nep-mon New Economics Papers
on Monetary Economics
Issue of 2020‒05‒18
thirty-two papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Does Quantitative Easing Affect People’s Personal Financial Situation and Economic Inequality? The View of the German Population By Bernd Hayo
  2. Is Central Bank Currency Fundamental to the Monetary System? By Hanna Armelius; Carl Andreas Claussen; Scott Hendry
  3. Monetary Policy, Self-Fulfilling Expectations and the U.S. Business Cycle By Giovanni Nicolo
  4. Dynamic Effects of Monetary Policy Shocks on Macroeconomic Volatility in the United Kingdom By Afees A. Salisu; Rangan Gupta
  5. The Phillips Curve at the ECB By Eser, Fabian; Karadi, Peter; Lane, Philip R.; Moretti, Laura; Osbat, Chiara
  6. On the Response of Inflation and Monetary Policy to an Immigration Shock By Benjamín García; Juan Guerra-Salas
  7. Effects of credit restrictions in the Netherlands and lessons for macroprudential policy By Gabriele Galati; Jan Kakes; Richhild Moessner
  8. Heterogeneity in corporate debt structures and the transmission of monetary policy By Holm-Hadulla, Fédéric; Thürwächter, Claire
  9. Words and deeds in managing expectations: empirical evidence on an inflation targeting economy By Paweł Baranowski; Wirginia Doryń; Tomasz Łyziak; Ewa Stanisławska
  10. Drivers of Bank Default Risk: Bank Business Models, the Sovereign and Monetary Policy By Nicolas Soenen; Rudi Vander Vennet
  11. Sterilized FX interventions may not be so sterilized By Shalva Mkhatrishvili; Giorgi Tsutskiridze; Lasha Arevadze
  12. On the instability of banking and other financial intermediation By Chao Gu; Cyril Monnet; Ed Nosal; Randall Wright
  13. The Real Effects of Monetary Shocks: Evidence from Micro Pricing Moments By Gee Hee Hong; Matthew Klepacz; Ernesto Pasten; Raphael Schoenle
  14. An Analysis of the 2008 Subprime Mortgage Crisis: Causes, Effects and Policy Response By Naape, Baneng
  15. Hopf Bifurcation from new-Keynesian Taylor rule to Ramsey Optimal Policy By Jean-Bernard Chatelain; Kirsten Ralf
  16. Sources of Macroeconomic Fluctuations in a Franc Zone Country: A Bayesian estimation By NANA DAVIES, Charles
  17. What Keeps Stablecoins Stable? By Richard K. Lyons; Ganesh Viswanath-Natraj
  18. Identifying the Phillips Curve in Georgia By Lasha Arevadze; Tamta Sopromadze; Giorgi Tsutskiridze; Shalva Mkhatrishvili
  19. The Taylor Curve: International Evidence By Semih Emre Cekin; Rangan Gupta; Eric Olson
  20. Distributional consequences of conventional and unconventional monetary policy By Marcin Bielecki; Michał Brzoza-Brzezina; Marcin Kolasa
  21. Does Low Inflation Pose a Risk to Economic Growth and Central Banks Reputation? By Marek Dabrowski
  22. Quantitative easing and the price-liquidity trade-off By Ferdinandusse, Marien; Freier, Maximilian; Ristiniemi, Annukka
  23. The Global Transmission of U.S. Monetary Policy By Degasperi,Riccardo; Hong, Seokki Simon; Ricco, Giovanni
  24. Forecasting exchange rates of major currencies with long maturity forward rates By Darvas, Zsolt; Schepp, Zoltán
  25. Do ECB introductory statements help to predict monetary policy: evidence from tone analysis By Paweł Baranowski; Hamza Bennani; Wirginia Doryń
  26. Exchange Rate Risk, Distribution Asymmetry and Deviations from Purchasing Power Parity By Arghyrou, Michael G; Lu, Wenna; Pourpourides, Panayiotis M.
