The Bernanke and Blinder Model in an Open Economy: The Italian Case

Abstract. This paper analyzes the functioning of monetary policy transmission mechanisms in Italy from 1984 to 1998, highlighting the role performed by the credit system. We extend the Bernanke and Blinder model (1988) to the case of an open economy under a quasi‐fixed exchange rate regime, deriving analytically the conditions for the functioning of the three monetary policy channels generally identified in the literature (‘money’, ‘exchange rate’ and ‘credit’). These conditions explain the partial effectiveness of monetary policy in achieving price and income targets, while maintaining external equilibrium. By means of a structural VECM analysis, we evaluate the effectiveness of the transmission of monetary policy through the three channels.     

Financial constraints and the balance sheet channel: a re-interpretation

Aggregate demand models extending IS/LM fixed price framework yield an enhancement mechanism of the traditional monetary transmission mechanism, the credit channel, which, according to the credit view, works through the ‘balance sheet channel’ and the ‘bank lending channel’. In this paper the augmented IS/LM model is modified assuming that investments may be financed by both internal and external sources of funds. The inclusion of internal funds in the augmented IS/LM fixed price model suggests a different interpretation of the ‘balance sheet channel’ as an enhancement mechanism amplifying monetary policy effects through the quantity rather than the cost of borrowing. Thus, changes in borrowers’ net worth over the cycle can amplify and propagate output fluctuations directly rather than indirectly as in the traditional interpretation of the balance sheet channel. The empirical analysis of the monetary transmission mechanism for Italy in the last decade accords with the interpretation of the balance sheet channel proposed in this paper.     

Structural VAR models for Malaysian monetary policy analysis during the pre- and post-1997 Asian crisis periods

This article conducts an in-depth investigation into building a Structural Vector Autoregression (SVAR) model and analysing the Malaysian monetary policy. Considerable attention is paid to: (i) the selection of foreign, policy and target variables; (ii) establish identifying restrictions and improve the estimates of impulse response functions; (iii) assess the importance of intermediate channels in transmitting monetary policy mechanism; and (iv) the way in which the 1997 Asian financial crisis affected the working of monetary policy. Malaysia is an interesting small open economy to study because, following this crisis, the government imposed capital and exchange rate control measures. The overall results suggest that the crisis and the subsequent major shift in the exchange rate regime have significantly affected the Malaysian ‘Black Box’. In the pre-crisis period, domestic variables appear to be more vulnerable to foreign monetary shocks. Further, the exchange rate played a significant role in transmitting the interest rate shocks, whereas credit and asset prices helped to propagate the money shock. In the post-crisis period however, asset prices play a more domineering role in intensifying the effects of both interest rate and money shocks on output, and the economy was insulated from foreign shocks.     

James Steuart and the making of Karl Marx’s monetary thought

Abstract

This paper analyses the influence of James Steuart on Karl Marx’s monetary thought. It deals more specifically with Marx’s rejection of an automatic mechanism that links variations in the quantity of money to their direct impact on prices. Steuart’s pioneering discoveries in economics inaugurate an anti-quantity theory tradition that Marx supported and which fed his own conception of money and credit. Here, we deal with the criticism of the assumptions of the quantity theory of money (QTM), the specifically social character of labour which creates exchange value, the distinction between the functions of money, the difference between income spending and capital advances, and the difference between simple circulation and reflux of money credit.     

State prices,liquidity, and default

We show, in a monetary exchange economy, that asset prices in a complete markets general equilibrium are a function of the supply of liquidity by the Central Bank, through its effect on default and interest rates. Two agents trade goods and nominal assets to smooth consumption across periods and future states, in the presence of cash-in-advance financing costs that have effects on real allocations. We show that higher spot interest rates reduce trade and as a result increase state prices. Hence, states of nature with higher interest rates are also states of nature with higher risk-neutral probabilities. This result, which cannot be found in a Lucas-type representative agent model, implies that the yield curve is upward sloping in equilibrium, even when short-term interest rates are fairly stable and the variance of the (macroeconomic) stochastic discount factor is 0. The risk-premium in the term structure is, therefore, a monetary-cost risk premium.     

