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on Central Banking |
| By: | Obstfeld, Maurice |
| Abstract: | In this lecture I document the proliferation of gross international asset and liability positions and discuss some of the consequences for individual countries’ external adjustment processes and for global financial stability. In light of the rapid growth of gross global financial flows and the serious risks associated with them, one might wonder about the continuing relevance of the net financial flow measured by the current account balance. I argue that global current account imbalances remain an essential target for policy scrutiny, for financial as well as macroeconomic reasons. Nonetheless, it is critically important for policymakers to monitor as well the rapidly evolving structure of global gross assets and liabilities. |
| Keywords: | current account balance; financial instability; global imbalances; international asset positions; international financial flows |
| JEL: | F32 F34 F36 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8611&r=cba |
| By: | George-Marios Angeletos; Luigi Iovino; Jennifer La'O |
| Date: | 2011–10–20 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:786969000000000293&r=cba |
| By: | Pesaran, Hashem (University of Cambridge); Xu, TengTeng (Bank of Canada) |
| Abstract: | This paper proposes a theoretical framework to analyze the impacts of credit and technology shocks on business cycle dynamics, where firms rely on banks and households for capital financing. Firms are identical ex ante but differ ex post due to different realizations of firm specific technology shocks, possible leading to default by some firms. The paper advances a new modelling approach for the analysis of financial intermediation and firm defaults that takes account of the financial implications of such defaults for both households and banks. Results from a calibrated version of the model highlight the role of financial institutions in the transmission of credit and technology shocks to the real economy. A positive credit shock, defined as a rise in the loan to deposit ratio, increases output, consumption, hours and productivity, and reduces the spread between loan and deposit rates. The effects of the credit shock tend to be highly persistent even without price rigidities and habit persistence in consumption behaviour. |
| Keywords: | bank credit, financial intermediation, firm heterogeneity and defaults, interest rate spread, real financial linkages |
| JEL: | E32 E44 G21 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp6027&r=cba |
| By: | Francis X. Diebold; Kamil Yilmaz |
| Abstract: | The authors propose several connectedness measures built from pieces of variance decompositions, and they argue that they provide natural and insightful measures of connectedness among financial asset returns and volatilities. The authors also show that variance decompositions define weighted, directed networks, so that their connectedness measures are intimately-related to key measures of connectedness used in the network literature. Building on these insights, the authors track both average and daily time-varying connectedness of major U.S. financial institutions' stock return volatilities in recent years, including during the financial crisis of 2007-2008. |
| Keywords: | Portfolio management ; Systemic risk ; Risk management |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:11-45&r=cba |
| By: | Prasad, Eswar (Cornell University) |
| Abstract: | I document that emerging markets have cast off their "original sin" – their external liabilities are no longer dominated by foreign-currency debt and have instead shifted sharply towards direct investment and portfolio equity. Their external assets are increasingly concentrated in foreign exchange reserves held in advanced economy government bonds. Given the enormous and rising public debt burdens of reserve currency economies, this means that the long-term risk on emerging markets' external balance sheets is shifting to the asset side. However, emerging markets continue to look for more insurance against balance of payments crises, even as self-insurance through reserve accumulation itself becomes riskier. I propose a mechanism for global liquidity insurance that would meet emerging markets' demand for insurance with fewer domestic policy distortions while facilitating a quicker adjustment of global imbalances. I also argue that emerging markets have become less dependent on foreign finance and more resilient to capital flow volatility. The main risk that increasing financial openness poses for these economies is that capital flows exacerbate vulnerabilities arising from weak domestic policies and institutions. |
| Keywords: | emerging markets, international investment positions, structure of external assets and liabilities, foreign exchange reserves, global liquidity insurance |
| JEL: | F3 F4 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp6032&r=cba |
| By: | Miles, David (Monetary Policy Committee Unit, Bank of England); Yang, Jing (Monetary Policy Committee Unit, Bank of England); Marcheggiano, Gilberto (Monetary Policy Committee Unit, Bank of England) |
