Record ID

267     [ Page 42 of 68, No. 1 ]

Date

2012-08

Author

Paolo Gelain, Kevin J. Lansing, and Caterina Mendicino

Affiliation

Norges Bank, FRB San Francisco, and Bank of Portugal

Title

House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macro-prudential Policy

Summary /
Abstract

Progress on the question of whether policymakers should respond directly to financial variables requires a realistic economic model that captures the links between asset prices, credit expansion, and real economic activity. Standard DSGE models with fully-rational expectations have difficulty producing large swings in house prices and household debt that resemble the patterns observed in many developed countries over the past decade. We introduce excess volatility into an otherwise standard DSGE model by allowing a fraction of households to depart from fully-rational expectations. Specifically, we show that the introduction of simple moving-average forecast rules for a subset of households can significantly magnify the volatility and persistence of house prices and household debt relative to otherwise similar model with fully-rational expectations. We evaluate various policy actions that might be used to dampen the resulting excess volatility, including a direct response to house price growth or credit growth in the central bank’s interest rate rule, the imposition of more restrictive loan-to-value ratios, and the use of a modified collateral constraint that takes into account the borrower’s loan- to-income ratio. Of these, we find that a loan-to-income constraint is the most effective tool for dampening overall excess volatility in the model economy. We find that while an interest-rate response to house price growth or credit growth can stabilize some economic variables, it can significantly magnify the volatility of others, particularly inflation.

Keywords

Asset Pricing, Excess Volatility, Credit Cycles, Housing Bubbles, Monetary policy, Macroprudential policy.

URL

http://www.norges-bank.no/Upload/English/Publications/Working%20Papers/2012/wp_2012_08.pdf

Record ID

266     [ Page 42 of 68, No. 2 ]

Date

2012-11

Author

Selim Elekdag, Phurichai Rungcharoenkitkul, and Yiqun Wu

Affiliation

Asia and Pacific Department, IMF

Title

The Evolution of Asian Financial Linkages: Key Determinants and the Role of Policy

Summary /
Abstract

This paper examines how Asian financial linkages with systemic economies have changed
over time. After developing a factor model, it estimates Asian financial sensitivities to
systemic economies, and then seeks to uncover their key determinants, which include trade
and financial linkages, as well as policies. In line with Asia’s growing role in the global
economy—including through deeper financial integration—regional financial markets have
become more sensitive to systemic economies. Asian financial sensitivities to systemic
economies exhibit cyclical fluctuations, and reached historically high levels during the latest
global financial crisis of 2008–09. While macroeconomic policy frameworks have helped
Asian economies cope well with market turbulence, they cannot completely insulate Asian
financial markets against major global financial shocks.

Keywords

Financial linkages; Asia; beta; global financial crisis

URL

http://www.imf.org/external/pubs/ft/wp/2012/wp12262.pdf

Record ID

265     [ Page 42 of 68, No. 3 ]

Date

2012-10

Author

Bong-Han Kim, Hyeongwoo Kim and Bong-Soo Lee

Affiliation

Auburn University and Florida State University

Title

Spillover Effects of the U.S. Financial Crisis on Financial Markets in Emerging Asian Countries

Summary /
Abstract

We examine spillover effects of the recent U.S. financial crisis on five emerging Asian countries by estimating conditional correlations of financial asset returns across countries using multivariate GARCH models. We propose a novel approach that simultaneously estimates the conditional correlation coefficient and the effects of its determining factors over time, which can be used to identify the channels of spillovers. We find some evidence of financial contagion around the collapse of Lehman Brothers in September 2008. We further find a dominant role of foreign investment for the conditional correlations in international equity markets. The dollar Libor-OIS spread, the sovereign CDS premium, and foreign investment are found to be significant factors affecting foreign exchange markets.

Keywords

Financial Crisis; Spillover Effects; Contagion; Emerging Asian Countries; Dynamic Conditional Correlation; DCCX-MGARCH

URL

http://d.repec.org/n?u=RePEc:abn:wpaper:auwp2012-06&r=cba

Remarks

The sample includes five emerging Asian countries: Indonesia, Korea, Philippines, Thailand, and Taiwan.

Record ID

264     [ Page 42 of 68, No. 4 ]

Date

2012-10

Author

Luis Felipe Céspedes, Roberto Chang and Andrés Velasco

Affiliation

National Bureau of Economic Research

Title

Financial Intermediation, Exchange Rates, and Unconventional Policy in an Open Economy

Summary /
Abstract

This paper develops an open economy model in which financial intermediation is subject to occasionally binding collateral constraints, and uses the model to study unconventional policies such as credit facilities and foreign exchange intervention. The model highlights the interaction between the real exchange rate, interest rates, and financial frictions. The exchange rate can affect the financial intermediaries' international credit limit via a net worth effect and a leverage ratio effect; the latter is novel and depends on the equilibrium link between exchange rates and interest spreads. Unconventional policies are nonneutral if and only if financial constraints are binding in equilibrium. Credit programs are more effective if targeted towards financial intermediaries rather than the corporate sector. Sterilized foreign exchange interventions matter because the increased availability of tradables, resulting from the sterilizing credit, can relax financial frictions; this perspective is new in the literature. Finally, self fulfilling expectations can lead to the coexistence of financially constrained and unconstrained equilibria, justifying a policy of defending the exchange rate and the accumulation of international reserves.