The dichotomy once again

Patinkin's contribution to monetary theory is discussed with particular attention given to his ‘dichotomy argument’. It is shown that he is perfectly correct, but there is a confusion in the literature between the ‘neutrality proposition’ and the independence of equilibrium of the quantity of money. I then turn to homogeneity and its importance, and stress that the homogeneity applies to current as well as expected prices. I am rather unkind to mathematizing the double coincidence of wants argument, since it seems very obvious and the mathematics is exceptionally ugly. The paper concludes with remarks on monetary policy and the connection between the theory of money and that of information.     

Should monetary policy respond to asset price misalignments?

This paper analyses the relationship between monetary policy and asset prices using a structural rational expectations open economy model that allows for the effect of asset prices and exchange rates on aggregate demand. We assume that asset prices and exchange rates follow a partial adjustment mechanism whereas they are positively affected by past changes, thus allowing for ‘momentum trading’, while at the same time we allow for reversion towards fundamentals. We then conduct stochastic simulations using two alternative monetary policy rules, inflation-forecast targeting and the standard Taylor rule. The results indicate that, under both rules, interest rate setting that takes into account asset price misalignments leads to lower overall macroeconomic volatility, as measured by the postulated loss function of the central bank.     

Simonsen and the early history of the cash\in-advance approach

The paper brings to light an early contribution to the cash-in-advance literature made by the Brazilian economist Mario Henrique Simonsen (1935–1997) in an article written in Portuguese as far back as 1964. Simonsen explicitly introduced the cash-in-advance constraint as an inequality in a non-linear programming problem and provided a diagrammatic illustration of the interior and boundary solutions. He also applied the concept to the discussion of the quantity theory of money and showed that the classical dichotomy is valid for the stationary equilibrium of prices over time.     

Economic Growth,Terms of Trade and Welfare in an Open Monetary Economy*

The authors investigate the impact of growth on terms of trade, absolute prices and welfare using a two-country, monetary model. Under flexible exchange rates export-biased growth would lead to a decline in the terms of trade if the two countries are ‘similar’. Under fixed exchange rates a weaker condition than the barter condition of export-biased growth is sufficient, namely, for the import commodity the demand creating effect of growth dominates the supply effect while for the exported commodity the opposite holds. Secondly, substitutability between money and commodities indicates that no necessary relation holds between the terms of trade and the trade balance. Thirdly, the introduction of money creates a real balance effect so that decline in terms of trade is no longer a necessary (or sufficient) condition for immiserization. Finally, the paper concludes by questioning two policy conclusions drawn in earlier models: one, that the declining terms of trade of less developed countries was due to a bias in the growth strategy and, two, that monetary models of trade support the ‘monetarist’ proposition that growth and a deteriorating trade balance can only co-exist if the domestic monetary policy is nonneutral.     

Nominal uniqueness and money non-neutrality in the limit-price exchange process

We define continuous-time dynamics for exchange economies with fiat money. Traders have locally rational expectations, face a cash-in-advance constraint, and continuously adjust their short-run dominant strategy in a monetary strategic market game involving a double-auction with limit-price orders. Money has a positive value except on optimal rest-points where it becomes a ??veil?? and trade vanishes. Typically, there is a piecewise globally unique trade-and-price curve both in real and in nominal variables. Money is not neutral, either in the short-run or long-run and a localized version of the quantity theory of money holds in the short-run. An optimal money growth rate is derived, which enables monetary trade curves to converge towards Pareto optimal rest-points. Below this growth rate, the economy enters a (sub- optimal) liquidity trap where monetary policy is ineffective; above this threshold inflation rises. Finally, market liquidity, measured through the speed of real trades, can be linked to gains-to-trade, households?? expectations, and the quantity of circulating money.     

Monetary policy through the ‘credit-cost channel’: Italy and Germany pre- and post-EMU

We present an empirical analysis of the ‘Credit-Cost Channel’ (CCC) of monetary policy transmission. This channel combines bank credit supply and interest rates on loans as a cost to firms. The thrust of the CCC is that it makes both aggregate demand and aggregate supply dependent on monetary policy. As a consequence (1) credit market conditions (e.g. risk spreads) are important sources and indicators of macroeconomic shocks, (2) the real effects of monetary policy are larger and persistent. We have applied the Cointegrated Vector Autoregression (CVAR) econometric methodology to Italy and Germany in the ‘hard’ EMS period and in the European Monetary Union (EMU) period. The short-run and long-run effects of the CCC are detectable for both countries in both periods. Simulation of the estimated model also confirms that inflation-targeting by way of inter-bank rate control stabilizes inflation through structural shifts of the stochastic equilibrium paths of both inflation and the output.     

