nep-mon New Economics Papers
on Monetary Economics
Issue of 2022‒04‒25
seventeen papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Consumption Heterogeneity and Monetary Policy in an Open Economy By Sihao Chen; Michael B. Devereux; Kang Shi; Jenny Xu
  2. A Note on Temporary Supply Shocks with Aggregate Demand Inertia By Ricardo J. Caballero; Alp Simsek
  3. Uncertainty and Monetary Policy Experimentation: Empirical Challenges and Insights from Academic Literature By Matteo Cacciatore; Dmitry Matveev; Rodrigo Sekkel
  4. Disinflation Costs and Macroprudential Policies: Real and Welfare Effects By Busato, Francesco; Ferrara, Maria; Varlese, Monica
  5. What Do the Data Tell Us About Inflation Expectations? By Francesco D’Acunto; Ulrike Malmendier; Michael Weber
  6. FinTech Lending, Social Networks and the Transmission of Monetary Policy By Xiaoqing Zhou
  7. Foreign Currency Debt and Exchange Rate Pass-Through By Anna Burova; Konstantin Egorov; Dmitry Mukhin
  8. Revisiting the accuracy of inflation forecasts in Nigeria: The oil price-exchange rate-asymmetry perspectives By Kazeem Isah; Abdulkader Cassim Mahomedy; Elias Udeaja; Ojo Adelakun; Yusuf Yakubua
  9. Flexible inflation targeting: Concepts and application in India By Ashima Goyal
  10. Monetary Policy and Economic Growth in a Schumpeterian Model with Incumbents and Entrants By Lu, You-Xun; Chen, Shi-kuan; Lai, Ching-chong
  11. Supply or Demand? Policy Makers' Confusion in the Presence of Hysteresis By Antonio Fatás; Sanjay R. Singh
  12. Big data forecasting of South African inflation By Byron Botha; Rulof Burger; Kevin Kotze; Neil Rankin,; Daan Steenkamp
  13. The Coming Rise in Residential Inflation By Marijn A. Bolhuis; Judd N. L. Cramer; Lawrence H. Summers
  14. "Is It Time for Rate Hikes? The Fed Cannot Engineer a Soft Landing but Risks Stagflation by Trying" By Yeva Nersisyan; L. Randall Wray
  15. The bond market impact of the South African Reserve Bank bond purchase programme By Roy Havemann; Henk Janse van Vuuren; Daan Steenkamp; Rossouw van Jaarsveld
  16. Saved by the bell? Equity market responses to surprise Covid-19 lockdowns and central bank interventions By Aakriti Mathur; Rajeswari Sengupta; Bhanu Pratap
  17. Optimal timing of policy interventions in troubled banks By König, Philipp Johann; Mayer, Paul; Pothier, David

  1. By: Sihao Chen; Michael B. Devereux; Kang Shi; Jenny Xu
    Abstract: We explore how consumption heterogeneity affects the international transmission mechanism of monetary shocks and the choice of optimal monetary policy in an open economy. Incorporating two types of agents (Ricardian versus Keynesian) into a standard open economy macro model, we find that there are sizeable ranges of household heterogeneity in which monetary policy become ineffective, but this depends sensitively on the interaction of aggregate demand and relative price effects. We derive the global optimal monetary policy with household heterogeneity under alternative pricing regimes. PPI targeting is still the optimal monetary policy under PCP and can restore the economy to the efficient equilibrium. Under LCP, however, the presence of consumption heterogeneity and currency misalignment implies that CPI inflation targeting is no longer optimal in most cases. Finally, we show that when fiscal instruments such as an import tax and export subsidy are introduced, both currency misalignment and consumption heterogeneity can be eliminated, and even under LCP, PPI targeting is the optimal monetary rule.
    JEL: F3 F4
    Date: 2022–03
  2. By: Ricardo J. Caballero; Alp Simsek
    Abstract: We study optimal monetary policy during temporary supply contractions when aggregate demand has inertia and expansionary policy is constrained. In this environment, it is optimal to run the economy hot until supply recovers. Positive output gaps in the low-supply phase lessen the negative output gaps expected to emerge once supply recovers. However, the policy does not remain loose throughout the low-supply phase: The central bank undoes the initial interest rate cuts once aggregate demand gains momentum. If inflation also has inertia, the central bank still overheats the economy during the low-supply phase but gradually cools it down over time.
