The macroeconomic impact of economic uncertainty and financial shocks under low and high financial stress

External financial frictions might increase the severity of economic uncertainty shocks. We analyze the impact of aggregate uncertainty and financial condition shocks using a threshold vector autoregressive (TVAR) model with stochastic volatility during distinct US financial stress regimes. We further examine the international spillover of the US financial shock. Our results show that the peak contraction in euro area industrial production due to uncertainty shocks during a financial crisis is nearly-four times larger than the peak contraction during normal times. The US financial shocks have an influential asymmetric spillover effect on the euro area. Furthermore, the estimates reveal that the European Central Bank (ECB) is more cautious in implementing a monetary policy against uncertainty shocks while adopting hawkish monetary policies against financial shocks. In contrast, the Fed adopts a more hawkish monetary policy during heightened uncertainty, whereas it acts more steadily when financial stress rises in the economy.     

The impact of macro news and central bank communication on emerging European forex markets

We employ a two-stage empirical strategy to analyze the impact of macroeconomic news and central bank communication on the exchange rates of three Central and Eastern European (CEE) currencies against the euro. First we estimate the nominal equilibrium exchange rate based on a monetary model. Second, we employ a high-frequency GARCH model to estimate the effects of the news and communication along with the estimated exchange rate misalignment on the exchange rate as well as its volatility. The analysis is performed during the pre-crisis (2004–2007) and crisis (2008–2009) periods. CEE currencies react to macroeconomic news during both periods in an intuitive manner that corresponds to exchange rate-related theories. However, the responsiveness of the currencies to central bank verbal interventions becomes important only during the crisis period.     

Internal and external transmissions of monetary and fiscal policies in the EMU

With the introduction of Economic and Monetary Union (EMU), the sovereignty of national monetary institutions has been replaced by a common monetary institution, the European Central Bank (ECB) and national currencies have been replaced by a common currency, the euro. EMU therefore implies the loss of national monetary policy autonomy and internal exchange rate flexibility inside the EMU area. However, external exchange rate adjustment, i.e. adjustment of the euro exchange rate, remains a feasible adjustment mechanism. This paper analyses how internal and external exchange rate flexibility affect macroeconomic adjustment in EMU and non-EMU countries. To do so, a model is constructed in which three countries interact: two countries that decide to form a monetary union and a third country that does not participate in the monetary union. Numerical simulations of a representative example are used to characterise the adjustment dynamics induced by monetary and fiscal policies before and after the start of the EMU.     

Macroeconomic and financial stability in a monetary union: The case of Lithuania

In this paper, we study the implications of macroprudential policies in a monetary union for macroeconomic and financial stability. For this purpose, we develop a two-country monetary union new Keynesian general equilibrium model with housing and collateral constraints, to be calibrated for Lithuania and the rest of the euro area. We consider two different scenarios for macroprudential policies: one in which the ECB extends its goals to also include financial stability and a second one in which a national macroprudential authority uses the loan-to-value ratio (LTV) as an instrument. The results show that both rules are effective in making the financial system more stable in both countries, and especially in Lithuania. This is because the financial sector in this country is more sensitive to shocks. We find that an extended Taylor rule is indeed effective in reducing the volatility of credit, but comes with a cost in terms of higher inflation volatility. The simple LTV rule, on the other hand, does not compromise the objective of monetary policy. This reinforces the “Tinbergen principle”, which argues that there should be two different instruments when there are two different policy goals.     

Monetary policy announcements and stock reactions: An international comparison

This article investigates the impact of domestic monetary policy rate announcements on the stock markets of New Zealand, Australia, the United Kingdom and the euro area, using event-study methods to identify stock price reactions to the unanticipated/surprise component of announcements. As Australia and New Zealand did not reach the zero bound we investigate whether there is an impact from the global financial crisis on stock market reactions that can be distinguished from the asymmetric reactions to surprises that characterise the business cycle. We find that the euro area and the UK both show a financial crisis effect but behaviour in New Zealand and Australia does not change. We conduct robustness checks and explore confounding factors, especially the impact of ‘guidance’ from central banks that prepares markets for policy rate changes.     

International spillovers of (un)conventional monetary policy: The effect of the ECB and the US Fed on non-euro EU countries

We estimate a global vector autoregression model to examine the effects of euro area and US monetary policy stances, together with the effect of euro area consumer prices, on economic activity and prices in non-euro EU countries using monthly data from 2001-2016. Along with some standard macroeconomic variables, our model contains measures of the shadow monetary policy rate to address the zero lower bound and the implementation of unconventional monetary policy by the European Central Bank and the US Federal Reserve. We find that these monetary shocks have the expected qualitative effects but their magnitude differs across countries, with southeastern EU economies being less affected than their peers in Central Europe. Euro area monetary shocks have a greater effect than those that emanate from the US. We also find certain evidence that the effects of unconventional monetary policy measures are weaker than those of conventional measures. The spillovers of euro area price shocks to non-euro EU countries are limited, suggesting that the law of one price materializes slowly.     

