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on Monetary Economics |
| By: | Aaron Mehrotra; Richhild Moessner; Chang Shu Author-X-Name_First: Chang |
| Abstract: | We analyse how movements in the components of sovereign bond yields in the United States affect long-term rates in 10 advanced and 21 emerging economies. The paper documents significant global spillovers from both the expectations and term premia components of long-term rates in the United States. We find that spillovers to domestic long-term rates in emerging economies from the US expectations components tend to be more sizeable than those from the US term premia. Finally, spillovers from US term premia are larger when an emerging economy displays greater macro-financial vulnerabilities. |
| Keywords: | interest rate spillovers, term premia, emerging economies |
| JEL: | E52 E43 F42 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:814&r=all |
| By: | Hassan Afrouzi (Columbia University); Laura Veldkamp (Columbia University) |
| Abstract: | Recent work finds that people's beliefs about inflation are systematically upward biased. Since inflation expectations are central to the efficacy of monetary policy, understanding these expectations, and their biases, is important for policy. While one can always find preference-based explanations for bias, the fact that more informed agents have less upward bias, suggests some connection to information, as opposed to preferences. This paper proposes a rational Bayesian explanation for the bias: Agents with parameter uncertainty over positively-skewed distributions have a positive bias in their forecast. We use inflation and survey data to show that this mechanism can quantitatively explain the magnitude of the bias. The model implies that communicating about inflation skewness may be an important dimension of forward guidance. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:894&r=all |
| By: | Markus K. Brunnermeier; Harold James; Jean-Pierre Landau |
| Abstract: | The ongoing digital revolution may lead to a radical departure from the traditional model of monetary exchange. We may see an unbundling of the separate roles of money, creating fiercer competition among specialized currencies. On the other hand, digital currencies associated with large platform ecosystems may lead to a re-bundling of money in which payment services are packaged with an array of data services, encouraging differentiation but discouraging interoperability between platforms. Digital currencies may also cause an upheaval of the international monetary system: countries that are socially or digitally integrated with their neighbors may face digital dollarization, and the prevalence of systemically important platforms could lead to the emergence of digital currency areas that transcend national borders. Central bank digital currency (CBDC) ensures that public money remains a relevant unit of account. |
| JEL: | E41 E42 E51 E52 E58 G21 G23 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26300&r=all |
| By: | Dániel Baksa (International Monetary Fund & Central European University); Zsuzsa Munkácsi (International Monetary Fund) |
| Abstract: | The empirical and theoretical evidence on the inflation impact of population aging is mixed, and there is no evidence regarding the volatility of inflation. Based on advanced economies’ data and a DSGE-OLG model - a multi-period general equilibrium framework with overlapping generations, - we find that aging leads to downward pressure on inflation and higher inflation volatility. Our paper is also the first to discuss, using this framework, how aging affects the short-term cyclical behavior of the economy and the transmission channels of monetary policy. Further, we are also the first to examine the interplay between aging and optimal central bank policies. As aging redistributes wealth among generations, generations behave differently, and the labor force becomes more scarce with aging, our model suggests that aging makes monetary policy less effective, and aggregate demand less elastic to changes in the interest rate. Moreover, in more gray societies central banks should react more strongly to nominal variables, and in a very old society the nominal GDP targeting rule might become the most effective monetary policy rule to compensate for higher inflation volatility. |
| Keywords: | aging, monetary policy transmission, optimal monetary policy, inflation targeting |
| JEL: | E31 E52 J11 |
| Date: | 2019–09–27 |
| URL: | http://d.repec.org/n?u=RePEc:lie:wpaper:67&r=all |
| By: | Konstantin Egorov (New Economic School); Dmitry Mukhin (Yale University) |
| Abstract: | The recent empirical evidence shows that most international prices are sticky in dollars. This paper studies the optimal non-cooperative monetary policy and the welfare implications of dollar pricing in a context of an open economy model with nominal rigidities. We establish the following results: 1) as in a closed economy, the optimal policy in both the U.S. and other economies stabilizes prices of local producers; 2) this policy generates asymmetric spillovers between countries such that the U.S. has a free floating exchange rate and an independent monetary policy, while other countries partially peg their exchange rates to the dollar giving rise to a “global monetary cycle”; 3) capital controls cannot insulate countries from U.S. spillovers; 4) the optimal cooperative policy is hard to implement because of the conflict of interest between countries; 5) there are potential gains from dollar pricing for the U.S., while other countries can benefit from forming a currency union such as the Eurozone. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1510&r=all |
| By: | Minseong Kim |
| Abstract: | We demonstrate that if all agents in an economy make time-consistent decisions and policies, then there exists no rational expectation equilibrium in a dynamic stochastic general equilibrium (DSGE) model, unless under very restrictive and special circumstances. Some time-consistent interest rate rules, such as Taylor rule, worsen the equilibrium non-existence issue in general circumstances. Monetary policy needs to be lagged in order to avoid equilibrium non-existence due to agents making time-consistent decisions. We also show that due to the transversality condition issue, either fiscal-monetary coordination may need to be modeled, or it may be necessary to write a model such that bonds or money provides utility as medium of exchange or has liquidity roles. |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1909.10915&r=all |
| By: | Perekunah B. Eregha (Pan-Atlantic University, Lekki-Lagos. Nigeria); Arcade Ndoricimpa (University of Burundi, Burundi) |
