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on Monetary Economics |
| By: | Riccardo DiCecio; Edward Nelson |
| Abstract: | Developments in open-economy modeling, and the accumulation of experience with the monetary policy regimes prevailing in the United Kingdom and the euro area, have increased our ability to evaluate the effects that joining monetary union would have on the U.K. economy. This paper considers the debate on the United Kingdom's monetary policy options using a structural open-economy model. We use the Erceg, Gust, and Lopez-Salido (EGL) (2007) model to explore both the existing U.K. regime (CPI inflation targeting combined with a floating exchange rate), and adoption of the euro, as monetary policy options for the United Kingdom. Experiments with a baseline estimated version of the model suggest that there is improved stability for the U.K. economy with monetary union. Once large differences in the degree of nominal rigidity across economies are considered, the balance tilts toward the existing U.K. monetary policy regime. The improvement in U.K. economic stability under monetary union also diminishes if imports from the euro area are modeled as primarily intermediates instead of finished goods; or if we assume that the pressures reflected in foreign exchange market shocks, instead of vanishing with monetary union, are now manifested as an additional source of disturbances to domestic aggregate spending. |
| Keywords: | Monetary policy - European Union countries ; Monetary policy - Great Britain ; Great Britain |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-012&r=mon |
| By: | Das, Rituparna Das |
| Abstract: | Against the backdrop of interest rate risk in the fixed income portfolios of the financial institutions in India that arose since the first quarter of the current financial year 2008-09 the influence of monetary policy on the term structure emerged as an important issue for research purposes. In this context the findings in this paper are (i) strongest sensitivity of the term structure at the short end compared to other parts to expected changes in monetary policy, (ii) existence of unutilized arbitraged opportunities in the case of short term securities in absence of stripping, (iii) a mitigating tendency in the fluctuations of Nelson-Siegel-Svensson short rate and the proxy monetary policy rate during the post sample period and (iv) existence of a fear among the market participants about the future liquidity conditions during the last quarter of 2007-08. |
| Keywords: | term structure; liquidity; monetary policy; Nelson-Siegel-Svensson; Vasicek; federal funds target rate; MIBOR |
| JEL: | E43 E52 |
| Date: | 2009–07–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:16436&r=mon |
| By: | Russell Cooper; Hubert Kempf; Dan Peled |
| Abstract: | This paper studies the effects of monetary policy rules in a monetary union. The focus of the analysis is on the interaction between the fiscal policy of member countries (regions) and the central monetary authority. When capital markets are integrated, the fiscal policy of one country will influence equilibrium wages and interest rates. Thus there are fiscal spillovers within a federation. The magnitude and direction of these spillovers, in particular the presence of a crowding out effect, can be influenced by the choice of monetary policy rules. We find that there does not exist a monetary policy rule which completely insulates agents in one region from fiscal policy in another. Some familiar policy rules, such as pegging an interest rate, can provide partial insulation. |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:30&r=mon |
| By: | Jane M. Binner; Peter Tino; Jonathan Tepper; Richard G. Anderson; Barry Jones; Graham Kendall |
| Abstract: | This paper provides the most fully comprehensive evidence to date on whether or not monetary aggregates are valuable for forecasting US inflation in the early to mid 2000s. We explore a wide range of different definitions of money, including different methods of aggregation and different collections of included monetary assets. In our forecasting experiment we use two non-linear techniques, namely, recurrent neural networks and kernel recursive least squares regression - techniques that are new to macroeconomics. Recurrent neural networks operate with potentially unbounded input memory, while the kernel regression technique is a finite memory predictor. The two methodologies compete to find the best fitting US inflation forecasting models and are then compared to forecasts from a naive random walk model. The best models were non-linear autoregressive models based on kernel methods. Our findings do not provide much support for the usefulness of monetary aggregates in forecasting inflation. |
| Keywords: | Forecasting ; Inflation (Finance) ; Monetary theory |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-030&r=mon |
