Monetary transmission in Germany: Lessons for the Euro area

This study analyses the transmission of monetary policy in Germany for the EMS period in the framework of a structural vector error correction model (S-VECM).Three stable cointegration relationships are found: a money demand relation, an interest rate spread and a stationary real interest rate. Based on both contemporaneous and long-run restrictions, five structural shocks to the economy are identified. In contrast to analyses for the euro area, we find that output and inflation are not independent in the long run for Germany. In accordance with results previously found for Europe, we do not find strong support for monetary targeting for Germany. Our analysis indicates that uncertainties remain concerning the controllability of money and its usefulness as a leading indicator with respect to inflation. Stability of the money demand relationship does not seem to be problematic.Jel classification:C32, C52, E41, E43, E52We would like to thank Jörg Breitung, Bertrand Candelon, Peter van Els, Carsten Folkertsma, Helmut Lütkepohl, Dieter Nautz, Hans-Eggert Reimers, Nikolaus Siegfried and Jürgen Wolters, two anonymous referees as well as participants of the 8th World Congress of the Econometric Society in Seattle and the Annual Meeting of the Verein für Sozialpolitik in Berlin for helpful comments. The views expressed in this paper do not necessarily reflect those of the European Central Bank or De Nederlandsche Bank.Both authors were working at the research department of De Nederlandsche Bank at the time of writing.First revision received: April 2002/Final revision received: January 2003     

Controllability and Persistence of Money Market Rates along the Yield Curve: Evidence from the Euro Area

Abstract. Controllability of longer‐term interest rates requires that the persistence of their deviations from the central bank's policy rate (i.e. the policy spreads) remains sufficiently low. This paper applies fractional integration techniques to assess the persistence of policy spreads of euro area money market rates along the yield curve. Independently from anticipated policy rate changes, there is strong evidence for all maturities that policy spreads exhibit long memory. We show that recent changes in the operational framework and the communication strategy of the European Central Bank (ECB) have significantly decreased the persistence of euro area policy spreads and, thus, have enhanced the ECB's influence on longer‐term money market rates.     

THE MONEY DEMAND FUNCTION FOR THE EURO AREA: SOME EMPIRICAL EVIDENCE

This paper sets out to re‐examine the money demand function for the euro area. Traditional specifications often yield unsatisfactory results: instability of short and long‐term coefficients; relatively large differences between estimated and actual value of variables; and significant changes in the number of long‐term relationships, etc. Using a standard Vector Error Correction Model, we find that the usual specification is indeed unstable. However, introducing a European equity price gives rise to a more stable system. Furthermore, recursive estimates confirm the relative stability of long‐term coefficients. Estimates of the real money gap, based on the money demand equation including equity prices, point to moderate, albeit persistent, excess liquidity in the euro area in recent years. The real money gap contains information about future inflation but this content may have diminished since 2001.     

New technologies and productivity growth in the euro area

This paper provides an overview of the available evidence on the importance of information and communication technologies (ICT) for developments in average labour productivity (ALP) growth in the euro area. The contribution of ICT to ALP growth is found to have increased both in terms of production and investment over the 1990s (up to 2001). However, there is no evidence of significant positive spillover effects from the use of ICT on ALP growth. This implies that there is no reason to believe that potential output growth in the euro area has increased significantly in recent years on account of new technologies. Comparing developments in the euro area and the United States, it appears, however, that ICT capital cannot account for much of the difference in ALP developments over the 1990s. This suggests that cyclical developments and, in particular, the structure of the economy are more important for explaining the difference in performance.First version received: March 2002/Final version received: May 2003We thank Bart van Ark, Neale Kennedy, Gerard Korteweg, Ad van Riet, Marcel Timmer, two anonymous referees and participants at the 17th Congress of the European Economic Association, Venice August 2002 for their comments. All errors and omissions remain ours, of course. We thank Erikos Velissaratos for his help in acquiring data on investment in ICT and Colin Webb for providing us with the OECD STAN database. This paper represents the views of the authors and does not necessarily reflect the views of the European Central Bank, the European Commission or their staff.     