| Abstract: | The study applies a BEKK GARCH-M model to examine the effect of uncertainty on the levels of inflation and output growth in Nigeria. The results suggest a significant positive effect of inflation uncertainty on the level of inflation, supporting the Cukierman and Meltzer (1986) hypothesis. In addition, uncertainty about inflation is found to be detrimental to output growth, supporting the Friedman’s (1977) hypothesis of a negative effect of inflation uncertainty on output growth. Uncertainty about growth does not have a significant effect on both the levels of inflation and output growth. The evidence in this study suggests that Nigeria should put in place policies minimizing inflation uncertainty to avoid its adverse effects on the economy. In addition, the independence relationship between output growth and its uncertainty in Nigeria suggest that they can be treated separately as suggested by business cycle models. |
| Keywords: | Inflation, Inflation Uncertainty, Output, Output Uncertainty, BEKK GARCH-M |
| JEL: | C22 E0 |
| Date: | 2019–01 |
| URL: | http://d.repec.org/n?u=RePEc:agd:wpaper:19/060&r=all |
| By: | David Berger (Northwestern University); Fabrice Tourre (Copenhagen Business School); Joseph Vavra (University of Chicago); Konstantin Milbradt (Northwestern University) |
| Abstract: | How much ability does the Fed have to stimulate the economy by cutting interest rates? We argue that the presence of substantial debt in fixed-rate, prepayable mortgages means that the ability to stimulate the economy by cutting interest rates depends not just on their current level but also on their previous path. Using a household model of mortgage prepayment matched to detailed loan level evidence on the relationship between prepayment and rate incentives, we argue that recent interest rate paths will generate substantial headwinds for future monetary stimulus. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:175&r=all |
| By: | Simone Auer (Bank of Italy); Marco Bernardini (Bank of Italy); Martina Cecioni (Bank of Italy) |
| Abstract: | Using country-industry level data and high-frequency identified monetary policy shocks, we find evidence of a positive but non-linear relationship between corporate leverage and the effectiveness of monetary policy in the euro area. More leveraged industries tend to increase their production more strongly after an expansionary monetary policy shock, pointing to a non-negligible role of financial frictions in the transmission mechanism. However, at high leverage ratios this positive relation becomes weaker and eventually inverts. This finding is consistent with recent theoretical studies arguing about the role of credit risk in dampening the financial accelerator channel. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1102&r=all |
| By: | Haelim Anderson (Federal Deposit Insurance Corporation); Guillermo Ordonez (University of Pennsylvania); Selman Erol (Carnegie Mellon University, Tepper School of Business) |
| Abstract: | Central banks provide public liquidity (through lending facilities and promises of bailouts) with the intent to stabilize financial markets. Even though this provision is restricted to member (regulated) banks, an interbank system can in principle develop so to give indirect access to nonmember (shadow) banks. We construct a model to understand how the network may change in the presence of Central Bank interventions and how those changes can translate into more room for contagion and an endogenously higher financial fragility. We provide evidence that upon the introduction of the Fed’s lending facilities in 1914, aggregate liquidity declined and systemic risks increased. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1285&r=all |
| By: | Ester Faia (Goethe University Frankfurt); Vincenzo Pezone (Goethe University and SAFE) |
| Abstract: | Using a unique confidential contract level dataset merged with firm-level asset price data, we find robust evidence that firms' stock market valuations and employment levels respond more to monetary policy announcements the higher the degree of wage rigidity. Data on the renegotiations of collective bargaining agreements allow us to construct an exogenous measure of wage rigidity. We also find that the amplification induced by wage rigidity is stronger for firms with high labor intensity and low profitability, providing evidence of distributional consequences of monetary policy. We rationalize the evidence through a model in which firms in different sectors feature different degrees of wage rigidity due to staggered renegotiations vis-a-vis unions. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:278&r=all |
| By: | Gabriela Cugat (Northwestern University) |
| Abstract: | I argue that household heterogeneity plays a key role in the transmission of aggregate shocks in emerging market economies. Using Mexico's 1995 crisis as a case study, I first document empirically that working in the tradable versus non-tradable sector is a crucial determinant of the income and consumption losses of different types of households. Specifically, households in the non-tradable sector suffered much larger income and consumption losses regardless of other household characteristics. To account for the effect of this observation on macroeconomic dynamics, I construct a New Keynesian small open economy model with household heterogeneity along two dimensions: uninsurable sector-specific income and limited financial-market participation. I find that the propagation of shocks in this economy is affected by both dimensions of heterogeneity, with uninsurable sector-specific income playing a quantitatively larger role. In terms of policy, a managed exchange rate policy is more costly overall when households are heterogeneous; however, households in the non-tradable sector benefit from it. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:526&r=all |
| By: | Rohan Kekre (University of Chicago); Moritz Lenel (Princeton University) |
| Abstract: | We explore the effects of monetary, fiscal, and macroprudential policies on risk premia and investment in a heterogeneous agent New Keynesian environment. Heterogeneity in agents' marginal propensity to save in capital (MPSK) summarizes differences in risk aversion, portfolio constraints, and background risk. Policies which redistribute to agents with high MPSKs reduce risk premia and, absent a monetary policy tightening, raise investment. We quantitatively evaluate the role of this mechanism for the transmission of conventional monetary policy. An unexpected reduction in the nominal interest rate redistributes to agents with high MPSKs. We characterize the necessary heterogeneity in MPSKs to rationalize the observed stock market and investment responses to monetary policy shocks. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1423&r=all |
| By: | Mordi, Charles N. O.; Adebiyi, Michael A.; Omotosho, Babatunde S. |