  27. Monetary policy implications of the COVID-19 outbreak, the social pandemic By Roedl, Marianne; Dupont, Genevieve
  28. International and domestic interactions of macroprudential and monetary policies: the case of Chile By Tomás Gómez; Alejandro Jara; David Moreno
  29. The (de)Stabilizing Role of Fiscal and Monetary Policy By Francesco MAGRIS; Daria ONORI
  30. The Inflation Target and the Equilibrium Real Rate By Christopher D. Cotton
  31. Exchange rate regimes and inflation in Tanzania By Longinus Rutasitara
  32. Time-Varying Impact of Monetary Policy Shocks on U.S. Stock Returns: The Role of Investor Sentiment By Oguzhan Cepni; Rangan Gupta

  1. By: Bernd Hayo (University of Marburg)
    Abstract: Using representative survey data collected in 2018, I study how laypersons in Germany perceive the effects of quantitative easing (QE) on their personal financial situation and on national economic inequality. Almost 40% think that their economic situation is unaffected by QE, whereas 20% and 6% believe that QE has made them worse off or better off, respectively. Regarding economic inequality, about one-third of the population is of the opinion that QE contributes to inequality, only 10% think it does not, and 13% cannot perceive an impact. These groups with the different views are characterised using multivariate ordered logit models. First, respondents who feel that their personal economic situation has deteriorated as a result of QE tend to be savers and those with better objective knowledge about monetary policy affairs, whereas those who feel their situation has improved have more trust in the ECB and support conservative (CDU/CSU) and liberal (FDP) parties. Second, the view that QE increases economic inequality in Germany is favoured by Left Party supporters, East Germans, and those with a relatively high level of monetary policy knowledge, whereas those who have more trust in the ECB have the opposite view. Third, persons with a high level of monetary policy knowledge and formal education are more likely to answer the questions on the effects of QE.
    Keywords: Economic inequality, income distribution, quantitative easing, QE, monetary policy, ECB, population survey, Germany
    JEL: E58 D31 Z1
    Date: 2020
  2. By: Hanna Armelius; Carl Andreas Claussen; Scott Hendry
    Abstract: In this paper, we discuss whether the ability of individuals to convert commercial bank money (i.e., bank deposits) into central bank money is fundamentally important for the monetary system. This is a significant question since the use of cash—the only form of central bank money that the public currently has access to—is declining rapidly in many countries. The question is highly relevant to the discussion around whether central banks need to issue a retail central bank digital currency (CBDC). We conclude that depositors’ need for control could be a reason why cash or a CBDC is essential, even in countries with strong measures safeguarding commercial bank money.
    Keywords: Bank notes; Digital Currencies and Fintech; Financial services; Payment clearing and settlement systems
    JEL: E4 E41 E42 E5
    Date: 2020–05
  3. By: Giovanni Nicolo
    Abstract: I estimate a medium-scale New-Keynesian model and relax the conventional assumption that the central bank adopted an active monetary policy by pursuing inflation and output stability over the entire post-war period. Even after accounting for a rich structure, I find that monetary policy was passive prior to the Volcker disinflation. Sunspot shocks did not represent quantitatively relevant sources of volatility. By contrast, such passive interest rate policy accommodated fundamental productivity and cost shocks that de-anchored inflation expectations, propagated via self-fulfilling inflation expectations and constituted the primary sources of the run-up in inflation from the 1960s through the late 1970s.
    Keywords: Monetary policy; Business cycle; Expectations; Indeterminacy; Bayesian methods
    JEL: C11 C52 C54 E31 E32 E52
    Date: 2020–05–05
  4. By: Afees A. Salisu (Department for Management of Science and Technology Development, Ton Duc Thang University, Ho Chi Minh City, Vietnam; Faculty of Business Administration, Ton Duc Thang University, Ho Chi Minh City, Vietnam); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa)
    Abstract: We use constant and time-varying parameters vector autoregressive models that allow the estimation of the impact of monetary policy shocks on volatility of macroeconomic variables in the United Kingdom. Estimates suggest that an increase in the policy rate by 1% is associated with a rise in unemployment and inflation volatility of about 10% on average, with peaks observed during episodes of local and global crises.
    Keywords: Non-Linear SVAR, Stochastic Volatility, Monetary Policy Shock
    JEL: C32 E30 E40 E52
    Date: 2020–05
  5. By: Eser, Fabian; Karadi, Peter; Lane, Philip R.; Moretti, Laura; Osbat, Chiara
    Abstract: We explain the role of the Phillips Curve in the analysis of the economic outlook and the formulation of monetary policy at the ECB. First, revisiting the structural Phillips Curve, we highlight the challenges in recovering structural parameters from reduced-form estimates and relate the reduced-form Phillips Curve to the (semi-)structural models used at the ECB. Second, we identify the slope of the structural Phillips Curve by exploiting cross-country variation and by using high-frequency monetary policy surprises as instruments. Third, we present reduced-form evidence, focusing on the relation between slack and inflation and the role of inflation expectations. In relation to the recent weakness of inflation, we discuss the role of firm profits in the pass-through from wages to prices and the contribution of external factors. Overall, the available evidence supports the view that the absorption of slack and a firm anchoring of inflation expectations remain central to successful inflation stabilisation. JEL Classification: E31, E52
    Keywords: European Central Bank, inflation, monetary policy, Phillips Curve
    Date: 2020–05
  6. By: Benjamín García; Juan Guerra-Salas
    Abstract: An immigration shock has an ambiguous effect on inflation. On one hand, aggregate consumption increases with a suddenly larger population; this “demand channel” creates inflationary pressures. On the other hand, the labor market becomes more slack as immigrants search for jobs, containing wage growth; this “labor supply channel” creates disinflationary pressures. The response of an inflationtargeting central bank to an immigration shock is, therefore, not obvious. We study these competingchannels in a New Keynesian model of a small open economy with search frictions in the labor market. Our simulations are designed to characterize the possible response of inflation and monetary policy in Chile, a small open emerging country that has experienced a substantial immigration flow in recent years.
