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on Monetary Economics |
| By: | Nicoletta Batini (IMF and University of Surrey); Vasco J. Gabriel (Department of Economics, University of Surrey and Universidade do Minho - NIPE); Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University) |
| Abstract: | We first develop a two-bloc model of an emerging open economy interacting with the rest of the world calibrated using Indian and US data. The model features a financial accelerator and is suitable for examining the effects of financial stress on the real economy. Three variants of the model are highlighted with increasing degrees of financial frictions. The model is used to compare two monetary interest rate regimes: domestic Inflation targeting with a floating exchange rate (FLEX(D)) and a managed exchange rate (MEX). Both rules are characterized as a Taylor-type interest rate rules. MEX involves a nominal exchange rate target in the rule and a constraint on its volatility. We find that the imposition of a low exchange rate volatility is only achieved at a significant welfare loss if the policymaker is restricted to a simple domestic inflation plus exchange rate targeting rule. If on the other hand the policymaker can implement a complex optimal rule then an almost fixed exchange rate can be achieved at a relatively small welfare cost. This finding suggests that future research should examine alternative simple rules that mimic the fully optimal rule more closely. |
| Keywords: | DSGE model, Indian economy, monetary interest rate rules, floating versus managed exchange rate, financial frictions |
| JEL: | E52 E37 E58 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:31/2010&r=mon |
| By: | Péter Gábriel (Magyar Nemzeti Bank) |
| Abstract: | Although in modern monetary economics it is usually assumed that inflation expectations play a prominent role when economic agents set prices and wages, the empirical evidence for this link is scarce. This paper aims to identify the effect of changes in inflation expectations on prices and wages in an SVAR framework for three inflation targeting countries (Czech Republic, Hungary and United Kingdom). The results show that in all countries the effect is significant. In comparison with the United Kingdom and the Czech Republic, inflation expectations in Hungary are more volatile and less anchored, which can be an important source of the high volatility of the inflation rate. |
| Keywords: | inflation expectations, consumer survey |
| JEL: | D84 E31 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:mnb:wpaper:2010/12&r=mon |
| By: | Edoardo GAFFEO; Ivan PETRELLA; Damjan PFAJFAR; Emiliano SANTORO |
| Abstract: | This paper proposes a novel explanation of the vast empirical evidence showing that output and prices react asymmetrically to monetary policy innovations over contractions and expansions in the business cycle. We use VAR techniques to show that monetary policy exerts stronger effects on the U.S. GDP during contractionary phases, as compared to expansionary ones. As to prices, their response is not statistically different across different cyclical stages. We show that these facts are consistent with a New Neoclassical Synthesis model based on the assumption that households. utility partly depends on deviations of their consumption from a reference level below which aversion to loss is displayed. In line with the theory developed by Kahneman and Tversky (1979), losses in consumption utility loom larger than gains. This implies state-dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption that generate competing effects on the responses of output and inflation following a monetary innovation. The key predictions of the model are in line with the data. We then explore the state-dependent trade-o¤ between inflation and output stabilization that naturally arises in this context. Greater elasticity of inflation to real activity during expansionary stages of the cycle promotes a stronger degree of policy activism in the response to the expected rate of inflation under discretion, compared to what is otherwise prescribed during contractions. |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:ete:ceswps:ces10.28&r=mon |
| By: | Guido Ascari; Neil Rankin |
| Abstract: | We construct a staggered-price dynamic general equilibrium model with overlapping generations based on uncertain lifetimes. Price stickiness plus lack of Ricardian Equivalence could be expected to make an increase in government debt, with associated changes in lump-sum taxation, effective in raising short-run output. However we find this is very sensitive to the monetary policy rule. A permanent increase in debt under a basic Taylor Rule does not raise output. To make debt effective we need either a temporary nominal interest rate peg; or inertia in the rule; or an exogenous money supply policy; or to make the debt increase temporary. |
| Keywords: | staggered prices, overlapping generations, government debt, fiscal policy effectiveness, monetary policy rules |
| JEL: | E62 E63 |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:yor:yorken:10/25&r=mon |
| By: | Drescher, Christian; Herz, Bernhard |
| Abstract: | We analyze monetary conditions in US asset markets — corporate equity, real estate, Treasury bond and corporate & foreign bond — from a market specific perspective, proposing the concept of market leverage. Market leverage measures the average leverage of all asset holders in a particular asset market. The concept builds on an accounting based network that links balance sheet leverages of asset holders to their corresponding shares of ownership. Our empirical analysis yields the following results. Firstly, market specific monetary conditions can differ considerably among asset markets. Secondly, market specific monetary conditions are positively related to asset prices. Thirdly, US asset markets have experienced a loosening in market specific monetary conditions in the last decades. Fourthly, the loosening of market specific monetary conditions explains long-term increases in US asset prices. Fifthly, the recent convergence of market specific monetary conditions of real asset markets towards those of financial asset markets implies a rise in upside risk to future US asset price inflation. |
| Keywords: | market leverage; monetary conditions; asset prices |