| Abstract: | This paper reports estimates of the long-run costs and benefits of banks funding more of their assets with loss-absorbing capital, or equity. Measuring those costs requires careful consideration of a wide range of issues about how shifts in funding affect required rates of return and on how costs are influenced by the tax system; it also rqeuires a clear distinction to be drawn between costs to individual institutions (private costs) and overall economic (or social) costs. Without a calculation of the benefits from having banks use more equity no estimate of costs - however accurate - can tell us what the optimal level of bank capital is. We use empirical evidence on UK banks to assess costs; we use data from shocks to incomes from a wide range of countries over a long period to assess risks to banks and how equity funding (or capital) protects against those risks. We find that the amount of equity capital that is likely to be desirable for banks to use is very much larger than banks have used in recent year and also higher than targets agreed under the Basel III framework. |
| Keywords: | Banks; capital regulation; capital structure; cost of equity; leverage; Modigliani-Miller |
| JEL: | G21 G28 |
| Date: | 2011–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:mpc:wpaper:0031&r=cba |
| By: | Mackowiak, Bartosz Adam; Wiederholt, Mirko |
| Abstract: | Why were people so unprepared for the global financial crisis, the European debt crisis, and the Fukushima nuclear accident? To address this question, we study a model in which agents make state-contingent plans - think about actions in different contingencies - subject to the constraint that agents can process only a limited amount of information. The model predicts that agents are unprepared in a state when the state has a low probability, the optimal action in that state is uncorrelated with the optimal action in normal times, and actions are strategic complements. We then compare the equilibrium allocation of attention to the efficient allocation of attention. We characterize analytically the conditions under which society would be better off if agents thought more carefully about optimal actions in rare events. |
| Keywords: | disasters; efficiency; rare events; rational inattention |
| JEL: | D83 E58 E60 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8626&r=cba |
| By: | Allen Head; Lucy Qian Liu; Guido Menzio; Randall Wright |
| Abstract: | Why do some sellers set nominal prices that apparently do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption; here it is a result. We use search theory, with two consequences: prices are set in dollars, since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When the money supply increases, some sellers may keep prices constant, earning less per unit but making it up on volume, so profit stays constant. The calibrated model matches price-change data well. But, in contrast with other sticky-price models, money is neutral. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:690&r=cba |
| By: | Chao Gu; Randall Wright |
| Abstract: | We study models of credit with limited commitment, which implies endogenous borrowing constraints. We show that there are multiple stationary equilibria, as well as nonstationary equilibria, including some that display deterministic cyclic and chaotic dynamics. There are also stochastic (sunspot) equilibria, in which credit conditions change randomly over time, even though fundamentals are deterministic and stationary. We show this can occur when the terms of trade are determined by Walrasian pricing or by Nash bargaining. The results illustrate how it is possible to generate equilibria with credit cycles (crunches, freezes, crises) in theory, and as recently observed in actual economies. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:689&r=cba |
| By: | Kuttner, Kenneth (Monetary Policy Committee Unit, Bank of England); Posen, Adam (Monetary Policy Committee Unit, Bank of England) |
| Abstract: | This paper takes up the issue of the flexibility of inflation targeting regimes, with the specific goal of determining whether the monetary policy of the Bank of England, which has a formal inflation target, has been any less flexible than that of the Federal Reserve, which does not have such a target. The empirical analysis uses the speed of inflation forecast convergence, estimated from professional forecasters' predictions at successive forecast horizons, to gauge the perceived flexibility of the central bank's response to macroeconomic shocks. Based on this criterion, these is no evidence to suggest that the Bank of England's inflation target has compelled it to be more aggressive in pursuit of low inflation than the Federal Reserve. |
| Keywords: | Inflation targeting; inflation expectations; monetary policy |
| JEL: | E42 E58 E65 |
| Date: | 2011–10–01 |
| URL: | http://d.repec.org/n?u=RePEc:mpc:wpaper:0034&r=cba |
| By: | Rose, Andrew (Monetary Policy Committee Unit, Bank of England); Wieladek, Tomasz (Monetary Policy Committee Unit, Bank of England) |
| Abstract: | We provide the first empirical tests for financial protectionism, defined as a nationalistic change in banks' lending behaviour, as the result of public intervention, which leads domestic banks either to lend less or at higher interest rates to foreigners. We use a bank-level panel data set spanning all British and foreign banks providing loans within the United Kingdom between 1997 Q3 and 2010 Q1. During this time, a number of banks were nationalised, privatised, given unusual access to loan or credit guarantees, or received capital injections. We use standard empirical panel-data techniques to study the 'loan mix', domestic (British) loans of a bank expressed as a fraction of its total loan activity. We also study effective short-term interset rates, though our data set here is much smaller. We examine the loan mix for both British and foreign banks, both before and after unusual public interventions such as nationalisations and public capital injections. We find strong evidence of financial protectionism. After nationalisations, foreign banks reduced the fraction of loans going to the United Kingdom by around 11 precentage points and increased their effective interest rates by about 70 basis points. By way of contrast, nationalised British banks did not significantly change either their loan mix or effect interest rates. Succinctly, foreign nationalised banks seem to have engaged in financial protectionism, while British nationalised banks have not. |
