Monetary Policymakers Research Articles

Proportionality and procedure of monetary policy-making

Abstract In a highly controversial decision, the German Federal Constitutional Court (FCC) decided that the Public Sector Purchase Program (PSPP) of the European Central Bank (ECB) was ultra vires because it violated the principle of proportionality. The FCC took a procedural approach to proportionality, finding that the ECB had failed to substantiate its balancing assessment. Therefore, the Court considered itself unable to review whether PSPP was substantively proportionate, but announced that it might do so in a future case. The judgment raises the fundamental question of how courts should review monetary policy. The article begins by exploring the role of central banks between independence and accountability. Then, it analyzes, in three steps, what role the principle of proportionality should play in the realm of monetary policy. First, I argue that a traditional substantive balancing test as part of proportionality review is not applicable to monetary policy decisions and highlight the pitfalls of the FCC’s approach. Second, I claim that the imposed procedural “duty to substantiate” is not suitable to promote the democratic accountability of the ECB. Third, I contend that, therefore, the PSPP ruling creates an impetus for strengthening the ECB’s supranational accountability. I suggest that improving the monetary dialogue with the EU Parliament and establishing a comprehensive transparency regime for the ECB could further this goal. Ultimately, I propose that a narrow reading of the PSPP ruling could reconcile the current conflict between the FCC and the ECB and still provide a sufficient level of judicial accountability for the ECB’s monetary policy-making.

International Historical Evidence on Money Growth and Inflation: The Role of High Inflation Episodes

Abstract How long is the long run in the relationship between money growth and inflation? How important are high inflation episodes for the unit slope finding in the quantity theory of money? To answer these questions, we study the relationship between excess money growth and inflation over time and across frequencies using annual data from 1870 to 2013 for 16 developed countries. Wavelet-based exploratory analysis shows the existence of a close stable relationship between excess money growth and inflation only over long time horizons, i.e. periods greater than 16–24 years, with money growth mostly leading. When we investigate the sensitivity of the unit slope finding to inflation episodes using a “time-frequency-based” panel data approach, we find that low-frequency regression coefficients estimated over variable-length subsamples are largely affected by high inflation episodes occurring in the 1910s, the 1940s, and the 1970s. Taken together, our results suggest that inflationary upsurges affect regression coefficients, but not the closeness of the long-run relationship. This reconciles the validity of the quantity theory of money with the current disinterest of monetary policymaking in money growth.

A principal component analysis of multivariate data on inflation for Nigeria

For quite some time now, the Central Bank of Nigeria (CBN) analyses multivariate data on inflation so as to account for diverse sources of inflationary pressures at the current period and to monitor the inflation pattern in the economy. When the data are subjected to the classical multiple regression analysis using the Ordinary Least Squares (OLS) method, some of the variables may be highly correlated causing statistical insignificance. This may lead to exclusion of some variables from the fitted model. When this happens, the cost of data collection for such variables is a waste. Regardless of the outcome from a variable selection technique, this study is designed to familiarise monetary policy makers with the possibility of integrating Principal Component Analysis (PCA) with regression analysis so that a few variable components are utilised without excluding any explanatory variable. The paper models the multivariate data at the CBN database on inflation, and extracts important artificial orthogonal variables from the linear combinations of the observed explanatory variables, although with a penalty cost of excluding components with observations that are minimally separated. The PC-based model explains 95.91% of variations in the headline inflation with a mean difference (between the actual and the predicted inflation) that is statistically not different from zero. The study is a significant addition to the existing methodologies for inflation forecasting in the literature as it is one of a few works that apply PCA-based technique to predict headline inflation.

Moving out of the linear rut: A period-specific and regime-dependent exchange rate and oil price pass-through in the BRICS countries

In this paper, we test for the period-specific and regime-dependent exchange rate and oil price pass-through (EROPPT) for the BRICS countries using monthly frequency data. To this end, we extend the Diebold-Yilmaz (DY) spillover index to nonlinear settings based on the vector smooth transition autoregressive (STVAR) model. The results suggest that changes in the exchange rate and oil price of different magnitudes have asymmetric effects between the lower and upper regimes of the period-specific and regime-dependent pass-through. The results further show that the pass-through effects are stronger during periods the BRICS economies have completely adjusted to a specific regime than periods in which the economies only partially adjusted. Furthermore, our findings show considerable evidence of a higher pass-through when nonlinearity is captured. Overall, these findings provide macroeconomic insights for the monetary policymakers.

