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on Monetary Economics |
| By: | Monique Reid (Department of Economics, University of Stellenbosch); Stan du Plessis (Department of Economics, University of Stellenbosch) |
| Abstract: | Inflation targeting is a forward-looking framework for monetary policy that has brought unprecedented transparency to the process of monetary policy. This paper aims to assess the degree to which the South African Reserve Bank’s (SARB) Monetary Policy Committee (MPC) has, since the introduction of inflation targeting, successfully communicated to the public its policy analysis, and, in particular, the expected future policy changes. This paper follows international literature (Rosa and Verga (2007), Ehrmann and Fratszcher (2005)) in constructing a numerical index that is used to reflect the information content of the SARB’s communications, specifically the monetary policy statements that accompanied each of the MPC meetings since 2000. Relating this index to subsequent policy decisions reveals the informativeness of the index and, by implication, the informativeness of the underlying monetary policy statements. This method allows us to judge, systematically, the degree to which the MPC has communicated successfully, and the evolution of that success over the past nine years. We find evidence that the MPC has succeeded in signalling their likely future policy decision with consistency over this period. |
| Keywords: | South Africa, Inflation targeting, Central bank communication, Effective monetary policy, forward-looking policy framework |
| JEL: | E42 E52 E58 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:sza:wpaper:wpapers110&r=mon |
| By: | Hanif, M. Nadim; Sheikh, Salman |
| Abstract: | Continuous growth in Islamic finance calls for studying the framework in which the monetary policy maker (i.e., central bank) performs its functions. Central banks in Muslim countries are using various instruments for monetary policy purpose including interest rate. As a result, Islamic financial institutions (IFIs) are facing issues in benchmarking the price of financial instruments. Acceptable solution to benchmarking lies in the presence of a real economic activity in the base of any proposal and its feasibility for business performance when put against conventional banking. This paper presents empirical evidence of statistical equivalence of nominal GDP growth rate and official interest rate for ‘advanced,’ ‘all,’ and some Muslim countries. We propose nominal GDP growth rate as benchmark for pricing domestic financial transactions of IFIs as well as for pricing external bilateral/ multilateral loans. The paper also suggests nominal income targeting as monetary policy regime. |
| Keywords: | Islamic Finance; Central Bank; Interest Rate; Nominal Income Targeting |
| JEL: | G12 E58 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:22907&r=mon |
| By: | Ana Beatriz Galvao; Massimiliano Marcellino |
| Abstract: | This paper contributes to the literature on the changing transmission mechanism of monetary policy by introducing a model whose parameter evolution explicitly depends on the conduct of monetary policy. We find that the model fits the data well, in particular when complemented with an estimated break around 1985 that could be associated with the re-gained credibility of the central bank. The responses of output and inflation to policy shocks change not only because of the break in 1985 but also according to the monetary policy stance: policy shocks have stronger negative e¤ects when policy is tight. There is also evidence in favour of large changes in the volatility of the output equation, but not of inflation. A set of counterfactual experiments indicate that good policy and good luck contributed to the great moderation, but neither of them can fully explain it. A more general variation in the model dynamics underlying the shock transmission mechanism is required. |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2010/22&r=mon |
| By: | Giuseppe Ferrero (Banca d'Italia); Alessandro Secchi (Banca d'Italia) |
| Abstract: | We study the impact of the publication of central bank’s macroeconomic projections on the dynamic properties of an economy where: (i) private agents have incomplete information and form their expectations using recursive learning algorithms, (ii) the short-term nominal interest rate is set as a linear function of the deviations of inflation and real output from their target level and (iii) the central bank, ignoring the exact mechanism used by private agents to form expectations, assumes that it can be reasonably approximated by perfect rationality and releases macroeconomic projections consistent with this assumption. Results in terms of stability of the equilibrium and speed of convergence of the learning process crucially depend on the set of macroeconomic projections released by the central bank. In particular, while the publication of inflation and output gap projections enlarges the set of interest rate rules associated with stable equilibria under learning and helps agents to learn faster, the announcement of the interest rate path exerts the opposite effect. In the latter case, in order to stabilize expectations and to speed up the learning process the response of the policy instrument to inflation should be stronger than under no announcement. |