| By: | Riccardo DiCecio; Edward Nelson |
| Abstract: | We argue that the Great Inflation experienced by both the United Kingdom and the United States in the 1970s has an explanation valid for both countries. The explanation does not appeal to common shocks or to exchange rate linkages, but to the common doctrine underlying the systematic monetary policy choices in each country. The nonmonetary approach to inflation control that was already influential in the United Kingdom came to be adopted by the United States during the 1970s. We document our position by examining official policymaking doctrine in the United Kingdom and the United States in the 1970s, and by considering results from a structural macroeconomic model estimated using U.K. data. |
| Keywords: | Inflation (Finance) ; Great Britain |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-015&r=mon |
| By: | Simone Elmer (KOF Swiss Economic Institute, ETH Zurich, Switzerland); Thomas Maag (KOF Swiss Economic Institute, ETH Zurich, Switzerland) |
| Abstract: | This paper investigates persistence of Swiss consumer price inflation using aggregate and disaggregate inflation data covering 1983{2008. We document that persistence of sectoral inflation rates is below persistence of aggregate inflation. Our main finding is that inflation persistence significantly declines in the early 1990s. An estimated factor model reveals that inflation persistence stems from a persistent component that is common to inflation rates across sectors. Both the relevance and the persistence of the common component decline in the 1990s. Depending on the sample period and aggregation level, 70 to 90 percent of the variance in sectoral inflation rates is accounted for by short-lived sectoral factors. |
| Keywords: | inflation persistence, inflation dynamics, relative price variability, factor model |
| JEL: | E31 E52 C22 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:kof:wpskof:09-235&r=mon |
| By: | Marika Karanassou (Queen Mary, University of London and IZA); Hector Sala (Universitat Autònoma de Barcelona and IZA) |
| Abstract: | This paper adresses the various methodological issues surrounding vector autoregressions, simultaneous equations, and chain reactions, and provides new evidence on the long-run inflation-unemployment tradeoff in the US. It is argued that money growth is a superior indicator of the monetary environment than the federal funds rate and, thus, the focus is on the inflation/unemployment responses to money growth shocks. SVAR (structural vector autoregression) and GMM (generalised method of moments) estimations confirm earlier findings in Karanassou, Sala and Snower (2005, 2008b) obtained from chain reaction structural models: the slope of the US Phillips curve is far from vertical, even in the long-run, which implies that the nominal and real sides of the economy are symbiotic. In the light of the significant and robust long-run inflation-unemployment tradeoffs, policy makers should reconsider the classical dichotomy thesis. |
| Keywords: | Inflation, Unemployment, Money growth, SVAR, GMM, Structural modelling, Chain reactions |
| JEL: | E24 E31 E51 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp647&r=mon |
| By: | Manfred Gärtner; Florian Jung |
| Abstract: | The paper shows that structural models of the IS-LM and Mundell-Fleming variety have a lot to tell about the macroeconomics of the current global crisis. In addition to demonstrating how the emergence of risk premiums in money and capital markets may drive economies into recessions, it shows the following: (1) Liquidity traps may occur not only when interest rates approach zero but at positive and/or rising rates as well; (2) Fiscal policy works even in a small, open economy under flexible exchange rates when the country is stuck in a liquidity trap; (3) Near the fringe of liquidity traps, the risk arises of perfect traps, in which neither monetary nor fiscal policy works when used in isolation, but policy coordination is called for; and (4) Massive financial crises in the domestic money market may even destabilize the economy. |
| Keywords: | financial crisis, credit crunch, liquidity trap, zero lower bound, risk premiums, policy options, fiscal policy, monetary policy, open economy. |
| JEL: | E63 F01 F41 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:usg:dp2009:2009-15&r=mon |
| By: | Nicolas Groshenny (Reserve Bank of New Zealand, Economics department) |
| Abstract: | This paper estimates a medium-scale DSGE model with search unemployment by matching model and data spectra. Price mark-up shocks emerge as the main source of business-cycle fluctuations in the euro area. Key factors in the propagation of these disturbances are a high degree of inflation indexation and a persistent response of monetary policy to deviations from the inflation target |