    Date: 2020–04
  7. By: Gabriele Galati; Jan Kakes; Richhild Moessner
    Abstract: Credit restrictions were used as a monetary policy instrument in the Netherlands from the 1960s to the early 1990s. We study the effects of credit restrictions being active on the balance sheet structure of banks and other financial institutions. We find that banks mainly responded to credit restrictions by making adjustments to the liability side of their balance sheets, particularly by increasing the proportion of long-term funding. Responses on the asset side were limited, while part of the banking sector even increased lending after the installment of a restriction. These results suggest that banks and financial institutions responded by switching to long-term funding to meet the restriction and shield their lending business. Arguably, the credit restrictions were therefore still effective in reaching their main goal, i.e. containing money growth.
    Keywords: Credit restrictions; Monetary policy; Macroprudential policy
    JEL: E42 E51 E52 E58 G28
    Date: 2020–03
  8. By: Holm-Hadulla, Fédéric; Thürwächter, Claire
    Abstract: We study how differences in the aggregate structure of corporate debt financing affect the transmission of monetary policy. Using high-frequency financial market data to identify monetary policy shocks in a panel of euro area countries, we find that: bond finance dampens the overall response of firm credit to monetary policy shocks in economies with a high initial share of bond- relative to bank-based finance; this effect weakens, and may even reverse, in economies with a low share of bond financing; and the dampening effect of a larger bond financing share also attenuates the ultimate impact of monetary policy on economic activity. These findings point to corporate bond markets acting as a “spare tire” in situations when bank lending contracts. JEL Classification: E44, E52, G21, G23
    Keywords: bank lending, corporate bonds, firm financing structure, high-frequency identification, local projections
    Date: 2020–05
  9. By: Paweł Baranowski (University of Łódź); Wirginia Doryń (University of Łódź); Tomasz Łyziak (Narodowy Bank Polski); Ewa Stanisławska (Narodowy Bank Polski)
    Abstract: The conduct of monetary policy nowadays involves not only interest rate decisions but also central bank communication, aimed at managing the expectations of the private sector. In this paper, we apply epidemiological model to private-sector experts’ forecasts regarding interest rates and inflation in Poland—an economy with over 20 years of inflation targeting history. We show that both of these factors affect interest rates and inflation expectations. Our study contributes to the literature by including a wide set of factors affecting expectations with a special focus on central bank decisions, projections and the tone of official documents. In general, the textual content of monetary policy minutes affects experts’ expectations more at the shortest horizons (nowcasts and one quarter ahead), while GDP and inflation projections released by the central bank play a larger role for slightly longer horizons (two quarters ahead or longer). As far as monetary policy actions are concerned, a positive interest rate surprise produces an upward shift in the whole path of interest rate expectations and leads to a decrease in one-year-ahead inflation expectations.
    Keywords: central bank communication, inflation expectations, interest rate expectations, text mining
    JEL: E52 E58
    Date: 2020
  10. By: Nicolas Soenen; Rudi Vander Vennet (-)
    Abstract: In this paper we empirically analyze the determinants of bank default risk (measured by the banks’ CDS spreads) for European banks during the period 2008-2018. We examine the effect of (1) bank business model characteristics, (2) sovereign default risk and (3) ECB monetary policy. We disentangle the effect of monetary policy in a direct channel and an indirect effect operating through a sovereign risk channel. In terms of business model variables, we find that the capital ratio and the reliance on stable deposits lowers the perceived default risk of banks, while non-performing loans significantly increase the CDS spreads. Hence, the CDS market distinguishes resilient banks from risky banks. In terms of monetary policy, we document that accommodative ECB actions in general lower bank default risk. We also show that the downward effect of monetary policy on bank risk is mainly transmitted through the sovereign risk channel. Our findings confirm the importance of the Basel 3 capital and stable funding rules and they suggest policy implications in terms of bank business model choices as well as approaches to tackle the bank-sovereign loop in Europe.
