nep-mon New Economics Papers
on Monetary Economics
Issue of 2024‒01‒22
nineteen papers chosen by
Bernd Hayo, Philipps-Universität Marburg

  1. Could Uncapped and Unremunerated Retail CBDC Accounts Disintermediate Banks? By Srichander Ramaswamy
  2. The Transmission of Supply Shocks in Different Inflation Regimes By Sarah Arndt; Zeno Enders
  3. Optimal Exchange Rate Policy By Oleg Itskhoki; Dmitry Mukhin
  4. Monetary Policy Frameworks Away from the ELB By Fiorella De Fiore; Benoit Mojon; Daniel Rees; Damiano Sandri
  5. The Influence of Central Bank's Projections and Economic Narrative on Professional Forecasters' Expectations: Evidence from Mexico By Antón Sarabia Arturo; Bazdresch Santiago; Lelo-de-Larrea Alejandra
  6. Quantitative Tightening: Lessons from the US and Potential Implications for the EA By Patrick Gruning; Andrejs Zlobins
  7. Central bank transparency, the role of institutions and inflation persistence By Taniya Ghosh; Yadavindu Ajit
  8. The Effects of Interest Rate Increases on Consumers' Inflation Expectations: The Roles of Informedness and Compliance By Edward S. Knotek; James Mitchell; Mathieu Pedemonte; Taylor Shiroff
  9. Does it matter if the Fed goes conventional or unconventional? By Marcin Kolasa; Grzegorz Wesołowski
  10. Can Supply Shocks Be Inflationary with a Flat Phillips Curve? By Jean-Paul L'Huillier; Gregory Phelan
  11. Financial Integration and Monetary Policy Coordination By Javier Bianchi; Louphou Coulibaly
  12. The Effect of Component Disaggregation on Measures of the Median and Trimmed-Mean CPI By Christian Garciga; Randal J. Verbrugge; Saeed Zaman
  13. India's exchange rate regime under inflation targeting By Ashima Goyal
  14. Asymmetric exchange rate pass-through in Vietnam By Ho Sy-Hoa; Idir Hafrad; Viet-Dung Tran
  15. Assessing the sources of heterogeneity in eurozone response to unconventional monetary policy By Eli Agba; Hamza Bennani; Jean-Yves Gnabo
  16. Lifetime Memories of Inflation: Evidence from Surveys and the Lab By Isabelle Salle; Yuriy Gorodnichenko; Olivier Coibion
  17. Expectation Formation and the Phillips Curve Revisited By Czudaj, Robert L.
  18. A DSGE Model Including Trend Information and Regime Switching at the ZLB By Paolo Gelain; Pierlauro Lopez
  19. What Drives the Exchange Rate? By Oleg Itskhoki; Dmitry Mukhin

  1. By: Srichander Ramaswamy (The South East Asian Central Banks (SEACEN) Research and Training Centre)
    Abstract: One of the challenges of issuing a central bank digital currency (CBDC) is its potential to disintermediate banks through deposit substitution. To avoid this outcome, much of the research on CBDC is focused on whether and what limits to set on CBDC holdings, and if CBDC accounts should be paid interest. But the issuance of CBDC can also generate significant fiscal revenue through central bank balance sheet expansion if they are funded by unremunerated CBDC liabilities. This can lead to a criticism of central bank policies and can potentially compromise its independence. Taking the view that a significant share of unremunerated bank demand deposits can migrate to retail CBDC account if there are no restrictions on the holding amounts, this paper raises and provides some indicative answers to a number of policy questions that arise in this setup. These include the following: Will the commercial bank’s money creation process et disrupted? How will it impact the efficient transmission of monetary policy? What role can central banks play to ensure that the demand for credit in the economy is met at reasonable price terms? Will non-bank actors be able to offer better terms and conditions for loans than banks in the changed intermediation landscape brought about by CBDC? What levers will central banks have to control non-bank actors so that they do not amplify procyclical lending behaviour? Will the remit of central banks need to broaden in scope and reach? We will explore the options and alternatives that might emerge while highlighting what the challenges might be.
    Keywords: Central banks, digital currency, financial stability, monetary policy, bank intermediation, non-banks, collateral.
