The financial accelerator and monetary policy rules

Comparing Bernanke et al.’s (1999) financial accelerator model to a comparable model without an operational financial accelerator mechanism, we find that financial acceleration is reduced when monetary policy reacts to the output gap and when firm-specific volatility rises.     

Predicting Canadian recessions using dynamic probit modelling approaches

Abstract This paper examines the ability of various financial and macroeconomic variables to forecast Canadian recessions. It evaluates four model specifications, including the advanced dynamic, autoregressive, dynamic autoregressive probit models as well as the conventional static probit model. The empirical results highlight several significant recession predictors, notably the government bond yield spread, growth rates of the housing starts, the real money supply and the composite index of leading indicators. Both the in‐sample and out‐of‐sample results suggest that the forecasting performance of the four probit models is mixed. The dynamic and dynamic autoregressive probit models are better in predicting the duration of recessions while the static and autoregressive probit models are better in forecasting the peaks of business cycles. Hence, the advanced dynamic models and the conventional static probit model can complement one another to provide more accurate forecasts for the duration and turning points of business cycles.     

Trade credit, bank lending and monetary policy transmission

This paper investigates the role of trade credit in the transmission of monetary policy. Most models of the transmission mechanism allow firms to access only financial markets or bank lending according to some net worth criterion. In our model we consider external finance from trade credit as an additional source of funding for firms that cannot obtain credit from banks. We predict that when monetary policy tightens there will be a reduction in bank lending relative to trade credit. This is confirmed with an empirical investigation of 16,000 UK manufacturing firms.     

Monetary Policy, Agency Costs and Output Dynamics

This paper examines the role of financial market imperfections for output reactions to nominal interest rate shocks. Empirical evidence shows a hump-shaped impulse response function of output and suggests that credit supply co-moves with output. A monetary business cycle model with staggered price setting is presented where the firms' outlays for capital and labor must be covered by the sum of net worth of entrepreneurs and loans in the form of debt contracts. These properties are shown to generate a hump-shaped impulse response of output, which takes on the smooth and persistent appearance of the empirical output response when nominal wages are set in a staggered way, too.     

The role of labor markets for euro area monetary policy

In this paper, we explore the role of labor markets for monetary policy in the euro area in a New Keynesian model in which labor markets are characterized by search and matching frictions. We first investigate to which extent a more flexible labor market would alter the business cycle behavior and the transmission of monetary policy. We find that while a lower degree of wage rigidity makes monetary policy more effective, i.e. a monetary policy shock transmits faster onto inflation, the importance of other labor market rigidities for the transmission of shocks is rather limited. Second, having estimated the model by Bayesian techniques we analyze to which extent labor market shocks, such as disturbances in the vacancy posting process, shocks to the separation rate and variations in bargaining power are important determinants of business cycle fluctuations. Our results point primarily towards disturbances in the bargaining process as a significant contributor to inflation and output fluctuations. In sum, the paper supports current central bank practice which appears to put considerable effort into monitoring euro area wage dynamics and which appears to treat some of the other labor market information as less important for monetary policy.     

Distortionary fiscal policy and monetary policy goals

We reconsider the role of an inflation conservative central banker in a setting with distortionary taxation. To do so, we assume monetary and fiscal policy are decided by independent authorities that do not abide to past commitments. If the two authorities make policy decisions simultaneously, inflation conservatism causes fiscal overspending. But if fiscal policy is determined before monetary policy, inflation conservatism imposes fiscal discipline. These results clarify that in our setting the value of inflation conservatism depends crucially on the timing of policy decisions.     

Dichotomy between macroprudential policy and monetary policy on credit and inflation

This paper compares macroprudential policy and monetary policy using a simple New Keynesian model with credit. Macroprudential policy is effective in stabilizing credit with limited impact on inflation. Monetary policy stabilizes inflation, but is ‘too blunt’ for credit stabilization.     

Debt, interest rates, and integration of financial markets

It is commonly believed that higher budget deficits raise interest rates. However, these crowding out effects of increasing public debt have usually been found to be small or non-existent. One explanation is that on globalised bond markets interest rate differentials are offset due to financial integration. This paper tests crowding out, and measures the degree of integration of government bond markets, using spatial modelling techniques. Our main finding is that the crowding out effect of public debt on domestic long term interest rates is small: a 1% increase in the debt ratio pushes up domestic rates by 2 pp at most. Financial integration implies an important spillover effect via international bond markets, but only between OECD, and in particular EU, countries. The feedback effect from these markets on long term interest rates is as important as the domestic crowding out effect of higher public debt. Emerging markets are not as well integrated into international capital markets, causing a stronger crowding out effect.     

Inflation, unemployment, and the time consistency of the US monetary policy

This paper verifies the performance of the Barro and Gordon (1983) model to explain the US inflation since the early 1950s. We divide the period from 1951:2 to 2010:2 according to each chairman of the Federal Reserve (FED). In addition, we consider aggregated periods, represented by pre-Volcker, Volcker-Greenspan, Greenspan-Bernanke, and whole sample. A genetic algorithm of stochastic search is applied to reduce the sensitivity of the maximum likelihood estimator to the initial parameter values. Surprisingly, our results show that the time consistency problem explains the US inflation during the Greenspan chairmanship at the FED.     