    JEL: E21 E32 E43 E44 E52 G12
    Date: 2022–03
  3. By: Matteo Cacciatore; Dmitry Matveev; Rodrigo Sekkel
    Abstract: Central banks face considerable uncertainty when conducting monetary policy. Some of the reasons for this include limitations of economic data, the unobservability of key macroeconomic variables such as potential output, structural changes to the economy and disagreements over the correct model for the transmission of monetary policy. At the same time, monetary policy is affected by uncertainty from various sources, including lack of or imperfect observation of economic variables, structural economic changes and possible misspecifications using models. We draw from the academic literature to review some of the key sources of this uncertainty and their implications for the conduct of monetary policy. First, we discuss evidence on release lags and revisions to economic data. We also highlight uncertainty around measuring unobservable variables such as the output gap and the natural rate of unemployment. The strength of a trade-off between these measures of economic slack and inflation—a cornerstone of monetary policy—is itself subject to continuous reassessment. Second, the literature finds that different sources of uncertainty may make the optimal conduct of monetary policy either more or less responsive to economic shocks. Additionally, the benefits of tackling uncertainty by engaging in purposeful monetary policy experimentation are typically small but may become more significant during major structural change or following unprecedented shocks.
    Keywords: Central bank research; Monetary policy and uncertainty; Potential output
    JEL: E3 E5
    Date: 2022–04
  4. By: Busato, Francesco; Ferrara, Maria; Varlese, Monica
    Abstract: This paper investigates the costs of disinflation in an otherwise standard DSGE model with borrowing constraints and credit frictions, augmented with macroprudential authority. Analyzing the real and welfare effects of a permanent change in the inflation rate, we study the role of macroprudential policy and its interaction with monetary policy in ensuring financial stability. Results show that when macroprudential authority intervenes actively in order to improve financial stability, disinflation costs are limited. As for the welfare effects, disinflation is welfare improving for savers but welfare costly for borrowers and banks.
    Keywords: Disinflation, Macroprudential policy, Loan-to-value ratio, Monetary policy, Sacrifice ratio, Welfare effects
    JEL: D60 E44 E58
    Date: 2022–02–28
  5. By: Francesco D’Acunto; Ulrike Malmendier; Michael Weber
    Abstract: Inflation expectations are central to economics because they affect the effectiveness of fiscal and monetary policy as well as realized inflation. We survey the recent literature with a focus on the inflation expectations of households. We first review standard data sources and discuss their advantages and disadvantages. We then document that household inflation expectations are biased upwards, dispersed across individuals, and volatile in the time series. We also provide evidence of systematic differences by gender, income, education, and race. Turning to the underlying expectations formation process, we highlight the role of individuals' exposure to price signals in their daily lives, such as price changes in groceries, the role of lifetime experiences, and the role of cognition. We then discuss the literature that links inflation expectations to economic decisions at the individual level, including consumption-savings and financial decisions. We conclude with an outlook for future research.
    JEL: C90 D14 D84 E31 E52 E71 G11 G51 G53
    Date: 2022–03
  6. By: Xiaoqing Zhou
    Abstract: One of the main channels through which monetary policy stimulus affects the real economy is mortgage borrowing. This channel, however, is weakened by frictions in the mortgage market. The rapid growth of financial technology-based (FinTech) lending tends to ease these frictions, given the higher quality services provided under this new lending model. This paper establishes that the role of FinTech lending in the monetary policy transmission is further amplified by consumers’ social networks. I provide empirical evidence for this network effect using county-level data and novel identification strategies. A 1 pp increase in the FinTech market share in a county’s socially connected markets raises the county’s FinTech market share by 0.23-0.26 pps. Moreover, I find that in counties where FinTech market penetration is high, the pass-through of market interest rates to borrowers is more complete. To quantify the role of FinTech lending and its network propagation in the transmission of monetary policy shocks, I build a multi-region heterogeneous-agent model with social learning that embodies key features of FinTech lending. The model shows that the responses of consumption and refinancing to a monetary stimulus are 13% higher in the presence of FinTech lending. Almost half of this improvement is accounted for by FinTech propagation through social networks.