| Keywords: | Monetary policy, Communication, Interest rates, Learning, Speed of Convergence |
| JEL: | E58 E52 E43 D83 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:nbp:nbpmis:72&r=mon |
| By: | Yu-chin Chen (University of Washington); Kwok Ping Tsang (Virginia Tech) |
| Abstract: | The nominal exchange rate is both a macroeconomic variable equilibrating international markets and a financial asset that embodies expectations and prices risks associated with cross border currency holdings. Recognizing this, we adopt a joint macro-finance strategy to model the exchange rate. We incorporate into a monetary exchange rate model macroeconomic stabilization through Taylor-rule monetary policy on one hand, and on the other, market expectations and perceived risks embodied in the cross-country yield curves. Using monthly data between 1985 and 2005 for Canada, Japan, the UK and the US, we employ a state-space system to model the relative yield curves between country-pairs using the Nelson and Siegel (1987) latent factors, and combine them with monetary policy targets (output gap and inflation) into a vector autoregression (VAR) for bilateral exchange rate changes. We find strong evidence that both the financial and macro variables are important for explaining exchange rate dynamics and excess currency returns, especially for the yen and the pound rates relative to the dollar. Moreover, by decomposing the yield curves into expected future yields and bond market term premiums, we show that both expectations about future macroeconomic conditions and perceived risks are priced into the currencies. These findings provide support for the view that the nominal exchange rate is determined by both macroeconomic as well as financial forces. |
| Date: | 2009–12 |
| URL: | http://d.repec.org/n?u=RePEc:udb:wpaper:uwec-2009-24-r&r=mon |
| By: | Silvia Gabrieli (Faculty of Economics, University of Rome "Tor Vergata") |
| Abstract: | This paper analyses the functioning of the overnight unsecured euro money market during the ongoing crisis in terms of i) operational efficiency of monetary policy implementation, ii) efficient reallocation of banking system’s reserves, iii) developments in the pricing of interbank loans. The results suggest that monetary policy implementation has been hampered by the crisis, particularly after the end of September 2008. A heightened awareness of counterparty credit risk seems to be one key factor behind the downward pressure on unsecured rates, as well as behind the notable increase in their cross-section dispersion. Starting from September 2008, and even more in October 2008, banks perceived as relatively “riskier” pre-turmoil paid significantly higher interest rates to borrow overnight funds. In November, a non-uniform softening of the strains occurred: only the most active (roughly the largest) borrowers experienced a notable price improvement. This is possibly a reflection of the bailouts of “too-big-to-fail” institutions. Heterogeneous developments in banks’ funding costs also suggest a move against the integration of the euro interbank market. |
| Keywords: | Interbank market; Financial crisis; Monetary policy operational efficiency; Moral hazard; European financial integration |
| JEL: | E58 G21 |
| Date: | 2010–05–28 |
| URL: | http://d.repec.org/n?u=RePEc:rtv:ceisrp:158&r=mon |
| By: | Maurice J. Roche (Department of Economics, Ryerson University, Toronto, Canada); Michael J. Moore (School of Management and Economics, The Queen's University of Belfast, Belfast, Northern Ireland) |
| Abstract: | We present a model that simultaneously explains why uncovered interest parity holds for some pairs of countries and not for others. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habit persistence is modeled using Campbell Cochrane preferences with ‘deep’ habits along the lines of the work of Ravn, Schmitt-Grohe and Uribe. By deep habits, we mean habits defined over goods rather than countries. The negative slope in the Fama regression arises when monetary instability is low and the precautionary savings motive dominates the intertemporal substitution motive. When monetary instability is high, the Fama slope is positive in line with uncovered interest parity. The model is simulated using the artificial economy methodology for 34 currencies against the US dollar. We conclude that, given the predominance of precautionary savings, the degree of monetary instability explains whether or not uncovered interest parity holds. |