| Abstract: | This paper investigates the size and adjustment pattern of the interest rate pass-through (IRPT) between the policy-controlled interest rate (MPR) and seven (7) retail interest rates (lending and deposit rates) in Nigeria. This study departs from previous studies on Nigeria in the sense that it takes account of the effects of structural breaks in our modelling approach. First, we confirm the existence of long-run relationships between MPR and two retail rates (prime lending rate and savings deposit rate), albeit with significant structural breaks occurring in their cointegrating vectors at different periods. Second, we find evidence of incomplete pass-through in the response of the retail rates to MPR shocks. Third, most of the retail interest rates adjust symmetrically to changes in the policy rate, with the exception of the savings rate. This implies that the response of savings rate varies depending on whether the innovation in the MPR is positive or negative. Fourth, positive innovations in the MPR are fully reflected in the savings rate within 2 months as against 8 months for negative MPR shocks. Fifth, innovations in the MPR are fully transmitted to the prime lending rate in about 14 months while the complete pass-through to the 6-month time deposit rate occurs in about 11 months. In view of these findings, we recommend that the monetary authority should always have an eye on the size of the pass-through as well as the heterogeneities found in the adjustment process of the retail rates while taking decisions on its policy rate. Also, the low IRPT obtained suggests a stronger monetary policy stance or other supplementary measures if the objectives of MPR changes are to be fully realized. |
| Keywords: | Interest rate pass-through, Co-integration, Asymmetric adjustments, Structural Break |
| JEL: | E43 E52 E58 |
| Date: | 2019–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:96171&r=all |
| By: | Matteo Leombroni (Stanford); Ciaran Rogers (Stanford University) |
| Abstract: | We study the heterogeneity of consumption responses across households to a common monetary policy shock. Households vary in age, wealth and ex-ante asset allocation. We combine an asset pricing framework with heterogeneous agents and incomplete markets with a life-cycle model. Within our environment, the transmission of monetary policy does not only work through the usual income and substitution motives, but also through an endogenous portfolio rebalancing effect which generates changes in equilibrium asset prices and a subsequent wealth effect on consumption. We find that, if the shock is such that prices are unchanged, the response of consumption is fully transitory, where younger households increase, and older households decrease, consumption. If equilibrium prices rise as a result of the monetary shock, wealth effects mitigate heterogeneity in current consumption responses, but introduce persistence in responses that increase significantly with age. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:684&r=all |
| By: | Thibaut Piquard; Dilyara Salakhova |
| Abstract: | We study the substitution between secured and unsecured interbank markets. Banks are competitive and subject to reserve requirements in a corridor rate system with deposit and lending facilities. Banks face counterparty risk in the unsecured market and incur an opportunity cost to pledge collateral. The model provides insights on interest rates, trading volumes and substitution between the two markets. Using transaction data on the Euro money market, we provide new empirical findings that the model accounts for: (i) borrowing banks are active on both markets even when their collateral constraint is not binding, (ii) secured interest rates may fall below the deposit facility rate. We derive and empirically test predictions on how "conventional" and "unconventional" monetary policies impact interbank markets, depending on whether marketable collateral is purchased or not. |
| Keywords: | : Monetary Policy, Interbank Markets, Secured and Unsecured Funding. |
| JEL: | E42 E52 E58 G21 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:730&r=all |
| By: | Klaus Adam (University of Mannheim); Henning Weber (Bundesbank) |
| Abstract: | We present a sticky price model featuring a product life cycle and rich amounts of heterogeneity that allow capturing salient features of micro price data. We analytically derive the optimal steady-state inflation rate and show how the optimal inflation target trades off price and mark-up distortions across different product categories. We then devise an empirical approach that permits identifying the optimal inflation target from relative price trends over the product life cycle. Using the micro Price data underlying the U.K. consumer price index, we show that the relative price of products decreases over the life cycle for almost all expenditure categories and that this causes positive inflation targets to be optimal. The optimal U.K. inflation target is estimated to range between 2.6% and 3.2% in the year 2016. The optimal target has steadily increased over the years 1996-2016. We explain how changes in relative price trends contributed to this increase. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1001&r=all |
| By: | Edmond Berisha (Feliciano School of Business, Montclair State University, Montclair, NJ 07043); Ram Sewak Dubey (Feliciano School of Business, Montclair State University, Montclair, NJ 07043); Eric Olson (Collins College of Business, The University of Tulsa, Tulsa, OK 74104); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa) |
| Abstract: | Understanding within and between group inequality is fundamental in understanding the evolution of income inequality in any country. Using a century of data for France, and the Theil measure of income inequality, which is decomposable, we show that income inequality within the bottom 90% accounts for over sixty percent of overall income inequality today. These findings indicate that income within the middle class has gotten substantially more unequal in France. We also document that inflation contributes to lower within-and-between group’s income inequalities. |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:pre:wpaper:201969&r=all |
| By: | John V. Leahy; Aditi Thapar |
| Abstract: | We study whether the effects of monetary policy are dependent on the demographic structure of the population. We exploit cross-sectional variation in the response of US states to an identified monetary policy shock. We find that there are three distinct age groups. In response to an increase in interest rates, the responses of private employment and personal income are weaker the greater the share of population under 35 years of age, are stronger the greater the share between 40 and 65 years of age, and are relatively unaffected by the share older than 65 years. We find that all age groups become more responsive to monetary policy shocks when the proportion of middle aged increases. We provide evidence consistent with middle aged entrepreneurs starting and expanding businesses in response to an expansionary monetary shock. |
| JEL: | E32 E52 J11 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26324&r=all |
| By: | Albert Queralto (Federal Reserve Board) |
