Sources of exchange rate fluctuations with Taylor rule fundamentals

This paper investigates the sources of exchange rate fluctuations when monetary policy follows a Taylor rule interest rate reaction function. We first present a simple dynamic exchange rate model with Taylor rule fundamentals which is triangular in the long-run impacts of shocks to the output market, the interest rate differential, and the Taylor rule. We then proceed to assess the relative importance of various shocks in exchange rate determination by estimating a structural VAR with long-run identification restrictions based on the triangular structure of the model. We find demand shocks to be less important than in earlier VAR studies, with both supply shocks and nominal shocks explaining a substantial part of real exchange rate fluctuations.     

Real exchange rate dynamics: Relative importance of Taylor‐rule fundamentals,monetary policy shocks,and risk‐premium shocks

We first show that the solution to the real exchange rate under the Taylor rule with interest rate smoothing can have two alternative representations—one based on a first‐order difference equation and the other based on a second‐order difference equation. Then, by comparing error terms from these two alternative representations and analyzing their second moments, we evaluate the relative importance of Taylor‐rule fundamentals, monetary policy shocks, and risk‐premium shocks in the dynamics of the real exchange rate. Empirical results suggest that the risk‐premium shock is the largest contributor to real exchange rate movements for all the countries examined, with the Taylor‐rule fundamentals and monetary policy shocks playing a limited role. These results are robust to various alternative sets of parameter values considered for the Taylor rule with interest rate smoothing.     

Foreign output shocks,monetary rules and macroeconomic volatilities in small open economies

The 2008 financial crisis is marked by the drop in output of major industrial countries which affected small open economies in various degrees. We examine the role of three different types of monetary policy rules in mitigating or exacerbating the effects of a negative foreign output shock on key macroeconomic variables of a small open economy by numerically solving a dynamic stochastic general equilibrium (DSGE) model. We find that compared to the Taylor rule, small open economies that follow either fixed exchange rate regime or strict inflation targeting tend to stabilize real exchange rate and inflation at the expense of substantial instability in the real economy.     

TAYLOR RULE REACTION COEFFICIENTS AND REAL EXCHANGE RATE PERSISTENCE

Recent literature has established a link between the persistence of real exchange rates and the degree of inertia in Taylor rule monetary policy reactions functions. This paper provides a different view on this link by investigating how the size of Taylor rule reaction coefficients impacts the adjustment dynamics of the real exchange rate. Within a stylized sticky‐price open‐economy macro model, it is demonstrated that a stronger interest rate reaction to inflation in the Taylor rule raises the convergence speed of the real exchange rate. Conversely, raising the coefficient on the output gap or attending to the exchange rate in an open‐economy version of the Taylor rule slows down real exchange rate adjustment. In all cases, more rapid convergence comes at the cost of stronger initial real exchange rate misalignments in the wake of monetary policy shocks.     

货币政策冲击、外汇干预与汇率 变动的同期与动态关联研究

本文采用SVAR模型以及2005年7月至2011年12月的月度数据，研究了2005年的新汇率改革之后，我国货币政策冲击、外汇干预与汇率间的动态关联。主要发现与结论如下：在货币政策冲击、外汇干预与汇率三者的同期博弈中，外汇干预不能即刻影响同期汇率。利率的上升及广义货币供应量的变动均会对同期名义有效汇率造成一定影响，但不太显著。在三者的动态博弈中，外汇干预是非冲销和有效性得到验证，外汇干预信号的假设可以成立。此外，即使利率的变动并不针对汇率，却带来汇率的大幅波动。名义有效汇率的上升可以有效抑制消费价格指数（CPI）的提高，并且数量型货币政策容易造成CPI的反弹。本文针对研究结论提出了一些政策建议。     

泰勒规则及其在中国货币政策中的检验

本文运用历史分析法和反应函数法首次将中国货币政策运用于检验泰勒规则。通过计算中国货币政策中利率的泰勒规则值 ,并与其实际值进行比较表明 ,泰勒规则可以很好地衡量中国货币政策 ,利率规则值与实际值的偏离之处恰恰是政策操作滞后于经济形势发展之时。这表明泰勒规则能够为中国货币政策提供一个参照尺度 ,衡量货币政策的松紧。对中国货币政策的反应函数GMM估计表明 ,通胀率对利率的调整系数小于 1 ,这是一种不稳定的货币政策规则 ,在这一制度下 ,通货膨胀或通货紧缩的产生和发展有着自我实现机制。     

Wage rigidities and unemployment fluctuations in a small open economy

This study analyzes the implications of the monetary policy for the unemployment rate in a small open economy. We introduce nominal wage rigidities and unemployment into the small open economy version of the dynamic stochastic general equilibrium model. We derive three main findings. First, under nominal wage rigidities, the cyclical properties of the calibrated model, in response to a productivity shock, are consistent with the empirical evidence on a decrease in employment and an increase in real wages. Second, for all the variables considered, the Taylor rule tracks the optimal policy better than the simple rule with unemployment as an argument. Third, regardless of the output or unemployment gap being targeted, it is not optimal that central banks respond to nominal exchange rate variations.     