| Keywords: | Monetary instability; Uncovered interest parity; Forward biasedness puzzle; Carry trade; Habit persistence |
| JEL: | F31 F41 G12 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:rye:wpaper:wp015&r=mon |
| By: | Bernardo Maggi; Eleonora Cavallaro; Marcella Mulino (Univ. of Rome “La Sapienza”) |
| Abstract: | The paper presents an open-economy macrodynamical growth model with the aim of giving an endogenous characterisation to the process that leads a small country with a currency-board arrangement to accumulate dangerously high levels of external debt and become vulnerable to macroeconomic instability. The macrodynamics of the model results from the combination of the commitment to maintain the peg - that makes liquidity closely dependent on the dynamics of foreign reserves – and the non-linear real and financial interactions that drives the pro-cyclical behaviour of the economy. Within this context, the external finance ease during an economic upswing leads to debt-supported growth and financial fragility; the consequent deterioration of profitability expectations brings about a capital reversal that, in the absence of monetary stabilization tools, makes the currency arrangement unsustainable. A financial crisis may thus turn into a currency crisis. We run a continuous-time estimation of a non-linear differential equations system for Argentina during the years of the currency-board arrangement. We find that two steady-state solutions exist. The local stability and sensitivity analysis show that both equilibria are unstable and that the qualitative nature of the equilibria depends in particular on lenders’ responsiveness to the degree of leverage. On the contrary, when considering a different currency arrangement with an autonomous monetary policy, the system becomes stable. |
| Keywords: | Currency Board, Financial Crisis, Monetary policy, Continuous Time Econometrics, Stability, Sensitivity |
| JEL: | C51 C62 F34 E52 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:des:wpaper:18&r=mon |
| By: | Kobayashi, Teruyoshi; Muto, Ichiro |
| Abstract: | This study examines the expectational stability of the rational expectations equilibria (REE) under alternative Taylor rules when trend inflation is non-zero. We find that when trend inflation is high, the REE is likely to be expectationally unstable. This result holds true regardless of the nature of the data (such as contemporaneous data, forecast, and lagged data) introduced in the Taylor rule. Our results suggest that a high macroeconomic volatility during the period of high trend inflation can be well explained by introducing the concept of expectational stability. |
| Keywords: | adaptive learning, E-stability, Taylor rule, trend inflation |
| JEL: | D84 E31 E52 |
| Date: | 2010–05–28 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:22952&r=mon |
| By: | Das, Rituparna |
| Abstract: | Researchers reported that - there were two approaches to money supply determination in India: balance sheet or structural approach and money multiplier approach; the former focused on individual items in the balance sheet of the consolidated monetary sector in order to explain changes in money supply and the latter focused on the relationship between money stock and reserve money; the money multiplier approach emerged strongly as a critic to the balance sheet approach; between January 1976 and January 1978 there was a hot and rich debate between two groups of researchers, one group led by Gupta who believed in the money multiplier theory, the other group of RBI economists, who were not accepting this theory; the debate gave rise to a number of research papers where mostly regression techniques were used to estimate and forecast money supply function; Bhattacharya (1972), Gupta (1972) and Marwah (1972) used regression techniques to estimate money multiplier in India four years before the debate took place. The above debate is narrated below in an analytical style. |
| Keywords: | money supply; high powered money; reserve money; RBI; Working Group; multiplier; balance sheet; forecast; currency |
| JEL: | E0 E4 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:22858&r=mon |
| By: | Kathryn M.E. Dominguez (Gerald R. Ford School of Public Policy, University of Michigan); Rasmus Fatum (School of Business, University of Alberta); Pavel Vacek (School of Business, University of Alberta) |
