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on Central Banking |
| By: | Allen, Franklin; Babus, Ana; Carletti, Elena |
| Abstract: | We develop a model in which asset commonality and short-term debt of banks interact to generate excessive systemic risk. Banks swap assets to diversify their individual risk. Two asset structures arise. In a clustered structure, groups of banks hold common asset portfolios and default together. In an unclustered structure, defaults are more dispersed. Portfolio quality of individual banks is opaque but can be inferred by creditors from aggregate signals about bank solvency. When bank debt is short-term, creditors do not roll over in response to adverse signals and all banks are inefficiently liquidated. This information contagion is more likely under clustered asset structures. In contrast, when bank debt is long-term, welfare is the same under both asset structures. |
| Keywords: | interim information; rollover risk.; Short-term debt |
| JEL: | D85 G21 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8476&r=cba |
| By: | Frankel, Jeffrey (Harvard University); Saravelos, George (Harvard University) |
| Abstract: | This paper investigates whether leading indicators can help explain the cross-country incidence of the 2008-09 financial crisis. Rather than looking for indicators with specific relevance to the current crisis, the selection of variables is driven by an extensive review of more than eighty papers from the previous literature on early warning indicators. The review suggests that central bank reserves and past movements in the real exchange rate were the two leading indicators that had proven the most useful in explaining crisis incidence across different countries and crises in the past. For the 2008-09 crisis, we use six different variables to measure crisis incidence: drops in GDP and industrial production, currency depreciation, stock market performance, reserve losses, and participation in an IMF program. We find that the level of reserves in 2007 appears as a consistent and statistically significant leading indicator of who got hit by the 2008-09 crisis, in line with the conclusions of the pre-2008 literature. In addition to reserves, recent real appreciation is a statistically significant predictor of devaluation and of a measure of exchange market pressure during the current crisis. So is the exchange rate regime. We define the period of the global financial crisis as running from late 2008 to early 2009, which probably explains why we find stronger results than earlier papers such as Obstfeld, Shambaugh and Taylor (2009, 2010) and Rose and Spiegel (2009a,b) which use annual data. |
| JEL: | F30 |
| Date: | 2011–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:harjfk:rwp11-024&r=cba |
| By: | Kotaro Ishi; Kenji Fujita; Mark R. Stone |
| Abstract: | What is the case for adding the unconventional balance sheet policies used by major central banks since 2007 to the standard policy toolkit? The record so far suggests that the new liquidity providing policies in support of financial stability generally warrant inclusion. As the balance sheet policies aimed at macroeconomic stability were used only by a small number of highly credible central banks facing a lower bound constraint on conventional interest rate policy, they are not relevant for most central banks or states of the world. Best practices of these policies are documented in this paper. |
| Keywords: | Central bank role , Central banks , Financial risk , Financial stability , Liquidity management , Monetary policy , Risk management , |
| Date: | 2011–06–22 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:11/145&r=cba |
| By: | Akito Matsumoto |
| Abstract: | What is global liquidity and how does it affect an economy? The paper addresses that question by looking at liquidity from two different perspectives: global liquidity as availability of funds in safe and risky asset markets. This distinction between safe and risky asset markets is important due to market segmentation, which called for unconventional monetary policy to restore a function of risky asset markets. To analyze the effect of global liquidity, I construct proxy variables and then asses how they affect an emerging economy whose interest rate is affected by a world risk-free rate and a risk premium. Using the data from four major Latin American countries, I find that these two aspects of global liquidity have similar effects on economic performance in emerging market economies except for their effect on inflation. |
| Keywords: | Asset prices , Cross country analysis , Economic models , Emerging markets , External shocks , Financial risk , Investment , Latin America , Liquidity , Risk premium , |
| Date: | 2011–06–10 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:11/136&r=cba |
| By: | Vives, Xavier (IESE Business School) |
| Abstract: | This paper performs a welfare analysis of economies with private information when public information is endogenously generated and agents can condition on noisy public statistics in the rational expectations tradition. We find that equilibrium is not (restricted) efficient even when feasible allocations share similar properties to the market context (e.g., linear in information). The reason is that the market in general does not internalize the informational externality when public statistics (e.g., prices) convey information. Under strategic substitutability, equilibrium prices will tend to convey too little information when the "informational" role of prices prevails over its index of scarcity" role and too much information in the opposite case. Under strategic complementarity, prices always convey too little information. These results extend to the internal efficiency benchmark (accounting only for the collective welfare of the active players). However, received results-on the relative weights placed by agents on private and public information, when the latter is exogenous-may be overturned. |
| Keywords: | information externality; strategic complementarity and substitutability; asymmetric information; team solution; rational expectations; schedule competition; behavioral traders; |
| Date: | 2011–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0925&r=cba |
| By: | Ang, Andrew; Timmermann, Allan G |