Does Foreign Debt have an Impact on Indonesia's Foreign Exchange Reserves?

Indonesia as one of the emerging market countries’ utilization of external resources of foreign debt to a boost in increasing economic growth in addition to international trade that supports accelerated growth Economy. Using time-series data of the period 1988-2017 and using the simultaneous approach of Two-Stage Least Square (TSLS), the research results find out and showed that the foreign debt and reserves have a two-way relationship. The study findings that macroeconomic variables of significant investment affect foreign debt and consumption expenditures significantly affect foreign exchange reserves. It as a basic contributor to monetary policymaking by the government in reducing foreign debt by utilizing investment in sustainable economic development and improving the performance of international trade net exports as well as public consumption expenditures thus supporting the acceleration in increasing foreign exchange reserves.

Does Foreign Debt have an Impact on Indonesia's Foreign Exchange Reserves?

Indonesia as one of the emerging market countries’ utilization of external resources of foreign debt to a boost in increasing economic growth in addition to international trade that supports accelerated growth Economy. Using time-series data of the period 1988-2017 and using the simultaneous approach of Two-Stage Least Square (TSLS), the research results find out and showed that the foreign debt and reserves have a two-way relationship. The study findings that macroeconomic variables of significant investment affect foreign debt and consumption expenditures significantly affect foreign exchange reserves. It as a basic contributor to monetary policymaking by the government in reducing foreign debt by utilizing investment in sustainable economic development and improving the performance of international trade net exports as well as public consumption expenditures thus supporting the acceleration in increasing foreign exchange reserves.

The Recovery from the Great Recession: Did the FOMC Learn the Right Lessons?

In August 2020, monetary policymakers articulated a new framework for conducting monetary policy. That framework reflected the conclusion, drawn from the recovery from the Great Recession, that monetary policy had erred in pursuing preemptive increases in the funds rate. Starting in December 2015, the Federal Open Market Committee (FOMC) had raised the funds rate off the zero lower bound and the inflation rate continued to run below the 2 percent target. Going forward, the FOMC will forgo preemptive increases to ensure an overshoot of its inflation target until the FOMC achieves the goal of “maximum employment.” What should policymakers have learned from the Great Recession recovery? It was a period of considerable nominal and real stability. In part, that stability was an artifact of an initial moderately contractionary monetary policy that limited the strength of the recovery. But that price stability provided the foundation for the significant decline in the unemployment rate during the recovery.

The Nexus Of Foreign Reserves, Exchange Rate And Inflation: Recent Empirical Evidence From Sri Lanka

The conventional mandates of the central banks on meeting stability objectives and maintaining a growth-maximizing inflation rate have come under some criticism since the global financial crises. Maintaining adequate foreign reserves is seen as a viable solution to foreign exchange liquidity needs during crisis periods. Since the end of 2011, many Asian economies, including China and Japan, led from the forefront in central bank-led reserves build-up. However, reserves build-up remains challenging and sensitive for small open economies. Such policies help create ‘risk-neutral’ buffers for monetary and fiscal authorities to absorb transitory current account shocks and foreign exchange stress to smoothen the balance of payments. This study is motivated by the importance of identifying the inflation–foreign reserves nexus that may affect inflation in a manner counterproductive to the central bank mandate of maintaining price stability. It probes the debate of the sustainability of reserves build-up in the long and the short term. The outcome of the study poses several vital questions for fiscal and monetary policymakers concerning their respective mandates. The reserves–inflation nexus and its magnitude is determined using monthly data spanning two decades, through engaging an autoregressive distributed lag (ARDL) model and relevant bounds-testing techniques proposed by Pesaran et al. The vector autoregression (VAR), error correction and Johansen cointegration methods supplement the robustness checks. Exchange rate is introduced to enrich the discussion on the reserves–inflation nexus and shows a cointegration relationship in the long run. The study provides an insight into the influence of exchange rate on reserves and inflation. The variance decomposition shows the presence of a lukewarm response from foreign reserves and exchange rate on inflation. Policymakers concerned with inflationary expectations in the medium-to-long term need to consider these signals, as reserves build-up is one of the important policy-driven objectives for a number of economies. JEL: C50, C32, E31, E52, E58, F30, F31, F39