| Keywords: | Bank; nationalisation; privatisation; crisis; loan; domestic; foreign; empirical; panel |
| JEL: | F36 G21 |
| Date: | 2011–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:mpc:wpaper:0032&r=cba |
| By: | Bask, Mikael (Department of Economics) |
| Abstract: | We argue that it is not necessary for the central bank to react to the exchange rate to have a desirable outcome in the economy. Indeed, when the Taylor rule includes contemporaneous data on the variables in the rule, the central bank can disregard from the exchange rate as long as there is enough with interest rate inertia in monetary policy. The reason is that interest rate inertia and a reaction to the current nominal exchange rate change are perfect substitutes in monetary policy. Hence, we give a rationale for the central bank to focus on the interest rate change rather than the interest rate level to have a desirable outcome in the economy, which we define as a determinate rational expectation equilibrium that is stable under least squares learning. |
| Keywords: | Determinacy; Foreign Exchange; Interest Rate Inertia; Least Squares Learning; Monetary Policy; Taylor Rule |
| JEL: | E52 F31 |
| Date: | 2011–10–19 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:uunewp:2011_016&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). It is shown that these transformations of the ADGE - including the fountainhead - are computably and constructively untenable. The policy implications of these (negative) results, via the Fundamental Theorems of Welfare Economics in particular, and against the backdrop of the mathematical theory of economic policy in general, are also discussed (again from computable and constructive points of view). Suggestions for going 'beyond DSGE' are, then, outlined on the basis of a framework that is underpinned - from the outset - by computability and constructivity considerations |
| Keywords: | Computable General Equilibrium, Dynamic Stochastic General Equilibrium, Computability, Constructivity, Fundamental Theorems of Welfare Economics, Theory of Policy, Coupled Nonlinear Dynamic |
| JEL: | C02 C62 C68 D58 E61 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:trn:utwpas:1125&r=cba |
| By: | Agustin S. Benetrix; Barry Eichengreen; Kevin H. O'Rourke |
| Abstract: | We construct a simple probit model of the determinants of real house price slump endings. We find that the probability of a house price slump ending is higher, the smaller was the pre-slump house price run-up; the greater has been the cumualtive house price decline; the lower are real mortgage interest rates; and the higher is GDP growth. Slumps are longer, other things being equal, where housing supply is more elastic, but shorter the more developed are financial institutions. For slumps of a given size, shorter sharper slumps are associated with worse macroeconomic performance in the short run, but with better performance in the long run. This suggests that for sufficiently low discount rates, policy makers should not impede the decline in real house prices, and this conclusion is reinforced by the finding that after a certain duration, house price slumps can become self-reinforcing. On the other hand, we also find evidence that during downturns, falling house prices can lead to lower private sector credit flows. Policy makers thus face a delicate balancing act. While they should not intervene to artifically prop up overvalued house prices, they should ensure that their macroeconomic and banking policies are such as to make a bottoming-out more likely. This suggests that they should keep real interest rates low, and ensure that banks are well-capitalised. |
| Keywords: | House prices, Slumps, Probit, VAR |
| JEL: | E32 C41 R30 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:577&r=cba |
| By: | Zheng Liu; Pengfei Wang; Tao Zha |
| Abstract: | We argue that positive co-movements between land prices and business investment are a driving force behind the broad impact of land-price dynamics on the macroeconomy. We develop an economic mechanism that captures the co-movements by incorporating two key features into a DSGE model: We introduce land as a collateral asset in firms’ credit constraints and we identify a shock that drives most of the observed fluctuations in land prices. Our estimates imply that these two features combine to generate an empirically important mechanism that amplifies and propagates macroeconomic fluctuations through the joint dynamics of land prices and business investment. |
| Keywords: | Real property |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2011-26&r=cba |
| By: | Elyas Elyasiani; Loretta J. Mester; Michael S. Pagano |