Endogenous trading constraints with incomplete asset markets

This paper endogenizes the borrowing constraints on capital in a production economy with incomplete markets. We find that these limits get looser with income, a property that is consistent with US data on credit limits. The framework with endogenous limits is then used to study the effects of a revenue neutral tax reform that eliminates capital income taxes. Our results illustrate that it is very important to take into account the effects of tax policies on the limits. Throughout the transition, these effects can be big enough to change the overall conclusion about the desirability of a tax reform.     

Measuring stress in money markets: A dynamic factor approach

We extract an index of interest rate spreads from various money market segments to assess the level of funding stress in real time. We find that during the 2007–2009 financial crisis, money markets switched between low and high stress regimes except for brief periods of extreme stress. Transitions to lower stress regimes are typically associated with the non-standard policy measures by the Federal Reserve.     

Fiscal policy and the Spanish business cycle

A main result of the RBC literature is that technological factors drive fluctuations of macroeconomic variables around its long-run growth path. Nevertheless, it has been shown that in some countries fluctuations of some fiscal variables may explain some of the business cycle fluctuations. In this paper I show that a result of this sort can be obtained for the Spanish economy. Specifically, I use both technological and fiscal shocks to reproduce the observed volatility of hours of work to output, hours of work to average productivity, and the negative correlation between hours and average productivity.     

Cross-country differences in monetary policy execution and money market rates’ volatility

Volatility patterns in overnight interest rates display differences across industrial countries that existing models—designed to replicate the features of individual countries’ markets—cannot account for. This paper presents an equilibrium model of the overnight interbank market that matches cross-country differences in patterns in interest volatility by incorporating differences in how central banks manage liquidity in response to shocks. Our model is consistent with central banks’ practice of rationing access to marginal facilities when the objective of stabilizing short-term interest rates conflicts with another high-frequency objective, such as an exchange rate target.     

Global imbalances,cross-market linkages,and the financial crisis: A multivariate Markov-switching analysis

Based on multivariate Markov-switching models, this paper presents new results on the interactions between global imbalances, credit spreads, housing markets, macroeconomic variables, commodities and equities during Q1-1987/Q1-2011. We show that rising global imbalances and the uncontrolled development of the US mortgage and housing markets have been deeply destabilizing the economy, with various shocks impacting subsequently equity markets and macroeconomic variables. But we also uncover, surprisingly, that the cross-market linkages with the commodity markets are strong. Finally, we identify that the US housing market lies at the epicenter of the crisis through its multiple and highly significant interactions with the other variables in the system (including the global imbalances). Sub-samples and alternative time series estimates are provided to check the statistical congruency of the various models.     

The composition of government spending and the multiplier at the zero lower bound

We investigate the size of the multiplier at the ZLB in a New Keynesian model. It ranges from around −0.25 to +1.5, depending on the extent to which the government spending is productive, substitutable or not for private consumption.     

Monetary and fiscal policy interactions: Evidence from emerging European economies

This paper examines the interactions between fiscal and monetary policy for some former transition, emerging European economies over the 1995Q1–2010Q4 period by using a Markov regime-switching model. We consider the monetary policy rule proposed by Taylor (1993) and the fiscal policy rule suggested by Davig and Leeper (2007) in accounting for monetary and fiscal policy interactions. Empirical results suggest that monetary and fiscal policy rules exhibit switching properties between active and passive regimes and all countries followed both active and passive monetary policies. As for fiscal policy, the Czech Republic, Estonia, Hungary, and Slovenia seem to have alternated between active and passive fiscal regimes while fiscal policies of Poland and the Slovak Republic can be characterized by a single fiscal regime. Although the policy mix and the interactions between monetary and fiscal policy point a diverse picture in our sample countries, the monetary policy seems to be passive in all countries after 2000. This finding is consistent with the constraints imposed by European Union enlargement on monetary policy.     

Jointly optimal monetary and fiscal policy rules under liquidity constraints

We study the welfare properties of an economy where both monetary and fiscal policies follow simple rules, and where a subset of agents is liquidity constrained. The welfare benefits of optimizing the fiscal rule are far larger than those of optimizing the monetary rule. The optimized fiscal rule implements strong automatic stabilizers that primarily stabilize the income of liquidity-constrained agents, rather than output. Transfers targeted to liquidity-constrained agents are the preferred fiscal instrument. The optimized monetary rule exhibits super-inertia and a weak inflation response. Optimized simple rules perform as well as the optimal policy under the timeless perspective.     

The role of financial sector competition for monetary policy

Abstract In this paper, we examine the impact of competition in the banking industry on financial market activity. In particular, we explore this issue in a setting where banks simultaneously insure individuals against liquidity risk and offer loans to promote intertemporal consumption smoothing. In addition, spatial separation and private information generate a transactions role for money. Interestingly, we demonstrate that the industrial organization of the financial system bears significant implications for the effects of monetary policy. Under perfect competition, higher rates of money growth lead to lower interest rates and a higher volume of lending activity. In contrast, in a monopoly banking sector, money growth restricts the availability of funds and raises the cost of borrowing.