Stock prices and monetary policy shocks: A general equilibrium approach

Empirical literature documents that unexpected changes in the nominal interest rates have a significant effect on real stock prices: a 100-basis point increase in the nominal interest rate is associated with an immediate decrease in broad real stock indices that may range from 2.2 to 9%, followed by a gradual decay as real stock prices revert towards their long-run expected value. We assess the ability of a general equilibrium New Keynesian asset-pricing model to account for these facts. We consider a production economy with elastic labor supply, staggered price and wage setting, as well as time-varying risk aversion through habit formation. We find that the model predicts a stock market response to policy shocks that matches empirical estimates, both qualitatively and quantitatively. Our findings are robust to a range of variations and parametrizations of the model.     

Asset market response to monetary policy news from SNB press releases

This paper analyses the effects of Swiss National Bank (SNB) communication on asset prices. It distinguishes between different monetary policy news contained in press releases following a monetary policy decision. Employing a latent variable approach and event-study methods, I find that medium- and long-term bond yields respond to changes in the communicated inflation and GDP forecasts as well as to the degree of pessimism expressed in press releases. Exchange rates mainly react to changes in the GDP forecast while stocks do not react to SNB communication on monetary policy announcement days. Additionally, short-term expectations about the future path of the policy rate are driven by the communicated inflation forecast. The results underline the role of qualitative news beyond quantitative forecasts in influencing market expectations and asset prices.     

Inflation targeting and expectation anchoring: Evidence from developed and emerging market economies

Inflation expectations can be inferred from treasury yields data. Previous studies utilizing such data have found evidence for the role of inflation targeting in anchoring inflation expectations in a number of developed market economies. The goal of this paper is to extend the evidence for emerging market economies. We estimate inflation expectations from nominal treasury yields data and infer the anchoring of inflation expectations from the sensitivity of inflation expectations to current inflation rates. Our analysis shows that the effect of inflation targeting is statistically significant in emerging market economies as well as in developed market economies and that the magnitude is marginally greater in the former. Our results are robust to alternative specifications.     

Housing prices and macroprudential policies: Evidence from microdata

This paper examines the efficacy of macroprudential policies in addressing housing prices in a developing country like India, utilizing two novel databases on city-level house prices in India. Though the empirical models provide evidence of a sizable effect of the fundamental factors in influencing house price dynamics, they also reveal strong countercyclical properties of macroprudential tools i.e., loan-to-value (LTV) limit, risk weights, and provisioning requirements, in influencing housing price movements. Among the macroprudential policy tools, the LTV limit emerges as the most potent one in influencing the price dynamics. A granular investigation of the effectiveness of macroprudential tools suggests that the countercyclical effect of the regulatory ratios for large-sized mortgages is much stronger as compared with those for the small-sized mortgages, attributed mainly to investment motives associated with the large-sized loans. We also find the presence of asymmetry in the impact of loosening versus the tightening of the LTV limit, which can be attributed to the procyclical behavior of the house prices.     

Debt constraints and monetary policy

In the present paper we show how simple monetary policies can mitigate real effects of credit frictions. We consider stationary overlapping generations economies in which consumers are not equally efficient in producing capital and cannot commit to repay loans. The presence of money in itself does not mitigate the real effects of credit frictions. Equilibrium allocations are generally not Pareto optimal unless the returns on money and capital production are identical for more productive consumers. However, printing money and distributing it to young consumers increase their incomes allowing young more productive consumers to produce more capital. Consequently money printing increases output.     

Finance-neutral potential output: An evaluation in an emerging market monetary policy context

In this paper, output gaps that include financial cycle information are evaluated against policy analysis models used by the Colombian central bank. This is an important feature, since policy-related models are the only relevant yardstick and emerging economies (such as Colombia) have been historically more vulnerable to financial imbalances. Unlike previous works, finance-neutral gaps were evaluated in a monetary policy context exactly as it is routinely performed by a central bank. The distribution of output gap revisions is analyzed and a metric to compare real-time robustness across models is developed. This metric constitutes a novel way to summarize the distribution of real-time uncertainty around output gaps, and policymakers should employ it for comparison purposes. Also, the real-time policy performance of finance-neutral gaps is studied, separating suggested ex post from operational ex ante usefulness. The results suggest that finance-neutral gaps are neither more robust in real time nor more operationally useful than the benchmark estimates. These results have important implications for policymakers and for the relevant literature.     

New perspectives on forecasting inflation in emerging market economies: An empirical assessment

We use a broad-range set of inflation models and pseudo out-of-sample forecasts to assess their predictive ability among 14 emerging market economies (EMEs) at different horizons (1–12 quarters ahead) with quarterly data over the period 1980Q1-2016Q4. We find, in general, that a simple arithmetic average of the current and three previous observations (the RW-AO model) consistently outperforms its standard competitors—based on the root mean squared prediction error (RMSPE) and on the accuracy in predicting the direction of change. These include conventional models based on domestic factors, existing open-economy Phillips curve-based specifications, factor-augmented models, and time-varying parameter models. Often, the RMSPE and directional accuracy gains of the RW-AO model are shown to be statistically significant. Our results are robust to forecast combinations, intercept corrections, alternative transformations of the target variable, different lag structures, and additional tests of (conditional) predictability. We argue that the RW-AO model is successful among EMEs because it is a straightforward method to downweight later data, which is a useful strategy when there are unknown structural breaks and model misspecification.     

