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Inflation-targeting central banks have only imperfect knowledge about the effect of policy decisions on inflation. An important source of uncertainty is the relationship between inflation and unemployment. This paper studies the optimal monetary policy in the presence of uncertainty about the natural unemployment rate, the short-run inflation-unemployment tradeoff and the degree of inflation persistence in a simple macroeconomic model, which incorporates rational learning by the central bank as well as private sector agents. Two conflicting motives drive the optimal policy. In the static version of the model, uncertainty provides a motive for the policymaker to move more cautiously than she would if she knew the true parameters. In the dynamic version, uncertainty also motivates an element of experimentation in policy. I find that the optimal policy that balances the cautionary and activist motives typically exhibits gradualism, that is, it still remains less aggressive than a policy that disregards parameter uncertainty. Exceptions occur when uncertainty is very high and in inflation close to target.
In this thesis the behavior of banks in financial markets which banks frequently use to obtain short-term as well as long-term financing is studied. In the first chapter we incorporate an interbank market for collateralized lending among banks into a dynamic, stochastic, general equilibrium (DSGE) framework to analyze the impact of variations in the expected value of the collateral on the interbank lending volume. We find that a central bank which decides to lower the haircut on eligible collateral in repurchase agreements is able to stimulate interbank markets. In the second chapter a microeconomic model of bank behavior on the interbank market is set up to analyze the impact of risk-taking behavior of interbank borrowing banks and uncertainty about their balance sheet quality on the lending behavior of interbank lending banks. It is found that the disruptions on the interbank market are the result of optimal behavior on the part of interbank lending banks in response to the uncertainty about the balance sheet quality of an interbank borrowing bank. In the third chapter we use monthly data on German bank bond spreads and regress it on bank-specific risk factors to assess the degree of market discipline in the German bank bond market. The regression results for the whole German bank bond market indicate that the bond spread does not show signs of market discipline. However, a structural break analysis uncovers that since the beginning of the financial crisis the German bank bond market exhibits at least a weak form of market discipline for bonds issued by medium-size and large banks.
The European Central Bank has assigned a special role to money in its two pillar strategy and has received much criticism for this decision. In this paper, we explore possible justifications. The case against including money in the central bank’s interest rate rule is based on a standard model of the monetary transmission process that underlies many contributions to research on monetary policy in the last two decades. Of course, if one allows for a direct effect of money on output or inflation as in the empirical “two-pillar” Phillips curves estimated in some recent contributions, it would be optimal to include a measure of (long-run) money growth in the rule. In this paper, we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output. Such misperceptions cause a bias in policy setting. We find that cross-checking and changing interest rates in response to sustained deviations of long-run money growth helps the central bank to overcome this bias. Our argument in favor of ECB-style cross-checking does not require direct effects of money on output or inflation. JEL Classification: E32, E41, E43, E52, E58