| Abstract: | Regime switching models can match the tendency of financial markets to often change their behavior abruptly and the phenomenon that the new behavior of financial variables often persists for several periods after such a change. While the regimes captured by regime switching models are identified by an econometric procedure, they often correspond to different periods in regulation, policy, and other secular changes. In empirical estimates, the regime switching means, volatilities, autocorrelations, and cross-covariances of asset returns often differ across regimes, which allow regime switching models to capture the stylized behavior of many financial series including fat tails, heteroskedasticity, skewness, and time-varying correlations. In equilibrium models, regimes in fundamental processes, like consumption or dividend growth, strongly affect the dynamic properties of equilibrium asset prices and can induce non-linear risk-return trade-offs. Regime switches also lead to potentially large consequences for investors' optimal portfolio choice. |
| Keywords: | jumps; mixture distributions; non-linear equilibrium asset pricing models; rare events; regime switching |
| JEL: | G11 G12 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8480&r=cba |
| By: | Tran, Ngoc-Khanh (MIT); Zeckhauser, Richard J. (Harvard University) |
| Abstract: | Movements in asset prices are a major risk confronting individuals. This paper establishes new asset pricing results when agents differ in risk preference, time preference and/or expectations. It shows that risk tolerance is a critical concept driving savings decisions, consumption allocations, prices and return volatilities. Surprisingly, due to the equilibrium risk sharing, the precautionary savings motive in the aggregate can vastly exceed that of even the most prudent actual agent in the economy. Consequently, a low real interest rate, resulting from large aggregate savings, can prevail with reasonable risk aversions for all agents. One downside of a large aggregate savings motive is that savings rates become extremely sensitive to output fluctuation. Thus, the same mechanism that produces realistically low interest rates tends to make them unrealistically volatile. A powerful isomorphism allows differences in time preference and expectations to be swept away in the analysis, yielding an equivalent economy whose agents differ merely in risk aversion. These results hold great potential to simplify the analysis of heterogeneous-agent economies, as we demonstrate in quantifying how asset prices move and bounding their volatilities. All results are obtained in closed form for any number of agents possessing additively separable preferences in an endowment economy. |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:harjfk:rwp11-026&r=cba |
| By: | Massimiliano Marzo (Department of Economics, Università di Bologna); Paolo Zagaglia (Department of Economics, Università di Bologna) |
| Abstract: | The present paper introduces two bonds in a standard New-Keynesian model to study the role of segmentation in bond markets for the determinacy of rational expectations equilibria. We use a strongly-separable utility function to model ‘liquid’ bonds that provide transaction services for the purchase of consumption goods. ‘Illiquid’ bonds, instead, provide the standard services of store of value. We interpret liquid bonds as mimicking short-term instruments, and illiquid bonds to represent long-dated instruments. In this simple setting, the expectation hypothesis holds after log-linearizing the model and after pricing the bonds according to an affine scheme. We assume that monetary policy follows a standard Taylor rule. In this context, the inflation targeting parameter should be higher than one for determinacy of rational expectations equilibria to be achieved. We compute an analytical solution for the bond pricing kernel. We also show that the possibility of obtaining this analytical solution depends on the type of utility function. When utility is weakly separable between consumption and liquid bonds, the Taylor principle holds conditional to the output and inflation coefficients in the Taylor rule. Achieving solution determinacy requires constraining these coefficients within bounds that depend on the structural parameters of the model, like the intertemporal elasticity of consumption substitution. |
| Keywords: | term structure, determinacy, pricing kernel, fiscal and monetary policy |
| JEL: | E43 E63 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:28_11&r=cba |
| By: | Guido Ascari (Department of Economics and Quantitative Methods, University of Pavia); Andrea Colciago (Department of Economics, University of Milano Bicocca); Lorenza Rossi (Department of Economics and Quantitative Methods, University of Pavia) |
| Abstract: | We study the design of monetary policy in an economy characterized by staggered wage and price contracts together with limited asset market participation (LAMP). Contrary to previous results, we find that once nominal wage stickiness, an incontrovertible empirical fact, is considered: i) the Taylor Principle is restored as a necessary condition for equilibrium determinacy for any empirically plausible degree of LAMP; ii) the effect of LAMP for the design of optimal monetary policy are minor; iii) optimal interest rate rules become active no matter the degree of asset market participation. For this reasons we argue that LAMP does not matter much for monetary policy. |
| Keywords: | optimal monetary policy, sticky wages, non-Ricardian household, determinacy, optimal simple rules. |
| JEL: | E50 E52 |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:pav:wpaper:247&r=cba |
| By: | Ester Faia (Department of Money and Macro, Goethe University Frankfurt); Lorenza Rossi (Department of Economics and Quantitative Methods, University of Pavia) |
| Abstract: | We study Ramsey policies and optimal monetary policy rules in a model with sticky prices and unionized labour markets. Collective wage bargaining and unions monopoly power dampen wage fluctuations and amplify employment fluctuations relatively to a DNK model. The optimal monetary policy must trade-off between stabilizing inflation and reducing inefficient unemployment fluctuations induced by unions' monopoly power. In this context the monetary authority uses inflation as a tax on unions' rents. The optimal monetary policy rule targets unemployment alongside inflation. |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:pav:wpaper:249&r=cba |