| Abstract: | We use a two-country New Keynesian model with balance sheet constraints to investigate the magnitude of international spillovers of U.S. monetary policy. Home borrowers obtain funds from domestic households in domestic currency, as well as from residents of the foreign economy (the U.S.) in dollars. In our economy, foreign lenders differ from domestic lenders in their ability to recover resources from defaulting borrowers' assets, leading to more severe financial constraints for foreign debt than for domestic borrowing. As a consequence, a deterioration in borrowers' balance sheets induces a rise in the home currency's premium and an exchange rate depreciation. We use the model to investigate how spillovers are affected by the degree of currency mismatches in balance sheets, and whether the latter make it desirable for policy to target the exchange rate. We find that the magnitude of spillovers is significantly enhanced by the degree of currency mismatches. Our findings also suggest that using monetary policy to stabilize the exchange rate is not necessarily more desirable with greater balance sheet mismatches and may actually exacerbate short-run exchange rate volatility. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:993&r=all |
| By: | Pedro Henrique da Silva Castro |
| Abstract: | Is monetary policy power reduced in the presence of governmental credit with subsidized interest rates, insensitive to the monetary cycle? I argue this question has not yet been reasonably answered even though a virtual consensus seems to have been reached. Using a general analytical decomposition I show that the available microeconometric evidence is not necessarily informative about the macroeconomic effect of interest, due to the presence of general equilibrium effects. Moreover, evidence of decreased power over output does not imply that power over inflation is also decreased. A simple New Keynesian model where fi rms take credit, from both the market and the government, to finance working capital needs is presented to exemplify those possibilities. |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:505&r=all |
| By: | Flora Lutz; Leopold Zessner-Spitzenberg |
| Abstract: | We propose a small open economy model where agents borrow internationally and invest in liquid foreign assets to insure against liquidity shocks, which tem-porarily shut out the economy of short-term credit markets. Due to the presence of a pecuniary externality individual agents borrow too much and hold too little liquid assets relative to a social planner. This ine?ciency rationalizes macropru-dential policy interventions in the form of reserve accumulation at the central bank coupled with a tax on foreign borrowing. Unless combined with other measures, a tax on foreign borrowing is detrimental to welfare; it reduces agents’ incentives to invest in liquid assets and thereby increases ?nancial instability. Our model can quantitatively match the simultaneous depreciation of the exchange rate and con-tractions in output, gross trade ?ows, foreign liabilities and liquid reserves during Sudden Stop episodes. |
| JEL: | D62 E44 F32 F34 F41 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:vie:viennp:1907&r=all |
| By: | Lutho Mbekeni (Department of Economics, Nelson Mandela University); Andrew Phiri (Department of Economics, Nelson Mandela University) |
| Abstract: | In this paper, we evaluate whether the South African Reserve Bank (SARB) has been successful at fulfilling it’s mandate of protecting the purchasing power of the country’s citizens. To this end, we use monthly data covering the post-inflation targeting era of 2002:01 to 2018:04 to re-examine Fisher’s hypothesis for the South African economy by testing for stationarity in real interest rates. Our study makes three noteworthy empirical contributions. Firstly, we use three measures of inflation in computing the real interest rate variable. Secondly, our inflation expectations variables are constructed in alignment with the inflation forecast horizons of 12 to 24 months as practiced by the SARB. Thirdly, we rely on the more powerful flexible Fourier unit root test in testing for integration properties of the real exchange rate. All-in-all, our findings highlight the Reserve Bank’s struggles in protecting the purchasing power of citizen’s for periods subsequent to the global financial crisis but not for periods before the crisis. Policy recommendations are also provided. |
| Keywords: | Fisher effect; SARB; Fourier unit root test; Monetary Policy. |
| JEL: | C12 C13 C22 E52 E58 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:mnd:wpaper:1906&r=all |
| By: | Francesco Zanetti; Tatsushi Okuda; Tomohiro Tsuruga |
| Abstract: | We establish novel empirical regularities on firms’ expectations about aggregate and idiosyncratic components of sectoral demand using industry-level survey data for the universe of Japanese firms. Expectations of the idiosyncratic component of demand differ across sectors, and they positively co-move with expectations about the aggregate component of demand. To study the implications for inflation, we develop a model with firms that form expectations based on the inference of distinct shocks from a common signal. We show that the sensitivity of inflation to changes in demand decreases with the volatility of idiosyncratic component of demand that proxies the degree of shock heterogeneity. We apply principal component analysis on Japanese sectoral-level data to estimate the degree of shock heterogeneity, and we establish that the observed increase in shock heterogeneity plays a significant role for the reduced sensitivity of inflation to movements in real activity since the late 1990s. |
| Keywords: | Imperfect information, Shock heterogeneity, Inflation dynamics |
| JEL: | E31 D82 C72 |
| Date: | 2019–09–24 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:881&r=all |
| By: | Aeimit Lakdawala (Michigan State University); Michael Bauer (Federal Reserve Bank of San Francisco); Philippe Mueller (University of Warwick) |
| Abstract: | Monetary policy announcements are surrounded by substantial uncertainty about the type, direction and magnitude of the policy action. Using a novel, market-based measure of monetary policy uncertainty we document a systematic, predictable pattern over the course of the FOMC meeting cycle: FOMC announcements lead to substantial resolution of uncertainty, which then gradually ramps up over the intermeeting period. Changes in uncertainty about the future policy path capture a distinct second dimension of monetary policy actions that is relevant for the transmission to financial markets. In particular, the Federal Reserve's forward guidance announcements affected asset prices not only by adjusting the expected policy path but also by changing market-perceived uncertainty about this path. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1403&r=all |
| By: | Lee Ohanian (University of California Los Angeles); Diana Van Patten (UCLA); Mark Wright (Federal Reserve Bank of Minneapolis); Paulina Restrepo-Echavarria (Federal Reserve Bank of St Louis) |
| Abstract: | The Bretton Woods international financial system, which was in place from roughly 1949- 1973, is the most significant modern policy experiment to attempt to simultaneously manage international payments, international capital flows, and international currency values. This paper addresses the questions of (1) how and why Bretton Woods failed, and (2) the implications of its failure for world economic activity after 1973. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:665&r=all |
