nep-mon New Economics Papers
on Monetary Economics
Issue of 2019‒08‒26
twenty-two papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Interest Rate Bands of Inaction and Play-Hysteresis in Domestic Investment - Evidence for the Euro Area By Belke, Ansgar; Frenzel Baudisch, Coletta; Göcke, Matthias
  2. Global Dimensions of U.S. Monetary Policy By Obstfeld, Maurice
  3. The effects of the eurosystem's APP on euro area bank lending: Letting different data speak By Blaes, Barno A.; Kraaz, Björn; Offermanns, Christian J.
  4. Federal Reserve Structure, Economic Ideas, and Monetary and Financial Policy By Michael D. Bordo; Edward S. Prescott
  5. Exchange Rate Pass-Through: A Competitive Search Approach By Beverly Lapham; Ayman Mnasri
  6. Do conventional monetary policy instruments matter in unconventional times? By Buchholz, Manuel; Schmidt, Kirsten; Tonzer, Lena
  7. Optimal Monetary Policy under Bounded Rationality By Jonathan Benchimol; Lahcen Bounader
  8. The dog that didn’t bark: the curious case of Lloyd Mints, Milton Friedman and the emergence of monetarism By Harris Dellas; George Tavlas
  9. Exchange Rate Reconnect By Lilley, Andrew; Maggiori, Matteo; Neiman, Brent; Schreger, Jesse
  10. Dominant-currency pricing and the global output spillovers from US dollar appreciation By Georgiadis, Georgios; Schumann, Ben
  11. Liquidity Ratios as Monetary Policy Tools: Some Historical Lessons for Macroprudential Policy By Eric Monnet; Miklos Vari
  12. How Does Consumption Respond to News about Inflation? Field Evidence from a Randomized Control Trial By Olivier Coibion; Dimitris Georgarakos; Yuriy Gorodnichenko; Maarten van Rooij
  13. Risk-Free Interest Rates By Jules H. van Binsbergen; William F. Diamond; Marco Grotteria
  14. Forward-Looking Policy Rules and Currency Premia By Filippou, Ilias; Taylor, Mark P
  15. The Short Rate Disconnect in a Monetary Economy By Moritz Lenel; Monika Piazzesi; Martin Schneider
  16. Output Hysteresis and Optimal Monetary Policy By Sanjay R. Singh; Vaishali Garga
  17. Covered Interest Parity deviations: Macrofinancial determinants By Cerutti, Eugenio; Obstfeld, Maurice; Zhou, Haonan
  18. Effects of QE on sovereign bond spreads through the safe asset channel By Jan Willem van den End
  19. The Signalling Channel of Negative Interest Rates By de Groot, Oliver; Haas, Alexander
  20. How Can a Central Bank Exit Quantitative Easing Without Rapidly Shrinking its Balance Sheet? By Atsushi Tanaka
  21. China's monetary policy and the loan market : How strong is the credit channel in China? By Breitenlechner, Max; Nuutilainen, Riikka
  22. Central bank independence and inflation preferences: new empirical evidence on the effects on inflation By Louka T. Katseli; Anastasia Theofilakou; Kalliopi-Maria Zekente

  1. By: Belke, Ansgar; Frenzel Baudisch, Coletta; Göcke, Matthias
    Abstract: The interest rate represents an important monetary policy tool to steer investment in order to reach price stability. Therefore, implications of the exact form and magnitude of the interest rate-investment nexus for the European Central Bank's effectiveness in a low interest rate environment gain center stage. We first present a theoretical framework of the hysteretic impact of changes in the interest rate on macroeconomic investment under certainty and under uncertainty to investigate whether uncertainty over future interest rates in the Euro area hampers monetary policy transmission. In this non-linear model, strong reactions in investment activity occur as soon as changes of the interest rate exceed a zone of inaction, that we call 'play' area. Second, we apply an algorithm describing path-dependent play-hysteresis to estimate investment hysteresis using data on domestic investment and interest rates on corporate loans for 5 countries of the Euro area in the period ranging from 2001Q1 to 2018Q1. We find hysteretic effects of interest rate changes on investment in most countries. However, their shape and magnitude differ widely across countries which poses a challenge for a unified monetary policy. By introducing uncertainty into the regressions, the results do not change much which may be due to the interest rate implicitly incorporating uncertainty effects in investment decisions, e.g. by risk premia.