    Keywords: banks, credit risk, bank business model, monetary policy, sovereign risk
    JEL: G01 G1 G12 G21 E52
    Date: 2020–05
  11. By: Shalva Mkhatrishvili (Macroeconomic Research Division, National Bank of Georgia); Giorgi Tsutskiridze (Macroeconomic Research Division, National Bank of Georgia); Lasha Arevadze (Macroeconomic Research Division, National Bank of Georgia)
    Abstract: It is widely believed that sterilized interventions do not affect domestic currency interest rates. The reason is the word "sterilized". Yet we show in this paper that when collateral base for central bank operations isn't huge, sterilized interventions may still affect interest rates, loan extension and, hence, real economy (beyond the effects of altered exchange rate). The mechanism is simple: when banks make decisions about loan extension and, hence, deposit (money) creation, they take liquidity risk into account. When collateral base for central bank operations isn't big enough, even if collateral constraint isn't currently binding, banks may still fear (massive) withdrawals that, in principle, can get them to the constraint. This fear is reduced when they get permanent liquidity (from the central bank that buys FX) as opposed to getting the same amount of liquidity by borrowing from the central bank (that requires collateral). Reduction in this fear will then result in loan interest rate reduction and/or easier terms for loans. We demonstrate the importance of this mechanism through three different approaches: accounting, theoretical and empirical. The quantitative importance of this channel depends on the amount of unused collateral: the more the collateral the lower the liquidity risk and associated interestrate-effects of FX interventions. In addition, the framework provides other interesting insights about the relationship between liquidity risk and reserve requirements.
    Keywords: Sterilized FX interventions; Interest rates; Collateral constraint; Central bank operations
    JEL: E43 E58 F31
    Date: 2020–04
  12. By: Chao Gu; Cyril Monnet; Ed Nosal; Randall Wright
    Abstract: Are financial intermediaries inherently unstable and, if so, why? To address this, we analyse whether model economies with financial intermediation are particularly prone to multiple, cyclic or stochastic equilibria. Several formalisations are considered: a dynamic version of Diamond-Dybvig banking incorporating reputational considerations; a model with fixed costs and delegated investment as in Diamond; one with bank liabilities serving as payment instruments similar to currency in Lagos-Wright; and one with intermediaries as dealers in decentralised asset markets, similar to Duffie et al. Although the economics and mathematics differ across specifications, in each case financial intermediation engenders instability in a precise sense.
    Keywords: banking, financial intermediation, instability, volatility
    JEL: D02 E02 E44 G21
    Date: 2020–05
  13. By: Gee Hee Hong; Matthew Klepacz; Ernesto Pasten; Raphael Schoenle
    Abstract: Cross-sectional variation in micro data can be used to empirically evaluate sufficient statistics for the response of aggregate variables to policy shocks of interest. We demonstrate an easy-to-use approach through a detailed example. We evaluate the sufficiency of micro pricing moments for the aggregate real effects of monetary policy shocks. Our analysis shows how a widely held notion about the kurtosis of price changes, as sufficient for summarizing the selection effect, turns out not to hold empirically. On theoretical grounds, we show how a small change in assumptions - removing random menu costs - can nonetheless reconcile the predictions of the existing theoretical literature with our empirical regularities.
    Date: 2020–04
  14. By: Naape, Baneng
    Abstract: This essay scrutinized the effects of Quantitative Easing (QE) on selected macroeconomic and financial variables. By means of a desktop approach, we find that QE1 had a strong and beneficial impact on the real economy through credit easing whereas QE2 and QE3 had small positive or neutral effects on banks and life Insurers. Although QE did not close the gap left by the 2008 global financial crisis, it helped reduce the rate at which the crisis was rising and proved to be an effective crisis management tool. QE boosts the economy in the short run but weakens the economy in the long run.
    Keywords: global financial crisis, quantitative easing, central banks, zero lower bound
    JEL: E4 E5 G1
    Date: 2020–05–02
  15. By: Jean-Bernard Chatelain (PSE - Paris School of Economics); Kirsten Ralf (ESCE International Business School, INSEEC U. Research Center)
    Abstract: This paper compares different implementations of monetary policy in a new-Keynesian setting. We can show that a shift from Ramsey optimal policy under short-term commitment (based on a negative feedback mechanism) to a Taylor rule (based on a positive feedback mechanism) corresponds to a Hopf bifurcation with opposite policy advice and a change of the dynamic properties. This bifurcation occurs because of the ad hoc assumption that interest rate is a forward-looking variable when policy targets (inflation and output gap) are forward-looking variables in the new-Keynesian theory.