Money and growth in a cash-in-advance economy with costly credit

This paper develops a stochastic growth model with a cash-in-advance constraint, costly credit, and intermediary services. We study how the behavior of financial intermediaries affects the relationship between economic growth and the monetary system. We show that the payment that intermediaries charge for providing financial services influences the money–growth relationship. When the intermediation cost increases proportionally with credit purchases, we do not observe any influence of growth on the monetary system. When the intermediation cost is not proportional to credit purchases, growth is responsible for a transformation of the monetary system, i.e. money is relatively driven out of the economy as the economy grows.     

The Conceptual Flaw in the Microeconomic Foundations of Dynamic Stochastic General Equilibrium Models

First-generation dynamic stochastic general equilibrium (DSGE) models have been criticized for their lack of financial markets but, more perceptively, for their barter properties. This note explains why the second of these criticisms is fundamental. All DSGE models are built on frictionless, perfect barter, Walrasian microeconomic foundations. Introducing money and banks into such models converts them into a ‘friction’ contra the fundamental principle that monetary exchange is more efficient than barter. This insoluble difficulty with the microeconomic foundations of DSGE models arises because theorists ignore the Hahn problem that applies to all monetary models based on Walrasian general equilibrium (GE) microeconomic foundations. The Hahn problem reveals three things. First, a perfect barter GE solution always exists in any ‘monetary’ model erected on Walrasian GE microeconomic foundations. Second, inessential monetary features are easily attached to perfect barter microeconomic foundations but as easily removed, leaving the perfect barter solution intact. Third, attaching such inessential additions leads to logical error; the misuse of language that produces invalid conclusions. A second-generation DSGE model that is intended to increase understanding of financial crises is then examined to show that it suffers from the Hahn problem; it converts banking and financial markets into ‘frictions’, and words and economic concepts take on different meanings. That renders the new DSGE model impossible to interpret or use as a basis for advice on monetary policy.     

零利率下限、货币政策与金融稳定?

文章通过构建包含零利率下限约束的D SGE 模型,系统探讨了存在零利率下限时外生不利冲击对经济的影响。研究结果表明：(1)当名义利率触及零利率下限时,宏观经济和金融体系的不稳定性和脆弱性会显著增加,外生不利冲击对产出、通胀、信贷等经济变量的影响也会明显放大。(2)当存在零利率下限时,传统泰勒规则已无法有效稳定经济,最优的货币政策规则不仅应盯住产出缺口和通胀缺口,还应对资产价格和信贷给予重点关注并做出适度反应。(3)货币政策更适于保持产出缺口和通胀缺口的稳定,但难以有效减缓房价和信贷的波动。只有将逆周期监管的宏观审慎政策和货币政策有效搭配,才能保证经济系统和金融系统的全面稳定。为了应对不利冲击,我国应进一步完善宏观审慎监管框架,并将其与货币政策有效搭配以保持宏观经济的全面稳定。     

The Exchange Rate and Inflation in the UK

The United Kingdom is a highly open economy, and has a monetary policy strategy of targeting inflation in consumer prices. In this paper, we look at the evidence from the UK on inflation behaviour, and examine the propositions from several theoretical models about inflation dynamics in an open economy, focusing in particular on the hypothesized connections between the exchange rate and consumer price inflation. Theoretical open‐economy macroeconomic models ‘cover the waterfront’ on this issue, ranging from ‘exchange rate disconnect’ to a rigid link between nominal exchange rate changes and inflation. We estimate on UK data the open‐economy Phillips curves implied by the alternative explanations. We argue that, of the alternatives considered, only a model where imports are modelled as an intermediate good, as in McCallum and Nelson (1999) , provides a reasonable match with the data. Unlike the standard model, in which imports are treated as a final consumer good, the intermediate‐goods specification provides support for a policy of CPI inflation targeting.     