| Abstract: | The authors examine investors' reactions to announcements of large seasoned equity offerings (SEOs) by U.S. financial institutions (FIs) from 2000 to 2009. These offerings include market infusions as well as injections of government capital under the Troubled Asset Relief Program (TARP). The sample period covers both business cycle expansions and contractions, and the recent financial crisis. They present evidence on the factors affecting FI decisions to issue capital, the determinants of investor reactions, and post-SEO performance of issuers as well as a sample of matching FIs. The authors find that investors reacted negatively to the news of private market SEOs by FIs, both in the immediate term (e.g., the two days surrounding the announcement) and over the subsequent year, but positively to TARP injections. Reactions differed depending on the characteristics of the FIs, stage of the business cycle, and conditions of financial crisis. Larger institutions were less likely to have raised capital through market offerings during the period prior to TARP, and firms receiving a TARP injection tended to be larger than other issuers. The authors find that while TARP may have allowed FIs to increase their lending (as a share of assets) in the year after the issuance, they took on more credit risk to do so. They find no evidence that banks' capital adequacy increased after the capital injections. |
| Keywords: | Securities ; Financial services industry ; Banks and banking |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:11-46&r=cba |
| By: | Alexander K. Karaivanov; Fernando M. Martin |
| Abstract: | We revisit the role of limited commitment in a dynamic risk-sharing setting with private information. We show that a Markov-perfect equilibrium, in which agent and insurer cannot commit beyond the current period, and an infinitely-long contract to which only the insurer can commit, implement identical consumption, effort and welfare outcomes. Unlike contracts with full commitment by the insurer, Markov-perfect contracts feature non-trivial and determinate asset dynamics. Numerically, we show that Markov-perfect contracts provide sizable insurance, especially at low asset levels, and are able to explain a significant part of wealth inequality beyond what can be explained by self-insurance. The welfare gains from resolving the commitment friction are larger than those from resolving the moral hazard problem at low asset levels, while the opposite holds for high asset levels. |
| Keywords: | Moral hazard ; Risk |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2011-030&r=cba |
| By: | Fernando M. Martin |
| Abstract: | I study the implications of different institutional frameworks for the conduct of fiscal policy, under the assumption that the government cannot commit to future policy choices. The environments analyzed vary on whether the government is endowed with the ability to commit to beginning-of-period policy announcements or not. If it cannot, then there are two variants, depending on which actions private agents take before observing the government’s policy choice. How the three possible cases rank in terms of tax rates and welfare varies substantially with the economy’s fundamentals and whether depreciation is tax deductible or not. More generally, I find that regimes with higher tax rates do not necessarily imply lower welfare. I also find that making depreciation not tax-deductible typically involves a welfare loss. Within the context of the environments studied in this paper, I find that there are only small gains from modifying the way fiscal policy is conducted in modern developed economies. Furthermore, some reforms may lead to large welfare losses. |
| Keywords: | Fiscal policy ; Welfare ; Equilibrium (Economics) |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2011-031&r=cba |
| By: | Di Bartolomeo Giovanni; Tirelli Patrizio; Acocella Nicola |
| Abstract: | Recent developments in macroeconomics resurrect the view that welfare costs of inflation arise because the latter acts as a tax on money balances. Empirical contributions show that wage re-negotiations take place while expiring contracts are still in place. Bringing these seemingly unrelated aspects together in a stylized general equilibrium model, we find a disciplining effect of a positive inflation target on the wage markup and identify a long-term trade-off between inflation and output. This has important policy implications, ranging from the opportunity of revising the target in response to shocks, to the possibility of exploiting inflation as a tool to increase tax revenues via its employment- enhancing effect. |
| Keywords: | trend inflation, long-run Phillips curve, inflation targeting, real money balances |
| JEL: | E52 E58 E24 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:ter:wpaper:0081&r=cba |
| By: | Di Bartolomeo Giovanni; Tirelli Patrizio; Acocella Nicola |
| Abstract: | Empirical contributions show that wage re-negotiations take place while expiring contracts are still in place. This is captured by assuming that nominal wages are pre-determined. As a consequence, wage setters act as Stackelberg leaders, whereas in the typical New Keynesian model the wage-setting rule implies that they play a Nash game. We present a DSGE New Keynesian model with pre-determined wages and money entering the representative household's utility function and show how these assumptions are sufficient to identify an inverse relationship between the inflation target and the wage markup (and thus employment) both in the short and the long run. This is due to the complementary effects that wage claims and the inflation target have on money holdings. Model estimates suggest that a moderate long-run inflation rate generates non-negligible output gains. |
| Keywords: | E52, E58, J51, E24 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:ter:wpaper:0079&r=cba |
| By: | Paolo Guarda; Abdelaziz Rouabah; John Theal |