    Keywords: European Central Bank,interest rate,investment,monetary policy,non-ideal relay,path-dependence,play-hysteresis,uncertainty
    JEL: C32 E44 E49 E52 F21
    Date: 2019
  2. By: Obstfeld, Maurice
    Abstract: This paper is a partial exploration of mechanisms through which global factors influence the tradeoffs that U.S. monetary policy faces. It considers three main channels. The first is the determination of domestic inflation in a context where international prices and global competition play a role, alongside domestic slack and inflation expectations. The second channel is the determination of asset returns (including the natural real safe rate of interest, râ??) and financial conditions, given integration with global financial markets. The third channel, which is particular to the United States, is the potential spillback onto the U.S. economy from the disproportionate impact of U.S. monetary policy on the outside world. In themselves, global factors need not undermine a central bank's ability to control the price level over the long term -- after all, it is the monopoly issuer of the numeraire in which domestic prices are measured. Over shorter horizons, however, global factors do change the tradeoff between price-level control and other goals such as low unemployment and financial stability, thereby affecting the policy cost of attaining a given price path.
    Keywords: current account; financial conditions; monetary policy; natural real interest rate; open-economy Phillips curve; spillbacks
    JEL: E52 E58 F36 F41 G15
    Date: 2019–07
  3. By: Blaes, Barno A.; Kraaz, Björn; Offermanns, Christian J.
    Abstract: We study the implications of the Eurosystem's expanded Asset Purchase Programme (APP) for the bank lending business of euro area banks with euro area non-financial corporations (NFCs) using microeconometric matching techniques. Based on confidential bank-level data on quantitative balance sheet items and interest rates as well as on qualitative survey responses to the Eurosystem's Bank Lending Survey, we identify the exposure of banks to the APP and corresponding effects on loan growth. We find that the APP was effective in stimulating the lending activity with NFCs for a subset of relatively sound banks. At the same time, our results show that there is a non-negligible number of banks with less healthy balance sheets which could not transfer the APP stimulus into more lending. Instead, such banks appear to have used the APP stimulus for consolidating their balance sheets, thereby also reducing their lending business with NFCs. This confirms the importance of accounting for the large degree of heterogeneity in the euro area banking sector in analyses of the effectiveness of monetary policy measures.
    Keywords: lending to non-financial corporations,bank-level data,bank heterogeneity,unconventional monetary policy,treatment effects,regression-adjusted matching
    JEL: E52 G21 C21
    Date: 2019
  4. By: Michael D. Bordo; Edward S. Prescott
    Abstract: The decentralized structure of the Federal Reserve System is evaluated as a mechanism for generating and processing new ideas on monetary and financial policy. The role of the Reserve Banks starting in the 1960s is emphasized. The introduction of monetarism in the 1960s, rational expectations in the 1970s, credibility in the 1980s, transparency, and other monetary policy ideas by Reserve Banks into the Federal Reserve System is documented. Contributions by Reserve Banks to policy on bank structure, bank regulation, and lender of last resort are also discussed. We argue that the Reserve Banks were willing to support and develop new ideas due to internal reforms to the FOMC that Chairman William McChesney Martin implemented in the 1950s. Furthermore, the Reserve Banks were able to succeed at this because of their private-public governance structure, a structure set up in 1913 for a highly decentralized Federal Reserve System, but which survived the centralization of the System in the Banking Act of 1935. We argue that this role of the Reserve Banks is an important benefit of the Federal Reserve’s decentralized structure by allowing for more competition in ideas and reducing groupthink.
