One monetary policy and 18 central bankers: The European monetary policy as a game of strategic delegation

This paper employs a multi-country delegation monetary policy model and argues that a decision-making mechanism based on the median voter theorem where intensity of preferences cannot play a role does not capture important aspects of policy setting in the European Monetary Union. Replacing the median voter mechanism with a less restrictive “weighted mean mechanism”, it is shown that strategic delegation can lead to a surprising degree of central bank inflation aversion. This finding supports the “The Twin Sister Hypothesis” and the perception of the European Central Bank implementing the policy of the Bundesbank rather than a more inflationary monetary policy.     

The Advantage of Flexible Targeting Rules

This paper investigates the consequences of debt stabilization for inflation targeting. If the fiscal authority holds constant the real value of debt at maturity under strict inflation targeting, the equilibrium dynamics are indeterminate for a wide range of parameters and steady‐state fiscal stances. “Flexible” targeting rules that include a concern for stabilization of the output gap can restore determinacy of the equilibrium. Flexible inflation targeting appears to be more robust than flexible debt targeting to alternative parameterizations. The fiscal authority can prevent indeterminacy under strict targeting rules by committing to hold constant debt net of interest rate spending.     

Observing and Shaping the Market: The Dilemma of Central Banks

While the central bank observes market activity to assess economic fundamentals, it shapes the market outcome through the conduct of monetary policy. A dilemma arises from this dual role because the more the central bank shapes the market, the more it influences the informational content of market outcomes. This paper analyzes how accounting for the endogeneity of information affects optimal monetary policy. By reducing the accuracy of central bank information, endogenous information calls for a higher degree of opacity, weakens accommodation policy to shocks, and broadens the range of parameters for which taking a signaling action is detrimental to welfare.     

Definition-consistent measurement of exchange market pressure

Currencies can be under severe pressure, but in a managed exchange rate regime that is not fully visible via the change in the exchange rate. The literature has proposed a way to measure such exchange market pressure (EMP) indirectly, by adding interest rate changes and forex interventions to the exchange rate change. We demonstrate that this measure is not consistent with the definition of EMP and develop a new measure that is consistent. This is first derived within the commonly used monetary exchange rate model. Then we generalize the analysis by avoiding the use of an exchange rate model. We find that the interest rate should not be taken in the first-difference form used so far, but rather in level form and relative to the interest rate chosen if the country had no exchange rate objective. Applications on the European Monetary System and East Asian crises confirm that this improvement is highly relevant in practice.     

Does government ideology matter in monetary policy? A panel data analysis for OECD countries

This paper examines whether government ideology has influenced monetary policy in OECD countries. We use quarterly data in the 1980.1–2005.4 period and exclude EMU countries. Our Taylor-rule specification focuses on the interactions of a new time-variant index of central bank independence with government ideology. The results show that leftist governments have somewhat lower short-term nominal interest rates than rightwing governments when central bank independence is low. In contrast, short-term nominal interest rates are higher under leftist governments when central bank independence is high. The effect is more pronounced when exchange rates are flexible. Our findings are compatible with the view that leftist governments, in an attempt to deflect blame of their traditional constituencies, have pushed market-oriented policies by delegating monetary policy to conservative central bankers.     

Flexible inflation targets,forex interventions and exchange rate volatility in emerging countries

Emerging economies with inflation targets (IT) face a dilemma between fulfilling the theoretical conditions of “strict IT”, which imply a fully flexible exchange rate, or applying a “flexible IT”, which entails a de facto managed-floating exchange rate with foreign exchange (forex) interventions to moderate exchange rate volatility. Using a panel data model for 37 countries we find that, although IT lead to higher exchange rate instability than alternative regimes, forex interventions in some IT countries have been more effective to lower volatility than in non-IT countries, which may justify the use of “flexible IT” by policymakers.     

Purdah—On the Rationale for Central Bank Silence around Policy Meetings

Many central banks share the practice of purdah , a guideline of abstaining from communication around policy meetings. Although seemingly contradicting the virtue of transparency by withholding information precisely when it is sought after intensely, it has been justified on grounds that such communication may create excessive market volatility. This paper assesses the purdah for the Federal Reserve and confirms that financial markets are substantially more sensitive to central bank communication around policy meetings. Short-term interest rates react three to four times more strongly in the purdah before Federal Open Market Committee meetings than otherwise, and volatility increases (compared to a reduction otherwise).     