Keywords

Financial intermediation, Financial Frictions, Exchange Rates, International Reserves, and Unconventional Monetary Policy

URL

http://d.repec.org/n?u=RePEc:nbr:nberwo:18431&r=cba

Remarks

You should expect a free download if you are a subscriber, a corporate associate of the NBER, a journalist, an employee of the U.S. federal government with a ".GOV" domain name, or a resident of nearly any developing country or transition economy.

Record ID

263     [ Page 42 of 68, No. 5 ]

Date

2012-10

Author

Juan José Echavarría and Mauricio Villamizar

Affiliation

Banco de la Republica Colombia

Title

Great expectations? Evidence from Colombia’s exchange rate survey

Summary /
Abstract

In this document we use the Expectations Survey conducted monthly by the Central Bank of Colombia during the period of October 2003 – August 2012. We find that exchange rate revaluations were generally followed by expectations of further revaluation in the short run (1 month), but by expectations of devaluations in the long run (1 year), and that expectations are stabilizing both in the short and long run. The forward rate is generally different from the future spot rate, mainly because forecast errors are on average different from zero. This suggests that exchange rate expectations are not rational. The role of the risk premium is also important, albeit statistically significant only for the 1 year ahead forecasts (not for 1 month). One month expectations are much better predictors than the models of extrapolative, adaptive or regressive expectations or even the forward discount, and all of them outperform a random walk. But results are almost the opposite for 1 year. In this case traders and analysts could actually do much better by following some simple models or by looking at some key variables rather than by following the strategy that they pursue today.

Keywords

Exchange rate expectations, risk premium, market efficiency, forecasting accuracy, random walk, forward discount, rational expectations hypothesis.

URL

http://d.repec.org/n?u=RePEc:bdr:borrec:735&r=cba

Record ID

262     [ Page 42 of 68, No. 6 ]

Date

2012-07

Author

José de Gregorio

Affiliation

University of Chile

Title

Commodity Prices, Monetary Policy and Inflation

Summary /
Abstract

During the second half of the 2000s, the world experienced a rapid and substantial rise in commodity prices. This shock posed complex challenges for monetary policy, in particular due to the significant increase in food and energy prices, and the repercussions they had on aggregate inflation measures. This paper discusses the role of commodity price shocks in monetary policy in the light of recent episodes of such shocks. It begins by discussing whether monetary policy should target core or headline inflation, and what should be the role of commodity price shocks in setting interest rates. It is argued that there are good reasons to focus on headline inflation, as most central banks actually do. Although core inflation provides a good indicator of underlying inflationary pressures, the evolution of commodity prices should not be overlooked, because of pervasive second-round effects. This paper reviews the evidence on the rise of inflation across countries and reports that food inflation, more than energy inflation, has relevant propagation effects on core inflation. This finding is particularly important in emerging market economies, where the share of food in the consumer basket is significant. The evidence also shows that countries that had lower inflation during the run up of commodity prices before the global crisis had more inflation in the subsequent rise after the global crisis, suggesting that part of the pre-crisis inflationary success may have been due to repressed inflation. This paper also discusses other factors that may explain different inflationary performances across countries.

Keywords

Commodity prices, inflation, and monetary policy

URL

http://d.repec.org/n?u=RePEc:udc:wpaper:wp359&r=cba

Record ID

261     [ Page 42 of 68, No. 7 ]

Date

2012-08

Author

Paolo Gelain, Kevin J. Lansing, and Caterina Mendicino

Affiliation

Norges Bank, FRB San Francisco, and Bank of Portugal

Title

House prices, credit growth, and excess volatility: Implications for monetary and macroprudential policy

Summary /
Abstract

Progress on the question of whether policymakers should respond directly to financial variables requires a realistic economic model that captures the links between asset prices, credit expansion, and real economic activity. Standard DSGE models with fully-rational expectations have difficulty producing large swings in house prices and household debt that resemble the patterns observed in many developed countries over the past decade. We introduce excess volatility into an otherwise standard DSGE model by allowing a fraction of households to depart from fully-rational expectations. Specifically, we show that the introduction of simple moving-average forecast rules for a subset of households can significantly magnify the volatility and persistence of house prices and household debt relative to otherwise similar model with fully-rational expectations. We evaluate various policy actions that might be used to dampen the resulting excess volatility, including a direct response to house price growth or credit growth in the central bank's interest rate rule, the imposition of more restrictive loan-to-value ratios, and the use of a modified collateral constraint that takes into account the borrower's loan-to-income ratio. Of these, we find that a loan-to-income constraint is the most effective tool for dampening overall excess volatility in the model economy. We find that while an interest-rate response to house price growth or credit growth can stabilize some economic variables, it can significantly magnify the volatility of others, particularly inflation.