    Keywords: Bifurcations,Commitment,Taylor Rule,Taylor Principle,New-Keynesian Model,Ramsey Optimal Policy
    Date: 2020–01–17
  16. By: NANA DAVIES, Charles
    Abstract: The Central African Economic and Monetary Community (CEMAC) is a constituent of the Franc Zone (FZ), whose roots may be traced back to 1901 when France created the West African Bank. Since its inception, FZ's monetary authorities' objective and monetary policy instruments have been evolving. Nevertheless, some FZ's features have endured, namely the fixed exchange rate between that monetary union's common currency (CFAF) and France's currency, the free capital mobility between Franc Zone countries (FZC) and France, the ceiling on the monetary budget financing and the obligation of FZC to entrust a share of their foreign exchange reserves to the French Treasury in exchange for the convertibility of CFAF into France's currency. Using Cameroon's data over 1979 and 2014, we estimate a DSGE model of a small open economy model that takes into account some of those features. We find that technology and fiscal shocks drive the bulk of economic fluctuations.
    Keywords: Franc Zone - Cameroon - DSGE model - Metropolis-Hasting
    JEL: C68 E32 F41 F45
    Date: 2018–09–10
  17. By: Richard K. Lyons; Ganesh Viswanath-Natraj
    Abstract: We take this question to be isomorphic to, "What Keeps Fixed Exchange Rates Fixed?" and address it with analysis familiar in exchange-rate economics. Stablecoins solve the volatility problem by pegging to a national currency, typically the US dollar, and are used as vehicles for exchanging national currencies into non-stable cryptocurrencies, with some stablecoins having a ratio of trading volume to outstanding supply exceeding one daily. Using a rich dataset of signed trades and order books on multiple exchanges, we examine how peg-sustaining arbitrage stabilizes the price of the largest stablecoin, Tether. We find that stablecoin issuance, the closest analogue to central-bank intervention, plays only a limited role in stabilization, pointing instead to stabilizing forces on the demand side. Following Tether's introduction to the Ethereum blockchain in 2019, we find increased investor access to arbitrage trades, and a decline in arbitrage spreads from 70 to 30 basis points. We also pin down which fundamentals drive the two-sided distribution of peg-price deviations: Premiums are due to stablecoins' role as a safe haven, exhibiting, for example, premiums greater than 100 basis points during the COVID-19 crisis of March 2020; discounts derive from liquidity effects and collateral concerns.
    JEL: E02 E4 E5 F3 F4 G12 G14 G15 G2 O16 O33
    Date: 2020–05
  18. By: Lasha Arevadze (Macroeconomic Research Division, National Bank of Georgia); Tamta Sopromadze (Macroeconomic Research Division, National Bank of Georgia); Giorgi Tsutskiridze (Macroeconomic Research Division, National Bank of Georgia); Shalva Mkhatrishvili (Macroeconomic Research Division, National Bank of Georgia)
    Abstract: There is an ongoing debate around the flattening of the Phillips Curve throughout the world. One of the most important challenges in looking at the statistical relationship between inflation and cyclical position of the economy is the endogenous nature of monetary policy. If monetary policy is successful in insulating the economy from demand shocks, all we are left with in the data is the effects of supply shocks. This makes the link between inflation and aggregate demand look negative, even if the underlying positively-sloped Phillips Curve relationship is alive and well. That's why it is important to take the endogeneity of monetary policy into account when estimating the Phillips Curve econometrically. In this paper we attempt to do that on the Georgian data using two econometric approaches: GMM and ARDL. Our results indicate that the slope of the Phillips Curve in Georgia is positive but relatively flat (despite the fact that it is still steeper than in the developed world). The resulting high sacrifice ratio makes it all the more important for the National Bank of Georgia to remain vigilant and proactive in anchoring inflation expectations. In addition, we show that half of economic agents' inflation expectations in Georgia are backward-looking (with the other half being forwardlooking). This, despite important improvements during the last decade, implies still significant room for monetary policy to further anchor inflation expectations to its target.
    Keywords: Phillips Curve; Inflation; Monetary policy; GMM; ARDL
    JEL: C13 E3 E52
    Date: 2020–01
  19. By: Semih Emre Cekin (Department of Economics, Turkish-German University, Istanbul, Turkey); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa); Eric Olson (College of Business, University of Tulsa, Tulsa, Oklahoma, United States)
    Abstract: We use the Taylor curve to gauge deviations of monetary policy from an efficiency locus for the United Kingdom (UK) and the four largest economies of the eurozone (Germany, France, Italy, Spain) for the period 2000-2018. For this purpose, we use shadow interest rates, which is a common metric for both conventional and unconventional monetary policies, and the newly proposed Hamilton-filter to measure output gap, which improves upon the drawbacks of the traditionally used Hodrick-Prescott filter. Our findings suggest that deviations in the UK mostly occurred amid the global financial crisis and the post-Brexit period, whereas eurozone members experienced more volatile deviations around 2001, during the global financial crisis and the eurozone sovereign debt crisis.