The Impact of Central Bank Independence on Political Monetary Cycles in Advanced and Developing Nations

This paper examines the extent to which monetary policy is manipulated for political purposes during elections. We do not detect political monetary cycles in advanced countries or developing nations with independent central banks. We do find evidence, however, in developing countries that lack central bank independence. Furthermore, we find some evidence that these cycles are not caused by monetization of election-related fiscal expansions. This suggests that pressure by politicians on the central bank to exploit the Phillips curve may be an important factor in generating political monetary cycles.     

Designing domestic institutions for international monetary policy cooperation: A Utopia?

In a wide variety of international macroeconomic models monetary policy cooperation is optimal, non-cooperative policies are inefficient, but optimal policies can be attained non-cooperatively by optimal design of domestic institutions/contracts. We show that given endogenous institutional design, inefficiencies of non-cooperation cannot and will not be eliminated. We model the delegation stage explicitly and show that subgame perfect, credible contracts (chosen by governments based on individual rationality) are non-zero, but are different from optimal contracts and hence lead to inefficient equilibria. Optimal contracts require cooperation at the delegation stage, which is inconsistent with the advocated non-cooperative nature of the solution. A general solution method for credible contracts and an example from international monetary policy cooperation are considered. Our results feature delegation as an equilibrium phenomenon, explain inefficiencies of existing delegation schemes and hint to a potentially stronger role for supranational authorities in international policy coordination.     

Do Shareholders Vote Strategically? Voting Behavior, Proposal Screening, and Majority Rules

We analyze how shareholders screen management proposals at annualgeneral meetings. First, we use a simple model of strategicvoting to develop a theoretical benchmark of effective informationaggregation through voting. Then, we derive testable implicationsand provide structural estimates of the model parameters. Themain conclusions are that shareholders vote strategically andthat proposal screening increases value. Shareholders largelyneutralize the lock-in effect of supermajority rules, therebypreventing the incorrect rejection of proposals.     

Financial globalization and monetary policy

Recent data show substantial increases in the size of gross external asset and liability positions. The implications of these developments for optimal conduct of monetary policy are analyzed in a standard open economy model which is augmented to allow for endogenous portfolio choice. The model shows that monetary policy takes on new importance due to its impact on nominal asset returns. Nevertheless, the case for price stability as an optimal monetary rule remains. In fact, it is reinforced. Even without nominal price rigidities, price stability is optimal because it enhances the risk sharing properties of nominal bonds.     

Exchange market pressure and absorption by international reserves: Emerging markets and fear of reserve loss during the 2008–2009 crisis

This paper evaluates how the global financial crisis emanating from the U.S. was transmitted to emerging markets. Our focus is on the extent that the crisis caused external market pressures (EMP), and whether the absorption of the shock was mainly through exchange rate depreciation or the loss of international reserves. Controlling for variety of factors associated with EMP, we find clear evidence that emerging markets with higher total foreign liabilities, including short- and long-term debt, equities, FDI and derivative products—had greater exposure and were much more vulnerable to the financial crisis. Countries with large balance sheet exposure – high external portfolio liabilities exceeding international reserves—absorbed the global shock by allowing greater exchange rate depreciation and comparatively less reserve loss. Despite the remarkable buildup of international reserves by emerging markets during the period prior to the financial crisis, countries relied primarily on exchange rate deprecation rather than reserve loss to absorb most of the exchange market pressure shock. This could reflect a deliberate choice (“fear of reserve loss”) or market actions that caused very rapid exchange rate adjustment, especially in emerging markets with open capital markets, overwhelming policy actions.     

The Central Banker as a Risk Manager: Estimating the Federal Reserve's Preferences under Greenspan

We derive a natural generalization of the Taylor rule that links changes in the interest rate to the balance of the risks implied by the dual objective of sustainable economic growth and price stability. This monetary policy rule reconciles economic models of expected utility maximization with the risk management approach to central banking. Within this framework, we formally test and reject the standard assumption of quadratic and symmetric preferences in inflation and output that underlies the derivation of the Taylor rule. Our results suggest that Fed policy decisions under Greenspan were better described in terms of the Fed weighing upside and downside risks to their objectives rather than simply responding to the conditional mean of inflation and of the output gap.     

