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The global financial crisis and the ensuing criticism of macroeconomics have inspired researchers to explore new modeling approaches. There are many new models that deliver improved estimates of the transmission of macroeconomic policies and aim to better integrate the financial sector in business cycle analysis. Policy making institutions need to compare available models of policy transmission and evaluate the impact and interaction of policy instruments in order to design effective policy strategies. This paper reviews the literature on model comparison and presents a new approach for comparative analysis. Its computational implementation enables individual researchers to conduct systematic model comparisons and policy evaluations easily and at low cost. This approach also contributes to improving reproducibility of computational research in macroeconomic modeling. Several applications serve to illustrate the usefulness of model comparison and the new tools in the area of monetary and fiscal policy. They include an analysis of the impact of parameter shifts on the effects of fiscal policy, a comparison of monetary policy transmission across model generations and a cross-country comparison of the impact of changes in central bank rates in the United States and the euro area. Furthermore, the paper includes a large-scale comparison of the dynamics and policy implications of different macro-financial models. The models considered account for financial accelerator effects in investment financing, credit and house price booms and a role for bank capital. A final exercise illustrates how these models can be used to assess the benefits of leaning against credit growth in monetary policy.
“Institutional Overburdening” to a large extent was a consequence of the “Great Moderation”. This term indicates that it was a period in which inflation had come down from rather high levels. Growth and employment were at least satisfying and variability of output had substantially declined. It was almost unavoidable that as a consequence expectations on future actions of central banks and their ability to control the economy reached an unprecedented peak which was hardly sustainable. Institutional overburdening has two dimensions. One is coming from exaggerated expectations on what central banks can achieve (“expectational overburdening”). The other dimension is “operational overburdening” i.e. overloading the central bank with more and more responsibilities and competences.
The eurozone remains in a deep, largely macro-economic crisis. A robust global economy and falling oil prices have supported Europe’s economy for some time, but by now it is clear that the eurozone will only be able to pull itself out of this crisis by means of more decisive action. One response, the recent easing of monetary policy by the European Central Bank (ECB), has, for the most part, been sharply and one-sidedly criticised in Germany. Monetary policy inaction seems to be the preferred option of many in Germany.
The authors discuss the following question: What would happen if the ECB failed to respond to the excessively low inflation and the weak economy? And what economic policy would be suitable under the current circumstances, if not monetary policy?
We study money creation and destruction in today’s monetary architecture and examine the impact of monetary policy and capital regulation in a general equilibrium setting. There are two types of money created and destructed: bank deposits, when banks grant loans to firms or to other banks and central bank money, when the central bank grants loans to private banks. We show that equilibria yield the first-best level of money creation and lending when prices are flexible, regardless of the monetary policy or capital regulation. When prices are rigid, we identify the circumstances in which money creation is excessive or breaks down and the ones in which an adequate combination of monetary policy and capital regulation can restore efficiency.
A number of contributions to research on monetary policy have suggested that policy should be asymmetric near the lower bound on nominal interest rates. As inflation and economic activity decline, policy should ease more aggressively than it would in the absence of the lower bound. As activity recovers and inflation picks up, the central bank should act to keep interest rates lower for longer than without the bound. In this note, we investigate to what extent the policy easing implemented by the ECB since summer 2013 mirrors the rate recommendations of a simple policy rule or deviates from it in a way that indicates a “lower for longer” approach to policy near zero interest rates.