    JEL: B0 E58 G28 H1
    Date: 2019–07
  5. By: Beverly Lapham; Ayman Mnasri (Qatar University)
    Abstract: We develop an open economy monetary model with heterogeneous households which is characterized by incomplete pass-through of exchange rate movements to import prices. Partial pass-through arises in our environment due to the presence of competitive search in international goods' markets. Under competitive search, agents choose a sub-market in which to exchange goods, where different sub-markets are characterized by different price and trading probability combinations. Preference and policy shocks which induce exchange rate movements cause households to choose a different sub-market for their purchases of traded goods--an extensive margin response. These responses mitigate the direct effect of nominal exchange rate changes on equilibrium traded goods' prices, thereby generating incomplete exchange rate pass-through to goods' prices. In the calibrated model, exchange rate pass-through due to foreign shocks ranges between 19% and 62%, which is in the range of import price pass-through estimates for developed economies. Due to risk aversion by households, the magnitude of pass-through depends on the size and direction of the initial shock, making the model consistent with the observed phenomenon of asymmetric pass-through. Importantly, by incorporating household heterogeneity, we are able to examine the role of precautionary savings in affecting pass-through, characterize how pass-through varies across different types of households, and examine the distributional effects of exchange rate movements.
    Keywords: Exchange Rate Pass-Through, Competitive Search, Monetary Policy
    JEL: F31 O24 E58
    Date: 2019–06
  6. By: Buchholz, Manuel; Schmidt, Kirsten; Tonzer, Lena
    Abstract: This paper investigates how declines in the deposit facility rate set by the ECB affect euro area banks' incentives to hold reserves at the central bank. We find that, in the face of lower deposit rates, banks with a more interest-sensitive business model are more likely to reduce reserve holdings and allocate freed-up liquidity to loans. The result is driven by wellcapitalized banks in the non-GIIPS countries of the euro area. This reveals that conventional monetary policy instruments have limited effects in restoring monetary policy transmission during times of crisis.
    Keywords: bank portfolio,central bank reserves,monetary policy
    JEL: E52 G11 G21
    Date: 2019
  7. By: Jonathan Benchimol (Bank of Israel); Lahcen Bounader (International Monetary Fund, Washington, D.C., United States)
    Abstract: A​bstract We build a behavioral New Keynesian model that emphasizes different forms of myopia for households and firms. By examining the optimal monetary policy within this model, we find four main results. First, in a framework where myopia distorts agents' inflation expectations, the optimal monetary policy entails implementing inflation targeting. Second, price level targeting emerges as the optimal policy under output gap, revenue, or interest rate myopia. Given that bygones are not bygones under price level targeting, rational inflation expectations are a minimal condition for optimality in a behavioral world. Third, we show that there are no feasible instrument rules for implementing the optimal monetary policy, casting doubt on the ability of simple Taylor rules to assist in the setting of monetary policy. Fourth, bounded rationality may be associated with welfare gains.
    Date: 2019–07
  8. By: Harris Dellas (University of Bern); George Tavlas (Bank of Greece)
    Abstract: Lloyd Mints has long been considered a peripheral figure in the development of monetary economics at the University of Chicago. We provide evidence showing that the standard assessment of Mints’s standing in Chicago monetary economics -- and in American monetary economics more broadly -- is mistaken. In light of the originality and the breadth of his monetary contributions, and given the degree to which those contributions shaped part of Milton Friedman’s monetary framework and were pushed forward by Friedman, we argue that, far from being a peripheral figure in the development of Chicago monetary economics, Mints played a catalytic role.
    Keywords: Lloyd Mints; Milton Friedman; monetarism; Chicago monetary tradition
    JEL: B22 E52
    Date: 2019–07
  9. By: Lilley, Andrew; Maggiori, Matteo; Neiman, Brent; Schreger, Jesse
    Abstract: The failure to find fundamentals that co-move with exchange rates or forecasting models with even mild predictive power â?? facts broadly referred to as "exchange rate disconnect" â?? stands among the most disappointing, but robust, facts in all of international macroeconomics. In this paper, we demonstrate that U.S. purchases of foreign bonds, which did not co-move with exchange rates prior to 2007, have provided significant in-sample, and even some out-of-sample, explanatory power for currencies since then. We show that several proxies for global risk factors also start to co-move strongly with the dollar and with U.S. purchases of foreign bonds around 2007, suggesting that risk plays a key role in this finding. We use security-level data on U.S. portfolios to demonstrate that the reconnect of U.S. foreign bond purchases to exchange rates is largely driven by investment in dollar-denominated assets rather than by foreign currency exposure alone. Our results support the narrative emerging from an active recent literature that the US dollar's role as an international and safe-haven currency has surged since the global financial crisis.