| JEL: | G1 E5 E4 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:27384&r=mon |
| By: | Scott Fullwiler; L. Randall Wray |
| Abstract: | Beyond its original mission to "furnish an elastic currency" as lender of last resort and manager of the payments system, the Federal Reserve has always been responsible (along with the Treasury) for regulating and supervising member banks. After World War II, Congress directed the Fed to pursue a dual mandate, long interpreted to mean full employment with reasonable price stability. The Fed has been left to decide how to achieve these objectives, and it has over time come to view price stability as the more important of the two. In our view, the Fed's focus on inflation fighting diverted its attention from its responsibility to regulate and supervise the financial sector, and its mandate to keep unemployment low. Its shift of priorities contributed to creation of the conditions that led to this crisis. Now in its third phase of responding to the crisis and the accompanying deep recession-so-called "quantitative easing 2," or "QE2'-the Fed is currently in the process of purchasing $600 billion in Treasuries. Like its predecessor, QE1, QE2 is unlikely to seriously impact either of the Fed's dual objectives, however, for the following reasons: (1) additional bank reserves do not enable greater bank lending; (2) the interest rate effects are likely to be small at best given the Fed's tactical approach to QE2, while the private sector is attempting to deleverage at any rate, not borrow more; (3) purchases of Treasuries are simply an asset swap that reduce the maturity and liquidity of private sector assets but do not raise incomes of the private sector; and (4) given the reduced maturity of private sector Treasury portfolios, reduced net interest income could actually be mildly deflationary. The most fundamental shortcoming of QE—or, in fact, of using monetary policy in general to combat the recession-is that it only "works" if it somehow induces the private sector to spend more out of current income. A much more direct approach, particularly given much-needed deleveraging by the private sector, is to target growth in after tax incomes and job creation through appropriate and sufficiently large fiscal actions. Unfortunately, stimulus efforts to date have not met these criteria, and so have mostly kept the recession from being far worse rather than enabling a significant economic recovery. Finally, while there is identical risk to the federal government whether a bailout, a loan, or an asset purchase is undertaken by the Fed or the Treasury, there have been enormous, fundamental differences in democratic accountability for the two institutions when such actions have been taken since the crisis began. Public debates surrounding the wisdom of bailouts for the auto industry, or even continuing to provide benefits to the unemployed, never took place when it came to the Fed committing trillions of dollars to the financial system—even though, again, the federal government is "on the hook" in every instance. |
| Keywords: | Quantitative Easing; Monetary Policy; Fiscal Policy; Macroeconomic Stabilization; Interest Rates; Central Bank Operations |
| JEL: | E42 E43 E62 E63 |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_645&r=mon |
| By: | Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Federico Ravenna (HEC Montreal.) |
| Abstract: | We show that the composition of imports has important implications for the optimal volatility of the exchange rate. Using input-output data for 25 countries we document substantial differences in the import and non-tradable content of final demand components, and in the role played by imported inputs in domestic production. We build a business cycle model of a small open economy to discuss how the problem of the optimizing policy-maker changes endogenously as the composition of imports and of final demand is altered. Contrary to models where steady state trade openness is entirely characterized by home bias, we find that trade openness is a very poor proxy of the welfare impact of alternative monetary policies. Finally, we quantify the loss from an exchange rate peg relative to the Ramsey policy conditional on the composition of imports, using parameter values that are estimated from OECD input-output tables data. We find that the main determinant of the losses is the share of non-traded goods in final demand. JEL Classification: E52, E31, F02, F41. |
| Keywords: | International Trade, Exchange Rate Regimes, Non-tradable Goods, Optimal Policy. |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20101279&r=mon |
| By: | Angelo Baglioni; Andrea Monticini (Catholic University, Milan, Italy) |
| Abstract: | We provide a simple model, able to explain why the overnight (ON) rate follows a downward intraday pattern, implicitly creating a positive intraday interest rate. While this normally reflects only some frictions, a liquidity crisis introduces a new component: the chance of an upward jump of the ON rate, which must be compensated by an intraday decline of the ON rate. By analyzing real time data for the e-MID interbank market, we show that the intraday rate has increased from a negligible level to a significant one after the start of the liquidity crisis in August 2007, and even more so since September 2008. The intraday rate is affected by the likelihood of a dry-up of the ON market, proxied by the 3M Euribor - Eonia swap spread. This evidence supports our model and it shows that a liquidity crisis impairs the ability of central banks to curb the market price of intraday liquidity, even by providing free daylight overdrafts. Such results have implications for the efficiency of the money market and of payment systems, as well as for the operational framework of central banks. |
| Keywords: | : interbank market, intraday interest rate, financial crisis, liquidity risk |
| JEL: | E4 E5 G21 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:gea:wpaper:4/2010&r=mon |
| By: | Heryan, Tomas; Stavarek, Daniel |