    Keywords: Taylor curve, Monetary policy, eurozone
    JEL: E31 E58 C32
    Date: 2020–05
  20. By: Marcin Bielecki (Narodowy Bank Polski); Michał Brzoza-Brzezina (Narodowy Bank Polski); Marcin Kolasa (Marcin Kolasa)
    Abstract: This paper uses a life-cycle model with a rich asset structure, and standard nominal and real rigidities, to investigate the distributional consequences of traditional monetary policy and communication about its future course (forward guidance). The model is calibrated to the euro area using both macroeconomic aggregates and microeconomic evidence from the Household Finance and Consumption Survey. We show that the lifecycle profiles of income and asset accumulation decisions are important determinants of redistributive effects of both anticipated and unanticipated monetary shocks. Even though house prices respond strongly to monetary policy easing, hurting young households, their distributional effects are dwarfed by changes in returns on nominal assets and labor market revival that work in the opposite direction. Both anticipated and unanticipated policy easing hence redistribute welfare from older to younger generations. The scale of this redistribution is larger for forward guidance if nominal interest rates are constrained by the effective lower bound.
    Keywords: monetary policy, forward guidance, life-cycle models, redistribution
    JEL: E31 E52 J11
    Date: 2020
  21. By: Marek Dabrowski
    Abstract: Inflation in advanced economies is low by historical standards but there is no threat of deflation. Slower economic growth is caused by supply-side constraints rather than low inflation. Below-the-target inflation does not damage the reputation of central banks. Thus, central banks should not try to bring inflation back to the targeted level of 2%. Rather, they should revise the inflation target downwards and publicly explain the rationale for such a move. Risks to the independence of central banks come from their additional mandates (beyond price stability) and populist politics.
    Keywords: monetary policy, inflation, inflation target, economic growth, central bank independence
    JEL: E31 E51 E52 E58 F62
    Date: 2020
  22. By: Ferdinandusse, Marien; Freier, Maximilian; Ristiniemi, Annukka
    Abstract: We consider the effects of quantitative easing on liquidity and prices of bonds in a search-and matching model. The model explicitly distinguishes between demand and supply effects of central bank asset purchases. Both are shown to lead to a decline in yields, while they have opposite effects on market liquidity. This results in a price-liquidity trade-off. Initially, liquidity improves in reaction to central bank demand. As the central bank buys and holds bonds, supply becomes scarcer and other buyers are crowded out. As a result, liquidity can fall below initial levels. The magnitude of the effects depend on the presence of preferred habitat investors. In markets with a higher share of these investors, bonds are scarcer and central bank asset purchases lower yields more. With a lower share of preferred habitat investors and a relatively illiquid market, central bank demand has a stronger positive effect on liquidity. We are the first to construct an index from bond holding data to measure the prevalence of preferred habitat investors in each euro area country. Subsequently, we calibrate the model to the euro area and show how yields and liquidity are affected by the European Central Banks asset purchase programme. JEL Classification: E52, E58, G12
    Keywords: asset purchases, liquidity, search and matching
    Date: 2020–05
  23. By: Degasperi,Riccardo (University of Warwick); Hong, Seokki Simon (University of Warwick); Ricco, Giovanni (University of Warwick, CEPR, OFCE-SciencesPo and Now-Casting Economics)
    Abstract: This paper studies the transmission of US monetary shocks across the globe by employing a high-frequency identification of policy shocks and large VAR techniques, in conjunction with a large macro-financial dataset of global and national indicators covering both advanced and emerging economies. Our identification controls for the information effects of monetary policy and allows for the separate analysis of tightenings and loosenings of the policy stance. First, we document that US policy shocks have large real and nominal spillover effects that affect both advanced economies and emerging markets. Policy actions cannot fully isolate national economies, even in the case of advanced economies with flexible exchange rates. Second, we investigate the channels of transmission and find that both trade and financial channels are activated and that there is an independent role for oil and commodity prices. Third, we show that effects are asymmetric and larger in the case of contractionary US monetary policy shocks. Finally, we contrast the transmission mechanisms of countries with different exchange rates, exposure to the dollar, and capital control regimes
    Keywords: Monetary policy ; Trilemma ; Exchange Rates ; Foreign Spillovers JEL codes: E5 ; F3 ; F4 ; C3
    Date: 2020
  24. By: Darvas, Zsolt; Schepp, Zoltán
    Abstract: This paper presents unprecedented exchange rate forecasting results based upon a new model which approximates the gap between the fundamental equilibrium exchange rate and the actual exchange rate with the long-maturity forward exchange rate. The theoretical derivation of our forecasting equation is consistent with the monetary model of exchange rates. Our model outperforms the random walk in out-of-sample forecasting of twelve major currency pairs in both short and long horizons forecasts for the 1990-2020 period. The results are robust for all sub-periods with the exception of years around the collapse of Lehman Brothers in September 2008. Our results are robust to alternative model specifications, single equation and panel estimation, recursive and rolling estimation, and alternate data construction methods. The model performs better when the long-maturity forward exchange rate is assumed to be stationary as opposed to assuming non-stationarity. The improvement in forecast accuracy of our model is economically and statistically significant for almost all exchange rate series. The model is simple, linear, easy to replicate, and the data we use are available in real time and not subject to revisions.