| By: | Barbara Annicchiarico (Department of Economics, University of Rome ‘Tor Vergata’); Alessandra Pelloni (Department of Economics, University of Rome ‘Tor Vergata’); Lorenza Rossi (Department of Economics and Quantitative Methods, University of Pavia) |
| Abstract: | We introduce endogenous growth in an otherwise standard NK model with staggered prices and wages. Some results follow: (i) monetary volatility negatively affects long-run growth; (ii) the relation between nominal volatility and growth depends on the persistence of the nominal shocks and on the Taylor rule considered; (iii) a Taylor rule with smoothing increases the negative effect of nominal volatility on mean growth. |
| Keywords: | Growth, volatility, business cycle, monetary policy |
| JEL: | E32 E52 O42 |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:pav:wpaper:243&r=cba |
| By: | Etienne Farvaque (Department of Economics, University of Lille 1); Muhammad Azmat Hayat (Department of Economics, University of Lille 1); Alexander Mihailov (Department of Economics, University of Reading) |
| Abstract: | This paper addresses empirically the still debated issue of the legitimacy of the European Central Bank (ECB) with regard to European polities, presenting evidence on public opinion support for the ECB as elicited from responses in the recent waves of the Eurobarometer survey. We employ a rich set of potential determinants, combining macroeconomic and socio-demographic data in logistic regressions, to explain trust in the ECB. We find that people with higher level of income and education and centre to right-wing political orientation tend to support the ECB, as well as people with optimistic expectations on the economic situation. Moreover, our results indicate that socio-demographic determinants of trust in the ECB dominate macroeconomic ones, in particular inflation performance, by a considerable margin of magnitude and in a quite robust way. The policy relevance of such results is important for ECB’s communication strategy with the EU public, especially in the years ahead of likely reforms of the European Monetary Union (EMU). |
| Keywords: | European Central Bank, communication, legitimacy, determinants of trust, Eurobarometer survey, logistic regression |
| JEL: | C23 E58 F33 H11 Z13 |
| Date: | 2011–07–08 |
| URL: | http://d.repec.org/n?u=RePEc:rdg:emxxdp:em-dp2011-04&r=cba |
| By: | Richard T. Harmsen; Jarkko Turunen; Tamim Bayoumi |
| Abstract: | Concerns about export growth within the euro area peripheral countries due to a lack of competitiveness within the euro area are a key policy issue. Our analysis suggests that: (i) Long-term price elasticities for intra-euro area exports are at least double those for extra-euro area exports, so traditional real effective exchange rate indexes may overstate the effectiveness of euro depreciation in restoring exports growth in the euro area periphery and; (ii) There are surprisingly wide divergences across alternative relative price measures and even when relative price data suggest a steady loss in intra- (and extra-) euro area competitiveness, the pace of deterioration depends on the measure of relative prices used. |
| Keywords: | Cross country analysis , Demand , Economic models , Euro Area , Export competitiveness , Export growth , Export performance , Exports , Price elasticity , Real effective exchange rates , |
| Date: | 2011–06–16 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:11/140&r=cba |
| By: | Cantore, Cristiano; Levine, Paul |
| Abstract: | We contribute to a recent literature on the normalization, calibration and estimation of CES production functions. The problem arises because CES ‘share’ parameters are not in fact shares, but depend on underlying dimensions - they are ‘dimensional constants’ in other words. It follows that such parameters cannot be calibrated, nor estimated unless the choice of units is made explicit. We use an RBC model to demonstrate two equivalent solutions. The standard one expresses the production function in deviation form about some reference point, usually the steady state of the model. Our alternative, ‘re-parametrization’, expresses dimensional constants in terms of a new dimensionless (share) parameter and all remaining dimensionless ones. We show that our ‘re-parametrization’ method is equivalent and arguably more straightforward than the standard normalization in deviation form. We then examine a similar problem of dimensional constants for CES utility functions in a two-sector model and in a small open economy model; then re-parametrization is the only solution to the problem, showing that our approach is in fact more general. |
| Keywords: | CES production function; normalization; CES utility function |
| JEL: | E23 E32 E37 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:dynare:009&r=cba |
| By: | Michael McAleer (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, Complutense University of Madrid, and Institute of Economic Research, Kyoto University); Paulo Araújo Santos (Escola Superior de Gestão e Tecnologia de Santarém and Center of Statistics and Applications University of Lisbon); Juan-Ángel Jiménez-Martín (Department of Quantitative Economics Complutense University of Madrid); Teodosio Pérez Amaral (Department of Quantitative Economics Complutense University of Madrid) |
| Abstract: | In McAleer et al. (2010b), a robust risk management strategy to the Global Financial Crisis (GFC) was proposed under the Basel II Accord by selecting a Value-at-Risk (VaR) forecast that combines the forecasts of different VaR models. The robust forecast was based on the median of the point VaR forecasts of a set of conditional volatility models. In this paper we provide further evidence on the suitability of the median as a GFC-robust strategy by using an additional set of new extreme value forecasting models and by extending the sample period for comparison. These extreme value models include DPOT and Conditional EVT. Such models might be expected to be useful in explaining financial data, especially in the presence of extreme shocks that arise during a GFC. Our empirical results confirm that the median remains GFC-robust even in the presence of these new extreme value models. This is illustrated by using the S&P500 index before, during and after the 2008-09 GFC. We investigate the performance of a variety of single and combined VaR forecasts in terms of daily capital requirements and violation penalties under the Basel II Accord, as well as other criteria, including several tests for independence of the violations. The strategy based on the median, or more generally, on combined forecasts of single models, is straightforward to incorporate into existing computer software packages that are used by banks and other financial institutions. |