The paper traces the developments from the formation of the European Economic and Monetary Union to this date. It discusses the fact that the primary mandate of the European System of Central Banks (ESCB) is confined to safeguarding price stability and does not include general economic policy. Finally, the paper contributes to the discussion on whether the primary law of the European Union would support a eurozone exit. The Treaty of Maastricht imposed the strict obligation on the European Union (EU) to establish an economic and monetary union, now Article 3(4) TEU. This economic and monetary union is, however, not designed as a separate entity but as an integral part of the EU. The single currency was to become the currency of the EU and to be the legal tender in all Member States unless an exemption was explicitly granted in the primary law of the EU, as in the case of the UK and Denmark. The newly admitted Member States are obliged to introduce the euro as their currency as soon as they fulfil the admission criteria. Technically, this has been achieved by transferring the exclusive competence for the monetary policy of the Member States whose currency is the euro on the EU, Article 3(1)(c) TFEU and by bestowing the euro with the quality of legal tender, the only legal tender in the EU, Article 128(1) sentence 3 TFEU.
We present an accessible narrative of the Turkish economy since its great 2001 crisis. We broadly survey economic developments and pay particular attention to monetary policy. The data suggests that the Central Bank of Turkey was a strong inflation targeter early in this period but began to pay less attention to inflation after 2009. Loss of the strong nominal anchor is visible in the break we estimate in Taylor-type rules as well as in asset prices. We also argue that recent discrete jumps in Turkish asset prices, especially the exchange value of the lira, are due more to domestic factors. In the post-2009 period the Central Bank was able to stabilize expectations and asset prices when it chose to do so, but this was the exception rather than the rule.
n a contribution prepared for the Athens Symposium on “Banking Union, Monetary Policy and Economic Growth”, Otmar Issing describes forward guidance by central banks as the culmination of the idea of guiding expectations by pure communication. In practice, he argues, forward guidance has proved a misguided idea. What is presented as state of the art monetary policy is an example of pretence of knowledge. Forward guidance tries to give the impression of a kind of rule-based monetary policy. De facto, however, it is an overambitious discretionary approach which, to be successful, would need much more (or rather better) information than is currently available. In Issing's view, communication must be clear and honest about the limits of monetary policy in a world of uncertainty.
In the wake of the Global Financial Crisis that started in 2007, policymakers were forced to respond quickly and forcefully to a recession caused not by short-term factors, but rather by an over-accumulation of debt by sovereigns, banks, and households: a so-called “balance sheet recession.” Though the nature of the crisis was understood relatively early on, policy prescriptions for how to deal with its consequences have continued to diverge. This paper gives a short overview of the prescriptions, the remaining challenges and key lessons for monetary policy.
We analyze the differential impact of domestic and foreign monetary policy on the local supply of bank credit in domestic and foreign currencies. We analyze a novel, supervisory dataset from Hungary that records all bank lending to firms including its currency denomination. Accounting for time-varying firm-specific heterogeneity in loan demand, we find that a lower domestic interest rate expands the supply of credit in the domestic but not in the foreign currency. A lower foreign interest rate on the other hand expands lending by lowly versus highly capitalized banks relatively more in the foreign than in the domestic currency.
Has economic research been helpful in dealing with the financial crises of the early 2000s? On the whole, the answer is negative, although there are bright spots. Economists have largely failed to predict both crises, largely because most of them were not analytically equipped to understand them, in spite of their recurrence in the last 25 years. In the pre-crisis period, however, there have been important exceptions – theoretical and empirical strands of research that largely laid out the basis for our current thinking about financial crises. Since 2008, a flurry of new studies offered several different interpretations of the US crisis: to some extent, they point to potentially complementary factors, but disagree on their relative importance, and therefore on policy recommendations. Research on the euro debt crisis has so far been much more limited: even Europe-based researchers – including CEPR ones – have often directed their attention more to the US crisis than to that occurring on their doorstep. In terms of impact on policy and regulatory reform, the record is uneven. On the one hand, the swift and massive liquidity provision by central banks in the wake of both crises is, at least partly, to be credited to previous research on the role of central banks as lenders of last resort in crises and on the real effects of bank lending and monetary policy. On the other hand, economists have had limited impact on the reform of prudential and security market regulation. In part, this is due to their neglect of important regulatory choices, which policy-makers are therefore left to take without the guidance of academic research-based analysis.
