–05
  13. By: Sun, Rongrong
    Abstract: This paper uses the event study to estimate the impact of various monetary policy announcements on market interest rates in China over the 2002-2017 period. I find that financial markets understand the quantitative signals better: the market response to an announced adjustment of the regulated retail interest rate and the required reserve ratio is positive and significant at all maturities of bond rates, but smaller at the long end of the yield curve. However, the market barely responds to announced changes in the qualitative policy stance index, which contains limited vague information and is easily anticipated. Two newly introduced central bank lending rates do not appear to be sufficient to replace the retail interest rate and the reserve ratio in guiding market rates in the post-deregulation era. My results suggest that the PBC adopts a publicly announced short-term interest-rate operating target regime, similar to the Fed’s federal funds rate target.
    Keywords: announcement effect, event study, monetary policy, monetary transmission, China
    JEL: E52 E58
    Date: 2018–04
  14. By: Raquel Ramos (CEPN - Centre d'Economie de l'Université Paris Nord - UP13 - Université Paris 13 - USPC - Université Sorbonne Paris Cité - CNRS - Centre National de la Recherche Scientifique)
    Abstract: The currencies of a few emerging market economies (EME) have being following a specific dynamic since the early 2000s: they are strongly connected to financial markets internationally , appreciating in moments of tranquility and presenting sharp depreciations in peaks of uncertainty. What is the mechanism behind this specific dynamic that contradicts mainstream exchange-rate theories? To answer this question, this article applies the Minskyan framework to the context of money managers and their portfolio allocation decisions. The approach allows the analysis of these currencies through money managers' decisions, putting forward that these might float according to their balance-sheet constraints-reasons not related to the currencies themselves, but to money managers' assets, liabilities, and currency mismatch. The result is a dynamic characterized by deviation-amplifying system, the opposite of the equilibrium-seeking mechanism needed for clearing markets, and high frequency of depreciations associated to the global extent of these institutions' balance-sheet.
    Keywords: Exchange rates,emerging market economies,Minsky
    Date: 2017–10–19
  15. By: Alexey Vasilenko (Bank of Russia, Russian Federation;National Research University Higher School of Economics, Laboratory for Macroeconomic Analysis; University of Toronto, Joseph L Rotman School of Management.)
    Abstract: This paper studies whether and how the central bank should prick asset price bubbles, if the effect of interest rate policy on bubbles can significantly vary across periods. For this purpose, I first construct a financial accelerator model with an agent-based financial market that can endogenously generate bubbles and account for their impact on the real sector of the economy. Then, I calculate the effect of different nonlinear interest rate rules for pricking asset price bubbles on social welfare and financial stability. The results demonstrate that pricking asset price bubbles can enhance social welfare and reduce the volatility of output and inflation, especially if asset price bubbles are caused by credit expansion. Pricking bubbles is also desirable when the central bank can additionally implement an effective communication policy to prick bubbles, for example, effective verbal interventions aimed at the expectations of agents in the financial market.
    Keywords: monetary policy, asset price bubble, New Keynesian macroeconomics, agent-based financial market.
    JEL: E44 E52 E58 G01 G02
    Date: 2018–06
  16. By: Dong, Feng (Antai College of Economics and Management, Shanghai Jiao Tong University); Wen, Yi (Federal Reserve Bank of St. Louis)
    Abstract: We develop a N-sector business cycle network model a la Long and Plosser (1983), featuring heterogenous money demand a la Bewley (1980) and Lucas (1980). Despite incomplete markets and a well-defined distribution of real money balances across heterogeneous households, the enriched N-sector network model remains analytically tractable with closed-form solutions up to the aggregate level. Relying on the tractability, we establish several important results: (i) The economy's input-output network linkages become endogenously time-varying over the business cycle—thanks to the influence of the endogenous distribution of money demand on cross-sector allocations of commodities. (ii) Despite flexible prices, money is neither neutral nor superneutral and transitory monetary injections can generate highly persistent effects on sectoral output, thanks to the time-varying distribution of money demand and its effect on input-output coefficients. (iii) Although money injection is distributed equally across households by design, the real effects are asymmetric across production sectors, e.g., the impact of money is strongest on downstream sectors that purchase intermediate goods from the rest of the economy, but weakest on upstream sectors that supply intermediate goods to the other sectors, in sharp contrast to the case of sectoral technology shocks and government spending shocks. Our model also shows that movements in the distribution of money demand could be an important source of the measured labor wedge documented by the business cycle accounting literature.