中国名义货币状况指数的构建

构建和监测货币状况指数是将汇率纳入货币政策框架中的一种可行方式.文章在系统分析汇率和货币供应量等变量对国内消费者价格水平的价格传递链条的基础上,运用VAR方法来构建了2005年7月人民币汇率制度改革以来的中国名义货币状况指数.研究表明,M1和名义有效汇率在名义MCI中的权重之比为1:1.17,在此基础上构建的名义MCI与消费价格指数走势是高度吻合的.从货币政策立场指示器和对通货膨胀进行监测的角度看,我国央行应关注并定期发布货币状况指数.     

Endogenous monetary policy and the liquidity effect

We compare the transmission mechanism of exogenous and endogenous monetary policies in a calibrated small open economy model with nominal and real rigidities. Under an exogenous monetary policy rule it takes implausible values of the intertemporal elasticity of substitution and the price adjustment costs to generate the liquidity and overshooting effects. Endogenous rules with strong feedback to inflation and output help to reproduce the response of the nominal interest and exchange rates to unanticipated monetary policy shocks that characterize the transmission mechanism of standard sticky price models. The liquidty and overshooting effects are always obtained when the model is augmented with a Taylor interest rate rule.JEL Classification: E32, E43Javier Andrés acknowledges support of CICYT grant SEC2002-0026. We thank the comments of two anonymous referees and the editor, Jordi Caballé, to an earlier version of the paper. The views expressed here are those of the authors and do not represent the view of the Banco de España.     

Re-exploring the nexus between monetary policy and banks' risk-taking

In this paper, we analyse the link between monetary policy and banks' risk-taking behaviour. Some theoretical and empirical studies show that monetary easing increases banks' appetite for risk related to asset valuation and the search for higher yield. However, the low interest rate environment that began in 2010 is casting doubt on these findings. Our study adds to analyses of the monetary risk-taking channel considering non-linearity, especially testing threshold effects in this channel. Using a dataset of US banks, we find that the impact of low interest rates on banks' risk behaviour depends on the previous monetary regime, that is on the deviation of monetary rates from the Taylor rule. We complement the literature on the Taylor rule and provide arguments that extend the use of the Taylor rule by Central Banks to financial stability purposes.     

Wealth in utility,the Taylor principle and determinacy

Wealth in the utility function leads to the discounting to consumer’s Euler equation, enlarging determinacy regions and making it easier for the monetary authority to ensure equilibrium determinacy. We show that a passive policy rule which adjusts nominal interest rate by less than one-for-one in response to the inflation rate is able to rule out equilibrium indeterminacy, if properly specified, due to the presence of the demand channel of the Taylor principle and equilibrium determinacy. Furthermore, the extent to which monetary policy rule can be passive in order to avoid indeterminacy depends critically on the degree of preference over wealth as well as the underlying structures and parameters of the model.     

Firms’ money demand and monetary policy

Standard New Keynesian models for monetary policy analysis are ‘cashless’. When the nominal interest rate is the central bank's operating instrument, the LM equation is endogenous and, it is argued, can be ignored. The modern theoretical and quantitative debate on the importance of money for monetary policy conduct, however, overlooks firms’ money demand. Working in an otherwise canonical New Keynesian setup, we show that macroeconomic dynamics are critically affected by the firms’ money demand choice. Under the conventional Taylor‐rule framework, we prove that equilibrium determinacy may require either an active interest rate policy, overreacting to inflation, or a passive interest rate policy, underreacting to inflation, depending on the elasticity of production with respect to cash balances. We then develop a numerical analysis to evaluate our theoretical results. We find that macroeconomic stability is more likely to occur under an active, but not overly aggressive, monetary policy stance. We also examine the dynamic effects of forward‐looking feedback rules. We show that, in this policy regime, indeterminacy is likely to be induced by both active and passive rules, even for relatively low productivity effects of money.     

Monetary policy in open economies

The recent literature on monetary policy in open economies has produced a strong presumption in favor of activistic policy and flexible exchange rates. We argue that this result may owe much to the combination of two commonly made assumptions: That nominal goods prices are rigid. And that the monetary authorities have a lot of information about the economy. When the source of nominal rigidity is found in wages and monetary policy is conducted according to less information demanding rules (such as a standard interest rate rule) policies that stabilize the money supply or the nominal exchange rate may perform better.     

Uncovering the link between a flexible exchange rate and fundamentals: the case of Central and Eastern European economies

This article examines the link between a nominal exchange rate and macrofundamentals in Central and Eastern European (CEE) countries. We use the model based on the monetary policy rule as a theoretical framework that explains the relations between the exchange rate and price level, risk premium, output gap, and expected inflation. It allows for endogeneity of the monetary policy – the issue ignored in the widely used monetary model. The sample covers the period January 2000 – December 2014, so the data are not plagued by high-inflation differentials characteristic for the early transition period and include countries with relatively flexible exchange rates. Our empirical strategy employs the panel error correction model that allows for cross-sectional dependence and a series of panel causality tests. The main finding is that the nominal exchange rates in CEE countries are not disconnected from macrofundamentals implied by the Taylor rule-based model. More specifically, we find that there is a strong cross-sectional dependence among CEE countries, exchange rates Granger-cause macrofundamentals and tend to revert to the long-run relation, and that the results are robust to the ‘extraordinary circumstances’ argument, i.e. do not rest on the dynamics during the global financial crisis.     