Monetary policy on twitter and asset prices: Evidence from computational text analysis

In this paper, we dissect the Twitter debate about the future course of monetary policy and trace the effects of selected topics of this discourse on U.S. asset prices. We focus on the “taper tantrum” episode in 2013, a period with large revisions in expectations about future Fed policy. Based on a novel data set of 90,000 Twitter messages (“tweets”) covering the debate of Fed tapering on Twitter, we use Latent Dirichlet Allocation, a computational text analysis tool, to quantify the content of the discussion. Several estimated topic frequencies are then included in a VAR model to estimate the effects of topic shocks on asset prices. We find that the discussion about Fed policy on social media contains price-relevant information. Shocks to the discussion about the timing of the tapering, about the broader economic policy context and worrying investors are shown to lead to significant asset price changes. We also show that the effects are mostly due to changes in the term premium of yields consistent with the portfolio balance channel of unconventional monetary policy.     

Macroeconomic responses of emerging market economies to oil price shocks: An analysis by region and resource profile

We analyze the impact of oil price shocks on the macroeconomic fundamentals in emerging economies in three regions that have different resource endowments. The existing literature on emerging economies remains inconclusive on how regional factors and resource characteristics affect the response of macroeconomic variables to oil price shocks. We show that (1) exports in Europe and Central Asia are driven by oil more than East Asia and the Pacific and that (2) policy makers in East Asia and the Pacific should be concerned about real exchange appreciation following a positive oil shock to mitigate losses in the non-oil export market. Analysis by resource endowment further reveals that, in less-resource-intensive economies, an oil price shock causes large variations in consumption and has a negative and persistent impact on the real gross domestic product (GDP). In mineral-exporting economies, real GDP and interest rates are driven largely by oil price shocks. The response of real GDP in mineral-exporting economies is short lived. In oil-exporting economies, only real GDP has a large variation in response to oil price shocks. Our findings highlight the need for customized policy responses to oil price shocks, depending on resource endowments, as we show that a “one size fits all" policy does not exist.     

Central bank transparency and financial market expectations: The case of emerging markets

In this paper, we study how central bank transparency influences the formation of money market expectations in emerging markets. The sample covers 25 countries for the period from January 1998 to December 2009. We find, first, that transparency reduces the bias (the difference between the money market rate and the weighted expected target rate over the contract period) in money market expectations. The effect is larger for countries with no exchange rate peg and countries with low income. Second, an intermediate level of transparency is found to have the most favorable influence on money market expectations: neither complete secrecy nor complete transparency is optimal. Finally, all subcategories of the Eijffinger and Geraats (2006) index lead to a smaller bias in expectations, with political transparency having the largest effect.     

News shocks and asset price volatility in general equilibrium

We study equity price volatility in general equilibrium with news shocks about future productivity and monetary policy. As West (1988) shows, in a partial equilibrium present discounted value model, news about the future cash flow reduces asset price volatility. We show that introducing news shocks in a canonical dynamic stochastic general equilibrium model may not reduce asset price volatility under plausible parameter assumptions. This is because, in general equilibrium, the asset cash flow itself may be affected by the introduction of news shocks. In addition, we show that neglecting to account for policy news shocks (e.g., policy announcements) can potentially bias empirical estimates of the impact of monetary policy shocks on asset prices.     

Firm entry, credit availability and monetary policy

This paper presents a dynamic general equilibrium model that incorporates firm entry under credit rationing. Goods-producing firms in this model are bank dependent in the sense that they have no choice but to borrow funds from banks to cover labor wages that must be paid in advance of production. The results show that a cut in the policy rate enhances firm entry by mitigating the severity of credit rationing. This policy transmission is different from the conventional balance sheet channel in that a change in the policy rate directly affects borrowers' credit availability. I also show that a sudden stop in the credit supply to new firms is most likely to occur shortly after a credit boom. This is because endogenous downward wage rigidity prohibits the credit risk of prospective firms from decreasing enough to re-equilibrate the loan market.     

Targeted monetary policy and agriculture business loans

This study examines the effect of a Targeted Easing (TE) policy, an unconventional monetary policy tool initiated by the Chinese central bank to reduce reserve requirement ratios of agricultural financial institutions. Utilizing a longitudinal sample of Chinese agriculture companies and a matching sample of industrial firms between 2012 and 2017, we find that the TE policy successfully achieves its intended policy goal to boost lending to the agriculture sector. Results from our difference-in-differences estimations indicate that loan levels of agriculture firms increases significantly more than that of matching nonagricultural firms under TE relative to the non-TE period. We also document heterogeneous TE effects and find that agricultural firms with smaller agency costs, larger financing constraints, and larger loan intensity levels benefit significantly more from a TE policy than their counterparts. In addition, the TE policy effect is more salient during a contractionary period than in an expansionary period.     