| By: | Makoto Nirei (University of Tokyo); Jose Scheinkman (Columbia University) |
| Abstract: | We present a state-dependent pricing model that generates inflation fluctuations from idiosyncratic shocks on firms. A firm's nominal price increase lowers the other firms' relative prices, thereby inducing those firms' nominal price increases. This snow-ball effect of repricing causes the fluctuations of aggregate price without exogenous aggregate shocks. The fluctuations caused by this mechanism are more volatile when the density of firms at repricing threshold is high, and the density at the threshold is high when the trend inflation level is high. Thus, the model implies that the higher trend inflation causes the larger volatility of short-term inflation rates. Analytical and numerical analyses show that the model can account for the positive relationship between inflation level and volatility that has been observed empirically. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1451&r=all |
| By: | Francesco Ferrante (Federal Reserve Board); Matthias Paustian (Federal Reserve Board) |
| Abstract: | We develop an incomplete-markets heterogeneous agent New-Keynesian (HANK) model in which households are allowed to borrow using nominal debt. We show that, in this framework, forward guidance, that is the promise by the central bank to lower future interest rates, can be a powerful policy tool, especially when the economy is in a liquidity trap. In our model, expected lower rates imply a future transfer of wealth from savers to borrowers, reducing precautionary motives and stimulating current demand and inflation. In addition, at the time of the policy announcement, debt deflation generates also a wealth transfer towards constrained agents, who have high marginal propensity to consume, further increasing aggregate consumption and inflation, and igniting a positive feedback loop. These results contrast with previous research on HANK models, which focused on frameworks where agents were not allowed to borrow, and which found negligible effects of forward guidance. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1256&r=all |
| By: | Marco Del Negro (Federal Reserve Bank of New York); Andrea Tambalotti (Federal Reserve Bank of New York); Domenico Giannone (Federal Reserve Bank of New York); Marc Giannoni (Federal Reserve Bank of Dallas) |
| Abstract: | The trend in the world real interest rate for safe and liquid assets fluctuated close to 2 percent for more than a century, but has dropped significantly over the past three decades. This decline has been common among advanced economies, as trends in real interest rates across countries have converged over this period. It was driven by an increase in the convenience yield for safety and liquidity and by lower global economic growth. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:77&r=all |
| By: | Fausto, Cavalli; Ahmad, Naimzada; Nicolò, Pecora |
| Abstract: | In this paper we consider a nonlinear model for the real economy described by a multiplieraccelerator setup. The model comprises the government sector, which infl uences the output dynamics by means of the fiscal policy, and the money market, where the money supply depends upon the fl uctuations in the economic activity. Through rigorous analytical tools combined with numerical simulations, we investigate the stability conditions of the unique steady state and the emergence of different kinds of endogenous dynamics, which are the results of the fraction of the fiscal and the monetary policy through their reactivity degrees. Such policies, if properly tuned, can lead the economy toward the desired full employment target but, on the other hand, can also generate endogenous fluctuations in the pace of the economic activity, associated with the occurrence of closed invariant curves and multistability phenomena. |
| Keywords: | nonlinear dynamics; monetary and fiscal policies; bifurcations; multistability. |
| Date: | 2019–05 |
| URL: | http://d.repec.org/n?u=RePEc:mib:wpaper:409&r=all |
| By: | Jason R. Donaldson; Giorgia Piacentino |
| Abstract: | We develop a model in which, as in practice, bank debt is both a financial security used to raise funds and a kind of money used to facilitate trade. This dual role of bank debt provides a new rationale for why banks do what they do. In the model, banks endogenously perform the essential functions of real-world banks: they transform liquidity, transform maturity, pool assets, and have dispersed depositors. Moreover, they make their debt redeemable on demand. Thus, they are endogenously fragile. We show novel effects of narrow banking, suspension of convertibility, and some other policies. |
| JEL: | G01 G21 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26298&r=all |
| By: | Povilas Lastauskas; Julius Stakénas |
| Abstract: | Do labor market reforms initiated in periods of loose monetary policy yield different outcomes from those that were introduced in periods when monetary tightening prevailed? Since economic theory usually pays attention to the steady state change and ignores business cycle interactions of structural reforms, we connect local projection methodology with the Mallow’s Cp averaging criterion to arrive at an inference that does not require knowledge of the exact functional form, is robust to mis-specification, admits non-linearities, and cross-sectional dependence and addresses uncertainty regarding interactions between labor reforms and macroeconomy. We also develop a test to check the importance of monetary policy for any horizon and the entire impulse response function, taking the multiple testing problem into account. We document that replacement rates deliver substantially different outcomes on real GDP, inflation and real effective exchange rate, whereas labor activation schemes bear different effects on unemployment in low- and high-interest rate environments. There is also evidence of monetary policy trend playing an important role and increasing synchronized monetary and labor market policies across European countries. |
| Keywords: | labor market reforms, nonlinear responses, Mallow’s Cp criterion for model averaging, error factor structure, low and high interest rate environments |
| JEL: | C33 C54 E52 E62 J08 J38 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_7844&r=all |
| By: | Feng Dong (Shanghai Jiao Tong University); Yi Wen (Federal Reserve Bank of St. Louis) |
| Abstract: | We build an analytically tractable model of dynamic production networks with incomplete insurance markets and heterogeneous money demand. We use the model to quantify the classic Baumol-Tobin redistribution channel of monetary policy. Our model can explain (i) the joint distribution of household consumption and money demand and (ii) the strong propagation mechanism of monetary shocks for the business cycle found in empirical VARs across production sectors. We show that the Baumol-Tobin redistribution channel of monetary non-neutrality can be greatly magnified and propagated through endogenous leisure choices and production networks. Our model can account for the hump-shaped impulse responses of sectoral output and employment to monetary shocks, thanks to the endogenous linkage between the distribution of household money demand and firms' input-output coefficient matrix. Our model provides an alternative framework to the Heterogeneous Agent New Keynesian (HANK) model for monetary policy analysis. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1464&r=all |