    JEL: E42 E51 E52 G21 G23
    Date: 2024–01
  2. By: Sarah Arndt; Zeno Enders
    Abstract: We show that the impact of supply and monetary policy shocks on consumer prices is state-dependent. First, we let the data determine two inflation regimes and find that they are characterized by high and low inflation volatility. We then identify upstream supply shocks using instrumental variables based on data outliers in the producer price series. Such shocks exhibit a more substantial and more persistent effect on downstream prices during periods of elevated inflation volatility (State 2) compared to phases of more stable consumer price growth (State 1). Similarly, monetary policy shocks are more effective in State 2. Exogenously differentiating regimes by the level of inflation or the shock size does not reveal state dependency. The evidence supports a model in which producers invest in price flexibility. This model predicts that stricter inflation targeting reduces price flexibility and, consequently, the pass-through of all shocks to inflation, beyond the standard channel that affects demand.
    Keywords: inflation regimes, supply shocks, monetary policy, cost pass-through, producer prices
    JEL: E31 E52 E32
    Date: 2023
  3. By: Oleg Itskhoki; Dmitry Mukhin
    Abstract: We develop a general policy analysis framework for an open economy that features nominal rigidities and financial frictions giving rise to endogenous PPP and UIP deviations. The efficient allocation can be implemented with monetary policy closing the output gap and FX interventions eliminating UIP deviations. When the “natural” real exchange rate is stable, both goals can be achieved solely by monetary policy that fixes the exchange rate — an open-economy divine coincidence. More generally, optimal policy features a managed float/crawling peg complemented with FX forward guidance and macroprudential accumulation of FX reserves, in line with the “fear of floating” observed in the data. Capital controls are not necessary to achieve the frictionless allocation, but they facilitate the extraction of rents in the currency market. Constrained unilateral policies are not optimal from the global perspective, and international cooperation features a complementary use of FX interventions across countries.
    Date: 2023
  4. By: Fiorella De Fiore; Benoit Mojon; Daniel Rees; Damiano Sandri
    Keywords: inflation; monetary policy frameworks; central bank reviews; inflation targeting; inflation expectations
    Date: 2023–09
  5. By: Antón Sarabia Arturo; Bazdresch Santiago; Lelo-de-Larrea Alejandra
    Abstract: This paper evaluates the influence of central bank's projections and narrative signals provided in the summaries of its Inflation Report on the expectations of professional forecasters for inflation and GDP growth in the case of Mexico. We use the Latent Dirichlet Allocation model, a text-mining technique, to identify narrative signals. We show that both quantitative and qualitative information have an influence on inflation and GDP growth expectations. We also find that narrative signals related to monetary policy, observed inflation, aggregate demand, and inflation and employment projections stand out as the most relevant in accounting for changes in analysts' expectations. If the period of the COVID-19 pandemic is excluded, we still find that forecasters consider both types of information for their inflation expectations.
    Keywords: Central bank projections;Economic forecasting;Machine learning;Text mining
    JEL: E52 E58 C55
    Date: 2023–12
  6. By: Patrick Gruning (Latvijas Banka); Andrejs Zlobins (Latvijas Banka)
    Abstract: Given the decades-high inflation, central banks are complementing conventional rate hikes with quantitative tightening (QT), i.e. a reduction of the sizeable asset holdings accumulated during the quantitative easing (QE) era. In this study, we employ empirical (proxy-SVAR) and structural (medium-scale NK DSGE) frameworks to study the macroeconomic implications of QT. Our empirical findings show that the impact of QT has been relatively muted in the US, suggesting asymmetric effects of QT compared to QE. This finding is corroborated by model simulations, calibrated to the post-pandemic high inflation environment. Nevertheless, QT can partly substitute conventional rate hikes by creating some deflationary pressure and requiring less aggressive conventional policy action. QT produces smaller effects in the euro area (EA) due to the smaller share of private bonds on the ECB’s balance sheet. However, a potential concern for QT in the EA is the proliferation of fragmentation risk. We empirically argue that the deployment of market-stabilisation QE can be used to stabilise sovereign spreads without creating considerable inflationary pressure in case QT leads to disorderly market dynamics.
    Keywords: monetary policy, quantitative tightening, quantitative easing, proxy-SVAR, DSGE
    JEL: C54 E31 E52 E58 G12
    Date: 2023–12–27
  7. By: Taniya Ghosh (Indira Gandhi Institute of Development Research); Yadavindu Ajit (Indira Gandhi Institute of Development Research)
    Abstract: With the transparency revolution across the world, this paper aims to investigate the effect of increased central bank transparency on inflation dynamics. We use the-oretical and empirical methods to show the importance of various institutional factors and their interdependence. Using a panel of advanced economies from 1998 to 2017, we investigate the role of central bank transparency in influencing inflation persistence in the presence of institutional factors such as central bank independence and labor market institutions, along with policy uncertainty. While previous research has examªined the role of these institutional variables independently, this paper focuses on how these variables influence the efficacy of central bank transparency. We find that while central bank transparency reduces inflation persistence, its overall effect depends on the level of other variables. The role of central bank transparency in reducing inflation persistence can further be enhanced when we have an independent central bank, colªlective wage bargaining happening at the central level, relaxed labor laws, and lower policy uncertainty.