| Abstract: | The stress testing literature abounds with reduced-form macroeconomic models that are used to forecast the evolution of the macroeconomic environment in the context of a stress testing exercise. These models permit supervisors to estimate counterparty risk under both baseline and adverse scenarios. However, the large majority of these models are founded on the assumption of normality of the innovation series. While this assumption renders the model tractable, it fails to capture the observed frequency of distant tail events that represent the hallmark of systemic financial stress. Consequently, these kinds of macro models tend to underestimate the actual level of credit risk. This also leads to an inaccurate assessment of the degree of systemic risk inherent in the financial sector. Clearly this may have significant implications for macro-prudential policy makers. One possible way to overcome such a limitation is to introduce a mixture of distributions model in order to better capture the potential for extreme events. Based on the methodology developed by Fong, Li, Yau and Wong (2007), we have incorporated a macroeconomic model based on a mixture vector autoregression (MVAR) into the stress testing framework of Rouabah and Theal (2010) that is used at the Banque centrale du Luxembourg. This allows the counterparty credit risk model to better capture extreme tail events in comparison to models based on assuming normality of the distributions underlying the macro models. We believe this approach facilitates a more accurate assessment of credit risk. |
| Keywords: | financial stability, stress testing, MVAR, mixture of normals, VAR, tier 1 capital ratio, counterparty risk, Luxembourg banking sector |
| JEL: | C15 E44 G21 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:bcl:bclwop:bclwp063&r=cba |
| By: | Corder, Matthew (Monetary Policy Committee Unit, Bank of England); Weale, Martin (Monetary Policy Committee Unit, Bank of England) |
| Abstract: | It is widely suggested that there is some relationship between banking crises and recessions. We assess whether there is evidence for interdependency between recessions and banking crises using both non-parametric tests and unconditional bivariate probit models and find strong evidence for interdependence. We then consider whether leading indicators can help predict banking crises and recessions and if these variables can explain the previously obvserved interdependence. Inclusion of exogenous variables means that the observed interdependence between banking crises and recessions disappears - indicating that the observed interdependence is a result of easily observable common causes rather than unobserved links. |
| Keywords: | Crises; recessions; interdependency; bivariate probit analysis |
| JEL: | E37 G21 |
| Date: | 2011–09–01 |
| URL: | http://d.repec.org/n?u=RePEc:mpc:wpaper:0033&r=cba |
| By: | George A. Waters (Department of Economics, Illinois State University) |
| Abstract: | Quantity rationing of credit, when some ?firms are denied loans, has macroeconomics effects not fully captured by measures of borrowing costs. This paper develops a monetary DSGE model with quantity rationing and derives a Phillips Curve relation where in?flation dynamics depend on cyclical unemployment, a risk premium and the fraction of fi?rms receiving ?financing. Unemployment arising from disruptions in credit ?flows is defi?ned to be cyclical. GMM estimates using data from a survey of bank managers con?firms the importance of these variables for in?flation dynamics. |
| Keywords: | Quantity Rationing, Phillips Curve, Cyclical Unemployment, GMM |
| JEL: | E24 E31 E51 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:ils:wpaper:20111004&r=cba |
| By: | George A. Waters (Department of Economics, Illinois State University) |
| Abstract: | Tests on simulated data from an asset pricing model with heterogeneous forecasts show excess variance in the price and ARCH effects in the returns, features not explained by the strong version of the efficient markets hypothesis. An evolutionary game theory dynamic describes how agents switch between a fundamental forecast, a rational bubble forecast and the reflective forecast, which is a weighted average of the former two. Conditions determining the frequency and duration of episodes where a significant fraction of agents adopt the rational bubble forecast leading to large deviations in the price-dividend ratio are discussed. |
| Keywords: | return predictability, excess variance, ARCH, evolutionary game theory, rational bubble |
| JEL: | C22 C73 G12 D84 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:ils:wpaper:20111003&r=cba |
| By: | Piotr Berman; Bhaskar DasGupta; Lakshmi Kaligounder; Marek Karpinski |
| Abstract: | Threats on the stability of a financial system may severely affect the functioning of the entire economy, and thus considerable emphasis is placed on the analyzing the cause and effect of such threats. The financial crisis in the current and past decade has shown that one important cause of instability in global markets is the so-called financial contagion, namely the spreading of instabilities or failures of individual components of the network to other, perhaps healthier, components. This leads to a natural question of whether the regulatory authorities could have predicted and perhaps mitigated the current economic crisis by effective computations of some stability measure of the banking networks. Motivated by such observations, we consider the problem of defining and evaluating stabilities of both homogeneous and heterogeneous banking networks against propagation of synchronous idiosyncratic shocks given to a subset of banks. We formalize the homogeneous banking network model of Nier et al. and its corresponding heterogeneous version, formalize the synchronous shock propagation procedures outlined in that paper, define two appropriate stability measures and investigate the computational complexities of evaluating these measures for various network topologies and parameters of interest. Our results and proofs also shed some light on the properties of topologies and parameters of the network that may lead to higher or lower stabilities. |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1110.3546&r=cba |