The impact of monetary policy in the midst of big shocks

This paper studies the impact of Federal Reserve policies that created the largest deviations from price stability during the Fed׳s first 100 years: the post-World War I deflation, the deflation of the Great Depression, the inflation of World War II, and the Great Inflation of the 1970s. In terms of their macroeconomic impacts, I find that deflation was uniquely depressing in the 1930s because of cartel policies that prevented nominal prices and wages from adjusting to clear markets, and not because deflation is generically depressing. I find that the biggest impact of monetary policy during World War II was in debasing debt through inflation. I find that the main drivers of the 1970s economy were long-run changes in productivity and the labor market, and that there may have been little that the Fed could have done at this time to expand employment and output. More broadly, I find that macroeconomic performance would have been better over the Fed׳s first century had the Fed followed a monetary policy to deliver stable prices.     

Global Financial Transmission of Monetary Policy Shocks*

The paper analyses the transmission of US monetary policy shocks to global equity markets and the macroeconomic determinants of the underlying transmission process. We show that there is a substantial cross‐country heterogeneity in reactions across 50 equity markets worldwide, with returns falling on average around 2.7% in response to a 100 basis point tightening of US monetary policy, but ranging from a zero response in some to a reaction of 5% or more in other markets. As to the determinants of the strength of transmission to individual countries, we test the relevance of their macroeconomic policies and the role of real and financial integration. We find that in particular the degree of global integration of countries – and not a country's bilateral integration with the United States – is a key determinant for the transmission process.     

Determinants of European stock market integration

We analyse the determinants of stock market integration among EU member states for the period 1999–2007. First, we apply bivariate DCC-MGARCH models to extract dynamic conditional correlations between European stock markets, which are then explained by interest rate spreads, exchange rate risk, market capitalisation, and business cycle synchronisation in a pooled OLS model. By grouping the countries into euro area countries, “old” EU member states outside the euro area, and new EU member states, we also evaluate the impact of euro introduction and the European unification process on stock market integration. We find a significant trend toward more stock market integration, which is enhanced by the size of relative and absolute market capitalisation and hindered by foreign exchange risk between old member states and the euro area. Interest rate spreads and business cycle synchronisation are also significant factors in explaining equity market integration.     

The Eurozone and financial integration: the employment relations issues

Together the macroeconomic and financial attributes of monetary union are changing the rules governing the European economy. This paper assesses the consequences of these changes for employment relations in member states. The analysis focuses on three matters in particular. First, how labour market actors are responding to the fact that macroeconomic policies are not only out of their own control but may therefore fail to correspond to the needs of particular countries. Second, how employment relations are adapting to the new microeconomic challenges released by the move towards deeper financial integration inside the EU, which has its main impact on the structures of corporate finance and thus on corporate strategy. Finally the implications of both patterns of change for the EU employment policy are assessed to gauge the impact of monetary union on the European social model.     

The currency denomination of external European Union imports after European Union expansion

Using a multiple market model I examine the impact of euro expansion on the optimal currency denomination of external EU imports. Results suggest euro invoicing will increase more in the EU-expansion country than in the original EU. Exporting firms from dollar bloc countries (the U.S. or countries with fixed exchange rates with the dollar) are more likely to invoice in the euro if price discrimination is already optimal. Firms from outside the dollar bloc are more likely to use the euro when the original EU market is relatively large or transaction costs of exchanging the euro are relatively small.     

MONETARY TRANSMISSION MECHANISM IN CENTRAL AND EASTERN EUROPE: SURVEYING THE SURVEYABLE

Abstract.  This paper surveys recent advances in empirical studies of the monetary transmission mechanism, with special attention to Central and Eastern Europe (CEE). Our results indicate that the strength of the exchange rate pass-through substantially declined over time mainly due to a fall in inflation rates and to some extent due to the so-called composition effect. The asset price channel is weak and is likely to remain weak because of shallow stock and private bond markets and because of low stock and bond holdings of domestic households. House prices may become an exception with booming mortgage lending and with high owner occupancy ratios. While the credit channel could be a powerful channel of monetary transmission – as new funds raised on capital markets are close to zero in CEE – it is actually not, as both commercial banks and non-financial corporations can escape domestic monetary conditions by borrowing from their foreign mother companies. The moderately good news, however, is that those banks and firms are influenced by monetary policy in the euro area because their parent institutions are themselves subjected to the credit channel in the euro area.     

ECB Monetary Policy Surprises: Identification Through Cojumps in Interest Rates

This paper proposes a new econometric approach to disentangle two distinct response patterns of the yield curve to monetary policy announcements. Based on cojumps in intraday tick data of short‐ and long‐term interest rate futures, we develop a day‐wise test that detects the occurrence of a significant policy surprise and identifies the market perceived source of the surprise. The new test is applied to 133 policy announcements of the European Central Bank (ECB) in the period from 2001 to 2012. Our main findings indicate a good predictability of ECB policy decisions and remarkably stable perceptions about the ECB's policy preferences. Copyright © 2015 John Wiley & Sons, Ltd.     