    Keywords: Inflation persistence, Central bank transparency, Central bank independence, Labor market institutions; Interdependence; Policy uncertainty
    JEL: D81 D82 E31 E52 E58 J51
    Date: 2023–11
  8. By: Edward S. Knotek; James Mitchell; Mathieu Pedemonte; Taylor Shiroff
    Abstract: We study how monetary policy communications associated with increasing the federal funds rate causally affect consumers' inflation expectations. In a large-scale, multi-wave randomized controlled trial (RCT), we find weak evidence on average that communicating policy changes lowers consumers' medium-term inflation expectations. However, information differs systematically across demographic groups, in terms of ex ante informedness about monetary policy and ex post compliance with the information treatment. Monetary policy communications have a much stronger effect on people who had not previously heard news about monetary policy and who take sufficient time to read the treatment, implying scope to increase the impact of communications by targeting specific groups of the general public. Our findings show that, in an inflationary environment, consumers expect that raising interest rates will lower inflation. More generally, our results emphasize the importance of measuring both respondents' information sets and their compliance with treatment when using RCTs in empirical macroeconomics, to better understand the well-documented evidence of heterogeneous treatment effects.
    Keywords: expectations formation; policy communication; monetary policy; inflation; surveys
    JEL: E31 E52 E58
    Date: 2024–01–03
  9. By: Marcin Kolasa (SGH Warsaw School of Economics; International Monetary Fund); Grzegorz Wesołowski (University of Warsaw, Faculty of Economic Sciences)
    Abstract: We investigate the domestic and international consequences of three types of Fed monetary policy instruments: conventional interest rate (IR), forward guidance (FG) and large scale asset purchases (LSAP). We document empirically that they can be seen as close substitutes when used to meet macroeconomic stabilization objectives in the US, but have markedly different spillovers to other countries. This is because each of the three monetary policy instruments transmits differently to asset prices and exchange rates of small open economies. The LSAP by the Fed lowers the term premia both in the US and in other countries, and results in bigger exchange rate adjustments compared to conventional policy. Importantly for international spillovers, LSAP is typically associated with a more accommodative reaction of other countries' monetary authorities, especially in emerging market economies. We demonstrate how these findings can be rationalized within a stylized dynamic theoretical framework featuring a simple form of international bond market segmentation.
    Keywords: monetary policy, forward guidance, quantitative easing, international spillovers
    JEL: E44 E52 F41
    Date: 2024
  10. By: Jean-Paul L'Huillier; Gregory Phelan
    Abstract: Not in standard models. With conventional pricing frictions, imposing a flat Phillips curve also imposes a price level that is rigid with respect to supply shocks. In the New Keynesian model, price markup shocks need to be several orders of magnitude bigger than other shocks in order to fit the data, leading to unreasonable assessments of the magnitude of the increase in costs during inflationary episodes. To account for the facts, we propose a strategic microfoundation of shock-dependent price stickiness: prices are sticky with respect to demand shocks but flexible with respect to supply shocks. This friction is demand-intrinsic, in line with narrative accounts for the imperfect adjustment of prices. Firms can credibly justify a price increase due to a rise in costs, whereas it is harder to do so when demand increases. Inflation from supply shocks is efficient and does not justify a monetary policy response.
    Keywords: cost-push shocks; shock dependence; price stickiness; output-inflation trade-off
    JEL: E31 E52 E58
    Date: 2023–12–28
  11. By: Javier Bianchi; Louphou Coulibaly
    Abstract: Financial integration generates macroeconomic spillovers that may require international monetary policy coordination. We show that individual central banks may set nominal interest rates too low or too high relative to the cooperative outcome. We identify three sufficient statistics that determine whether the Nash equilibrium exhibits under-tightening or over-tightening: the output gap, sectoral differences in labor intensity, and the trade balance response to changes in nominal rates. Independently of the shocks hitting the economy, we find that under-tightening is possible during economic expansions or contractions. For large shocks, the gains from coordination can be substantial.