| Abstract: | Many developing countries have increased their foreign reserve stocks dramatically in recent years, often motivated by the desire for precautionary self-insurance. One of the negative consequences of large accumulations for these countries is the risk of valuation losses. In this paper we examine the implications of systematic reserve decumulation by the Czech authorities aimed at mitigating valuation losses on euro-denominated assets. The policy was explicitly not intended to influence the value of the koruna relative to the euro. Initially the timing and size of reserve sales was not predictable, eventually sales occurred on a daily basis (in three equal installments within the day). This project examines whether these reserve sales, both during the regime of discretionary timing as well as when sales occurred every day, had unintended consequences for the domestic currency. Our findings using intraday exchange rate data and time-stamped reserve sales indicate that when decumulation occurred every day these sales led to significant appreciation of the koruna. Overall, our results suggest that the manner in which reserve sales are carried out matters for whether reserve decumulation influences the relative value of the domestic currency. |
| Keywords: | foreign exchange reserves; exchange rate determination; high-frequency volatility modeling |
| JEL: | E58 F31 F32 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:kud:epruwp:10-06&r=mon |
| By: | Kahn, Charles M. (University of Illinois, Urbana-Champaign) |
| Abstract: | This paper examines competition between private and public payments settlement systems, and examines the consequences of round-the-clock private payments arrangements on the competitiveness of public systems. Central to the issue is the role of collateral both as a requirement for participation in central bank sponsored payments arrangements and as the backing for private intermediary arrangements. The presence of private systems serves as a check on the ability of a monetary authority to tighten monetary policy. Round-the-clock systems are an example of a collateral saving innovation that further pressures central bank pre-eminence in payments settlement. |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:illbus:10-0100&r=mon |
| By: | Massimo Guidolin; Daniel L. Thornton |
| Abstract: | Despite its role in monetary policy and finance, the expectations hypothesis (EH) of the term structure of interest rates has received virtually no empirical support. The empirical failure of the EH was attributed to a variety of econometric biases associated with the single-equation models most often used to test it, although no bias seems to account for the extent and magnitude of the failure. This paper analyzes the EH by focusing on the predictability of the short-term rate. This is done by comparing h-month ahead forecasts for the 1- and 3-month Treasury bill yields implied by the EH with the forecasts from random-walk, Diebold and Li’s (2006), and Duffee’s (2002) models. The evidence suggests that the failure of the EH is likely a consequence of market participants’ inability to adequately predict the short-term rate, in that none of these models out-performs a simple random walk model in recursive, real time experiments. Using standard methods that take into account the additional uncertainty caused by the need to estimate model parameters, the null hypothesis of equal predictive accuracy of each models relative to the random walk alternative is never rejected |
| Keywords: | Rational expectations (Economic theory) ; Interest rates |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2010-013&r=mon |
| By: | Nicola Cetorelli; Linda S. Goldberg |
| Abstract: | Global banks played a significant role in transmitting the 2007-09 financial crisis to emerging-market economies. We examine adverse liquidity shocks on main developed-country banking systems and their relationships to emerging markets across Europe, Asia, and Latin America, isolating loan supply from loan demand effects. Loan supply in emerging markets across Europe, Asia, and Latin America was affected significantly through three separate channels: 1) a contraction in direct, cross-border lending by foreign banks; 2) a contraction in local lending by foreign banks' affiliates in emerging markets; and 3) a contraction in loan supply by domestic banks, resulting from the funding shock to their balance sheets induced by the decline in interbank, cross-border lending. Policy interventions, such as the Vienna Initiative introduced in Europe, influenced the lending-channel effects on emerging markets of shocks to head-office balance sheets. |
| Keywords: | Capital market ; Emerging markets ; International finance ; International liquidity ; Banks and banking, International ; Banks and banking, Foreign ; Financial crises ; Loans, Foreign |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:446&r=mon |
| By: | Enghin Atalay; Antoine Martin; James McAndrews |