| By: | Rudiger Ahrend; Antoine Goujard |
| Abstract: | This paper examines whether the composition of a country’s external liabilities and assets has an incidence on its risk of suffering financial turmoil. Particular emphasis is put on the role of international financial integration, using newly-constructed measures of contagion shocks. These new measures capture well the contagion observed e.g. in the wake of the Mexican and Asian crises, and confirm that contagion shocks observed in 2009/10 dwarfed those observed during previous financial crises.<p> Using a panel of 184 developed and emerging economies from 1970 to 2009, the empirical analysis finds that the structure of the financial account has an important influence on financial stability. A key result is that a bias in external liabilities towards debt strongly increases the risk of a systemic banking crisis. Moreover, certain forms of international financial integration are found to amplify contagion shocks and increase crisis risk, such as integration through international bank lending, and in particular through short-term bank debt. |
| JEL: | E44 F34 F36 G32 |
| Date: | 2011–10–26 |
| URL: | http://d.repec.org/n?u=RePEc:oec:ecoaaa:902-en&r=cba |
| By: | George A. Waters (Department of Economics, Illinois State University) |
| Abstract: | Quantity rationing of credit, when ?firms are denied loans, has greater potential to explain macroeconomics ?fluctuations than borrowing costs. This paper develops a DSGE model with both types of financial frictions. A deterioration in credit market con?fidence leads to a temporary change in the interest rate, but a persistent change in the fraction of ?firms receiving ?financing, which leads to a persistent fall in real activity. Empirical evidence confi?rms that credit market con?fidence, measured by the survey of loan officers, is a signi?cant leading indicator for capacity utilization and output, while borrowing costs, measured by interest rate spreads, is not. |
| Keywords: | Quantity Rationing, Credit, VAR |
| JEL: | E10 E24 E44 E50 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:ils:wpaper:20111005&r=cba |
| By: | Matthias Neuenkirch (University of Marburg) |
| Abstract: | In this paper, we study the role central bank communication plays in the monetary policy transmission mechanism. We employ the Swiss Economic Institute’s Monetary Policy Communicator to measure the future stance of the European Central Bank’s monetary policy. Our results indicate that, first, communication influences prices and output. Second, communication partly crowds out the effects of the short-term interest rate as the latter’s influence is lower and its implementation lag increases compared to a benchmark model without central bank communication. Future work on monetary policy transmission should incorporate both a short-term interest rate and a communication indicator. |
| Keywords: | Central Bank Communication, European Central Bank, Monetary Policy Shocks, Monetary Policy Transmission, Vector Autoregression |
| JEL: | E52 E58 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:mar:magkse:201143&r=cba |
| By: | Eric Dor (IESEG School of Management (Lille Catholic University, LEM-CNRS)) |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:ies:wpaper:e201106&r=cba |
| By: | Parag Waknis (University of Connecticut and University of Massachusetts Dartmouth) |
| Abstract: | This paper studies the nature of optimal monetary policy under a Leviathan monetary authority in a microfounded model of money based on ?. Such a monetary authority is a reality whenever and wherever fiscal policy is a primary driver of the monetary policy. Under no commitment, we characterize and solve for a Markov perfect equilibrium as well as for equilibrium with reputation concerns. For the Markov equilibrium, a generalized Euler equation is derived to characterize optimal policy that trades off the current benefit of increasing consumption against the reduced ability to do so in the future. Under reputation equilibrium, centralized market interaction is modeled as an infinitely repeated game of perfect monitoring, between a Leviathan monetary authority (a large player) and the economic agents (small players). Such a game has multiple equilibriums but the large-small player dynamics pins down the equilibrium set of payoffs and features less than maximum inflation tax. Depending on howwe interpret the Leviathan central bank, the factors determining the realized equilibrium differ. Higher fiscal profligacy of the underlying political authority leads to a higher monetary growth rate and inflation tax, while existence of threat of competition in case of a private money supplier or threat of external aggression in case of a self interested sovereign leads to a lower one. The realized equilibrium monetary growth rate and the associated inflation tax is thus, affected by the intensity of context contingent factors. Concentrating only on Markov strategies in this repeated game shows that the Markov perfect equilibrium features maximum inflation tax. |
| Keywords: | Endogenous monetary policy, Leviathan, central bank, inflation tax, money search |
| JEL: | E52 E61 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:uct:uconnp:2011-20&r=cba |