    Keywords: Production Networks; Distributional Effect of Monetary Policy; Heterogeneous Money Demand; Incomplete Markets; Time-Varying Velocity of Money; Time-Varying Labor Wedge
    JEL: E12 E13 E23 E31 E32 E41 E43 E51
    Date: 2018–04–01
  17. By: Hashmat Khan (Department of Economics, Carleton University); Louis Phaneuf (Université du Québec à Montréal); Jean Gardy Victor (Inter-American Development Bank)
    Abstract: Low inflation is not perceived as a potential threat to determinacy and macroeconomic stability. Should the Fed return to a rules-based monetary policy, the prospect of indeterminacy would be particularly acute if the Fed adopted a mixed policy rule with the nominal interest rate responding to the output gap and output growth. This is true for a rate of inflation as low as that observed on average since the early 1990s. This finding contrasts sharply with the existing literature where the threat of indeterminacy was high before 1983 and almost nonexistent afterwards. Key to our result is a strong interaction between low trend inflation, sticky wages and technological trend growth. Accounting for a cost channel of monetary policy and a roundabout production process increases the threat of indeterminacy under low inflation. When removing the output gap or output growth from the mixed rule, we find that a rule responding to output growth sharply widens the scope for stability. By stark contrast, the results obtained under a rule reacting to the output gap only essentially mimic those with the mixed rule.
    Keywords: Low trend inflation; Taylor rule; Output gap; Output growth; Indeterminacy; Sticky wages; Trend growth; Working capital; Roundabout production.
    JEL: E31 E32 E37
  18. By: Ampudia, Miguel; Georgarakos, Dimitris; Slacalek, Jiri; Tristiani, Oreste; Vermeulen, Philip; Violante, Giovanni L.
    Abstract: This paper considers how monetary policy produces heterogeneous effects on euro area households, depending on the composition of their income and on the components of their wealth. We first review the existing evidence on how monetary policy affects income and wealth inequality. We then illustrate quantitatively how various channels of transmission — net interest rate exposure, inter-temporal substitution and indirect income channels— affect individual euro area households. We find that the indirect income channel has an overwhelming importance, especially for households holding few or no liquid assets. The indirect income channel is therefore also a substantial driver of changes in consumption at the aggregate level. JEL Classification: D14, D31, E21, E52, E58
    Keywords: household heterogeneity, inequality, monetary policy, quantitative easing
    Date: 2018–07
  19. By: Sandström, Maria (Financial Stability Department, Central Bank of Sweden)
    Abstract: This paper combines identication of monetary policy shocks from high-frequency financial market data with local projections IV to study the effects of monetary policy on household borrowing using Swedish data. The results are uncertain but indicate that the stock of household loans is 1.6 percent lower two years after a 1 percentage point shock to the repo rate. This is a relatively modest effect considering that the stock of household loans on average grew by 7.8 percent per year over this period.
    Keywords: Monetary policy; Household credit; High-frequency identification; External instrument; Local projections
    JEL: C26 E51 E52 G14
    Date: 2018–02–01
  20. By: Giovanni Caggiano; Efrem Castelnuovo; Gabriela Nodari
    Abstract: We employ real-time data available to the US monetary policy makers to estimate a Taylor rule augmented with a measure of financial uncertainty over the period 1969-2008. We find evidence in favor of a systematic response to financial uncertainty over and above that to expected inflation, output gap, and output growth. However, this evidence regards the Greenspan-Bernanke period only. Focusing on this period, the “risk-management” approach is found to be responsible for monetary policy easings for up to 75 basis points of the federal funds rate.
    Keywords: Risk management-driven policy rate gap, uncertainty, monetary policy, Taylor rules, real-time data.