| By: | Hördahl, Peter; Tristani, Oreste |
| Abstract: | We propose a regime-switching approach to deal with the lower bound on nominal interest rates in dynamic term structure modelling. In the “lower bound regime”, the short term rate is expected to remain constant at levels close to the effective lower bound; in the “normal regime”, the short rate interacts with other economic variables in a standard way. State-dependent regime switching probabilities ensure that the likelihood of being in the lower bound regime increases as short rates fall closer to zero. A key advantage of this approach is to capture the gradualism of the monetary policy normalization process following a lower bound episode. The possibility to return to the lower bound regime continues exerting an influence in the early phases of normalization, pulling expected future rates downwards. We apply our model to U.S. data and show that it captures key properties of yields at the lower bound. In spite of its heavier parameterization, the regime-switching model displays a competitive out-of-sample forecasting performance. It can also be used to gauge the risk of a return to the lower bound regime in the future. As of mid-2018, it provides a more benign assessment than alternative measures. JEL Classification: E31, E40, E44, E52, E58, E62, E63 |
| Keywords: | monetary policy rate expectations, regime switches, term premia, term structure of interest rates, zero lower bound |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20192320&r=all |
| By: | Federico, Salvatore (Center for Mathematical Economics, Bielefeld University); Ferrari, Giorgio (Center for Mathematical Economics, Bielefeld University); Schuhmann, Patrick (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | Consider a central bank that can adjust the inflation rate by increasing and decreasing the level of the key interest rate. Each intervention gives rise to proportional costs, and the central bank faces also a running penalty, e.g., due to misaligned levels of inflation and interest rate. We model the resulting minimization problem as a Markovian degenerate two-dimensional bounded-variation stochastic control problem. Its characteristic is that the mean-reversion level of the diffusive inflation rate is an affine function of the purely controlled interest rate's current value. By relying on a combination of techniques from viscosity theory and free-boundary analysis, we provide the structure of the value function and we show that it satisfies a second-order smooth-fit principle. Such a regularity is then exploited in order to determine a system of functional equations solved by the two monotone curves that split the control problem's state space in three connected regions. |
| Keywords: | singular stochastic control, Dynkin game, viscosity solution, free boundary, smooth-fit, inflation rate, interest rate |
| Date: | 2019–09–27 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:624&r=all |
| By: | Georgiadis, Georgios; Mösle, Saskia |
| Abstract: | A large share of global trade being priced and invoiced primarily in US dollar rather than the exporter’s or the importer’s currency has important implications for the transmission of shocks. We introduce this “dominant currency pricing” (DCP) into ECB-Global, the ECB’s macroeconomic model for the global economy. To our knowledge, this is the first attempt to incorporate DCP into a major global macroeconomic model used at central banks or international organisations. In ECB-Global, DCP affects in particular the role of expenditure-switching and the US dollar exchange rate for spillovers: In case of a shock in a non-US economy that alters the value of its currency multilaterally, expenditure-switching occurs only through imports; in case of a US shock that alters the value of the US dollar multilaterally, expenditure-switching occurs both in non-US economies’ imports and – as these are imports of their trading partners – exports. Overall, under DCP the US dollar exchange rate is a major driver of global trade, even for transactions that do not involve the US. In order to illustrate the usefulness of ECB-Global and DCP for policy analysis, we explore the implications of the euro rivaling the US dollar as a second dominant currency in global trade. According to ECB-Global, in such a scenario the global spillovers from US shocks are smaller, while those from euro area shocks are amplified; domestic euro area monetary policy effectiveness is hardly affected by the euro becoming a second globally dominant currency in trade. JEL Classification: F42, E52, C50 |
| Keywords: | dominant currency paradigm, global macroeconomic modelling, spillovers |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20192321&r=all |
| By: | Serhan Cevik; Tianle Zhu |
| Abstract: | Monetary independence is at the core of the macroeconomic policy trilemma stating that an independent monetary policy, a fixed exchange rate and free movement of capital cannot exist at the same time. This study examines the relationship between monetary autonomy and inflation dynamics in a panel of Caribbean countries over the period 1980–2017. The empirical results show that monetary independence is a significant factor in determining inflation, even after controlling for macroeconomic developments. In other words, greater monetary policy independence, measured as a country’s ability to conduct its own monetary policy for domestic purposes independent of external monetary influences, leads to lower consumer price inflation. This relationship—robust to alternative specifications and estimation methodologies—has clear policy implications, especially for countries that maintain pegged exchange rates relative to the U.S. dollar with a critical bearing on monetary autonomy. |
| Date: | 2019–09–20 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:19/197&r=all |
| By: | Roger Farmer (University of Warwick); Pawel Zabczyk (International Monetary Fund) |
| Abstract: | We demonstrate that the Fiscal Theory of the Price Level (FTPL) cannot be used to determine the price level uniquely in the overlapping generations (OLG) model. We provide two examples of OLG models, one with 3-period lives and one with 62-period lives. Both examples are calibrated to an income profile chosen to match the life-cycle earnings process in U.S. data estimated by Guvenen et al. (2015). In both examples, there exist multiple steady-state equilibria. Our findings challenge established views about what constitutes a good combination of fiscal and monetary policies. As long as the primary deficit or the primary surplus is not too large, the fiscal authority can conduct policies that are unresponsive to endogenous changes in the level of its outstanding debt. Monetary and fiscal policy can both be active at the same time. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:39&r=all |
