Working Paper Series : Institute for Monetary and Financial Stability
Capital inflows and asset prices: evidence from emerging Asia
- The withdrawal of foreign capital from emerging countries at the height of the recent financial crisis and its quick return sparked a debate about the impact of capital flow surges on asset markets. This paper addresses the response of property prices to an inflow of foreign capital. For that purpose we estimate a panel VAR on a set of Asian emerging market economies, for which the waves of inflows were particularly pronounced, and identify capital inflow shocks based on sign restrictions. Our results suggest that capital inflow shocks have a significant effect on the appreciation of house prices and equity prices. Capital inflow shocks account for - roughly - twice the portion of overall house price changes they explain in OECD countries. We also address crosscountry differences in the house price responses to shocks, which are most likely due to differences in the monetary policy response to capital inflows.
Complexity and monetary policy
- The complexity resulting from intertwined uncertainties regarding model misspecification
and mismeasurement of the state of the economy defines the monetary policy landscape.
Using the euro area as laboratory this paper explores the design of robust policy guides
aiming to maintain stability in the economy while recognizing this complexity. We document
substantial output gap mismeasurement and make use of a new model data base to capture
the evolution of model specification. A simple interest rate rule is employed to interpret
ECB policy since 1999. An evaluation of alternative policy rules across 11 models of the
euro area confirms the fragility of policy analysis optimized for any specific model and shows
the merits of model averaging in policy design. Interestingly, a simple difference rule with
the same coefficients on inflation and output growth as the one used to interpret ECB policy
is quite robust as long as it responds to current outcomes of these variables.
(Un)anticipated monetary policy in a DSGE model with a shadow banking system
Manuel M. F. Martins
- Motivated by the U.S. events of the 2000s, we address whether a too low for too long interest
rate policy may generate a boom-bust cycle. We simulate anticipated and unanticipated monetary
policies in state-of-the-art DSGE models and in a model with bond financing via a shadow banking
system, in which the bond spread is calibrated for normal and optimistic times. Our results suggest
that the U.S. boom-bust was caused by the combination of (i) too low for too long interest rates,
(ii) excessive optimism and (iii) a failure of agents to anticipate the extent of the abnormally
Lumpy investment in sticky information general equilibrium
- In this paper, I introduce lumpy micro-level capital adjustment into a sticky information general equilibrium model. Lumpy adjustment arises because of inattentiveness in capital investment decisions instead of the more common assumption of non-convex adjustment costs. The model features inattentiveness as the only source of stickiness. I find that the model with lumpy investment yields business cycle dynamics which differ substantially from those of an otherwise identical model with frictionless investment and are much more consistent with the empirical evidence. These results therefore strengthen the case in favour of the relevance of microeconomic investment lumpiness
for the business cycle.
Organizational choices of banks and the effective supervision of transnational financial institutions
- This paper outlines relatively easy to implement reforms for the supervision of
transnational banking-groups in the E.U. that should not be primarily based on legal form
but on the actual risk structures of the pertinent financial institutions. The proposal also
aims at paying close attention to the economics of public administration and international
relations in allocating competences among national and supranational supervisory bodies.
Before detailing the own proposition, this paper looks into the relationship between
sovereign debt and banking crises that drive regulatory reactions to the financial turmoil in
the Euro area. These initiatives inter alia affirm effective prudential supervision as a pivotal
element of crisis prevention.
In order to arrive at a more informed idea, which determinants apart from a perceived
appetite for regulatory arbitrage drive banks’ organizational choices, this paper scrutinizes
the merits of either a branch or subsidiary structure for the cross-border business of
financial institutions. In doing so, it also considers the policy-makers perspective. The analysis
shows that no one size fits all organizational structure is available and concludes that
banks’ choices should generally not be second-guessed, particularly because they are subject
to (some) market discipline.
The analysis proceeds with describing and evaluating how competences in prudential
supervision are currently allocated among national and supranational supervisory authorities.
In order to assess the findings the appraisal adopts insights form the economics of public
administration and international relations. It argues that the supervisory architecture has to
be more aligned with bureaucrats’ incentives and that inefficient requirements to cooperate
and share information should be reduced. Contrary to a widespread perception, shifting responsibility
to a supranational authority cannot solve all the problems identified.