Hungary's entry into the euro area: Lessons for prospective members from a monetary policy perspective

This paper evaluates the conduct of monetary policy in Hungary using standard Taylor rules as well as extended rules that incorporate real exchange rate effects. Moreover, we explicitly consider the impact of future euro area entry by estimating instrument rules that permit an influence from Maastricht Treaty inflation requirements via the estimation of Markov switching models as well as by estimating a differential rule vis-à-vis the existing euro area. Lastly, the paper also considers the impact on policy rules from the large data revision that affects real exchange rate and output estimates. I find that interest rate setting behavior in Hungary does not resemble that of the euro area. Also, counterfactual experiments reveal that the potential macroeconomic costs of entry into the euro area sooner rather than later may be lower than if membership in the single currency area is delayed beyond 2008.     

The daily relationship between U.S. asset prices and stock prices of American countries

The daily transmission of U.S. comprehensive stock indices to foreign stock markets has been studied extensively, but the transmission may just be that the foreign stock prices respond to news underlying the change in the U.S. stock indices. Besides the regularly economic announcements, news relevant for the U.S. economy may include qualitative news and non-economic events. Due the daily nature of the news, there is no appropriate reference as to its impact on the U.S. or foreign economy and the only accessible reference probably is the change in the financial asset prices. But the U.S. stock index is general in nature and cannot be used to offer specific information about the U.S. economy. Some U.S. asset prices other than stock indices may reveal more specific information about the U.S. economy. Looking into the daily relationship between these U.S. asset prices and stock indices of four American countries in two periods with drastically different economic conditions, this study finds that the daily relationship between these U.S. asset prices and foreign stock prices is consistent with the prevailing U.S. economic fundamentals. From the relationship we identify some U.S. economic conditions foreign stock prices respond to. These economic conditions include real economic shocks, monetary policies, and business default risks.     

Some empirical evidence on the effects of U.S. monetary policy shocks on cross exchange rates

This paper examines the impact of U.S. monetary policy shocks on the cross exchange rates of sterling, yen and mark. The main finding of the paper is a ‘delayed overshooting’ pattern for all currency cross rates examined (sterling/yen, yen/mark and mark/sterling) following an unexpected U.S. monetary policy change, which in turn generates excess returns. We also provide evidence that the ‘delayed overshooting’ pattern in cross exchange rates is accompanied by asymmetric interventions by central banks in the foreign exchange markets under consideration triggered by a U.S. monetary policy shock.     

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.     

Currency news and international bond markets

We use a sample of 27 countries and 63 currency news announcements in an event study framework to examine the impact of currency news on international government bond markets. Our findings reveal a significant spillover of currency news into bond markets. Specifically, the evidence shows significant negative abnormal bond returns, whether measured in dollar terms or local currency terms, implying that currency news plays a role in changing the performance of international government bond markets. We also show that abnormal bond returns remain significantly negative even after controlling for macroeconomic variables. Our results are robust to using alternative risk model specifications, country-level data, and corporate bond data. Our evidence of the significant impact of currency news on bond markets provides essential insights to professional traders, policymakers, and academic researchers.     

Relative importance of scheduled macroeconomic news for stock market investors

This paper investigates the relative importance of scheduled U.S. macroeconomic news releases for stock valuation. The study focuses on 11 macroeconomic announcements selected on the basis of the previous literature and the Bureau of Labor Statistics classifications of major economic indicators. The paper shows that five out of the 11 announcements have significant influence on stock valuation. These are the Employment Report, NAPM (manufacturing), Producer Price Index, Import and Export Price Indices, and Employment Cost Index. Of these six announcements, the Employment Report and NAPM (manufacturing) exert the greatest influence. The time of the announcement, measured by days from the beginning of the month to the release day, has a moderating impact on the relationship between macroeconomic announcements and its importance.     

CENTRAL BANK POLICIES AND INCOME AND WEALTH INEQUALITY: A SURVEY

This paper reviews recent research on the relationship between central bank policies and inequality. A new paradigm which integrates sticky‐prices, incomplete markets, and heterogeneity among households is emerging, which allows for the joint study of how inequality shapes macroeconomic aggregates and how macroeconomic shocks and policies affect inequality. The new paradigm features multiple distributional channels of monetary policy. Most empirical studies, however, analyze each potential channel of redistribution in isolation. Our review suggests that empirical research on the effects of conventional monetary policy on income and wealth inequality yields mixed findings, although there seems to be a consensus that higher inflation, at least above some threshold, increases inequality. In contrast to common wisdom, conclusions concerning the impact of unconventional monetary policies on inequality are also not clear cut. To better understand policy effects on inequality, future research should focus on the estimation of General Equilibrium models with heterogeneous agents.