    Keywords: exchange rate, error correction, forecasting performance, monetary model, out-of-sample, random walk
    JEL: F31 F37
    Date: 2020–03–30
  25. By: Paweł Baranowski (Institute of Econometrics, University of Lodz); Hamza Bennani (EconomiX-CNRS, Universite Paris Nanterre); Wirginia Doryń (Institute of Economics, University of Lodz)
    Abstract: In this paper, we examine whether a tone shock derived from ECB communication helps to predict ECB monetary policy decisions. For that purpose, we first use a bag-of-words approach and several dictionaries on the ECB’s Introductory Statements to derive a measure of tone. Next, we orthogonalize the tone measure on the latest data available to market participants to compute the tone shock. Finally, we relate the tone shock to future ECB monetary policy decisions. We find that the tone shock is significantly and positively related to future ECB monetary policy decisions, even when controlling for market expectations of economic conditions and monetary policy and the ECB’s Governing Council inter-meeting communication. Further extensions show that the predictive power of the tone shock regarding future monetary policy decisions is robust to (i) the normalization of the tone measure, (ii) alternative market expectations about monetary policy and (iii) the macroeconomic variables used in the Taylortype monetary policy. These findings thus highlight an additional channel by which ECB communication improves monetary policy predictability, and suggest that the ECB may have private information that it communicates through its Introductory Statements.
    Keywords: Central Bank Communication; European Central Bank; Tone; Forecasts; Taylor Rule
    JEL: E43 E52 E58
    Date: 2020
  26. By: Arghyrou, Michael G (Department of Economics, University of Piraeus); Lu, Wenna (Cardiff School of Management, Cardiff Metropolitan University); Pourpourides, Panayiotis M. (Cardiff Business School)
    Abstract: Firstly, we show that domestic prices of net importer countries incorporate a risk premium, driven by higher moments of future nominal exchange rate returns and secondly, using US dollar exchange rates against three currencies of major net exporting countries to the US such as Canada, Japan and the European Union, we find that the skewness of the future nominal exchange rate is the major and statistically robust moment-based factor of the deviations from purchasing power parity (PPP). Our estimates further suggest that only low and moderate exchange rate risks induce risk premia that drive deviations from PPP.
    Keywords: Purchasing Power Parity, risk-aversion, exchange rate, downside risk
    JEL: G15 F31 F41
    Date: 2020–05
  27. By: Roedl, Marianne; Dupont, Genevieve
    Abstract: Whilst the magnitude and consequences of the outbreak can certainly not be compensated – at least for many, or even quantified, it is hoped that greater cooperation between global economies, will be fostered in the ongoing efforts to find a solution to address the outbreak. This paper is aimed at contributing to the literature on a topic on which previous literature, at least prior to December 12 2019, practically and literally, in respect of COVID-19, did not exist. Many major economies and global economies have extended shut downs from excluding essential workers, to 80-90% of its citizens being ordered to stay at home Whilst it is certainly crucial to ensure that the outbreak is contained, it appears that certain economies, given uncertainties associated with the nature, scope of recent developments, are willing to take risks at salvaging their economies. At what stage does a government decide that prevailing restrictive social distancing measures should be relaxed? What are possible mental, long term consequences associated with, and attributable to a protracted economic shut down? What options exist for monetary policy and central banks in particular, given less options available amidst historically low interest rate levels? These constitute some of the questions which this paper aims to address.