| By: | Parag Waknis (University of Connecticut and University of Massachusetts Dartmouth) |
| Abstract: | In this paper, we use a dual currency Lagos-Wright model to explore the nature of optimal monetary policy under currency competition using different timing protocols. The central banks are utility maximizing players. To characterize equilibrium with reputation, we model the centralized market sub period of the Lagos-Wright economy as an infinitely repeated game between the two Leviathan central banks (long run players) and a continuum of competitive agents (short run players). Concentrating on Markov strategies in such a game shows that the Markov perfect equilibrium features highest inflation tax. However, allowing for reputation concerns improves the inflation outcome. Such a game typically features multiple equilibriums but the competition between the banks allows the use of renegotiation proof-ness as an equilibrium selection mechanism. Accordingly, equilibrium featuring the lowest inflation tax is weakly renegotiation proof, suggesting that better inflation outcome is more likely in the case of Leviathan currency competition than in the single Leviathan bank case. |
| Keywords: | Monetary policy, currency competition, Leviathan, inflation tax, money search |
| JEL: | E52 E61 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:uct:uconnp:2011-21&r=cba |
| By: | Fabian Krüger (Department of Economics, University of Konstanz, Germany); Ingmar Nolte (Warwick Business School, Financial Econometrics Research Centre (FERC), University of Warwick) |
| Abstract: | This paper generalizes the discussion about disagreement versus uncertainty in macroeconomic survey data by emphasizing the importance of the (unknown) true predictive density. Using a forecast combination approach, we ask whether cross sections of survey point forecasts help to approximate the true predictive density. We find that although these cross-sections perform poorly individually, their inclusion into combined predictive densities can significantly improve upon densities relying solely on time series information. |
| Keywords: | Disagreement, Uncertainty, Predictive Density, Forecast Combination |
| JEL: | C53 E F |
| Date: | 2011–09–01 |
| URL: | http://d.repec.org/n?u=RePEc:knz:dpteco:1143&r=cba |
| By: | Svatopluk Kapounek (Department of Finance, FBE MENDELU in Brno) |
| Abstract: | The author focuses on the current problems of the common monetary policy implementation in the Eurozone in context of output stabilization function. The author focuses on the money demand function stability and its estimation. The stable money demand function ensures that the money supply would have predictable impact on the macroeconomic variables such as inflation and real economic growth. The instability is described by Poskeynesianś assumptions of money endogeneity. Although central banks may have certain control over the money supply, they cannot fix the stock of money in a country. According to the Postkeynesianś assumptions, the enterprises do not need ex ante stock of savings in order to carry out investment decisions. The causality is directed from economic activity to money demand. Interaction between the money demand and supply is arranged by multiplier effect of deposits. |
| Keywords: | monetary transmission mechanism, money endogeneity, European integration process, Post- Keynesian economics |
| JEL: | E5 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:men:wpaper:12_2011&r=cba |
| By: | William R. Parke (Department of Economics, University of North Carolina); George A. Waters (Department of Economics, Illinois State University) |
| Abstract: | Evolutionary game theory provides a fresh perspective on the prospects that agents with heterogeneous expectations might eventually come to agree on a single expectation corresponding to the efficient markets hypothesis. We establish conditions where agreement on a unique forecast is stable, but also show that persistent heterogeneous expectations can arise if those conditions do not hold. The critical element is the degree of curvature in payoff weighting functions agents use to value forecasting performance. We illustrate our results in the context of an asset pricing model where a martingale solution competes with the fundamental solution for agents’ attention. |
| Keywords: | rational expectations, hetergeneous expectations, evolutionary game theory, asset pricing, efficient markets hypothesis |
| JEL: | C73 D84 G12 C22 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:ils:wpaper:20111002&r=cba |
| By: | Delatte, Anne-Laure (BOFIT); Fouquau, Julien (BOFIT); Holz, Carsten A. (BOFIT) |
| Abstract: | We examine the transition process from a centrally planned to a market-based monetary system in China, with the objective of giving a functional form to the transition in money demand. Applying the cointegrating Time-Varying Smooth Transition Regression model proposed by Choi and Saikkonen (2004) on a constructed dataset spanning the period from 1984 to 2010, and using a seasonal unit-root test developed by Hylleberg et al. (1990), our findings invalidate much of the earlier literature. Our examination of disaggregate as well as aggregate money balances yields the following findings. (1) Households have an infinite demand for money at prevailing interest rates. <p> (2) Enterprises have gradually gained decision-making authority over their deposits. <p> (3) Money is a complement rather than a substitute to capital and this has become more prominent over the period. <p> (4) The credit plan has ceased to be a significant driver of money holdings after 1997. <p> (5) In the aggregate monetary sphere, the deposit interest rate has gained only a minor role as a monetary instrument, and only since 2000. |