    JEL: C2 E4 E5
    Date: 2018–07
  21. By: Jamel Saadaoui (CEPN - Centre d'Economie de l'Université Paris Nord - UP13 - Université Paris 13 - USPC - Université Sorbonne Paris Cité - CNRS - Centre National de la Recherche Scientifique, BETA - Bureau d'Économie Théorique et Appliquée - INRA - Institut National de la Recherche Agronomique - UNISTRA - Université de Strasbourg - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique)
    Abstract: From the onset of the euro crisis to the Brexit vote, we have witnessed impressive reductions of current account imbalances in peripheral countries of the euro area. These reductions can be the result of either a compression of internal demand or an improvement in external competitiveness. In this paper, we compute exchange rate misalignments within the euro area to assess whether peripheral countries have managed to improve their external competitiveness. After controlling for the reduction of business cycle synchronization within the EMU, we find that peripheral countries have managed to reduce their exchange rate misalignments thanks to internal devaluations. To some extent, these favourable evolutions reflect improvements in external competitiveness. Nevertheless, these gains could only be temporary if peripheral countries do not improve their non-price competitiveness, their trade structures and their international specializations in the long run.
    Keywords: Internal Devaluation,Equilibrium Exchange Rate,External Competitiveness
    Date: 2017–11–11
  22. By: Klaus Adam (University of Mannheim & CEPR (E-mail:; Henning Weber (Deutsche Bundesbank (E-mail:
    Abstract: Sticky price models featuring heterogeneous firms and systematic firm-level productivity trends deliver radically different predictions for the optimal inflation rate than their popular homogenous- firm counterparts: (1) the optimal steady-state inflation rate generically differs from zero and (2) inflation optimally responds to productivity disturbances. We show this by aggregating a heterogenous- firm model with sticky prices in closed form. Using firm-level data from the U.S. Census Bureau, we estimate the historically optimal inflation path for the U.S. economy. In the year 1977, the optimal inflation rate stood at 1.5%, but subsequently declined to around 1.0% in the year 2015. Inflation rates up to twice these numbers can be rationalized if one considers product demand elasticities more in line with the trade literature or if one considers firms that (partially) index prices to lagged inflation rates.
    Keywords: optimal inflation rate, sticky prices, firm heterogeneity
    JEL: E52 E31 E32
    Date: 2018–07
  23. By: Michael Woodford
    Abstract: It is common to analyze the effects of alternative monetary policy commitments under the assumption of fully model-consistent expectations. This implicitly assumes unrealistic cognitive abilities on the part of economic decision makers. The relevant question, however, is not whether the assumption can be literally correct, but how much it would matter to model decision making in a more realistic way. A model is proposed, based on the architecture of artificial intelligence programs for problems such as chess or go, in which decision makers look ahead only a finite distance into the future, and use a value function learned from experience to evaluate situations that may be reached after a finite sequence of actions by themselves and others. Conditions are discussed under which the predictions of a model with finite-horizon forward planning are similar to those of a rational expectations equilibrium, and under which they are instead quite different. The model is used to re-examine the consequences that should be expected from a central-bank commitment to maintain a fixed nominal interest rate for a substantial period of time. Neo-Fisherian predictions are shown to depend on using rational expectations equilibrium analysis under circumstances in which it should be expected to be unreliable.
    Keywords: forward guidance, neo-Fisherianism, Fisher equation, bounded rationality
    JEL: E52
    Date: 2018
  24. By: Jean-Bernard Chatelain (PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Kirsten Ralf (Ecole Supérieure du Commerce Extérieur - ESCE - International business school)
    Abstract: Using US data, we estimate optimal policy with a probability below one that the Fed reneges on its commitment ("limited credibility") versus discretionary policy where the Fed reneges on its commitment at all periods with a probability equal to one ("zero credibility"). The transmission mechanism is the new-Keynesian Phillips curve with auto-correlated cost-push shock. It includes the labor cost channel or the working capital channel. Discretion with zero credibility of the Fed is rejected. The working capital channel fits the data before Volcker's mandate. The labor cost channel fits the data since Volcker's mandate.