| Keywords: | Value-at-Risk (VaR), DPOT, daily capital charges, robust forecasts, violation penalties, optimizing strategy, aggressive risk management, conservative risk management, Basel, global financial crisis. |
| JEL: | G32 G11 C53 C22 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:kyo:wpaper:782&r=cba |
| By: | Wenli Cheng (Department of Economics, Monash University); Dingsheng Zhang (China Economics and Management Academy, Central University of Finance and Economics) |
| Abstract: | This paper investigates how monetary shocks are transmitted internationally. It shows that where a national currency is used as an international medium of exchange, the international money is non-neutral. In particular, an increase in the supply of international money leads to a transfer of real resources to the international money-issuing country from its trading partner. It also induces an expansion of the non-tradable sector in the international money-issuing country, and an expansion the tradable sector in its trading partner. The real impact of a monetary shock is greater under a fixed exchange rate system than under a flexible exchange rate system. |
| Keywords: | demand for money, demand for international currency, monetary policy, exchange rate, non-neutrality of money |
| JEL: | F11 F31 E41 E52 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:cuf:wpaper:434&r=cba |
| By: | Daly, Mary C. (Federal Reserve Bank of San Francisco); Hobijn, Bart (Federal Reserve Bank of San Francisco); Valletta, Rob (Federal Reserve Bank of San Francisco) |
| Abstract: | The U.S. economy is recovering from the financial crisis and ensuing deep recession, but the unemployment rate has remained stubbornly high. Some have argued that the persistent elevation of unemployment relative to historical norms reflects the fact that the shocks that hit the economy were especially disruptive to labor markets and likely to have long lasting effects. If such structural factors are at work they would result in a higher underlying natural or nonaccelerating inflation rate of unemployment, implying that conventional monetary and fiscal policy should not be used in an attempt to return unemployment to its pre-recession levels. We investigate the hypothesis that the natural rate of unemployment has increased since the recession began, and if so, whether the underlying causes are transitory or persistent. We begin by reviewing a standard search and matching model of unemployment, which shows that two curves – the Beveridge curve (BC) and the Job Creation curve (JCC) – determine equilibrium unemployment. Using this framework, our joint theoretical and empirical exercise suggests that the natural rate of unemployment has in fact risen over the past several years, by an amount ranging from 0.6 to 1.9 percentage points. This increase implies a current natural rate in the range of 5.6 to 6.9 percent, with our preferred estimate at 6.25 percent. After examining evidence regarding the effects of labor market mismatch, extended unemployment benefits, and productivity growth, we conclude that only a small fraction of the recent increase in the natural rate is likely to persist beyond a five-year forecast horizon. |
| Keywords: | equilibrium unemployment, Beveridge curve, structural unemployment, mismatch |
| JEL: | E24 J3 J6 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp5832&r=cba |
| By: | Martin Bijsterbosch (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Tatjana Dahlhaus (Universitat Autònoma de Barcelona, Spain.) |
| Abstract: | This paper aims to shed light on the characteristics and particularly the determinants of credit-less recoveries. After building a dataset and documenting some stylised facts of credit-less recoveries in emerging market economies, this paper uses panel probit models to analyse key determinants of credit-less recoveries. Our main findings are the following. First, our frequency analysis confirms earlier findings that credit-less recoveries are not at all rare events. Moreover, our analysis shows that the frequency of credit-less recoveries doubles after a banking or currency crisis. Second, results from estimated panel probit models suggest that credit-less recoveries are typically preceded by large declines in economic activity and financial stress, in particular if private sector indebtedness is high and the country is reliant on foreign capital inflows. Finally, we find that the predicted probability of a credit-less recovery in central and eastern European EU Member States during the coming years varies across countries, but is relatively high in the Baltic States. JEL Classification: C23, C25, E32, E51, G01. |
| Keywords: | Credit-less Recoveries, Financial Crises, Panel Probit Models. |
| Date: | 2011–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20111358&r=cba |
| By: | Gaowang Wang (Wuhan University) |
| Abstract: | This paper reexamines monetary non-superneutrality and the optimality of the optimum quantity of money in the money-in-utility Sidrauski model with endogenous fluctuations of the time preference by introducing in?ation aversion. It is shown that the long-run superneutrality of the standard Sidrauski model does not hold, and Friedman's optimum quantity of money is not optimal. |
| Keywords: | Inflation Aversion, Endogenous Time Preference, Monetary Superneutrality, Optimum Quantity of Money |
| JEL: | E31 E5 O41 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:cuf:wpaper:471&r=cba |
| By: | K. Vela Velupillai |
| Abstract: | The genesis and the path towards what has come to be called the DSGE model is traced, from its origins in the Arrow-Debreu General Equilibrium model (ADGE), via Scarf's Computable General Equilibrium model (CGE) and its applied version as Applied Computable General Equilibrium model (ACGE), to its ostensible dynamization as a Recursive Competitive Equilibrium (RCE). An outline of a similar nature, albeit very briefly, of the development and structure of Agent-Based Economics (ABE) is also included. It is shown that these transformations of the ADGE model are computably and constructively untenable. Suggestions for going 'beyond DSGE and ABE' are, then, outlined on the basis of a framework that is underpinned -from the outset- by computability and constructivity consideration |