Interpreting euro area inflation at high and low frequencies

Several authors have recently interpreted the European Central Bank's (ECB's) two-pillar framework as separate approaches to forecast and analyse inflation at different time horizons or frequency bands. The ECB has publicly supported this understanding of the framework. This paper presents further evidence on the behaviour of euro area inflation using band spectrum regressions, which allow for a natural definition of the short and long run in terms of specific frequency bands, and causality tests in the frequency domain. The main finding is that variations in inflation are well explained by low-frequency movements of money and real output growth and high-frequency fluctuations of the output gap.     

Financial Factors and the Empirical Behavior of Money Demand: A Case Study of Malaysia

The paper analyses the roles of financial factors in the behavior of M1 and M2 demands for Malaysia. The focus is on the possible changes in the elasticities of the M1 and M2 money demands in the environment of financial innovations and on the influence of real stock prices on the holdings of monetary assets. Our results reinforce existing studies that find the presence of the long-run M1 and M2 money demands and structural instability in the dynamic specification of the M1 demand. However, we are able to identify stable error-correction model for the post-1986 M1 demand and for the M2 demand. Our results also indicate the reduction in the Long run income and exchange rate elasticities of the money demands. Meanwhile, the interest rate sensitivity of the demands becomes more inelastic. Lastly, we document the significance of real stock prices in influencing the demand behavior, indicating the dominance of the wealth effect over the substitution effect. [E41, E44]     

Are monetary policy shocks causal to bank health? Evidence from the euro area

Despite considerable efforts of the European Central Bank (ECB) to support bank intermediation after the 2008 financial crisis, the recovery of euro area banks remained incomplete. Although many studies indicate that central banks can influence the stock prices of firms through their policy actions and communication, a knowledge gap exists as to whether the ECB's monetary policy can influence bank health. Through a high-frequency identification approach, this study reveals that the causal effect of conventional monetary policy action and communication by the ECB on bank stock prices differed over time, whereas its influence on bank financing costs was robust. This study provides new evidence showing that information effects related to policy easing surprises in the aftermath of the 2008 financial crisis hampered the ECB efforts to improve bank health and that its Odyssean communication signals (related to forward-looking announcements of policy easing) supported bank health during this phase. Local projections suggest that the response of banks to monetary policy shocks displayed some persistence, where ECB policy surprises and communications that shifted up (down) the yield curve were normally positive (negative) for bank health. The findings solicit a new perspective when assessing the influence of the ECB's monetary policy measures on euro area banks.     

Sharing Money Creation in a Monetary Union*

How to share money creation among the members of the European Monetary Union? To address this issue, we construct a two‐country New Open‐economy Macroeconomics model of an asymmetric monetary union with an incomplete financial market and home bias in consumption. We consider two sharing rules consistent with the current regulations of the European System of Central Banks. First, each participating National Central Bank supplies half of the European Central Bank determined money creation in the monetary union. Secondly, each National Central Bank adapts the national increase in money demand, under the constraint that the total money creation in the union does not exceed the level determined by the ECB for the whole union. We show that the current sharing rule, which ignores countries’ heterogeneity, is superior in terms of welfare. The key role of the current account is emphasized. It proves an efficient decentralized mechanism for allocation of money.     

Data uncertainty and the role of money as an information variable for monetary policy

In this study, we perform a quantitative assessment of the role of money as an indicator variable for monetary policy in the euro area. We document the magnitude of revisions to euro area-wide data on output, prices, and money, and find that monetary aggregates have a potentially significant role in providing information about current real output. We then proceed to analyze the information content of money in a forward-looking model in which monetary policy is optimally determined subject to incomplete information about the true state of the economy. We show that monetary aggregates may have substantial information content in an environment with high variability of output measurement errors, low variability of money demand shocks, and a strong contemporaneous linkage between money demand and real output. As a practical matter, however, we conclude that money has fairly limited information content as an indicator of contemporaneous aggregate demand in the euro area.     