| Keywords: | money demand; cointegrating time-varying smooth transition regression model; seasonal unit-root test; Chinese economy |
| JEL: | C51 E41 O11 P24 P52 |
| Date: | 2011–10–25 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofitp:2011_027&r=cba |
| By: | Roger Hammersland and Cathrine Bolstad Træe (Statistics Norway) |
| Abstract: | This paper gives a brief description and studies the salient features of a core macro-econometric model that allows for self-reinforcing co-movements between credit, asset prices and real economic activity, often denominated a financial accelerator in the literature. In contrast to the economic literature that cultivates highly stylized model representations aimed at illustrating the working and the implications of such a feature, the model of this paper integrates no less than two mutually reinforcing financial accelerator mechanisms in a full-fledged core macroeconomic model framework. Noteworthy, the impulse response pattern overall of such a model turns out to be very much in line with the ones one would have expected using a SVAR/DSGE modelling framework, though the amplitude of shocks is in most cases stronger than the ones pertaining to these kind of models. This is due to the working of the financial accelerators that contribute to magnify the effects of shocks to the economy. Furthermore, a forecast comparison undertaken between our model and an alternative macro econometric model not furnished with a financial block, suggests that financial feedback mechanisms have got the potential of boosting the forecasting property of theory-informed macro econometric models. Hence, in addition to enhancing the practical relevance of a model by incorporating a mechanism of high real-world authenticity, financial accelerators seem to come with a couple of values added. Namely, to i) guarantee against a systematic underestimation of the effects of macroeconomic shocks and to ii) be forecast-promoting |
| Keywords: | The Financial Accelerator; Structural Vector Error Correction Modelling; Core Macroeconomic Modelling; Impulse response analysis |
| JEL: | E1 E32 E44 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:ssb:dispap:668&r=cba |
| By: | Gastón Andrés Giordana; Ingmar Schumacher |
| Abstract: | In this article we investigate the leverage cycle in Luxembourg?s banking sector using individual bank-level data for the period 2003 Q1 to 2010 Q1. We discuss the mechanics behind the leverage cycle in Luxembourg?s banks and show that these banks predominantly adjust leverage by changing both loans and deposits. One of our findings is that Luxembourg?s banks have a procyclical leverage. This procyclicality is not due to marking-to-market but because Luxembourg?s banks are liquidity providers to the EU banking sector. This also explains the different evolution of leverage compared to the US commercial banks (Adrian and Shin [1]) that, even though their balance sheet structure is similar to that of the Luxembourgish banks, target a constant leverage. To further understand what drives leverage in Luxembourg?s banks we empirically investigate the role of bank characteristics as well as real, financial and expectation variables that proxy for macroeconomic conditions in the pre-crisis and crisis period. We find that off-balance sheet exposures have different effects in the pre-crisis and crisis period, and that the share of liquid assets in the portfolio only affects the amount of security holdings. In terms of macroeconomic variables, we find that the Euribor-OIS spread is a significant driver of the build-up in leverage in the pre-crisis period. The reason is that most banks in Luxembourg are either branches or subsidiaries. This, firstly, makes leverage a less relevant indicator of riskiness for investors. Secondly, it implies that in times of liquidity shortages, mother companies or groups demand further liquidity from their branch or subsidiary. The downturn in leverage during the crisis can be accredited to reductions in expectations, which we proxy by an economic sentiment indicator. It can also be explained by increasing bond prices which induce depositors to shift their funds from bank deposits into bonds. We find no important role for GDP growth. |
| Keywords: | leverage dynamics, banking sector, GMM estimation, crisis effect |
| JEL: | E51 E52 E58 G21 G28 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:bcl:bclwop:bclwp066&r=cba |
| By: | Gábor Kátay (Magyar Nemzeti Bank (central bank of Hungary)) |
| Abstract: | Following the approach recently developed for the International Wage Flexibility Project (IWFP), the paper presents new estimates of downward real and nominal wage rigidity for Hungary. Results suggest that nominal rigidity is more prominent in Hungary than real rigidity. When compared to other countries participating in the IWFP, Hungary ranks among the countries with the lowest degree of downward real rigidity. The estimated downward nominal rigidity for Hungary is higher, the measure is close to but still below the overall cross-country average. Using the same methodology, the paper also confirms the widespread view that the wage growth bargained at the national level has little compulsory power in Hungary. On the other hand, the minimum wage remains an important source of potential downward wage rigidity in Hungary. |
| Keywords: | downward nominal and real wage rigidity, wage change distributions, wage flexibility |
| JEL: | C23 E24 J3 J5 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:mnb:wpaper:2011/9&r=cba |