| Keywords: | Computable General Equilibrium, Dynamic Stochastic General Equilibrium, Computability, Constructivity, Classical Behavioural Economics |
| JEL: | C02 C62 C68 D58 E61 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:trn:utwpas:1122&r=cba |
| By: | Luca Agnello (Banque de France); Vítor Castro (Universidade de Coimbra and NIPE); Ricardo M. Sousa (Universidade do Minho - NIPE) |
| Abstract: | We assess the response of fical policy to developments in asset markets in the US and the UK. We estimate fical polyce rules augmented with aggregate wealth, wealth composition (i.e. financial and housing wealth) and asset prices (i.e. stock and housing prices) using: (i) a linear framework based on a fully simultaneous system approach; and (ii) two nonlinear specifications that rely on a smooth transition regression (STR) and a Markov-switching (MS) model. The linear framework suggests that, while primary spending does not seem to react to wealth composition or asset prices, taxes and primary surplus are significantly: (i) cut when financial wealth or stock prices rise, and (ii) raised when housing wealth or housing prices increase. The smooth transition regression model shows that primary spending and fiscal balance are adjusted in a nonlinear fashion to both wealth and price effects, while the Markov-switching framework highlights the importance of tax cuts (in the US) and spending hikes (in the UK) to offset the decline in wealth suring major recessions and financial crises. Overall, our results provide evidence of a non-stabilizing effect of government debt, a countercyclical policy and a vigilant track of wealth developments by fiscal authorities. |
| Keywords: | fiscal policy, wealth composition, asset prices |
| JEL: | E37 E52 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:24/2011&r=cba |
| By: | Marek Rusnak; Tomas Havranek; Roman Horvath |
| Abstract: | The short-run increase in prices following an unexpected tightening of monetary policy represents a frequently reported puzzle. Yet the puzzle is surprisingly easy to explain away when all published models are quantitatively reviewed. We collect about 1,000 point estimates of impulse responses from 70 articles using vector autoregressive models and present a simple method of research synthesis for graphical results. We find some evidence of publication selection against the price puzzle. Our results suggest that the reported impulse responses depend systematically on the study design: when misspecifications are filtered out, the average impulse response shows that prices decrease soon after a tightening. The long-run response of prices to monetary policy shocks depends on the characteristics of the economy. |
| Keywords: | Meta-analysis, monetary policy transmission, price puzzle, publication selection bias. |
| JEL: | E52 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:cnb:wpaper:2011/02&r=cba |
| By: | João Sousa (Banco de Portugal); Ricardo M. Sousa (Universidade do Minho - NIPE) |
| Abstract: | The goal of thes paper is to analyze predictability of future asset returns in the context of model uncertainty. Using data for the euro area, the US and the U.K., we show that one can improve the forecasts of stock returns using a Bayesian Model Averaging (BMA) approach, and there is a large amount of model uncertainty. The empirical evidence for the euro area suggests that several macroeconomic, financial and macro-financial variables are consistently among the most prominent determinants of risk premium. As for the U.S, only a few number of predictors play an important role. In the case of the UK, future stock returns are better forecasted by financial variables. These results are corroborated for both the M-open and the M-closed perspectives and in the context of "in-sample" and "out-of-sample" forescating. Finally, we highlight that the predictive ability of the BMA framework is stronger at longer periods, and clearly outperforms the constant expected returns and the autoregressive benchmark models. |
| Keywords: | stock returns, model uncertainty, Bayesian Model Averaging |
| JEL: | E21 G11 E44 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:21/2011&r=cba |
| By: | Ulrich Bindseil; Jeroen Lamoot |
| Abstract: | Basel III introduces for the first time an international framework for liquidity risk regulation, reflecting the experience of excessive liquidity risk taking of banks in the run up to the financial crisis that erupted in August 2007, and associated negative externalities. As central banks play a crucial role in the liquidity provision to banks during normal times and in a financial crisis, the treatment of central bank operations in the regulation is obviously important. To ensure internalisation of liquidity risks (i.e. pricing of liquidity risk) and to address excessive reliance ex ante on central bank liquidity support by the banks, the regulation deliberately does not establish a direct close link with the monetary policy operational framework. While this reflects the purpose of the regulation and is also natural outcome of an international rule being applied under a multitude of very different monetary policy operational frameworks, this paper shows that the interaction between the two areas can be substantial, depending on the operational and collateral framework of the central bank. This implies the need for further study and the development of policies at the central bank and regulatory/supervisory side on how to handle these potential interactions in practice. |
| Keywords: | Basle III, Liquidity Risk, Banking Regulation, monetary policy implementation |
| JEL: | E58 G21 G28 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2011-041&r=cba |
| By: | Barbara Annicchiarico (Faculty of Economics, University of Rome "Tor Vergata"); Nicola Giammaroli (International Monetary Fund); Alessandro Piergallini (Faculty of Economics, University of Rome "Tor Vergata") |