Money velocity and asset prices in the euro area

Monetary growth in the euro area has exceeded its target since several years. At the same time, the money demand function seems to be increasingly unstable if more recent data are used. If the link between money balances and the macroeconomy is fragile, the rationale of monetary aggregates in the ECB strategy has to be doubted. In fact, a rise in the income elasticity after 2001 can be observed, and may reflect the exclusion of real and financial wealth in conventional specifications of money demand. This presumption is explored by means of a cointegration analysis. To separate income from wealth effects, the specification in terms of money velocity is preferred. Evidence for the presence of wealth in the long run relationship is provided. In particular, both stock and house prices have exerted a negative impact on velocity after 2001 and lead to almost identical equilibrium errors. The extended error correction model is stable over the entire sample period and survive a battery of specification tests.

Predicting European Union Recessions in the Euro Era: The Yield Curve as a Forecasting Tool of Economic Activity

Several studies have established the predictive power of the yield curve for the U.S. and various European countries. In this paper we use data from the European Union (EU15), from 1994:Q1 to 2008:Q3. We use the European Central Bank’s euro area yield spreads to predict European real GDP deviations from the long-run trend. We also augment the models tested with non monetary policy variables: the unemployment and a composite European stock price index. The methodology employed is a probit model of the inverse cumulative distribution function of the standard distribution using several formal forecasting and goodness of fit evaluation tests. The results show that the yield curve augmented with the composite stock index has significant forecasting power in terms of the EU15 real output.     

Stock prices and long-run demand for money: evidence from Malaysia

This paper investigates the money demand function for Malaysia in the 1971-1996 period using the multivariate cointegration and error correction model methodology. The results suggest that a stable long-run relationship exist between real M2, the interest rate differential, income and stock prices. Stock prices have a significant negative substitute effect on long-run as well as short-run broad-money demand (M2) and its omission can lead to serious misspecification in the money demand function. The analysis from the vector error correction model (VECM) and the Toda & Yamamoto (1995) causality tests find that money is endogenous and that there is at least a unidirectional relationship between stock prices and real M2. Stock prices Granger cause real M2 indirectly through income between interest rates and stock prices and stock prices and money stock. This paper comes to the conclusion that due to the endogeneity of money, M2 cannot be completely controlled by Malaysia's central bank. Therefore, in formulating future monetary policy, the response of money demand to stock prices should be considered.     

Business cycle,interest rate and money in the euro area: A common factor model

In this paper we model and analyze the contemporaneous correlation between interest rate, monetary aggregates, production and prices (of consumer goods, financial assets and real estate) of the euro area. To do this, firstly we estimate a common cyclical factor by means of an unobserved component model with the common factor located in variations in the underlying growth rates, that is, accelerations and decelerations of the variables. The variables mentioned share a significant cyclical factor being all procyclical except for narrow money. Finally we offer an explanation of this empirical finding based on the monetary policy strategy of interest rate pegging followed by the European Central Bank. In this regard, the shared cyclical information suggests (a) that inflation should be considered as a phenomenon that affects the whole economy, and therefore all prices, and (b) that monetary indicators such as monetary aggregates may contribute to the assessment of inflationary risks throughout the cycle.     

Estimating A European Demand For Money

European Monetary Union will come into existence in 1999. This raises questions related to the monetary policy targets that will be adopted by the European Central Bank (ECB). For both likely candidates, targeting a money aggregate or an inflation target, the existence of a stable money demand function at a European level is important. In this paper estimates of such a European money demand for narrow and broad money for the actual 11 EMU countries based on quarterly aggregate data from 1964 to 1994 are presented. It is argued that statistically satisfactory and economically interpretable functions can be found. Moreover, the estimated models appear to be stable over a period of 20 quarters. This raises the hopes that the ECB will face a stable money demand and be able—at least for a certain time—to use past aggregate data for policy purposes.     