    Date: 2019–07
  10. By: Georgiadis, Georgios; Schumann, Ben
    Abstract: Different export-pricing currency paradigms have different implications for a host of issues that are critical for policymakers such as business cycle co-movement, optimal monetary policy, optimum currency areas and international monetary policy co-ordination. Unfortunately, the literature has not reached a consensus on which pricing paradigm best describes the data. Against this background, we test for the empirical relevance of dominant-currency pricing (DCP). Specifically, we first set up a structural three-country New Keynesian dynamic stochastic general equilibrium model which nests DCP, producer-currency pricing (PCP) and local-currency pricing (LCP). In the model, under DCP the output spillovers from shocks that appreciate the US dollar multilaterally decline with an economy’s export-import US dollar pricing share differential, i.e. the difference between the share of an economy’s exports and imports that are priced in the dominant currency. Underlying this prediction is a change in an economy’s net exports in response to multilateral changes in the US dollar exchange rate that arises because of differences in the extent to which exports and imports are priced in the dominant currency. We then confront this prediction of DCP with the data in a sample of up to 46 advanced and emerging market economies for the time period from 1995 to 2018. Specifically, controlling for other cross-border transmission channels, we document that consistent with the prediction from DCP the output spillovers from US dollar appreciation correlate negatively with recipient economies’ export-import US dollar invoicing share differentials. We document that these findings are robust to considering US demand, US monetary policy and exogenous exchange rate shocks as a trigger of US dollar appreciation, as well as to accounting for the role of commodity trade in US dollar invoicing. JEL Classification: F42, E52, C50
    Keywords: dominant-currency pricing, spillovers, US shocks
    Date: 2019–08
  11. By: Eric Monnet; Miklos Vari
    Abstract: This paper explores what history can tell us about the interactions between macroprudential and monetary policy. Based on numerous historical documents, we show that liquidity ratios similar to the Liquidity Coverage Ratio (LCR) were commonly used as monetary policy tools by central banks between the 1930s and 1980s. We build a model that rationalizes the mechanisms described by contemporary central bankers, in which an increase in the liquidity ratio has contractionary effects, because it reduces the quantity of assets banks can pledge as collateral. This effect, akin to quantity rationing, is more pronounced when excess reserves are scarce.
    Date: 2019–08–16
  12. By: Olivier Coibion; Dimitris Georgarakos; Yuriy Gorodnichenko; Maarten van Rooij
    Abstract: We implement a survey of Dutch households in which random subsets of respondents receive information about inflation. The resulting exogenously generated variation in inflation expectations is used to assess how expectations affect subsequent monthly consumption decisions relative to those in a control group. The causal effects of elevated inflation expectations on non-durable spending are imprecisely estimated but there is a sharp negative effect on durable spending. We provide evidence that this is likely driven by the fact that Dutch households seem to become more pessimistic about their real income as well as aggregate spending when they increase their inflation expectations. There is little evidence to support the idea that the degree to which respondents change their beliefs or their spending in response to information treatments depends on their level of cognitive or financial constraints.
    JEL: C83 D84 E31
    Date: 2019–07
  13. By: Jules H. van Binsbergen; William F. Diamond; Marco Grotteria
    Abstract: We estimate risk-free interest rates unaffected by convenience yields on safe assets. We infer them from risky asset prices without relying on any specific model of risk. We obtain a term structure of convenience yields with maturities up to 2.5 years at a minutely frequency. The convenience yield on treasuries equals about 40 basis points, is larger below 3 months maturity, and quadruples during the financial crisis. In high-frequency event studies, conventional and unconventional monetary stimulus reduce convenience yields, particularly during the crisis. We further study convenience-yield-free CIP deviations, and we show significant bond return predictability related to convenience yields.