| Abstract: | This paper presents a dynamic stochastic general equilibrium model with nominal rigidities, capital accumulation and finite horizons. Our New Keynesian framework exhibits intergenerational wealth effects and is intended to investigate the macroeconomic implications of fiscal policy, which is specified by either a debt-based tax rule or a balanced-budget rule allowing for temporary deficits. The model predicts that fiscal expansions generate a tradeoff in output dynamics between short-term gains and medium-term losses. It is shown that the effects of fiscal shocks crucially depend upon the conduct of monetary policy. Simulation analysis suggests that balanced-budget requirements enhance the determinacy properties of feedback interest rate rules by guaranteeing inflation stabilization. |
| Keywords: | Fiscal Policy; Monetary Policy; Nominal Rigidities; Capital Accumulation;Finite Horizons; Simulations. |
| JEL: | E52 E58 E63 |
| Date: | 2011–07–12 |
| URL: | http://d.repec.org/n?u=RePEc:rtv:ceisrp:207&r=cba |
| By: | Michal Skořepa (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Czech National Bank) |
| Abstract: | A number of authors have used the concept of an optimum currency area (or OCA) index to assess the relative proximity of various pairs of economies to the ideal of an optimum currency area. Alas, a significant deficiency of this approach as used so far is that it provides no room for long-term real income convergence - a frequently observed process that can be viewed as a specific type of long-term asymmetric shock. In this paper, a novel way to construct the OCA index is suggested that is sensitive to any real convergence (or divergence) between the two economies under study. Estimation of this convergence-sensitive OCA index for a sample of OECD economies yields an intuitively plausible result: real convergence gains on significance within the OCA index after an initial sample, a group of advanced OECD economies, is broadened with a group of emerging economies. Applied to the 2001-2008 period, the convergence-sensitive index shows a few Central and Eastern European late-transition economies to be better prepared for a common currency with Germany than several current euro area members. |
| Keywords: | optimum currency area, OCA index, real convergence, real exchange rate, trend appreciation |
| JEL: | E58 F15 F31 O2 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2011_23&r=cba |
| By: | Yu Sun |
| Abstract: | This paper investigates the degree of bank competition in the euro area, the U.S. and U.K. before and after the recent financial crisis, and revisits the issue whether the introduction of EMU and the euro have had any impact on bank competition. The results suggest that the level of bank competition converged across euro area countries in the wake of the EMU. The recent global financial crisis led to a fall in competition in several countries and especially where large credit and housing booms had preceded the crisis.. |
| Keywords: | Banks , Competition , Cross country analysis , Economic models , Euro Area , European Economic and Monetary Union , United Kingdom , |
| Date: | 2011–06–24 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:11/146&r=cba |
| By: | Marek Jarocinski; Albert Marcet |
| Abstract: | We propose a benchmark prior for the estimation of vector autoregressions: a prior about initial growth rates of the modelled series. We first show that the Bayesian vs frequentist small sample bias controversy is driven by different default initial conditions. These initial conditions are usually arbitrary and our prior serves to replace them in an intuitive way. To implement this prior we develop a technique for translating priors about observables into priors about parameters. We find that our prior makes a big difference for the estimated persistence of output responses to monetary policy shocks in the United States. |
| Keywords: | Vector autoregression, initial condition, bayesian estimation, prior about growthrate, monetary policy shocks, small sample distribution, bias correction |
| JEL: | C11 C22 C32 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp1061&r=cba |
| By: | Luc Bauwens (Université catholique de Louvain, CORE); Gary Koop (University of Strathclyde); Dimitris Korobilis (Université catholique de Louvain, CORE); Jeroen V.K. Rombouts (Institute of Applied Economics at HEC Montréal, CIRANO, CIRPEE; Université catholique de Louvain, CORE) |
| Abstract: | This paper compares the forecasting performance of different models which have been proposed for forecasting in the presence of structural breaks. These models differ in their treatment of the break process, the model which applies in each regime and the out-of-sample probability of a break occurring. In an extensive empirical evaluation involving many important macroeconomic time series, we demonstrate the presence of structural breaks and their importance for forecasting in the vast majority of cases. We find no single forecasting model consistently works best in the presence of structural breaks. In many cases, the formal modeling of the break process is important in achieving good forecast performance. However, there are also many cases where simple, rolling window based forecasts perform well. |
| Keywords: | Forecasting, change-points, Markov switching, Bayesian inference |
| JEL: | C11 C22 C53 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:38_11&r=cba |
| By: | Miguel A. G. Belmonte (University of Strathclyde); Gary Koop (University of Strathclyde); Dimitris Korobilis (Université Catholique de Louvain) |
| Abstract: | In this paper, we forecast EU-area inflation with many predictors using time-varying parameter models. The facts that time-varying parameter models are parameter-rich and the time span of our data is relatively short motivate a desire for shrinkage. In constant coefficient regression models, the Bayesian Lasso is gaining increasing popularity as an effective tool for achieving such shrinkage. In this paper, we develop econometric methods for using the Bayesian Lasso with time-varying parameter models. Our approach allows for the coefficient on each predictor to be: i) time varying, ii) constant over time or iii) shrunk to zero. The econometric methodology decides automatically which category each coefficient belongs in. Our empirical results indicate the benefits of such an approach. |
| Keywords: | hierarchical prior; time-varying parameters; Bayesian Lasso |
| JEL: | C11 C52 E37 E47 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:35_11&r=cba |
| By: | Mai Dao; Ruo Chen |