人民币汇率波动与货币政策调控难度

文章采用动态随机一般均衡（DSGE）模型研究了中国货币政策实施时不能忽略的人民币汇率波动特征。文章构建了人民币汇率波动与中国货币政策及其宏观经济系统影响机制的理论模型,并在模型参数校准的基础上进行了政策模拟。研究结果表明,较大的人民币汇率波动会在一定程度上减弱中国货币政策的调控效果,但是对每个变量冲击响应的影响程度有所不同。较大的人民币汇率波动将显著干扰货币政策对宏观经济需求的调控,人民币汇率升值波动幅度较大时,货币政策对需求变量的调控作用会减弱,但不会影响相关需求变量在不同时点的冲击响应走势特征。较大的汇率波动会减弱利率上行对出口的负面影响,有利于缓解货币政策对出口的负面冲击,但会导致贸易条件（出口价格和进口价格的比值）进一步恶化。     

Long-Run Links among Money, Prices and Output: Worldwide Evidence

Abstract. Starting from the quantity theory of money we analyse the dynamic relationships between money, real output and prices for an unbalanced panel of 110 economies. Complementary to trivariate analyses we also adopt a P-star model explaining inflation via an equilibrium price level (P-star), which in turn depends on potential output and money. A key issue of the paper is the cross-sectional stability of estimation and inference results. We find cointegration among the considered variables. Particularly for high inflation countries homogeneity between prices and money cannot be rejected. Given homogeneity we find evidence for an error-correction mechanism linking current price changes and the lagged price gap. Parameter estimates indicating the adjustment towards the price equilibrium are larger in absolute value for high inflation countries. The latter results indicate that central banks, even in high inflation countries, can improve price stability by controlling monetary growth.     

Credit and Business Cycles

This paper presents two dynamic models of the economy in which credit constraints arise because creditors cannot force debtors to repay debts unless the debts are secured by collateral. The credit system becomes a powerful propagation mechanism by which the effects of shocks persist and amplify through the interaction between collateral values, borrowers' net worth and credit limits. In particular, when fixed assets serve as collateral, I show that relatively small, temporary shocks to technology or wealth distribution can generate large, persistent fluctuations in output and asset prices.
JEL Classification Numbers: E32, E44     

FEER for the CFA franc

We investigate the behaviour of the real effective exchange rates (REER) of the two CFA franc zone monetary unions?–?CEMAC and WAEMU?–?vis-à-vis their long-run equilibrium paths. A reduced form of the Edwards’ (1989) fundamentals equilibrium exchange rate (FEER) model is estimated using the Johansen's (1995) cointegration methodology, and equilibrium paths and associated misalignments are derived for the period 1970 to 2005. Our results suggest that, for both CEMAC and WAEMU, the fundamentals account for most of the exchange rates’ fluctuation: increases in the terms-of-trade, government consumption and productivity tend to appreciate the exchange rate, while increases in investment and openness tend to depreciate it. At end of 2005, we find no evidence that either the CEMAC or WAEMU REERs were significantly over-valued, which suggests that no exchange rate action is currently needed. Our analysis also reveals significant differences in the fundamentals’ marginal impact, and speed of reversion to equilibrium following a shock, which may raise questions about the desirability of maintaining the same parity for both monetary unions.     

A bank lending channel or a credit supply shock?

Shifts in credit supply could have a bearing on house prices e.g. through financial innovations and changes in regulation independently of the existence of a bank lending channel of monetary policy. This paper assesses the responses of US house prices to an exogenous credit supply shock and compares them with the effects from variations in credit supply associated with a bank lending channel. The contribution of the study is twofold. First, innovations in credit supply are identified using a mortgage mix variable, thereby accounting for the market-based financial intermediaries. As a robustness check a survey variable of bank lending standards for mortgage loans is also used. Second, the policy-induced credit supply effect on house prices is disentangled and compared with the effect from an exogenous credit supply shock. It is shown that in the first 3 years credit supply shocks affect house prices exogenously rather than through the bank lending channel. Monetary policy has still a large impact on house prices, even when the bank lending channel is ‘turned off’.