    Keywords: FinTech; social networks; mortgage; monetary policy; regional transmission
    JEL: E21 E44 E52 G21 G23
    Date: 2022–03–25
  7. By: Anna Burova (Bank of Russia, Russian Federation); Konstantin Egorov (New Economic School); Dmitry Mukhin (London School of Economics)
    Abstract: This paper studies both theoretically and empirically the firm’s choice of currency for its debt. We use a parsimonious model with financial frictions to derive an intuitive sufficient statistic for the share of foreign-currency debt in firm’s liabilities and demonstrate its robustness in several extensions. Due to the risk management considerations, firms are more likely to borrow in dollars when the pass-through of the exchange rate into their profits is higher. We leverage this insight empirically using the micro-level data on loans issued by Russian banks to local firms as well as the data on firms’ balance sheets and cash flows. The data strongly supports the predictions of the model indicating that firms with profits more stable in dollars are more likely to borrow in foreign currency than firms with profits stable in local currency. These results extend to a choice between the euro and the dollar and survive after controlling for firms’ size and export status. Note that our results describe efficiency at the firm level, and they do not have direct implications for macroprudential policy as foreign currency debt may also affect exchange rate volatility, inflation and output.
    Keywords: currency choice, invoicing currency, borrowing currency, dollar in global economy, bank loans, exporter status, optimal debt composition
    JEL: D22 F31 F34 G11 G21 G32
    Date: 2022–02
  8. By: Kazeem Isah; Abdulkader Cassim Mahomedy; Elias Udeaja; Ojo Adelakun; Yusuf Yakubua
    Abstract: Motivated by the distinctive paradoxical nature of the Nigerian economy as the only OPEC oil-exporting economy that yet depends heavily on the importation of gasoline, we are compelled to re-examine the accuracy of the oil-based augmented Philips curve model in the predictability of inflation. Using quarterly data from 1970 to 2020, we investigate whether including the exchange rate into the oil price-based augmented Phillips curve improves the accuracy of forecasting inflation for the Nigerian economy. We rely on the outcomes of our preliminary analysis to account for the presence of endogeneity, persistence, and conditional heteroscedasticity in the predictability of inflation following the Westerlund & Narayan (2015) procedure. We find the extended variant of the oil price-based Phillips curve model that includes the exchange rate pass-through as most accurate for improving inflation forecasts in Nigeria. Given the robustness of our results from several models, we conclude that the exchange rate channel through which shocks to the oil price transmit into the economy is essential for forecasting inflation.
    Keywords: Nigeria, Inflation forecasts, Phillips curve, Oil price-exchange rate asymmetry
    JEL: E53 E31 E37
    Date: 2022–02
  9. By: Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: The paper examines considerations that arise in adapting IT to emerging markets (EMs). These include the necessity of flexibility, the working of the expectations channel, the dominance of supply shocks, fiscal-monetary coordination, forecasting issues and guidance of thin markets. Implementation of inflation targeting in India has matured from a strict form that imposed a large output sacrifice, towards flexibility with better forecasting that kept inflation in the tolerance band, contributed to good growth recoveries as well as improved financial parameters in the first two years of the pandemic.
    Keywords: Flexible inflation targeting, concepts, India, market imperfections, anchoring
    JEL: E52 E63 E65
    Date: 2022–03
  10. By: Lu, You-Xun; Chen, Shi-kuan; Lai, Ching-chong
    Abstract: An important aspect of economic growth is the interaction between incumbents and new firms. In this study, we develop a monetary Schumpeterian model with an endogenous market structure (EMS) and two types of quality improvements (the own-product improvements of incumbents and creative destruction of entrants) to analyze the effects of monetary policy. The key finding of our analysis is that an increase in the nominal interest rate importantly affects the composition of innovation that drives economic growth, stimulating the incumbents’ own-product improvements and reducing the entrants’ creative destruction. Therefore, the growth effect of monetary policy is ambiguous, and depends on the relative magnitudes of the incumbents’ and entrants’ contributions to R&D and growth. Finally, we provide a quantitative analysis of the growth and welfare effects of monetary policy and consider an extension of the benchmark model with an elastic labor supply and a CIA constraint on consumption.