    Keywords: digital currency; interest rates; consumer spending; investor confidence; global markets; new Keynesian Philips Curve
    JEL: F33 F42 F45 F47 F63 K21 M41
    Date: 2020–05–01
  28. By: Tomás Gómez; Alejandro Jara; David Moreno
    Abstract: In this paper, we study whether prudential and monetary policy interactions play a role in the dynamic of domestic banks' lending growth rates in Chile. We look at a group of internationally active banks during 2000q1-2017q4. We ask whether the stance of domestic prudential (monetary) policies in Chile changes international monetary (prudential) policy spillovers and if the transmission of domestic monetary policy shocks to bank credit is affected by the stance of domestic prudential policy. We stress the importance of analysing each prudential policy separately, as results may vary due to banks' exposure to such policies as well as different mechanisms of transmission in place. Overall, tight foreign-currency reserve requirements seem to dampen the transmission of foreign monetary policy shocks significantly, while reinforcing that of local monetary policy. However, this result is less robust for other prudential policies considered. Finally, adverse spillovers from tightening capital requirements abroad may be amplified by a tight monetary policy at home.
    Date: 2020–04
  29. By: Francesco MAGRIS; Daria ONORI
    Keywords: , Cash-in-advance , Fiscal Policy Indeterminacy, Nominal rigidities, Taylor rule
    Date: 2020
  30. By: Christopher D. Cotton
    Abstract: Many economists have proposed raising the inflation target to reduce the probability of hitting the zero lower bound (ZLB). It is both a common assumption and a feature of standard models that raising the inflation target does not impact the equilibrium real rate. I demonstrate that in the New Keynesian model, once heterogeneity is introduced, raising the inflation target causes the equilibrium real rate to fall. This implies that raising the inflation target will increase the nominal interest rate by less than expected and thus will be less effective in reducing the probability of hitting the ZLB. The channel involves a rise in the inflation target lowering the average markup by price rigidities and a fall in the average markup lowering the equilibrium real rate by household heterogeneity, which could come from overlapping generations or idiosyncratic labor shocks. I find that raising the inflation target from 2 percent to 4 percent lowers the equilibrium real rate between 3 and 28 basis points. Since raising inflation lowers the equilibrium real rate, it might seem optimal to raise inflation by more in response to the ZLB. However, this channel also implies that the marginal benefit of raising inflation is lower because a given increase in inflation raises the nominal interest rate by less and thus is less effective at preventing the ZLB. In a welfare simulation, these two effects approximately cancel out each other. Therefore, even though this channel implies that raising the inflation target is less effective in preventing the ZLB, the inflation target should still be raised by a similar amount in response to the problem of the ZLB.
    Keywords: inflation target; steady state real interest rate; equilibrium real rate; heterogeneity; zero lower bound
    JEL: E31 E52 E58
    Date: 2020–02–01
  31. By: Longinus Rutasitara (Department of Economics University of Dar es Salaam Tanzania)
    Abstract: The study examines the influence of the major determinants of inflation with a particular focus on the role of exchange rate policy changes. The gradual change in policy orientation from “controls” to “market” in Tanzania is associated with a change from a highly controlled exchange rate (until 1985) to a more liberalized regime from 1986 to the present (2002). The parallel exchange rate dominated price changes from the late 1970s to 1985; the parallel premium tapered off gradually from 1986, almost disappearing by 1992. The problem of inflation cuts across both regimes despite improvements in the past four to five years. The model estimations using quarterly data for 1967–1995 show that the parallel rate had a stronger influence on inflation up until the early 1990s compared with the official rate. Continued macroeconomic (tighter monetary and fiscal), trade and exchange rate reforms, and slow but steady improvements in the growth rates of GDP, may explain the recent (1993–2002) fall in inflation and a more “stable” market for foreign exchange in the inter-bank foreign exchange market (IFEM) arrangement. The charged debates of the 1980s about devaluation are no longer fashionable, but the exchange rate remains potentially sensitive to exogenous shocks and certainly any policy reversal or similar lapse.
  32. By: Oguzhan Cepni (Central Bank of the Republic of Turkey, Haci Bayram Mah. Istiklal Cad. No:10 06050, Ankara, Turkey); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa)
    Abstract: This paper investigates how monetary policy shock affects the stock market of the United States (US) conditional on states of investor sentiment. In this regard, we use a recently developed estimator that uses high-frequency surprises as a proxy for the structural monetary policy shocks, which in turn is achieved by integrating the current short-term rate surprises, which are least affected by an information effect, into a vector autoregressive (VAR) model as an exogenous variable. When allowing for time-varying model parameters, we find that, compared to the low investor sentiment regime, the negative reaction of stock returns to contractionary monetary policy shocks is stronger in the state associated with relatively higher investor optimism. Our results are robust to alternative sample period (which excludes the zero lower bound) and model specification and also have important implications for academicians, investors, and policymakers.
    Keywords: Investor sentiment; External instruments; Monetary policy surprises; Time-varying parameter VAR model
    JEL: E44 E52 G12 G14
    Date: 2020–05

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