| Keywords: | DSGE models, business cycles, frequency-domain analysis |
| JEL: | E32 C51 C52 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbb:reswpp:200907-27&r=mon |
| By: | Yi Wen |
| Abstract: | This paper reconsiders the welfare costs of inflation and the welfare gains from financial intermediation in a heterogeneous-agent economy where money is held as a store of value (as in Bewley, 1980). The dynamic stochastic general equilibrium model recaptures some essential features of the liquidity-preference theory of Keynes (1930, 1936). Because of heterogeneous liquidity demand, transitory lump-sum money injections can have persistent expansionary effects despite flexible prices, and such effects can be greatly amplified by the banking system through the credit channel. However, permanent money growth can be extremely costly: With log utility functions, consumers are willing to reduce consumption by 15% (or more) to avoid a 10% annual inflation. For the same reason, financial intermediation can significantly improve welfare: The welfare costs of a collapse of the banking system is estimated as about 10-68% of aggregate output. These welfare implications differ dramatically from those of the existing literature. |
| Keywords: | Liquidity (Economics) |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-019&r=mon |
| By: | David H. Romer |
| Abstract: | This paper describes a new data set of the forecasts of output growth, inflation, and unemployment prepared by individual members of the Federal Open Market Committee. The paper discusses the scope of the data set, possibilities for extending it, and some potential uses. It offers a preliminary examination of some of the cross-sectional features of the data. |
| JEL: | E52 E58 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15208&r=mon |
| By: | Kaltenbrunner, Annina; Nissanke, Machiko |
| Abstract: | Set in the context of the recent theoretical and policy debates on appropriate exchange rate regimes for emerging market economies in a world of free capital mobility, the paper attempts to present the case for an intermediate exchange rate regime, drawing on recent theoretical and empirical literatures on behavioural finance and currency market structures; and to examine empirically the experiences and evolution of Brazil.s foreign exchange market under different exchange rate regimes. |
| Keywords: | exchange rate management, emerging markets, Brazil |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:unu:wpaper:rp2009-29&r=mon |
| By: | Soderlind, Paul (University of St. Gallen) |
| Abstract: | Nominal and real U.S. interest rates (1997Q1-2008Q2) are combined with inflation expectations from the Survey of Professional Forecasters to calculate time series of risk premia. It is shown that survey data on inflation and output growth uncertainty, as well as a proxy for liquidity premia can explain a large amount of the variation in these risk premia. |
| Keywords: | break-even inflation; liquidity premium; Survey of Professional Forecasters |
| JEL: | E27 E47 |
| Date: | 2009–01–28 |
| URL: | http://d.repec.org/n?u=RePEc:ris:snbwpa:2009_004&r=mon |
| By: | Kim , Insu; Kim, Minsoo |
| Abstract: | This paper investigates the issue of rational expectations using inflation forecasts from the Survey of Professional Forecasters (SPF) and the Green Book. We provide an alternative test of rational expectations hypothesis by measuring the degree of persistence of potential systematic mistakes. The test is obtained by solving a signal extraction problem that distinguishes between systematic and non-systematic forecast errors. The findings indicate highly persistent systematic mistakes, which are driven by the inefficient use of available information, and reject the rational expectations hypothesis. The estimated time-varying bias can be used to improve the SPF and Green Book inflation forecast performance by at least 13.4%. This paper also documents evidence that the real interest rate plays a crucial role in explaining the level of bias that leads to under- and over predictions of actual inflation. |
| Keywords: | Inflation Expectations; Bias; Forecasts; Rational Expectations. |
| JEL: | D84 E31 E37 |
| Date: | 2009–07–23 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:16447&r=mon |
| By: | Thomas Maag (KOF Swiss Economic Institute, ETH Zurich, Switzerland) |
| Abstract: | This paper assesses the probability method for quantifying EU consumer survey data on perceived and expected inflation. Based on micro-data from the Swedish consumer survey that asks for both qualitative and quantitative responses, I find that the theoretical assumptions of the method do not hold. In particular, estimated models of response behavior indicate that qualitative inflation expectations are not ordered. Nevertheless, the probability method generates series that are highly correlated with the mean of actual quantitative beliefs. For quantifying the cross-sectional dispersion of beliefs, however, an index of qualitative variation outperforms the probability method. |