    Keywords: Ramsey optimal policy,zero-credibility policy,Identification,Central bank preferences,New-Keynesian Phillips curve,Working capital channel
    Date: 2017–12
  25. By: Corbo, Vesna (Monetary Policy Department, Central Bank of Sweden); Di Casola, Paola (Monetary Policy Department, Central Bank of Sweden)
    Abstract: The pass-through from exchange rate changes to inflation differs depending on the underlying shock. This paper quantifies the conditional exchange rate pass-through (CERPT) to prices, i.e. the change in prices relative to that in the exchange rate following a certain exogenous shock, with a structural econometric approach using data for Sweden, a small economy that is very open to trade. We find that the pass-through to consumer prices following an exogenous exchange rate shock is rather small. Importantly, this shock is not the most important driver of exchange rate uctuations, unlike what standard structural macroeconomic models would indicate. For Sweden, the CERPT is negative not only for domestic but also for global demand shocks. The estimated combination of shocks with positive and negative CERPT implies that the average pass-through to consumer prices is roughly zero.
    Keywords: Exchange rate; pass-through; consumer prices; import prices; monetary policy; SVAR.
    JEL: E31 E52 F31 F41
    Date: 2018–03–01
  26. By: Rehme, Günther
    Abstract: Silvio Gesell hypothesized that money depreciation is economically and socially beneficial, ideas that have often been contended. Here I analyze that in a Sidrauski model in which households additionally have a "love of wealth"-motive. It is shown Gesell's claims may be valid in a demand-determined, short-run equilibrium and why money depreciation overcomes the zero lower bound on nominal interest rates. However, for a typical long-run equilibrium introducing money depreciation in isolation may be bad. But money depreciation, when coupled with expansionary monetary policy, is a necessary condition for a positive Mundell-Tobin effect on long-run real variables and so creates wealth in the model. It is found that this also holds in the transition to the long-run equilibrium. Hence, the spirit of Gesell's hypotheses can be verified for a plausible, long-run environment.
    Keywords: Economic Performance,Depreciating Money,Zero Lower Bound,Demonetization,Love of Wealth
    JEL: E1 E5 O4
    Date: 2018
  27. By: Weshah Razzak
    Abstract: We show that the Purchasing Power Parity (PPP) puzzle, whereby the half-life of the shock to the real exchange rate is long and unjustifiable by monetary and financial shocks, is a result of specification and estimation issues. We provide an alternative specification for PPP and show that the half-life of the shock could be as short as 6.8 months and as long as 2 years, which is considerably shorter than what have been reported in the literature.
    Keywords: PPP, unit root, half-life of shocks
    JEL: C13 C18 F31
    Date: 2018–06–05
  28. By: Richard Clarida
    Abstract: This paper highlights some of the theoretical and practical implications for monetary policy and exchange rates that derive specifically from the presence of a global general equilibrium factor embedded in neutral real policy rates in open economies. Using a standard two country DSGE model, we derive a structural decomposition in which the nominal exchange rate is a function of the expected present value of future neutral real interest rate differentials plus a business cycle factor and a PPP factor. Country specific "r*" shocks in general require optimal monetary policy to pass these through to the policy rate, but such shocks will also have exchange rate implications, with an expected decline in the path of the real neutral policy rate reflected in a depreciation of the nominal exchange rate. We document a novel empirical regularity between the equilibrium error in the VECM representation of the empirical Holston Laubach Williams (2017) four country r* model and the value of the nominal trade weighted dollar. In fact, the correlation between the dollar and the 12 quarter lag of the HLW equilibrium error is estimated to be 0.7. Global shocks to r* under optimal policy require no exchange rate adjustment because passing though r* shocks to policy rates 'does all the work' of maintaining global equilibrium. We also study a richer model with international spill overs so that in theory there can be gains to international policy cooperation. In this richer model we obtain a similar decomposition for the nominal exchange rate, but with the added feature that r* in each country is a function global productivity and business cycle factors even if these factors are themselves independent across countries. We argue that in practice, there could well be significant costs to central bank communication and credibility under a regime formal policy cooperation, but that gains to policy coordination could be substantial given that r*'s are unobserved but are correlated across countries.