| Abstract: | We examine the impact of real exchange rate fluctuations on sectoral and regional employment in China from 1980 to 2008. In contrast to theoretical predictions, employment in both the tradable and non-tradable sectors contracts following a real appreciation. Our results are robust across different sub-samples, levels of sectoral disaggregation, and are more pronounced for regions with higher export exposure. We attribute our findings to the importance of services as intermediate input in exportable production. We test this channel of exchange rate transmission using regional input-output tables linked with employment data at the region-sector level. The results of this paper have important implications for China’s labor market adjustment should the Chinese RMB strengthen in the future. To mitigate the costs of short-run labor market adjustment, appropriate demand management and structural reforms in the non-traded sectors should play an important role. |
| Keywords: | China , Economic models , Employment , Labor markets , Real effective exchange rates , |
| Date: | 2011–06–27 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:11/148&r=cba |
| By: | Fredj Jawadi (University of Evry Val d?Essone & Amiens School of Management); Sushanta K. Mallick (Queen Mary University of London); Ricardo M. Sousa (Universidade do Minho - NIPE) |
| Abstract: | Given limited research on monetary policy rules in emerging markets, this paper estimates monetary policy rules for five key emerging market economies: Brazil, Russia, India, China and South Africa (BRICS) analysing whether the monetary authority reacts to changes in financial markets, in monetary conditions, in the foreign exchange sector and in the commodity price. To get a deeper understanding of the central bank’s behaviour, we assess the importance of nonlinearity using a smooth transition (STAR) model. Using quarterly data, we find strong evidence that the monetary policy followed by the Central Banks in the BRICS varies from one country to another and that it exhibits nonlinearity. In particular, considerations about economic growth (in the cases of Brazil and Russia), inflation (for India and China) and stability of financial markets (in South Africa) seem to be the major drivers of such nonlinear monetary policy behaviour. Moreover, the findings suggest that the monetary authorities pursue, with the exception of India, a target range for the threshold variable rather than a specific point target. In fact, the exponential smooth transition regression (ESTR) model seems to be the best description of the monetary policy rule in these countries. |
| Keywords: | monetary policy, emerging markets, smooth transition. |
| JEL: | E37 E52 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:18/2011&r=cba |
| By: | Fredj Jawadi (University of Evry Val d?Essone & Amiens School of Management); Sushanta K. Mallick (Queen Mary University of London); Ricardo M. Sousa (Universidade do Minho - NIPE) |
| Abstract: | This paper assesses the macroeconomic impact of fiscal policy shocks for four key emerging market economies - Brazil, Russia, India and China (BRICs) – using a Bayesian Structural Vector Auto-Regressive (BSVAR) approach, a Sign-Restrictions Vector Auto-Regressive framework and a Panel Vector Auto-Regressive (PVAR) model. To get a deeper understanding of the government’s behaviour, we also estimate fiscal policy rules using a Fully Simultaneous System of Equations and analyze the importance of nonlinearity using a smooth transition (STAR) model. Drawing on quarterly frequency data, we find that government spending shocks have strong Keynesian effects for this group of countries while, in the case of government revenue shocks, a tax hike is harmful for output. This suggests that there is no evidence in favour of ‘expansionary fiscal contraction’ in the context of emerging economies where spending policies are largely pro-cyclical. Our findings also show that considerations about growth (in the case of China), exchange rate and inflation (for Brazil and Russia) and commodity prices (in India) drive the nonlinear response of fiscal policy to the dynamics of the economy. All in all, our results are consistent with the idea that fiscal policy can be a powerful stabilization tool and can provide an important short-term economic boost for emerging markets, in particular, in the context of severe downturns as in most recent financial turmoil. |
| Keywords: | fiscal policy, emerging markets, fully simultaneous system of equations, sign-restrictions VAR, smooth transition regression model |
| JEL: | E37 E62 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:19/2011&r=cba |
| By: | Avouyi-Dovi, Sanvi (Bank of France); Fougère, Denis (CREST); Gautier, Erwan (Bank of France) |
| Abstract: | Using several unique data sets on wage agreements at both industry and firm levels in France, we document stylized facts on wage stickiness and the impact of wage-setting institutions on wage rigidity. First, the average duration of wages is a little less than one year and around 10 percent of wages are modified each month by a wage agreement. Data patterns are consistent with predictions of a mixture of Calvo and Taylor models. The frequency of wage change agreements is rather staggered over the year but the frequency of effective wage changes is seasonal. The national minimum wage has a significant impact on the probability of a wage agreement and on the seasonality of wage changes. Negotiated wage increases are correlated with inflation, the national minimum wage increases and the firm profitability. |
| Keywords: | wage stickiness, wage bargaining, minimum wage, downward nominal wage rigidity |
| JEL: | J31 J50 E30 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp5835&r=cba |
| By: | Kristin Magnusson |
| Abstract: | Countries’ absolute and relative international reserves adequacy has recently attracted considerable attention. The analysis has however concentrated on the largest and most advanced economies. We apply various methodologies for assessing reserve adequacy in Central America, taking into account the region’s high degree of deposit dollarization. We find that reserve cover is low both in an absolute and relative sense, suggesting further reserve accumulation is an important policy option for reducing vulnerabilities. |
| Keywords: | Central America , Costa Rica , Dominican Republic , Economic models , Emerging markets , Guatemala , Honduras , Nicaragua , Reserves accumulation , Reserves adequacy , |
| Date: | 2011–06–20 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:11/144&r=cba |
| By: | Selim Elekdag; Harun Alp |