| Keywords: | quantification, inflation expectations, inflation perceptions, qualitative response data, belief formation |
| JEL: | C53 D84 E31 |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:kof:wpskof:09-230&r=mon |
| By: | Hume, Michael (Monetary Policy Committee Unit, Bank of England); Sentance, Andrew (Monetary Policy Committee Unit, Bank of England) |
| Abstract: | The recent financial crisis has put the spotlight on the rapid rise in credit which preceded it. In this paper, we provide an empirical and theoretical analysis of the credit boom and the macroeconomic context in which it developed. We find that the boom was unusually long and associated with neither particularly strong growth nor rising inflation in the economies in which it took place. We show that this type of credit and financial cycle is hard to reconcile with existing economic theory and argue that, while the 'global savings glut' may account for the cycle's initial phase, other factors - such as the conduct of monetary policy and perceptions of declining macroeconomic risk - were more important from the mid-2000s onwards. We conclude by identifying some of the challenges now facing macroeconomics and policy. |
| Keywords: | credit; business cycle; financial crisis; monetary policy; asset prices; boom and bust |
| JEL: | E30 E50 |
| Date: | 2009–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:mpc:wpaper:0027&r=mon |
| By: | Nicola Cetorelli; Linda S. Goldberg |
| Abstract: | As banking has become more globalized, so too have the consequences of shocks originating in home and host markets. Global banks can provide liquidity and risk-sharing opportunities to the host market in the event of adverse host-country shocks, but they can also have profound effects across international markets. Indeed, global banks played a significant role in the transmission of the current crisis to emerging-market economies. Flows between global banks and emerging markets include both cross-border lending, which has long been recognized as responding significantly to shocks at home or abroad, and internal capital-market lending, which is the internal flow of funds within a banking organization (such as between a headquarters and its offices in foreign locations). Adverse liquidity shocks to developed-country banking, such as those that occurred in the United States in 2007 and 2008, have reduced lending in local markets through contractions in cross-border lending to banks and private agents and also through contractions in parent banks' support of foreign affiliates. Because all these forms of transmission impinge on the lending channel in recipient markets, the ownership structure of emerging-market banks does not by itself provide sufficient basis for identifying the degree of shock transmission from abroad. |
| Keywords: | Globalization ; Banks and banking, International ; Emerging markets ; Liquidity (Economics) |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:377&r=mon |
| By: | Daniel L. Thornton |
| Abstract: | An unresolved puzzle in the empirical foreign exchange literature is that tests of forward rate unbiasedness using the forward rate and forward premium equations yield markedly different conclusions about the unbiasedness of the forward exchange rate. This puzzle is resolved by showing that because of the persistence in exchange rates, estimates of the slope coefficient from the forward premium equation are extremely sensitive to small violations of the null hypothesis of the type and magnitude that are likely to exist in the real world. Moreover, contrary to suggestions in the literature and common practice, the forward premium equation does not necessarily provide a better test of unbiasedness than the forward rate equation. |
| Keywords: | Foreign exchange |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-002&r=mon |
| By: | Peroni, Chiara |
| Abstract: | Recent empirical studies suggests that affine models, a popular framework to analyse term structures of interest rates, are misspecified. This evidence is mainly based on time series properties of the data. This article re-examines this controversy, by investigating both cross-sectional and dynamic properties of affine models. To do so, it applies robust non-parametric techniques to two different sets of financial data, which contain information on the UK and US yield curve. The analysis shows the strong non-linearity in the relationship of yields to the US and UK short rate. The non-linear pattern is concave in the state variable, and increasing with respect to the maturity, for both countries. Linear and non-linear specifications are then compared by means of a formal statistical criterion, the Generalised Likelihood-Ratio test statistics, which confirms evidence against the linear specification. |