    Keywords: monetary policy, policy coordination, exchange rates, r*
    JEL: E4 E5 F3 F31
    Date: 2018–07
  29. By: Jean-Pierre Allegret (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis - UCA - Université Côte d'Azur - CNRS - Centre National de la Recherche Scientifique); Audrey Allegret (LEAD - Laboratoire d'Économie Appliquée au Développement - UTLN - Université de Toulon)
    Abstract: In a context of increased foreign exchange reserves holding from emerging and developing countries, this paper investigates the diminishing return of reserves holding assumption over the most severe phase of the global financial crisis (2008Q1-2010Q4). Relying on a Panel Smooth Transition Regression model, we highlight the differential effect of the accumulation of foreign exchange reserves for a set of financial vulnerabilities variables. Specifically, while reserve accumulation is effective above a critical threshold to cope with vulnerabilities related to the financial channel, we show that it becomes less effective beyond a certain threshold for domestic bank vulnerabilities.
    Keywords: Panel Smooth Transition Regression model, reserve accumulation,Financial crisis, Financial vulnerabilities,Reserves accumulation
    Date: 2018
  30. By: Maximilian Podstawski; Thore Schlaak; Malte Rieth
    Abstract: We develop a vector autoregressive framework for combining the information in an external instrument with the information in the second moments of the data to identify latent monetary shocks in the United States. We show that the framework improves the identification of the structural model and allows testing the validity of instruments proposed in the literature. Using a valid instrument, we then document that surprise monetary contractions lead to a medium-sized significant decline in economic activity, that the contractionary effect is also present during the great moderation, and that the role of monetary shocks in driving real and financial fluctuations is small in low and big in high volatility regimes.
    Keywords: Monetary policy, structural vector autoregressions, identification with external instruments, heteroskedasticity, Markov switching
    JEL: E52 C32 E58 E32
    Date: 2018
  31. By: Fiorentini, Gabriele; Galesi, Alessandro; Pérez-Quirós, Gabriel; Sentana, Enrique
    Abstract: We document a rise and fall of the natural interest rate (r*) for several advanced economies, which starts increasing in the 1960's and peaks around the end of the 1980's. We reach this conclusion after showing that the Laubach and Williams (2003) model cannot estimate r* accurately when either the IS curve or the Phillips curve is flat. In those empirically relevant situations, a local level specification for the observed interest rate can precisely estimate r*. An estimated Panel ECM suggests that the temporary demographic effect of the young baby-boomers mostly accounts for the rise and fall.
    Keywords: demographics; Kalman filter; Natural rate of interest; observability
    JEL: C18 C32 E43 E52
    Date: 2018–07
  32. By: Hess Chung; Cynthia L. Doniger; Cristina Fuentes-Albero; Bernd Schlusche; Wei Zheng
    Abstract: In this note, we describe a method for calculating simulation results and demonstrate the benefits of the integrated model by analyzing a policy that entails an endogenous balance sheet response.
    Date: 2018–07–20
  33. By: Ricardo de Menezes Barboza (Banco Nacional de Desenvolvimento Econômico e Social - BNDES)
    Abstract: Sterling balances were a major issue from the point of view of British policy makers. They amounted to £3,555 million in mid-1945 corresponding to almost seven times British pre-war yearly exports. Egyptian sterling balances were importante as Egypt was the second holder of such balances only behind India. Moreover, the Egyptian case has not been adequately dealt in the literature. This is partly explained by the fact that Egypt was excluded from the Sterling Area as a result of the 1947 negotiations with Britain.The strategic interest in the control of the Suez canal did not diminish after the war and provided the main justification to maintain at a very high cost 80,000-100,000 British troops stationed in the Canal Zone. This required not less than £20 million of yearly British military expenditures. Successive complications led the Suez crisis of 1956 and the end of British influence in Egypt and in the Middle East. The paper is divided into four sections. The first section focuses on the war and the initial post war period up to the visit to Cairo of Wilfrid Eady, of the Treasury, and Cameron Cobbold, of the Bank of England, on their return from India in early 1947. The next section is a detailed discussion of the successive negotiations involving Egyptian sterling balances between 1947 and 1959. Section III analyses the main issues involved in the negotiations: sterling and dollar releases, cancellation and inflation in the creditor economy, gold guarantees and the interest rate on balances. The following section is on international comparisons of Egypt with other significant sterling balance holders: Argentina, Brazil, India and Portugal. Egyptian losses with the delay in releases and consequent erosion by inflation, low interest rates and sterling devaluation are assessed. It concludes with an evaluation of the Egytian case in contrast with other sterling balance holders.
    Date: 2017–07

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