| By: | Fernando Arce; Julien Bengui; Javier Bianchi |
| Abstract: | This paper proposes a theory of foreign reserves as macroprudential policy. We study an open-economy model of financial crises in which pecuniary externalities lead to overborrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross-section, and can quantitatively account for the recent upward trend in international reserves. |
| Keywords: | Balance of payments and components; Financial stability; Financial system regulation and policies; Foreign reserves management; International financial markets |
| JEL: | D52 D62 F34 |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:19-43&r=all |
| By: | Valentina MERA; Monica POP SILAGHI; Camélia TURCU |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:leo:wpaper:2694&r=all |
| By: | Vincent Sterk (University College London); Wei Cui (University College London) |
| Abstract: | Is Quantitative Easing (QE) an effective substitute for conventional monetary policy? We study this question using a quantitative heterogeneous-agents model with nominal rigidities, as well as liquid and partially liquid wealth. The direct effect of QE on aggregate demand is determined by the difference in marginal propensities to consume out of the two types of wealth, which is large according to the model and empirical studies. A comparison of optimal QE and interest rate rules reveals that QE is indeed a very powerful instrument to anchor expectations and to stabilize output and inflation. However, QE interventions come with strong side effects on inequality, which can substantially lower social welfare. A very simple QE rule, which we refer to as Real Reserve Targeting, is approximately optimal from a welfare perspective when conventional policy is unavailable. We further estimate the model on U.S. data and find that QE interventions greatly mitigated the decline in output during the Great Recession. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:29&r=all |
| By: | Jonathan Chiu (Bank of Canada); Janet Hua Jiang (Bank of Canada); Seyed Mohammadreza Davoodalhosseini (Bank of Canada); Yu Zhu (Bank of Canada) |
| Abstract: | This paper builds a model with imperfect competition in the banking sector. In the model, banks issue deposits and make loans, and deposits can be used as payment instruments by households. We use the model to assess the general equilibrium effects of introducing central bank digital currency (CBDC). We identify a new channel through which CBDC can improve the efficiency of bank intermediation and increase lending and aggregate output even if its usage is low, i.e., CBDC serves as an outside option for households, thus limiting banks' market power in the deposit market. We then calibrate the model to evaluate the quantitative implication of this channel. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:862&r=all |
| By: | Kozo Ueda (Waseda University) |
| Abstract: | Central banks across the globe are paying increasing attention to the distributional aspects of monetary policy. In this study, we focus on reallocation among heterogeneous firms triggered by nominal growth. Japanese firm-level data show that large firms tend to grow faster than small firms under higher inflation. We then construct a model that introduces nominal rigidity into endogenous growth with heterogeneous firms. The model shows that, under a high nominal growth rate, firms of inferior quality bear a heavier burden of menu cost payments than do firms of superior quality. This outcome increases the market share of superior firms, while some inferior firms exit the market. This reallocation effect, if strong, yields a positive effect of monetary expansion on both real growth and welfare. The optimal nominal growth can be strictly positive even under nominal rigidity, whereas standard New Keynesian models often conclude that zero nominal growth is optimal. Moreover, the presence of menu costs can improve welfare. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:128&r=all |
| By: | Nina Biljanovska (International Monetary Fund); Alexandros Vardoulakis (Federal Reserve Board); Lucyna Gornicka (International Monetary Fund) |
| Abstract: | An asset bubble relaxes collateral constraints and increases borrowing of credit-constrained agents. At the same time, as the bubble deflates when constraints start binding, it amplifies downturns. We show analytically and quantitatively that the macroprudential policy should optimally respond to building asset price bubbles in a non-linear fashion depending on the underlying indebtedness. If credit is moderate, policy should accommodate the bubble to reduce the incidence of binding collateral constraints. If credit is elevated, policy should lean against the bubble more aggressively to mitigate the pecuniary externalities from a deflating bubble when constraints bind. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:663&r=all |
| By: | Ricardo Lagos (New York University); Gaston Navarro (Federal Reserve Board) |
| Abstract: | The federal funds market changed drastically during the last decade, as new policy tools were implemented while large-scale asset purchases programs increased reserve balances to unprecedented levels. We develop a model of the federal funds market that incorporates most of its salient features and recent changes. The model includes heterogeneous types of banks and we estimate the parameters governing this heterogeneity using bank-level transaction data. Consistent with the data, a small set of very active banks in the model participate in the majority of loan transactions. We use the model to analyze the consequences of a balance sheet normalization. We argue that the increase in interest rates will be larger if reserves decrease disproportionately more for the set of active banks. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1521&r=all |
| By: | John Geanakoplos (Yale University); David Rappoport (Federal Reserve Board) |
| Abstract: | A synthesis of new and old approaches in understanding macroeconomic fluctuations and the role of monetary policy (MP) is the credit surface, where the interest rate is a function of multiple credit terms: leverage, credit rating, term, etc. We gauge credit conditions using the credit surface in mortgage, corporate bond, and peer-to-peer lending markets, and explore its relationship with economic activity in these segments of the economy. In addition, we study the transmission of MP through the corporate bond credit surface. Our results suggest that the passthrough of MP is heterogeneous and non-monotonic in ex-ante riskiness, initially declining as risk increases but then increasing. Our preliminary results support the view that the credit surface is important for macroeconomic fluctuations and the transmission of MP. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1516&r=all |