| Keywords: | interest rates; term structure; affine models; non-linearity; non-parametric regression. |
| JEL: | E43 G12 C14 |
| Date: | 2009–07–13 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:16471&r=mon |
| By: | Dufourt, Frédéric (BETA-CNRS); Lloyd-Braga, Teresa (Universidade Catolica Portuguesa, Lisbon); Modesto, Leonor (Universidade Catolica Portuguesa, Lisbon) |
| Abstract: | We propose and estimate a model where unemployment fluctuations result from self-fulfilling changes in expected inflation (sunspot shocks) affecting nominal wage bargaining. Since the estimated parameters fall near the locus of Hopf bifurcations, country-specific expected inflation shocks can replicate the strong persistence and heterogeneity observed in European unemployment rates. They also generate positive comovements in macroeconomic variables and a large relative volatility of consumption. All these features, hardly accounted for by standard sunspot-driven models, are explained here by the fact that liquidity constrained workers, facing earnings uncertainty in the context of imperfect unemployment insurance, choose to consume their current income. |
| Keywords: | unemployment fluctuations, sunspots equilibria, expected inflation, wage bargaining |
| JEL: | J60 E32 E37 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4302&r=mon |
| By: | Guillermo L. Ordoñez |
| Abstract: | It is well known that movements in lending rates are asymmetric; they rise quickly and sharply, but fall slowly and gradually. Not known is the fact that the asymmetry is stronger the less developed a country's financial system is. This new fact is here documented and explained in a model with an endogenous flow of information about economic conditions. The stronger asymmetry in less developed countries stems from their greater financial system frictions, such as monitoring and bankruptcy costs, which first magnify jumps of lending rates and then delay their recoveries by restricting the generation of information after the crisis. A quantitative exploration of the model shows the data are consistent with this explanation. |
| Keywords: | Financial crises ; Developing countries |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:429&r=mon |
| By: | Douglas W. Diamond; Raghuram G. Rajan |
| Abstract: | The cheapest way for banks to finance long term illiquid projects is typically to borrow short term from households. But when household needs for funds are high, interest rates will rise sharply, debtors will have to shut down illiquid projects, and in extremis, will face more damaging runs. Authorities may want to push down interest rates to maintain economic activity in the face of such illiquidity, but intervention may not always be feasible, and when feasible, could encourage banks to increase leverage or fund even more illiquid projects up front. This could make all parties worse off. Authorities may want to commit to a specific policy of interest rate intervention to restore appropriate incentives. For instance, to offset incentives for banks to make more illiquid loans, authorities may have to commit to raising rates when low, to counter the distortions created by lowering them when high. We draw implications for interest rate policy to combat illiquidity. |
| JEL: | E4 E44 E5 E52 E58 G21 G38 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15197&r=mon |
| By: | Edward Nelson |
| Abstract: | This paper analyzes the interaction of Milton Friedman and U.K. economic policy from 1938 to 1979. The period under study is separated into 1938-1946, 1946-1959, 1959-1970, and 1970-1979. For each of these subperiods, I consider Friedman's observations on and dealings with key events, issues, and personalities in U.K. monetary policy and in general U.K. economic policy. |
| Keywords: | Friedman, Milton ; Economic policy - Great Britain |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-017&r=mon |
| By: | Dimitris Christopoulos; Miguel A. León-Ledesma |
| Abstract: | This note revisits the temporal causality between exchange rates and fundamentals put forward by Engel and West (2005). We analyze the causal link within multivariate VARs by making use of the concept of multi-step causality. Our results show that, considering information content beyond one-period ahead, the causal link between exchange rates and fundamentals is stronger than previously reported. We find Granger-causality running from exchange rates to fundamentals at some horizon in 49% of our tests and running from fundamentals to exchange rates in 59% of them. |
| Keywords: | Granger-causality; multi-step; exchange rates; fundamentals |
| JEL: | F31 F37 C32 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:ukc:ukcedp:0909&r=mon |