Resting on these foundations, the last part of this paper finally sketches an alternative
solution that dwells on far-reaching mutual recognition of national supervisory regimes
and allocates competences in line with supervisors’ incentives and the risk inherent in crossborder
Optimal monetary and fiscal policy with a zero bound on nominal interest rates
- I characterize optimal monetary and fiscal policy in a stochastic New Keynesian model when nominal interest rates may occasionally hit the zero lower bound. The benevolent policymaker controls the short-term nominal interest rate and the level of government spending. Under discretionary policy, accounting for fiscal stabilization policy eliminates to a large extent the welfare losses associated with the presence of the zero bound. Under commitment, the gains associated with the use of the fiscal policy tool remain modest, even though fiscal stabilization policy is part of the optimal policy mix.
The new keynesian approach to dynamic general equilibrium modeling: models, methods, and macroeconomic policy evaluation
- This chapter aims to provide a hands-on approach to New Keynesian models and their
uses for macroeconomic policy analysis. It starts by reviewing the origins of the New Keynesian
approach, the key model ingredients and representative models. Building blocks of
current-generation dynamic stochastic general equilibrium (DSGE) models are discussed in
detail. These models address the famous Lucas critique by deriving behavioral equations
systematically from the optimizing and forward-looking decision-making of households and
firms subject to well-defined constraints. State-of-the-art methods for solving and estimating
such models are reviewed and presented in examples. The chapter goes beyond the mere
presentation of the most popular benchmark model by providing a framework for model
comparison along with a database that includes a wide variety of macroeconomic models.
Thus, it offers a convenient approach for comparing new models to available benchmarks
and for investigating whether particular policy recommendations are robust to model uncertainty.
Such robustness analysis is illustrated by evaluating the performance of simple
monetary policy rules across a range of recently-estimated models including some with financial
market imperfections and by reviewing recent comparative findings regarding the
magnitude of government spending multipliers. The chapter concludes with a discussion of
important objectives for on-going and future research using the New Keynesian framework.
The competition effect in business cycles
- How do changes in market structure affect the US business cycle? We estimate a monetary DSGE model with endogenous
rm/product entry and a translog expenditure function by Bayesian methods. The dynamics of net business formation allow us to identify the 'competition effect', by which desired price markups and inflation decrease when entry rises. We
find that a 1 percent increase in the number of competitors lowers desired markups by 0.18 percent. Most of the cyclical variability in inflation is driven by markup fluctuations due to sticky prices or exogenous shocks rather than endogenous changes in desired markups.
Optimal monetary policy and firm entry
- This paper characterises optimal monetary policy in an economy with endogenous
firm entry, a cash-in-advance constraint and preset wages. Firms must make pro
fits to cover entry costs; thus the markup on goods prices is efficient. However, because leisure is not priced at a markup, the consumption-leisure tradeoff is distorted. Consequently, the real wage, hours and production are suboptimally low. Due to the labour requirement in entry, insufficient labour supply also implies that entry is too low. The paper shows that in the absence of
fiscal instruments such as labour income subsidies, the optimal monetary policy under sticky wages achieves higher welfare than under flexible wages. The policy maker uses the money supply instrument to raise the real wage - the cost of leisure - above its flexible-wage level, in response to expansionary shocks to productivity and entry costs. This raises labour supply, expanding production and
A new comparative approach to macroeconomic modeling and policy analysis
Gernot J. Müller
Maik Hendrik Wolters
- In the aftermath of the global financial crisis, the state of macroeconomicmodeling and the use
of macroeconomic models in policy analysis has come under heavy criticism. Macroeconomists
in academia and policy institutions have been blamed for relying too much on a particular class
of macroeconomic models. This paper proposes a comparative approach to macroeconomic policy
analysis that is open to competing modeling paradigms. Macroeconomic model comparison
projects have helped produce some very influential insights such as the Taylor rule. However,
they have been infrequent and costly, because they require the input of many teams of researchers
and multiple meetings to obtain a limited set of comparative findings. This paper provides a new
approach that enables individual researchers to conduct model comparisons easily, frequently, at
low cost and on a large scale. Using this approach a model archive is built that includes many
well-known empirically estimated models that may be used for quantitative analysis of monetary
and fiscal stabilization policies. A computational platform is created that allows straightforward
comparisons of models’ implications. Its application is illustrated by comparing different monetary
and fiscal policies across selected models. Researchers can easily include new models in the
data base and compare the effects of novel extensions to established benchmarks thereby fostering
a comparative instead of insular approach to model development.