    Keywords: innovation, monetary policy, economic growth, endogenous market structure
    JEL: E41 O31 O41
    Date: 2022–01–18
  11. By: Antonio Fatás; Sanjay R. Singh (Department of Economics, University of California Davis)
    Abstract: Policy makers need to separate between temporary demand-driven shocks and permanent shocks in order to design optimal aggregate demand policies. In this paper we study the case of a central bank that ignores the presence of hysteresis when identifying shocks. By assuming that all low-frequency output fluctuations are driven by permanent technology shocks, monetary policy is not aggressive enough in response to demand shocks. In addition, we show that errors in assessing the state of the economy can be self-perpetuating if seen through the lens of the mistaken views of the policy maker. We show that a central bank that mistakes a demand shock for a supply shock, will produce permanent effects on output through their suboptimal policies. Ex-post, the central bank will see an economy that resembles what they had forecast when designing their policies. The shock is indeed persistent and this persistence validates their assumption that the shock was a supply-driven one. The interaction between forecasts, policies and hysteresis creates the dynamics of self-perpetuating errors that is the focus of this paper.
    Keywords: business cycles, hysteresis, Potential Output, Stabilization Policy
    JEL: E32 E60 O4
    Date: 2022–04–19
  12. By: Byron Botha; Rulof Burger; Kevin Kotze; Neil Rankin,; Daan Steenkamp
    Abstract: We investigate whether the use of machine learning techniques and big data can enhance the accuracy of inflation forecasts and our understanding of the drivers of South African inflation. We make use of a large dataset for the disaggregated prices of consumption goods and services to compare the forecasting performance of a suite of different statistical learning models to several traditional time series models. We find that the statistical learning models are able to compete with most benchmarks, but their relative performance is more impressive when the rate of inflation deviates from its steady state, as was the case during the recent COVID-19 lockdown, and where one makes use of a conditional forecasting function that allows for the use of future information relating to the evolution of the inflationary process. We find that the accuracy of the Reserve Bank’s near-term inflation forecasts compare favourably to those from the models considered, reflecting the inclusion of off-model information such as electricity tariff adjustments and within-month data. Lastly, we generate Shapley values to identify the most important contributors to future inflationary pressure and provide policymakers with information about the potential sources of future inflationary pressure.
    Keywords: Micro-data, Inflation, High dimensional regression, Penalised likelihood, Bayesian methods, Statistical learning
    JEL: C10 C11 C52 C55 E31
    Date: 2022–02
  13. By: Marijn A. Bolhuis; Judd N. L. Cramer; Lawrence H. Summers
    Abstract: We study how the recent run-up in housing and rental prices affects the outlook for inflation in the United States. Housing held down overall inflation in 2021. Despite record growth in private market-based measures of home prices and rents, government measured residential services inflation was only four percent for the twelve months ending in January 2022. After explaining the mechanical cause for this divergence, we estimate that, if past relationships hold, the residential inflation components of the CPI and PCE are likely to move close to seven percent during 2022. These findings imply that housing will make a significant contribution to overall inflation in 2022, ranging from one percentage point for headline PCE to 2.6 percentage points for core CPI. We expect residential inflation to remain elevated in 2023.