    JEL: E41 E43 E44 E52 E58 G12 G15
    Date: 2019–08
  14. By: Filippou, Ilias; Taylor, Mark P
    Abstract: We evaluate the cross-sectional predictive ability of a forward-looking monetary policy reaction function, or Taylor rule, in both statistical and economic terms. We find that investors require a premium for holding currency portfolios with high implied interest rates while currency portfolios with low implied rates offer negative currency excess returns. Our forward-looking Taylor rule signals are orthogonal to current nominal interest rates and disconnected from carry trade portfolios and other currency investment strategies. The profitability of the Taylor rule portfolio spread is mainly driven by inflation forecasts rather than the output gap and is robust to data snooping and a wide range of robustness checks.
    Keywords: currency risk premium; data snooping bias; foreign exchange; Taylor rules
    JEL: F31 G11 G15
    Date: 2019–07
  15. By: Moritz Lenel; Monika Piazzesi; Martin Schneider
    Abstract: In modern monetary economies, most payments are made with inside money provided by payment intermediaries. This paper studies interest rate dynamics when payment intermediaries value short bonds as collateral to back inside money. We estimate intermediary Euler equations that relate the short safe rate to other interest rates as well as intermediary leverage and portfolio risk. Towards the end of economic booms, the short rate set by the central bank disconnects from other interest rates: as collateral becomes scarce and spreads widen, payment intermediaries reduce leverage, and increase portfolio risk. We document stable business cycle relationships between spreads, leverage, and the safe portfolio share of payment intermediaries that are consistent with the model. Structural changes, especially in regulation, induce low frequency shifts, such as after the financial crisis.
    JEL: E0 E3 E4 E5 G0 G1 G11 G12 G2 G21 G23
    Date: 2019–07
  16. By: Sanjay R. Singh; Vaishali Garga (Department of Economics, University of California Davis)
    Abstract: We analyze the implications for monetary policy when deficient aggregate demand can cause a permanent loss in potential output, a phenomenon termed as output hysteresis. In the model, incomplete stabilization of a temporary shortfall in demand reduces the return to innovation, thus reducing TFP growth and generating a permanent loss in output. Using a purely quadratic approximation to welfare under endogenous growth, we derive normative implications for monetary policy. Away from the zero lower bound (ZLB), optimal commitment policy sets interest rates to eliminate output hysteresis. A strict inflation targeting rule implements the optimal policy. However, when the nominal interest rate is constrained at the ZLB, strict inflation targeting is sub-optimal and admits output hysteresis. A new policy rule that targets output hysteresis returns the output to the pre-shock trend and approximates the welfare gains under optimal com- mitment policy. A central bank unable to commit to future policy actions suffers from hysteresis bias: it does not offset past losses in potential output.
    Keywords: zero lower bound, optimal monetary policy, endogenous potential output, hysteresis bias
    JEL: E52 E32 O42
    Date: 2019–08–18
  17. By: Cerutti, Eugenio; Obstfeld, Maurice; Zhou, Haonan
    Abstract: For several decades until the Global Financial Crisis (GFC), Covered Interest Parity (CIP) appeared to hold quite closely-even as a broad macroeconomic relationship applying to daily or weekly data. Not only have CIP deviations significantly increased since the GFC, but potential macrofinancial drivers of the variation in CIP deviations have also become significant. The variation in CIP deviations seems to be associated with multiple factors, not only regulatory changes. Most of these do not display a uniform importance across currency pairs and time, and some are associated with possibly temporary drivers (such as asynchronous monetary policy cycles).
    Keywords: Covered Interest Parity; forward FX market; Interest Rate Differentials
    JEL: F31 G15
    Date: 2019–07
  18. By: Jan Willem van den End
    Abstract: We show that through the safe asset channel the excess liquidity created by QE can lead to higher sovereign bond spreads in the euro area. This unintended effect is most likely in stressed markets when excess liquidity spurs demand for tradeable safe assets, pushing down the interest rate of these assets, which widens risk spreads. Outcomes of a panel regression model estimated for individual euro area countries confirm that the excess liquidity created by QE had an upward effect on sovereign bond spreads. It indicates that the safe asset channel dominates the usual portfolio rebalancing channel. For monetary policy the results imply that QE is not an appropriate instrument to address country specific shocks.