This paper investigates the role of monetary policy in the collapse in the long-term real interest rates in the decade before the onset of the financial crisis using a sample of five advanced economies (United States, United Kingdom, the euro area, Sweden and Canada). The results from an estimated panel VAR with monthly data show that, while monetary policy shocks had negligible effects on long-term real interest rates, shocks to the long-term real interest rates had a one-to-one effect on the short nominal rate.
Exit strategies
(2014)
We study alternative scenarios for exiting the post-crisis fiscal and monetary accommodation using a macromodel where banks choose their capital structure and are subject to runs. Under a Taylor rule, the post-crisis interest rate hits the zero lower bound (ZLB) and remains there for several years. In that condition, pre-announced and fast fiscal consolidations dominate - based on output and inflation performance and bank stability - alternative strategies incorporating various degrees of gradualism and surprise. We also examine an alternative monetary strategy in which the interest rate does not reach the ZLB; the benefits from fiscal consolidation persist, but are more nuanced.
This note reviews the legal issues and concerns that are likely to play an important role in the ongoing deliberations of the Federal Constitutional Court of Germany concerning the legality of ECB government bond purchases such as those conducted in the context of its earlier Securities Market Programme or potential future Outright Monetary Transactions.
We assess the effects of monetary policy on bank risk to verify the existence of a risk-taking channel - monetary expansions inducing banks to assume more risk. We first present VAR evidence confirming that this channel exists and tends to concentrate on the bank funding side. Then, to rationalize this evidence we build a macro model where banks subject to runs endogenously choose their funding structure (deposits vs. capital) and risk level. A monetary expansion increases bank leverage and risk. In turn, higher bank risk in steady state increases asset price volatility and reduces equilibrium output.
In the aftermath of the global financial crisis, the state of macroeconomic modeling 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.
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.
We examine both the degree and the structural stability of inflation persis tence at different quantiles of the conditional inflation distribution. Previous research focused exclusively on persistence at the conditional mean of the inflation rate. Economic theory, however, provides various reasons -for example downward wage rigidities or menu costs- to expect higher inflation persistence at the upper than at the lower tail of the conditional inflation distribution.
Based on post-war US data we indeed find slower mean reversion in response to positive than to negative shocks. We find robust evidence for a structural break in persistence at all quantiles of the inflation process in the early 1980s. Inflation persistence has decreased and become more homogeneous across quantiles. Persistence at the conditional mean became more informative about the degree of persistence across the entire conditional inflation distribution. While prior to the 1980s inflation was not mean reverting in response to large positive shocks, our evidence strongly suggests that since the end of the Volcker disinflation the unit root can be rejected at every quantile including the upper tail of the conditional inflation distribution.
This dissertation introduces in chapter 1 a new comparative approach to model-based research and policy analysis by constructing an archive of business cycle models. It includes many well-known models used in academia and at policy institutions. A computational platform is created that allows straightforward comparisons of models’ implications for monetary and fiscal stabilization policies. Chapter 2 applies business cycle models to forecasting. Several New Keynesian models are estimated on historical U.S. data vintages and forecasts are computed for the five most recent recessions. The extent of forecast heterogeneity for models and professional forecasts is analysed. Chapter 3 extends the forecasting analysis to a long sample and to the evaluation of density forecasts. Weighted forecasts are computed using a variety of weighting schemes. The accuracy of forecasts is evaluated and compared to professional forecasts and forecasts from nonstructural time series methods. Chapter 4 adds a new feature to existing business cycle models. Specifically, a medium-scale New Keynesian model is constructed that allows for strategic complementarities in price-setting. The role of trade integration for monetary policy transmission is explored. A new dimension of the exchange rate channel is highlighted by which monetary policy directly impacts domestic inflation. Chapter 5 tests whether simple symmetric monetary policy rules used in most business cycle models are a sufficient description of reality. I use quantile regressions to estimate policy parameters and find asymmetric reactions to inflation, the output gap and past interest rates.