The impact of monetary policy on the exchange rate: evidence from three small open economies

This paper studies the impact effect of monetary policy shocks on the exchange rate in Australia, Canada, and New Zealand during the 1990s. Shocks are identified by the reaction of three month market interest rates to policy announcements that were not themselves endogenous to economic news on the same day. The main result is that a 100 basis point contractionary shock will appreciate the exchange rate by 2-3 percent on impact. The association of interest rate hikes with depreciations that is sometimes observed during periods of exchange market pressure is mainly attributable to reverse causality.     

Optimal Constrained Interest-Rate Rules

We show that if policymakers compute the optimal unconstrained interest-rate rule within a Taylor-type class, they may be led to rules that generate indeterminacy and/or instability under learning. This problem is compounded by uncertainty about structural parameters since an optimal rule that is determinate and stable under learning for one calibration may be indeterminate or unstable under learning under a different calibration. We advocate a procedure in which policymakers restrict attention to rules constrained to lie in the determinate learnable region for all plausible calibrations, and that minimize the expected loss, computed using structural parameter priors, subject to this constraint.     

The learning cost of interest rate reversals

Many central banks in many time periods have sought to avoid interest rate reversals, but at present there is no good explanation of this phenomenon. Our analysis identifies a new learning cost associated with reversing the interest rate. In a standard monetary model with forward-looking expectations, data uncertainty and parameter uncertainty, a policy that frequently reverses the interest rate makes learning the key parameters of the model more difficult. Optimal monetary policy internalises this learning cost and therefore has a lower number of interest rate reversals.     

Outsiders at the Bank of England's MPC

The monetary policy committee (MPC) of the Bank of England consists of five internal and four external members. We study the voting record and show that outsiders dissent more often than insiders and tend to prefer lower rates, especially during economic downturns. Moreover, dissents by outsiders help forecast future interest rate changes, in contrast to dissents by insiders. A model in which outsiders in contrast to insiders are "recession averse" and more uncertain regarding the appropriate level of interest rates replicates the observed voting pattern well.     

Bidding behavior in the SNB’s repo auctions

The Swiss National Bank (SNB) provides reserves to market participants via fixed rate tender auctions. We analyze the banks’ bidding behavior and identify the determinants for the decision to participate as well as on the amount to tender. We find that a bank’s bids from the previous day, the amount of maturing repo operations with the SNB as well as the maturing volume on the interbank repo market have for most banks a significant effect. The autonomous factors (government balances at the SNB and currency in circulation) are of only minor importance. A further determinant is the attractiveness of the SNB’s auction rate compared to the prevailing interbank market repo rate. Further, the question is addressed whether the bidding behavior changed in the financial market crisis of 2007/2008. There is little evidence of a systematic change in bidding behavior in the crisis. This results from the fact that the SNB has addressed the volatile demand for reserves in the crisis with overnight fine-tuning operations.     

Bidding behavior in the longer term refinancing operations of the European Central Bank: Evidence from a panel sample selection model

This paper analyzes individual bidding data of the longer term refinancing operations (LTROs) of the European Central Bank. We investigate how banks’ bidding behavior is related to a series of exogenous variables including collateral costs, interest rate expectations, market volatility and to individual bank characteristics like country of origin, size, and experience. A specific feature of these auctions is that the number and composition of bidders varies over time. Therefore, we estimate panel sample selection models to control for a bank’s endogenous participation decision. We find that bidding strategies depend on the banks’ attributes. Yet, different bidding behavior generally does not translate into differences concerning bidder success. There is evidence for the winner’s curse effect in LTROs indicating a common value component in banks’ demand for longer term refinancing.     

Changing Monetary Policy Rules, Learning, and Real Exchange Rate Dynamics

When the exchange rate is priced by uncovered interest parity and central banks set nominal interest rates according to a reaction function such as the Taylor rule, the real exchange rate will be determined by expected inflation and the output gap or the unemployment gap of the home and foreign countries. This paper examines the implications of these Taylor rule fundamentals for real exchange rate determination. Because the true parameters in central bank policy rules are unknown to the public and change over time, the model is presented in the context of a least squares learning environment. This simple learning model captures the volatility and the major swings in the real deutschemark/euro–dollar exchange rate from 1976 to 2007.