| By: | Hoffmann, Peter; Kremer, Manfred; Zaharia, Sonia |
| Abstract: | This paper develops composite indicators of financial integration within the euro area for both price-based and quantity-based indicators covering money, bond, equity and banking markets. Prior to aggregation, individual integration indicators are harmonised by applying the probability integral transform. We find that financial integration in Europe increased steadily between 1995 and 2007. The subprime mortgage crisis marked a turning point, bringing about a marked drop in both composite indicators. This fragmentation trend reversed when the European banking union and the ECB's Outright Monetary Transactions Programme were announced in 2012, with financial integration recovering more strongly when measured by price-based indicators. In a growth regression framework, we find that higher financial integration tends to be associated with an increase in per capita real GDP growth in euro area countries. This correlation is found to be stronger the higher a country's growth opportunities. JEL Classification: F36, F43, F45, G01, G15 |
| Keywords: | composite indicator, economic growth, European Monetary Union, financial integration, financial stress |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20192319&r=all |
| By: | Todorov, Karamfil |
| Abstract: | This paper studies the impact of the European Central Bank’s (ECB) Corporate Sector Purchase Programme (CSPP) announcement on prices, liquidity, and debt issuance in the European corporate bond market using a data set on bond transactions from Euroclear. I find that the quantitative easing (QE) programme increased prices and liquidity of bonds eligible to be purchased substantially. Bond yields dropped on average by 30 basis points (bps) (8%) after the CSPP announcement. Tri-party repo turnover rose by 8.15 million USD (29%), and bilateral turnover went up by 7.05 million USD (72%). Bid-ask spreads also showed significant liquidity improvement in eligible bonds. QE was successful in boosting corporate debt issuance. Firms issued 2.19 billion EUR (25%) more in QE-eligible debt after the CSPP announcement, compared to other types of debt. Surprisingly, corporates used the attracted funds mostly to increase dividends. These effects were more pronounced for longer-maturity, lower-rated bonds, and for more credit-constrained, lower-rated firms. |
| Keywords: | Quantitative easing; Corporate Sector Purchase Programme; ECB; Bond market; Corporate debt issuance |
| JEL: | E52 E58 G12 G18 |
| Date: | 2019–08–09 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:101665&r=all |
| By: | Ricardo Reyes-Heroles (Federal Reserve Board); Gabriel Tenorio |
| Abstract: | We characterize optimal macroprudential policy in response to external risks---shocks to the level and volatility of world interest rates--in a small open economy subject to financial crises. Low and stable world interest rates reinforce overborrowing arising from a pecuniary externality generated by collateral constraints that depend on asset prices. We show that this mechanism leads to greater exposure to crises typically accompanied by abrupt increases in interest rates and a persistent rise in their volatility, as commonly observed for crises in emerging market economies. A tax on international borrowing implementing the optimal policy depends on two factors, the incidence and severity of future crises. We show that the interaction of these factors implies that the tax responds to external risks even though equilibrium allocations do not, and that it does so non-monotonically with respect to the direction of external shocks|higher macroprudential taxes are not always the optimal policy in response to an increase in external risks|. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed019:1138&r=all |
| By: | Ṣebnem Kalemli-Özcan |
| Abstract: | I show that monetary policy divergence vis-a-vis the U.S. has larger spillover effects in emerging markets than advanced economies. The monetary policy of the U.S. affects domestic credit costs in other countries through its effect on global investors’ risk perceptions. Capital flows in and out of emerging market economies are particularly sensitive to fluctuations in such risk perceptions and have a direct effect on local credit spreads. Domestic monetary policy is ineffective in mitigating this effect as the pass-through of policy rate changes into short-term interest rates is imperfect. This disconnect between short rates and monetary policy rates is explained by changes in risk perceptions. A key policy implication of my findings is that emerging markets’ monetary policy actions designed to limit exchange rate volatility can be counterproductive. |
| JEL: | E0 F0 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26297&r=all |
| By: | Francesco Bianchi; Howard Kung; Thilo Kind |
| Abstract: | This paper presents market-based evidence that President Trump influences expectations about monetary policy. The main estimates use tick-by-tick fed funds futures data and a large collection of Trump tweets criticizing the conduct of monetary policy. These collected tweets consistently advocate that the Fed lowers interest rates. Identification in our high-frequency event study exploits a small time window around the precise time stamp for each tweet. The average effect of these tweets on the expected fed funds rate is strongly statistically significant and negative, with a cumulative effect of around negative 10 bps. Therefore, we provide evidence that market participants believe that the Fed will succumb to the political pressure from the President, which poses a significant threat to central bank independence. |
| JEL: | E52 E58 G1 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26308&r=all |
| By: | Jonathan Chiu; Thorsten Koeppl |
| Abstract: | A cryptocurrency system such as Bitcoin relies on a decentralized network of anonymous validators to maintain and update copies of the ledger in a process called mining. In such a permissionless system, someone can cheat by spending a coin twice, which leads to the so-called double-spending problem. A well-functioning cryptocurrency system must ensure that users do not have an incentive to double spend. We develop a general-equilibrium model of a cryptocurrency. We use the model to obtain a condition that rules out double spending and study the optimal design of cryptocurrencies. We also quantify the welfare costs of using a cryptocurrency as a payment instrument. We find that it is better to use the revenue from currency creation rather than transaction fees to finance the costly mining process. We estimate that Bitcoin generates a large welfare loss that is about 500 times bigger than the welfare loss in a monetary economy with 2 percent inflation. This welfare loss can be lowered in an optimal design to the equivalent of that in a monetary economy with moderate inflation of about 45 percent. |
| Keywords: | Digital Currencies and Fintech; Monetary Policy; Payment clearing and settlement systems |
| JEL: | E4 E5 L5 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:19-40&r=all |