| Abstract: | This paper investigates the nature of the causal relationships among interbank market interest rates and corporate loans interest rates in four countries from the euro area (Austria, Belgium, France and Italy), and in the Czech Republic. The paper also estimates a development of bank credit margin in banking industries of these countries in period from January 2004 to March 2010. Using Johansen cointegration and Granger causality tests on monthly data we investigate long-term as well as short-term causalities between the interest rates. The results suggest that interest rate relationships differ in all selected countries, and also that foreign majority owners of the Czech banks could affect interest rate policy of the subsidiaries to offset losses realized by the parent banks. |
| Keywords: | Cointegration; Granger Causality; Interbank Interest Rates; Lending Interest Rates; European Union |
| JEL: | E43 C32 E40 F36 |
| Date: | 2010–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:27276&r=mon |
| By: | Vasco J. Gabriel (Department of Economics, University of Surrey and Universidade do Minho - NIPE); Luis F. Martins (Department of Quantitative Methods and UNIDE, ISCTE-LUI, Portugal) |
| Abstract: | We re-examine the empirical relevance of the cost channel of monetary policy (e.g. Ravenna and Walsh, 2006), employing recently developed moment-conditions inference methods, including identification-robust procedures. Using US data, our results suggest that the cost channel effect is poorly identified and we are thus unable to corroborate the previous results in the literature. |
| Keywords: | Cost channel; Phillips curve; GMM; Generalized Empirical Likelihood; Weak Identification. |
| JEL: | C22 E31 E32 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:30/2010&r=mon |
| By: | Sebastián Dellepiane Avellaneda (Institute of Development Policy and Management, University of Antwerp) |
| Abstract: | This article combines theory and historical narratives to shed new light on the politics surrounding the making of central bank independence in contemporary Britain. Its central argument is that Gordon Brown’s decision to rewrite the British monetary constitution in May 1997 constituted an act of political manipulation in a Rikerian sense. The institutional change involved can be conceptualized as a heresthetic move, that is, structuring the process of the political game so you can win. The incoming government removed a difficult issue from the realm of party politics in order to signal competence and enforce internal discipline in the context of a government that was moving toward the right. But building on Elster’s constraint theory, the paper argues that the institutional reform was not a case of self-binding in an intentional sense. Rather, Brown adopted a precommitment strategy that was aimed at binding others, including members of his government. The reform had dual consequences: it was not only constraining, it was also enabling. The institutionalization of discipline enabled New Labour to achieve key economic and political goals. By revisiting the political rationality of precommitment, this paper questions the dominant credibility story underlying the choice of monetary and fiscal institutions. |
| Date: | 2010–12–16 |
| URL: | http://d.repec.org/n?u=RePEc:ucd:wpaper:201052&r=mon |
| By: | Gabriele Galati; Richhild Moessner |
| Abstract: | The recent financial crisis has highlighted the need to go beyond a purely micro approach to financial regulation and supervision. In recent months, the number of policy speeches, research papers and conferences that discuss a macro perspective on financial regulation has grown considerably. The policy debate is focusing in particular on macroprudential tools and their usage, their relationship with monetary policy, their implementation and their effectiveness. Macroprudential policy has recently also attracted considerable attention among researchers. This paper provides an overview of research on this topic. We also identify important future research questions that emerge from both the literature and the current policy debate. |
| Keywords: | Macroprudential policy |
| JEL: | E58 G28 |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:267&r=mon |
| By: | Masaaki Fujii (Graduate School of Economics, University of Tokyo); Akihiko Takahashi (Faculty of Economics, University of Tokyo) |
| Abstract: | Collateral has been used for a long time in the cash market and we have also experienced significant increase of its use as an important credit risk mitigation tool in the derivatives market for this decade. Despite its long history in the financial market, its importance for funding has been recognized relatively recently following the explosion of basis spreads in the crisis. This paper has demonstrated the impact of collateralization on derivatives pricing through its funding effects based on the actual data of swap markets. It has also shown the importance of the "choice" of collateral currency. In particular, when a contract allows multiple currencies as eligible collateral as well as its free replacement, the paper has found that the embedded "cheapest-todeliver" option can be quite valuable and significantly change the fair value of a trade. The implications of these findings for risk management have been also discussed. |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2010cf778&r=mon |
| By: | Lee C. Spector (Department of Economics, Ball State University); Courtenay C. Stone (Department of Economics, Ball State University) |
| Abstract: | The ex ante real rate of interest is an important concept in economics and finance. These disciplines treat Irving Fischer’s theory of interest as canonical; it is used universally. In the world as we know it, the Fisher theory requires positive ex ante real interest rates. Consequently, empirical estimates of the ex ante real interest rate derived from the Fisher theory of interest should also be positive. Virtually all estimates of the ex ante real interest rate published in economic journals and/or used in macroeconomic models and policy discussions for the past 35 years, however, contain negative values for extended time periods. These negative ex ante real interest rate estimates would thus seem to be theoretically flawed. Moreover, it was shown more than 30 years ago that the procedures generally used to estimate ex ante real interest rates produce biased estimates. We document this problem, explore why it exists, and assess alternative approaches for estimating the ex ante real interest rate. |
| Keywords: | ex ante real interest rate, estimation problems |
| JEL: | B4 E0 E3 |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:bsu:wpaper:201010&r=mon |