Keywords

Asset pricing, Excess volatility, Credit cycles, Housing bubbles, Monetary policy, Macroprudential policy

URL

http://www.norges-bank.no/en/about/published/publications/working-papers/2012/wp-201208/

Record ID

260     [ Page 42 of 68, No. 8 ]

Date

2012-09

Author

Francesco Drudi, Alain Durré and Francesco Paolo Mongelli

Affiliation

European Central Bank

Title

The interplay of economic reforms and monetary policy: the case of the Euro area

Summary /
Abstract

The world has been struck by a mutating systemic financial crisis that is unprecedented in terms of financial losses and fiscal costs, geographic reach, and speed and synchronisation. The crisis from August 2007 to date can be divided into three main phases: the financial turmoil from August 2007 to the collapse of Lehman Brothers; the global financial crisis from September 2008 until spring 2010; and the euro area sovereign debt crisis from spring 2010 to the current period. While each phase has brought significant challenges, the current sovereign debt crisis has been the most critical stage for the euro area. It has brought unprecedented challenges for the monetary union and triggered extraordinary adjustments in both monetary policy and institutional arrangements at the euro area level. The purpose of this article is to outline the features of each crisis phase, to describe the actions taken by the European Central Bank (ECB) during each phase and to explain the rationale for such measures. It also discusses the need to strengthen further the economic union in order to guarantee the sustainability of the monetary union of the euro area. In this respect, it is argued that the recent institutional adjustments made at the EU level would have been necessary independently of the financial crisis.

Keywords

Monetary policy decision-making, Eurosystem, financial crisis, financial and institutional reforms

URL

http://d.repec.org/n?u=RePEc:ecb:ecbwps:20121467&r=mon

Record ID

259     [ Page 42 of 68, No. 9 ]

Date

2012-06

Author

Martin Schmitz, Maarten De Clercq, Michael Fidora, Bernadette Lauro and Cristina Pinheiro

Affiliation

European Central Bank

Title

Revisiting the effective exchange rates of the Euro

Summary /
Abstract

This paper describes in detail the methodology currently used by the European Central Bank (ECB) to determine the nominal and real effective exchange rate indices of the euro. Building on the work of Buldorini et al. (2002), it shows how the ECB’s techniques for calculating effective exchange rates have been updated over time and explains the related theoretical foundations. In particular, the paper discusses the use and development of trade weights based on trade in manufactured goods (taking account of third market effects), the trading partners selected, and the choice of deflators for constructing the real effective exchange rate indices. In addition, it presents evidence on exchange rate and competitiveness developments for both the euro area as a whole and individual Member States. While the growing importance of China is reflected in the updated trade weights of euro effective exchange rates, it appears that the increasing integration of the euro area with other European economies accounts for the largest variation in trade weights. The US dollar, an anchor currency for a number of large emerging markets, continues to play an important role for the effective exchange rate of the euro and euro area competitiveness. Overall, euro area competitiveness has improved slightly since the introduction of the single currency, despite significant heterogeneity within the euro area.

Keywords

Competitiveness, effective exchange rate (EER), harmonised competitiveness indicator (HCI), nominal effective exchange rate (NEER), real effective exchange rate (REER), trade weights

URL

http://d.repec.org/n?u=RePEc:ecb:ecbops:20120134&r=mon

Record ID

258     [ Page 42 of 68, No. 10 ]

Date

2012-08

Author

Michael D. Bauer and Christopher J. Neely

Affiliation

Federal Reserve Bank of San Francisco and Federal Reserve Bank of St. Louis

Title

International channels of the Fed’s unconventional monetary policy

Summary /
Abstract

Previous research has established that the Federal Reserve large scale asset purchases (LSAPs) significantly influenced international bond yields. This paper analyzes the channels through which these effects occurred. We use dynamic term structure models to decompose international yield changes into changes in term premia and expected short rates. The conclusions for most countries are model dependent. Models that impose a unit root tend to imply large signaling effects for Australia, Canada, Germany and the United States. Models that do not restrict persistence imply negligible signaling effects for any country. Our preferred bias-corrected model implies large signaling effects for Canada and the United States. The idea that LSAP announcements signal information about Canadian rates is intuitively attractive because conventional US monetary policy shocks strongly predict Canadian rates.

Keywords

Monetary policy, bonds, international finance

URL

http://d.repec.org/n?u=RePEc:fip:fedfwp:2012-12&r=mon