    JEL: E21 E23 E43 E44 E52 E62 F32
    Date: 2023–12
  12. By: Christian Garciga; Randal J. Verbrugge; Saeed Zaman
    Abstract: For decades, the Federal Reserve Bank of Cleveland (FRBC) has produced median and trimmed-mean consumer price index (CPI) measures. These have proven useful in various contexts, such as forecasting and understanding post-COVID inflation dynamics. Revisions to the FRBC methodology have historically involved increasing the level of disaggregation in the CPI components, which has improved accuracy. Thus, it may seem logical that further disaggregation would continue to enhance its accuracy. However, we theoretically demonstrate that this may not necessarily be the case. We then explore the empirical impact of further disaggregation along two dimensions: shelter and non-shelter components. We find that significantly increasing the disaggregation in the shelter indexes, when combined with only a slight increase in non-shelter disaggregation, improves the ability of the median and trimmed-mean CPI to track the medium-term trend in CPI inflation and marginally increases predictive power over future movements in CPI inflation. Finally, we examine the practical implications of our preferred degree of disaggregation. Our preferred measure of the median CPI suggests that trend inflation was lower pre-pandemic, while both our preferred median and trimmed-mean measures suggest a faster acceleration in trend inflation in 2021. We also find that higher disaggregation marginally weakens the Phillips curve relationship between median CPI inflation and the unemployment gap, though it remains statistically significant.
    Keywords: inflation measurement; median CPI; trimmed-mean CPI; trend inflation; disaggregates of inflation
    JEL: E31 E37 E52 C8
    Date: 2024–01–04
  13. By: Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: While the basic exchange rate regime has stayed the same since the liberalizing reforms of the nineties, its implementation has varied over the years. The paper assesses the evolution of India's nominal exchange rate regime and its suitability under inflation targeting. It also examines the evolving impact on trade, inflation, on currency and financial markets, country risk premium and the cost of borrowing. The analysis suggests a flexible exchange rate with intervention to prevent excess volatility as well as misalignment from competitive real exchange rates, while allowing some volatility to aid price discovery in foreign exchange markets, would work best in inflation targeting emerging markets.
    Keywords: India, exchange rate regime, capital flows, inflation targeting
    JEL: F41 F31 E52
    Date: 2023–12
  14. By: Ho Sy-Hoa (VNU - Vietnam National University [Hanoï]); Idir Hafrad; Viet-Dung Tran
    Abstract: In this paper, we study the measure of exchange rate pass-through on consumer price for Vietnam using the Nonlinear Autoregressive Dynamic Lag from 2000Q4 to 2018Q2. Our findings can be summarized as follows: (i) we demonstrate the existence of the asymmetric effect of the exchange rate to domestic price in both short run and long run; (ii) the exchange rate pass-through is high; (iii) the impact of exchange rate depreciation on domestic price is stronger than appreciation; (iv) the exchange rate pass-through is higher in the long run than in the short run; and (v) foreign competitor price plays an important role in domestic price movement.
    Keywords: Exchange rate pass-through, Asymmetric Exchange Rate, ARDL models, NARDL models, Vietnam
    Date: 2022–08–26
  15. By: Eli Agba (CeReFiM - Center for Research in Finance and Management [UNamur] - UNamur - Université de Namur [Namur], NaXys - Namur Center for Complex Systems [Namur] - UNamur - Université de Namur [Namur]); Hamza Bennani (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - IMT Atlantique - IMT Atlantique - IMT - Institut Mines-Télécom [Paris] - Nantes Univ - IAE Nantes - Nantes Université - Institut d'Administration des Entreprises - Nantes - Nantes Université - pôle Sociétés - Nantes Univ - Nantes Université - IUML - FR 3473 Institut universitaire Mer et Littoral - UM - Le Mans Université - UA - Université d'Angers - UBS - Université de Bretagne Sud - IFREMER - Institut Français de Recherche pour l'Exploitation de la Mer - CNRS - Centre National de la Recherche Scientifique - Nantes Université - pôle Sciences et technologie - Nantes Univ - Nantes Université - Nantes Univ - ECN - École Centrale de Nantes - Nantes Univ - Nantes Université); Jean-Yves Gnabo (CeReFiM - Center for Research in Finance and Management [UNamur] - UNamur - Université de Namur [Namur], NaXys - Namur Center for Complex Systems [Namur] - UNamur - Université de Namur [Namur])
    Abstract: In this paper, we aim at explaining a specific type of heterogeneity in the euro area pertaining to the diverging responses of countries and sectors to the European Central Bank's Unconventional Monetary Policy. Equipped with stock markets indices of 17 sectors for each euro area country, we first preform an event-study analysis to assess the reaction of the markets. Next, we regress the responses on a set of country-specific drivers. Our main findings show that variables related to the nature of banking industry (e.g. cost-to-income, return on assets), macroeconomic environment (e.g. gross debt) and macroprudential policy all contribute to observe diverging responses to ECB's monetary policies. While some sectors and countries responded more negatively than positively to the policies, the Unconventional Monetary Policy impacts the markets positively on average. A policy implication is that the heterogeneous response calls for domestic structural reforms that should target the discrepancies in the banking and the macroeconomic environments across euro area countries.