| Abstract: | This paper attempts to quantify the benefits associated with operating a liquidity-saving mechanism (LSM) in Fedwire, the large-value payment system of the Federal Reserve. Calibrating the model of Martin and McAndrews (2008), we find that potential gains are large compared to the likely cost of implementing an LSM, on the order of hundreds of thousands of dollars per day. |
| Keywords: | Fedwire ; Liquidity (Economics) ; Payment systems ; Federal Reserve System |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:447&r=mon |
| By: | Luis M. Viceira (Harvard Business School); Ricardo Gimeno (Banco de España) |
| Abstract: | In this article, we explore the demand for the euro for risk management purposes, and the evidence of stock market integration in the euro area. We define a reserve currency as one that investors demand either because it helps them hedge real interest risk and inflation risk, or because it helps them reduce the volatility of their portfolio of stocks and bonds because its return is negatively correlated with the returns on those assets. This article re-examines the role of the euro as a reserve currency in the sense of Campbell, Viceira and White (2003), updating their evidence, and reviews the evidence of Campbell, Serfaty-de Medeiros and Viceira (2010) in detail. Consistent with the intuition that an integrated capital market is one in which there is a common discount factor pricing securities, we also investigate whether stocks in the euro area have moved from a regime in which national stock markets were priced with discount rates that were predominantly country specific, to a regime in which national stock markets are predominantly priced by a euro area-wide common discount rate. We adopt the beta decomposition approach of Campbell and Vuolteenaho (2004) and Campbell, Polk and Vuolteenaho (2010) to test for capital market integration, and find robust evidence of increased capital market integration in the euro zone, and consequently improved risk sharing among euro zone economies. |
| Keywords: | Euro, Reserve Currency, Currency hedging, Market Integration, Beta decomposition |
| JEL: | G12 G15 F31 F15 E42 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:1014&r=mon |
| By: | Patnaik, Ila (National Institute of Public Finance and Policy); Shah, Ajay (National Institute of Public Finance and Policy); Sethy, Anmol (National Institute of Public Finance and Policy); Balasubramaniam, Vimal (National Institute of Public Finance and Policy) |
| Abstract: | Prior to the Asian financial crisis, most Asian exchange rates were de facto pegged to the US Dollar. In the crisis, many economies experienced a brief period of extreme flexibility. A `fear of oating' gave reduced exibility when the crisis subsided, but flexibility after the crisis was greater than that seen prior to the crisis. Contrary to the idea of a durable Bretton Woods II arrangement, Asia then went on to slowly raise flexibility and reduce the role for the US Dollar. When the period from April 2008 to December 2009 is compared against periods of high in flexibility, from January 1991 to November 1991 and October 1995 to March 1997, the increase in flexibility is economically and statistically significant. This paper proposes a new measure of dollar pegging, the "Bretton Woods II score". We find that by this measure Asia has been slowly moving away from a Bretton Woods II arrangement. |
| Keywords: | Exchange rate regime, Asia, Bretton Woods II hypothesis |
| JEL: | F31 F33 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:npf:wpaper:10/69&r=mon |
| By: | Baafi Antwi, Joseph |
| Abstract: | This essay extends the capital based macroeconomic theory to include international capital flow thus extending it to an open economy and analyze it in the context of the BFH system, Free banking system and 100 percent reserve ration. In all these, it was noticed that interest rate will barely change even though the possibility of interest rate changes was not ruled out completely. A test of these systems was conducted on Latvia, Lithuanian, Kazakhstan and Kyrgyzstan and was successful. However, it must be noted that these are just prepositions as these system are not in place at the moment. In furtherance to this, past and present monetary system used by the countries exhibited similarities to these systems, even though difference could largely be seen. |
| Keywords: | International Capital Flows: Interest rate: 100 percent reserve system: free banking system: BFH system |
| JEL: | F0 F41 |
| Date: | 2010–02–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:22935&r=mon |
| By: | Karsten Staehr |