Determinants of commonality in liquidity: Evidence from an order-driven emerging market

Using an extensive, time-series, cross-sectional data-set of actively traded Indian stocks with up to 1.75 million firm-day observations, we discern the key determinants of commonality in liquidity among emerging markets. The paper shows evidence for both supply-side and demand-side factors contributing to liquidity commonality. However, the results are more supportive towards supply-side rationale for liquidity commonality among the firms where regulators and banks play an important source of commonality in liquidity, especially during market turmoil. Results are partially driven by the fact that the Indian stick exchange is an order-driven market. Economic activities like cheap exports and undervalued currency, rather than correlated trading by the institutional investors determine the demand for liquidity. These findings endorse the effect of high firm value, market return, liquidity, volatility, turnover, and alternate proxies of commonality in liquidity estimation.     

The role of state ownership and institutions in the innovation performance of emerging market enterprises: Evidence from China

Although it has been suggested that institutional context influences a firm's innovation performance, the role of regulatory institutions has been underexplored. Extending previous research, this study investigates whether and how regulatory institutions (i.e. state ownership, region-specific marketization and industry-specific institutional policy) affect innovation performance of emerging market enterprises (EMEs). Evidence derived from a large sample of Chinese manufacturing firms demonstrates that state ownership positively moderates the effect of R&D intensity on innovation performance. However, state ownership is not equally beneficial for all firms. Our analysis shows that region-specific marketization and industry-specific institutional policy enhance the innovation-enhancing effect of state ownership. By revealing the role of regulatory institutions, our study points to the importance of looking beyond firm boundaries to understand why EMEs are able to innovate despite their weak internal capabilities.     

Lessons from a century of FED policy: Why monetary and credit policies need rules and boundaries

Wide operational and financial independence given to monetary and credit policies subjects the Federal Reserve to incentives detrimental for macroeconomic and financial stability. The absence of a monetary policy rule created go-stop incentives that produced inefficient volatility of both inflation and unemployment during the Great Inflation. Fed credit policy has undergone massive “mission creep” since the Fed was established. Being debt-financed fiscal policy, Fed credit policy beyond ordinary temporary lending to solvent depositories creates friction with the fiscal authorities and jeopardizes the Fed׳s independence. An ambiguous boundary of expansive Fed credit policy creates expectations of Fed accommodation in financial crisis—that blunts the incentive of private entities to take protective measures beforehand (to shrink counter-party risk and reliance on short-term finance, and build up equity capital) and blunts the incentive of the fiscal authorities to prepare procedures in advance to act systematically in times of credit turmoil. These points are illustrated with reference to the 2007–09 financial crisis. Part of the problem is that the independent Fed does not have the same incentive as the 19th century Bank of England to follow Bagehot׳s Rule. The paper concludes with a set of principles to preserve a workable, sustainable division of responsibilities between the independent central bank and the fiscal authorities.     

The macroeconomic response to real and financial factors,commodity prices,and monetary policy: International evidence

This study estimates a variety of small dynamic factor macro models where the factors are time-varying. The sample consists of 20 economies from around the world. Using quarterly data since the late 1990s, I find that the focus of some policymakers on the negative spillovers from monetary shocks is exaggerated. Four separate types of shocks are identified, and these can easily offset each other with a neutral to positive overall economic impact in some economies investigated here. However, a few economies, namely Brazil, Chile and China, experience a net economic loss from spillovers.     

Monetary policy transparency in a forward-looking market: Evidence from the United States

Because unsatisfactory measures of the monetary policy transparency were used, the existing literature found mixed empirical results for the relationship between the monetary policy transparency and risk/volatility. This paper extends the literature by using a recently developed monetary transparency index [Kia’s (2011) index] which is dynamic and continuous. Furthermore, the existing literature ignores the fact that market participants can be forward looking and, therefore, not policy invariant. This study also finds that the agents in the market are not policy invariant and the more transparent the monetary policy is the less risky and volatile the money market will be.     

Reprint of "The role of state ownership and institutions in the innovation performance of emerging market enterprises: Evidence from China"

Although it has been suggested that institutional context influences a firm's innovation performance, the role of regulatory institutions has been underexplored. Extending previous research, this study investigates whether and how regulatory institutions (i.e. state ownership, region-specific marketization and industry-specific institutional policy) affect innovation performance of emerging market enterprises (EMEs). Evidence derived from a large sample of Chinese manufacturing firms demonstrates that state ownership positively moderates the effect of R&D intensity on innovation performance. However, state ownership is not equally beneficial for all firms. Our analysis shows that region-specific marketization and industry-specific institutional policy enhance the innovation-enhancing effect of state ownership. By revealing the role of regulatory institutions, our study points to the importance of looking beyond firm boundaries to understand why EMEs are able to innovate despite their weak internal capabilities.