    Keywords: Event-study ordered probit heterogeneity cross-sector /cross-country UMP, Event-study, ordered probit, heterogeneity, cross-sector /cross-country, UMP
    Date: 2022–03–28
  16. By: Isabelle Salle; Yuriy Gorodnichenko; Olivier Coibion
    Abstract: We study how individuals’ memories of inflation shape their expectations about future inflation using both surveys and laboratory experiments. Recalling having lived through prior disinflations has pronounced effects on how long-lived people expect the current inflation episode to last. Information treatments in which we show people prior disinflationary experiences similarly strongly reduce inflation expectations of individuals on average and are often recalled as inflation memories months later. We also show that when people try to forecast inflation in the lab, the inflation dynamics in the game can affect their beliefs much like the inflation experienced in real life. Methodologically, we compare and contrast surveys and lab experiments and discuss the pros and cons of each method, emphasizing the general consistency across the two methodologies.
    JEL: E03 E4 E5 E7
    Date: 2023–12
  17. By: Czudaj, Robert L.
    Abstract: This paper studies expectation formation of professional forecasters in the context of the Phillips curve. We assess whether professionals form their expectations regarding inflation and unemployment consistent with the Phillips curve based on individual forecast data taken from the ECB Survey of Professional Forecasters. We consider expectations over different horizons and do not restrict the analysis to point forecasts but we also take the information inherent in density forecasts into account. We explicitly consider the role of anchoring of inflation expectations as potential source of nonlinearity and we also assess whether the Phillips curve relation translates to a link between uncertainty regarding inflation and unemployment. Our findings show that professionals tend to build their expectations in line with the Phillips curve but this is only observed for expectations made for shorter horizons (one- or two-years-ahead). For longer horizons (five-years-ahead) the Phillips curve connection is much weaker. This relationship also depends on the degree of anchoring and results in a connection between uncertainty regarding future inflation and unemployment.
    Keywords: Anchoring; Inflation expectations; Phillips curve; Uncertainty; Unemployment
    JEL: E24 E31
    Date: 2023
  18. By: Paolo Gelain; Pierlauro Lopez
    Abstract: This paper outlines the dynamic stochastic general equilibrium (DSGE) model developed at the Federal Reserve Bank of Cleveland as part of the suite of models used for forecasting and policy analysis by Cleveland Fed researchers, which we have nicknamed CLEMENTINE (CLeveland Equilibrium ModEl iNcluding Trend INformation and the Effective lower bound). This document adopts a practitioner's guide approach, detailing the construction of the model and offering practical guidance on its use as a policy tool designed to support decision-making through forecasting exercises and policy counterfactuals.
    Keywords: DSGE model; labor market frictions; zero lower bound; trends; expectations
    JEL: E32 E23 E31 E52 D58
    Date: 2023–12–27
  19. By: Oleg Itskhoki; Dmitry Mukhin
    Abstract: We use a general open-economy wedge-accounting framework to characterize the set of shocks that can account for major exchange rate puzzles. Focusing on a near-autarky behavior of the economy, we show analytically that all standard macroeconomic shocks — including productivity, monetary, government spending, and markup shocks — are inconsistent with the broad properties of the macro exchange rate disconnect. News shocks about future macroeconomic fundamentals can generate plausible exchange rate properties. However, they show up prominently in contemporaneous asset prices, which violates the finance exchange rate disconnect. International shocks to trade costs, terms of trade and import demand, while potentially consistent with disconnect, do not robustly generate the empirical Backus-Smith, UIP and terms-of-trade properties. In contrast, the observed exchange rate behavior is consistent with risk-sharing (financial) shocks that arise from shifts in demand of foreign investors for home-currency assets, or vice versa.
    JEL: F31 F41 F44
    Date: 2023–12

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