Inflation and capital accumulation in an OLG model with money in the production function

This article analyses the consequences of the money supply growth rate on capital intensity and economic growth in an overlapping-generations model with real balances entering the production function. Within this theoretical framework, anticipated inflation generates an ambiguous effect on capital–labour ratio, because two forces work simultaneously in opposite directions: one driving towards a pure Tobin effect (due to the OLG demographic structure of the economy) and the other pushing down the capital stock (due to the productive role of real balances). Despite the unclear effects exerted on capital intensity, higher monetary growth rates unambiguously reduce real money demand, consumption, total wealth and welfare.     

Modelling industrial new orders

This article models industrial new orders across the European Union (EU) countries for various breakdowns. A common modelling framework exploits soft (business opinion surveys) as well as hard data (industrial turnover). The estimates show for about 200 cases that the model determinants significantly help in explaining new orders' monthly growth rates. An alternative estimation method, different model specifications and out-of-sample and real-time forecasting all show that the model results are robust. We present real-time outcomes of a European Central Bank (ECB) indicator on industrial new orders at an aggregated euro area level. This indicator is largely based on national new orders data and on estimates yielded by the model for those countries that no longer report new orders at the national level. Finally, we demonstrate the leading content of the ECB indicator on euro area new orders for industrial production.     

Risk sharing through capital gains

Abstract We estimate channels of international risk sharing between European Monetary Union (EMU), European Union, and other OECD countries, 1992–2007. We focus on risk sharing through savings, factor income flows, and capital gains. Risk sharing through factor income and capital gains was close to zero before 1999 but has increased since then. Risk sharing from capital gains, at about 6%, is higher than risk sharing from factor income flows for European Union countries and OECD countries. Risk sharing from factor income flows is higher for euro zone countries, at 14%, reflecting increased international asset and liability holdings in the euro area.     

Money growth,uncertainty and macroeconomic activity: a multivariate GARCH analysis

The impact uncertainty has on money growth has received much attention in recent years and is an issue of critical importance to central banks, particularly for those, such as the European Central Bank (ECB), which place a strong emphasis on monetary analysis in monetary policy formulation. Some recent papers examining this issue use ad hoc estimates and measure variability rather than uncertainty. We employ a multivariate GARCH model, which measures uncertainty by the conditional variance of the data series, to investigate whether macroeconomic uncertainty and monetary uncertainty Granger-cause changes in real money. The estimated model also allows us to investigate how monetary uncertainty impacts economic activity. We find that macroeconomic uncertainty impacts positively on US real M2 growth over a two-year horizon but that monetary uncertainty does not cause changes in real M2. Instead, our results indicate that real money growth causes monetary uncertainty. Monetary uncertainty is found to have a negative effect on real economic activity and on macroeconomic uncertainty. We conclude by discussing the implications of these results and the methodological approach used for institutions such as the ECB that give monetary analysis a prominent role in their monetary policy strategy.     

Revising the European Central Bank’s fiscal rules to support growth and employment

Abstract

The paper presents a reform proposal for the operations of the European Central Bank (ECB) whose purpose is to create a common set of risk-free assets for financial institutions operating in the euro area (EA), which is the necessary condition for having a single internal financial market. The proposal does not require the introduction of changes in the existing European Union treaties. The effects of this reform on the debt dynamic of EA member countries permit a revision of the existing fiscal rules. With the help of some simulations, it is shown that maintaining compliance with the European treaties, the reform of the ECB operations and revised fiscal rules would transform the current fiscal deflationary stance into a reflationary one. Some implications for aggregate demand and growth for the EA are briefly discussed.     

On the empirical relevance of the Lucas critique: the case of euro area money demand

This paper examines the relevance of the Lucas critique for euro area money demand. Based on the money in the utility function approach, a vector error correction model is specified to investigate the relationship between money and inflation in times of policy shifts. A well defined equation for money demand is obtained. The results indicate that the evolution of M3 is still in line with money demand. In the long run, inflation is affected by asset prices and detrended output. Our results show that the Lucas critique can be refuted in case of euro area money demand for the period of quantitative easing. Thus, the estimated money demand equation provides reliable information for the conduct of future monetary policy.