| Abstract: | This paper seeks to identify factors driving consumer price inflation in the new EU member countries from Central and Eastern Europe. Different theories are discussed, including some of particular importance to economies experiencing high economic growth and rapid structural change. The explanatory power of the theories is tested using panel data estimations based on annual data from 1997 to 2007. Convergence- related factors, including the Balassa-Samuelson and the Bhagwati capital-deepening effects, are important drivers of inflation. Import inflation and, by implication, exchange rate developments have an important impact, while the exchange rate regime is unimportant. Higher government debt and larger revenues are associated with higher inflation. The cyclical position as measured by unemployment, employment changes or the current account balance is found to affect inflation. Food price shocks have large but short-lived effects, while energy price shocks have longer-lasting effects on the inflation rate. Multicollinearity across the explanatory variables makes it difficult to identify the effect of each individual factor |
| Keywords: | inflation, inflation theories, real and nominal convergence, inflation determinants |
| JEL: | E31 E42 E63 P24 |
| Date: | 2010–05–26 |
| URL: | http://d.repec.org/n?u=RePEc:eea:boewps:wp2010-06&r=mon |
| By: | Hyunsok Kim; Ronald MacDonald |
| Abstract: | The large appreciation and depreciation of the US dollar in the 1980s stimulated an important debate on the usefulness of unit root tests in the presence of structural breaks. In this paper, we propose a simple model to describe the evolution of the real exchange rate. We then propose a more general smooth transition (STR) function than has hitherto been employed, which is able to capture structural changes along the (long-run) equilibrium path, and show that this is consistent with our economic model. Our framework allows for a gradual adjustment between regimes and allows for under- and/or over-valued exchange rate adjustments. Using monthly and quarterly data for up to twenty OECD countries, we apply our methodology to investigate the univariate time series properties of CPI-based real exchange rates with both the U.S. dollar and German mark as the numeraire currencies. The empirical results show that, for more than half of the quarterly series, the evidence in favour of the stationarity of the real exchange rate was clearer in the sub-sample period post-1980. |
| Keywords: | Unit root tests, structural breaks, purchasing power parity |
| JEL: | C16 C22 F31 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:gla:glaewp:2010_14&r=mon |
| By: | Kishor N. Kundan (University of Wisconsin-Milwaukee) |
| Abstract: | In this paper, we investigate the role of recessions on the relative forecasting performance of the Fed and the private sector. Romer and Romer (2000) showed that the Fed's forecasts of inflation and output were superior to that of the private sector in the pre-1991 period. D'Agostino and Whelan (2008) found that the information superiority of the Fed deteriorated after 1991. Our results show that the information superiority of the Fed in forecasting real activity did arise from its forecasting dominance during recessions. If recessions are excluded from the pre-1992 period, the informational advantage of the Fed disappears, and in some cases, private sector forecasts perform better. We do not find any systematic effect of recessions on inflation forecasts. |
| Keywords: | Greenbook Forecasts, Recessions, Business Cycle Turning Points |
| JEL: | E31 E32 E37 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:nbp:nbpmis:74&r=mon |
| By: | Mengmeng Guo; Wolfgang Karl Härdle |
| Abstract: | A good description of the dynamics of interest rates is crucial to price derivatives and to hedge corresponding risk. Interest rate modelling in an unstable macroeconomic context motivates one factor models with time varying parameters. In this paper, the local parameter approach is introduced to adaptively estimate interest rate models. This method can be generally used in time varying coefficient parametric models. It is used not only to detect the jumps and structural breaks, but also to choose the largest time homogeneous interval for each time point, such that in this interval, the coeffcients are statistically constant. We use this adaptive approach and apply it in simulations and real data. Using the three month treasure bill rate as a proxy of the short rate, we nd that our method can detect both structural changes and stable intervals for homogeneous modelling of the interest rate process. In more unstable macroeconomy periods, the time homogeneous interval can not last long. Furthermore, our approach performs well in long horizon forecasting. |
| Keywords: | CIR model, Interest rate, Local parametric approach, Time homogeneous interval, Adaptive statistical techniques |
| JEL: | E44 G12 G32 N22 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2010-029&r=mon |