    JEL: E01 E31 E37 R21 R31
    Date: 2022–02
  14. By: Yeva Nersisyan; L. Randall Wray
    Abstract: Roughly two years into the economic recovery from the COVID-19 crisis, the topic of elevated inflation dominates the economic policy discourse in the United States. And the aggressive use of fiscal policy to support demand and incomes has commonly been singled out as the culprit. Equally as prevalent is the clamor for the Federal Reserve to raise interest rates to relieve inflationary pressures. According to Research Scholar Yeva Nersisyan and Senior Scholar L. Randall Wray, this narrative is flawed in a number of ways. The problem with the US economy is not one of excess of demand in their view, and the Federal Reserve will not be able to engineer a "soft landing" in the way many seem to be expecting. The authors also deliver a warning: excessive tightening, combined with headwinds in 2022, could lead to stagflation. Moreover, while this recovery looks robust in comparison to the jobless recoveries and secular stagnation that have typified the last few decades, in Nersisyan and Wray's estimation there are few signs of an overheating economy to be found in the macro data. In their view, this inflation is not centrally demand driven; rather dynamics at the micro-level are playing a much more central role in driving the price increases in question, while significant supply chain problems have curtailed productive capacity by disrupting the availability of critical inputs. The authors suggest there is a better way to conduct policy—one oriented around targeted investments that would increase our real resource space. This will serve not only to address inflationary pressures, according to Nersisyan and Wray, but also the far more pressing climate emergency.
    Date: 2022–04
  15. By: Roy Havemann; Henk Janse van Vuuren; Daan Steenkamp; Rossouw van Jaarsveld
    Abstract: We use a unique dataset comprising over a million trades and quotes to assess the impact of the unexpected announcement of a bond purchase programme by the South African Reserve Bank on intraday market liquidity, yields and pricing volatility. Our dataset details the timing and order details of individual bonds purchased by the South African Reserve Bank during the COVID-19 pandemic, as well as data from over a million other fixed-coupon bond trades and intraday quotes. We find that the programme was successful at shoring up market confidence and addressing dislocation in the government bond market. We show that bond spreads fell both on announcement and after purchases themselves. Bond pricing adjusted slowly, with effects typically strengthening over the course of the trading day. We find that announcement effects dominated the impact of purchases themselves. Lastly, our intraday dataset enables assessment of the spillovers of central bank announcements in major economies and we show that the Federal Reserve played an important role in stabilising South Africa’s bond market, helping to support the actions of SARB.
    Keywords: bond purchase programme, liquidity, yield curve
    JEL: C5 E43 E58 G12 G14
    Date: 2022–03
  16. By: Aakriti Mathur (The Graduate Institute of International and Development Studies); Rajeswari Sengupta (Indira Gandhi Institute of Development Research); Bhanu Pratap (Reserve Bank of India)
    Abstract: Negative equity market reactions at the onset of the Covid-19 crisis raised concerns about the vulnerabilities in non-financial firms, requiring swift actions by central banks to prevent system-wide stresses. We investigate the Indian context, where the announcement of a surprise, nationwide lockdown in March 2020, was followed by the announcement of an unanticipated policy package by the central bank a few days later. Using natural language processing on quarterly earnings call reports, we construct a firm-specific measure of concern about the pandemic for a set of Indian non-financial firms. We find that firms that were exposed to the pandemic in early 2020 had worse stock market performance when the lockdown was announced. These results are explained by the implications of pandemic-related uncertainty for the future cash flows of these firms. The central bank's policy package seemed to have reversed the impact of the lockdown announcement in the short-term.
    Keywords: Covid-19, event study, earnings calls, firm performance, uncertainty, central bank policies
    JEL: G14 G18 G32 E58 L25 D8
    Date: 2022–03
  17. By: König, Philipp Johann; Mayer, Paul; Pothier, David
    Abstract: We analyze the problem of a policy authority (PA) that must decide when to resolve a troubled bank whose underlying solvency is uncertain. Delaying resolution increases the chance that information arrives that reveals the bank's true solvency state. However, delaying resolution also gives uninsured creditors the opportunity to withdraw, which raises the cost of bailing out insured depositors. The optimal resolution date trades off these costs with the option value of making a more efficient resolution decision following the arrival of information. Providing the bank with liquidity support buys the PA time to wait for information, but increases the PA's losses if the bank is insolvent. The PA may therefore optimally choose to delay the provision of liquidity support in order to minimize its losses.
    Keywords: Bank Resolution,Lender of Last Resort,Banking Crises
    JEL: G01 G21 G28
    Date: 2022

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