| Abstract: | Turkey is an interesting case study because it was one of the hardest hit emerging economies by the global financial crisis, with a year-over-year contraction of 15 percent during the first quarter of 2009. At the same time, anticipating the fallout from the crisis, the Central Bank of the Republic of Turkey (CBRT) decreased policy rates by an astounding 1025 basis points over the November 2008 to November 2009 period. In this context, this paper addresses the following broad question: If an inflation targeting framework underpinned by a flexible exchange rate regime was not adopted, how much deeper would the recent recession have been? Counterfactual experiments based on an estimated structural model provide quantitative evidence which suggests that the recession would have been substantially more severe. In other words, the interest rate cuts implemented by the CBRT and exchange rate flexibility both helped substantially soften the impact of the global financial crisis. |
| Date: | 2011–06–28 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:11/150&r=cba |
| By: | Gonzalo Varela (Department of Economics, University of Sussex) |
| Abstract: | This paper analyses the importance attached to the past behaviour of the exchange rate when forming expectations and tests for the uncovered interest parity hypothesis. Using interest rate dierentials for Uruguay over 1980-2010, we identify a strong and time-varying extrapolative component in exchange rate expectations. Agents attach more importance to the past behaviour of exchange rates the higher the level of in ation is. Yet agents are able to internalise policy announcements and external events that are likely to aect exchange rate fun- damentals. Further, we nd deviations from the uncovered interest parity hy- pothesis. These are lower than those usually reported for developed economies. Also, they tend to be higher for the period of low in ation and freely oating exchange rates. As long as what it takes to predict well is rather simple | i.e. look backwards, follow policy announcements, the interest rate dierential per- forms well. Once the exchange rate determination model becomes more intricate or less familiar to the agents, they tend to fail at predicting exchange rate depre- ciations. These results point to expectational failures as a likely explanation for the `uncovered interest parity puzzle'. |
| Keywords: | Exchange rates, Uncovered interest parity, Expectations, Emerging Economies, Bias, Puzzle |
| JEL: | F31 G14 |
| Date: | 2011–02 |
| URL: | http://d.repec.org/n?u=RePEc:sus:susewp:1911&r=cba |
| By: | Hassan, Rubina; Mirza, M. Shahzad |
| Abstract: | This paper deals with the computation and analysis of some fundamental reserve aggregates and associated monetary statistics which impart important information regarding the design and conduct of monetary policy at the State Bank of Pakistan. Specifically, we compute the data series for borrowed, unborrowed, free and drainable reserves using balance sheet data published by the State Bank of Pakistan for the period 1985-2009. Results show that Pakistan’s monetary policy revolves around managing the exchange rate while using the t-bill rate as the key policy instrument. However, the value of the t-bill rate is both incorrectly and sub-optimally related to macroeconomic fundamentals rendering monetary policy time inconsistent. This hinges on the finding that since 2000-01, State Bank of Pakistan is targeting net free reserves of the banking system at 4% of total private deposits. Among other observations, we find that the scope of open market operations as a tool of monetary policy remains but limited and that this limited role of open market defenses derives from an indiscreet concern of the central bank to sterilize its own foreign exchange reserves. Furthermore, the growth rate of unborrowed plus drainable reserves bears a strong negative correlation with the annual average rate of inflation, which, on account of the former being consistently negative since 2005, implies that the government and the State Bank of Pakistan both have absolutely no concern for controlling inflation. |
| Keywords: | Measurement of Money Supply; Analysis of Monetary Policy; Central Banks and Their Policies; Taylor Rule; Operational Targets of Monetary Policy. |
| JEL: | E51 E58 E52 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:32149&r=cba |
| By: | Joey Chew; Siang Meng Tan; Sam Ouliaris |
| Abstract: | This paper investigates exchange rate pass-through in Singapore using band-pass spectral regression techniques, allowing for asymmetric effects over the business cycle. First stage pass-through is estimated to be complete and relatively quick, confirming existing views that the exchange rate provides an effective tool to moderate imported inflation in Singapore. Asymmetric pass-through effects over the business cycle are also detected, with importers passing on a smaller share of exchange rate movements during boom periods as compared to recessions. This result suggest that Singapore’s exchange rate policy could afford to "lean against the wind," especially during cyclical expansions. |
| Keywords: | Business cycles , Economic models , Exchange rate policy , Monetary policy , Singapore , |
| Date: | 2011–06–17 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:11/141&r=cba |
| By: | Patnaik, Ila (National Institute of Public Finance and Policy); Shah, Ajay (National Institute of Public Finance and Policy) |
| Abstract: | In 2010 and 2011, there has been a fresh wave of interest in cap- ital controls. India is one of the few large countries with a complex system of capital controls, and hence offers an opportunity to assess the extent to which these help achieve goals of macroeconomic and fi- nancial policy. We find that the capital controls were associated with poor governance, were unable to sustain the erstwhile exchange rate regime, and did not support financial stability. India's experience is thus inconsistent with the revisionist view of capital controls. Macroe- conomic policy in India has moved away from the erstwhile strategies, towards greater exchange rate flexibility combined with capital ac- count liberalisation. |
| Keywords: | Capital controls ; Exchange rate regime ; Monetary policy ; Impossible trinity ; Financial stability |
| JEL: | F32 F33 |
| Date: | 2011–04 |
| URL: | http://d.repec.org/n?u=RePEc:npf:wpaper:11/87&r=cba |