Disinflation costs in China and monetary policy regimes

This paper investigates the real effects of a disinflationary policy in China, in which we conduct a disinflation experiment in a medium-scale New Keynesian model. We highlight two key features of China's economy: the relevance of money to monetary policy rules and household inequality. For the former, we consider two monetary policy regimes: an expanded Taylor rule with money and a money supply rule. For the latter, we take into account a share of the population that is limited in its ability to participate in assets markets. Our analysis suggests that a disinflation policy is more costly when the central bank controls the money supply than the case in which the nominal interest rate is the policy instrument. Our results are driven by the different impacts of disinflation on nominal and real interest rates under the two regimes.     

Foreign output shock in small open economies: A welfare evaluation of monetary policy regimes

We examine the impact of negative foreign output shocks, which entail negative demand side effects by lowering exports and positive supply side effects by lowering oil prices, on the welfare of non-oil producing, small open economies under five exchange rate and monetary policy regimes. We use a dynamic stochastic general equilibrium model with parameter values calibrated for Hong Kong, Israel, Singapore, South Korea and Taiwan. We find that welfare levels among the five policy regimes depend on the economy's share of oil imports in world oil consumption. Hong Kong, Singapore and Israel, which have smaller shares, maximize welfare under the Taylor rule, which targets both CPI inflation and real output. South Korea, with higher shares, and Taiwan, with more rigid prices, maximize welfare under real output targeting. CPI inflation targeting, nominal output growth targeting and fixed exchange rate regimes generate lower welfare. However, optimal monetary policy, which generates the highest welfare, gives greater weight on real output than CPI inflation.     

Monetary transmission mechanism in Turkey under the monetary conditions index: an alternative policy rule

This study analyses monetary transmission mechanism in Turkey using a small structural macroeconomic model. The core equations of the model consist of aggregate demand, wage-price setting, uncovered interest rate parity, foreign sector and a monetary policy rule. The aim of the paper is to analyse the disinflation path, the output gap, the output level, the exchange rate and the interest rate, and also the output–inflation variance frontier of the economy under various scenarios. The first scenario assumes that a standard Taylor rule is implemented as the policy rule. In the alternative scenario, instead of the standard Taylor rule, the MCI, Monetary Conditions Index – combination of the changes in the short-term real interest rate and in the real effective exchange rate in a single variable – is used as a policy instrument. The results indicate that the economy stabilizes much more quickly and shows significantly less volatility under this new setting. Therefore, the paper concludes that the policymakers should consider using MCI as an instrument when conducting monetary policy.     

Time-varying transmission efficiency of China’s monetary policy

This paper tries to investigate the time-varying characteristics of China’s monetary policy transmission from the impulse response evidence of both open-economy DSGE model and TVP-VAR model. We find that the transmission efficiency of price-based monetary policy has significantly improved over the sample period, while quantity-based monetary policy is weakening. The resume of exchange reform in 2010 also strengthens the exchange rate channel especially in terms of price-based monetary policy. Combining with the evidence from DSGE model underlines the importance of further interest rate liberalization and price-based monetary policy Taylor rule should also consider the exchange rate stability.     

NOMINAL GDP TARGETING AND CENTRAL BANK CONSERVATIVENESS

In the literature on monetary economics, there is the ‘inflationary bias’ result which predicts that the rate of inflation will be biased towards a higher level under discretionary monetary policy than under a rule‐based policy regime. It is established that a credible nominal target can eliminate this ‘inflationary bias’. In this paper, we examine the case of nominal GDP targeting, which is a rule‐based monetary regime. Depending on the degree of conservativeness by the central bank, we show in a stylized model the choice of different combination of inflation and real GDP targets can still result in an ‘inflationary bias’, and there also exists the possibility of a ‘dis‐inflationary bias’.     

The lower bound and the causes of monetary policy inertia: evidence from Sweden

In 2009, in the midst of a global recession, Sweden’s Riksbank approached a lower bound on nominal interest rates. This encounter with the lower bound provides a natural experiment for investigating the causes of monetary policy inertia. To exploit this experiment, we estimate Taylor rules with Tobit specifications that permit both interest rate smoothing and persistent shocks (serial correlation) as explanations for inertia. The interest rate smoothing hypothesis leads to a specification in which lagged actual values of the dependent variable appear on the right-hand side of the Taylor rule, while the persistent shocks hypothesis leads to a specification in which lagged values of an unobserved latent dependent variable appear on the right-hand side of the Taylor rule. The divergence of actual and latent dependent variables that occurs at the lower bound provides leverage in distinguishing the two hypotheses. For a conventional Taylor rule, we find evidence of both sources of inertia. For a modified Taylor rule that includes a measure of financial stress, our evidence suggests that interest rate smoothing is the principal source of monetary policy inertia.