    Keywords: interest rates, central banks and their policies, monetary policy
    JEL: E43 E58 E52
    Date: 2019–08
  19. By: de Groot, Oliver; Haas, Alexander
    Abstract: Negative interest rates are a new (and controversial) monetary policy tool. This paper studies a novel signalling channel and asks whether negative rates can be 1) an effective and 2) an optimal policy tool. 1) We build a financial-friction new-Keynesian model in which monetary policy can set a negative reserve rate, but deposit rates are constrained by zero. All else equal, a negative rate contracts bank net worth and increases credit spreads (the costly "interest margin" channel). However, it also signals lower future deposit rates, even with current deposit rates constrained, boosting aggregate demand and net worth. Quantitatively, we find the signalling channel dominates, but the effectiveness of negative rates depends crucially on three factors: i) degree of policy inertia, ii) level of reserves, iii) zero lower bound duration. 2) In a simplified model we prove two necessary conditions for the optimality of negative rates: i) time-consistent policy setting, ii) preference for policy smoothing.
    Keywords: Monetary policy, Taylor rule, Forward guidance, Liquidity trap
    JEL: E5 E6
    Date: 2019–08–01
  20. By: Atsushi Tanaka (School of Economics, Kwansei Gakuin University)
    Abstract: This study constructs a simple dynamic optimization model of a central bank and examines its optimal behavior after exiting quantitative easing using interest-bearing liabilities instead of selling assets and rapidly shrinking its balance sheet. With high interest payments on liabilities, the bank may be forced to expand the monetary base to maintain its solvency, which leads to higher inflation. The model shows when the bank faces such a situation and derives the optimal paths of the monetary base supply and liabilities to deal with this. The study applies the model to the Bank of Japan and examines how the bank can exit quantitative easing.
    Keywords: central bank, monetary base, inflation, quantitative easing, exit strategy, solvency.
    JEL: E52 E58
    Date: 2019–08
  21. By: Breitenlechner, Max; Nuutilainen, Riikka
    Abstract: We study the credit channel of Chinese monetary policy in a structural vector autoregressive framework. Using combinations of zero and sign restrictions, we identify monetary policy shocks linked to supply and demand responses in the loan market. Our results show that policy shocks coinciding with loan supply effects account for roughly 10 percent of output dynamics after two years, while loan demand effects represent up to 7 percent of output dynamics depending on the policy measure. The credit channel thus constitutes an important and economically relevant transmission channel for monetary policy in China. Monetary policy in China also accounts for a relatively high share of business cycle dynamics.
    JEL: C32 E44 E52
    Date: 2019–08–09
  22. By: Louka T. Katseli (University of Athens); Anastasia Theofilakou (Bank of Greece and University of Athens); Kalliopi-Maria Zekente (Alpha Bank and University of Athens)
    Abstract: On theoretical grounds, a clear distinction exists between central bank independence and inflation aversion. In the conduct of monetary policy, both contribute to lower inflation. In this paper, we empirically re-examine the nexus between central bank independence and inflation for a large sample of advanced and developing countries over the period 1992-2014 by explicitly accounting for the effect of central bank inflation preferences on inflation developments. Our evidence suggests that both features matter for mitigating inflationary pressures, in line with the relevant theoretical studies. Central bank independence alone seems not to be a sufficient condition to curtail inflation; the expected inverse relationship between central bank independence and inflation appears to hold when we account for the (inflation) conservatism of the central bank. At the same time, higher central bank conservatism seems to result in lower inflationary pressures in the economy. Our results do not support the hypothesis of an interaction (either as substitutes of complements) between the degree of independence and conservatism of the central bank.
    Keywords: Central bank independence; inflation conservatism;System GMM
    JEL: E52 E58
    Date: 2019–07

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