Euro Area Banking and Monetary Policy Shocks in the QE Era: A Structural Credit Risk and Vector-autoregression Approach

This paper assesses the effects of monetary policy shocks on the macroeconomy and the euro area banking sector after the global financial crisis. Financial risk-return indicators of the banking sector based on a compound option-based structural credit risk model are embedded in a large macro-financial quarterly database covering the period 2008Q4-2019Q4. A SFAVAR identifies and estimates the shocks’ responses relating them to the endogenous build-up of banks’ vulnerabilities. The study finds that unconventional monetary policy, in particular the Asset Purchase Program of the European Central Bank, seems to have been more successful than conventional monetary policy in raising output and inflation. The desired boost to bank lending has been muted and loan cyclicality has varied across countries and loan types. The performance of the banking sector following monetary policy shocks can be characterized by a drop in expected ROE and ROA, a relaxation of lending conditions and increased correlation between banks’ assets return and the market return, a mechanism pointing to enhanced risk-taking. While banks’ probabilities of default fall following monetary policy shocks, financial leverage and the price of risk increase. Banks’ net worth rises via higher market capitalization and implied assets value together with lower volatility, albeit often incurring more debt. Risk-taking in the banking sector, such as the one observed in the run-up to the global financial crisis, may pose a risk to financial stability, especially if its effects on banks’ vulnerability spread to systemic risk. The endogenous build-up of macro-financial vulnerabilities may need to become part of monetary policymaking.

Household Level Inflation Rates and Inflation Inequality in Turkey

This paper aims to explore the distribution of inflation rates at the household level and estimate their determinants using the Household Budget Surveys. It derives the household level inflation rates using the democratic price index and analyzes inflation inequality and its persistency. The main contributions of the paper are as follows: (i) to determine inflation inequality by examining the distribution of household-specific inflation rates calculated by the democratic price index, (ii) to examine new dimensions of inflation inequality in Turkey by income groups and household characteristics, (iii) to estimate the micro-level determinants of household inflation rates in Turkey. Results suggest that inflation rates are lower for the rich than for the poor, and the distribution of inflation has worsened the income inequality in Turkey. This analysis provides rich information for monetary policymakers. Households have different responses to price changes or monetary policy tools because of their unique characteristics and economic conditions. Thus, we need to know how inflation rates differ at the household level in order to understand how monetary policy and inflation affect the well-being of households.

Exchange rate pass-through to price indices in Iran

One of the major challenges for monetary policy is to predict how exchange rate fluctuations affect inflation and price indices. Hence, the main objective of this study is to examine the exchange rate fluctuation in the price indices in Iran. This paper analyzes the effects of exchange rate fluctuations on price indices and other macroeconomic variables of Iran during the period of 2004-Q1 to 2018-Q4, using the framework of a recursive VAR model, drawing on Bernanke (1986) and Sims (1986).The results indicate that the transfer of exchange rate changes to price indices is imperfect, such that the exchange rate path through to consumer, producer, and import prices is from 14.68%, 15.55% and 18.22% in the first period increase to 51.78%, 53.15% and 88.14% in the 13th period. In addition, the results indicate that the exchange rate path-through decreases along the distribution chain, with the highest exchange rate passing through the import prices, producer prices and consumer prices, respectively. The result has interesting implications for Iran’s ability to attain an effective inflation-targeting regime. Monetary policy makers should curb exchange rate fluctuations by adopting appropriate exchange rate policies in order to minimize the uncertainty of the consumer price index. The study contributes to the literature by assessing the effect of changes in the exchange rate (the Iranian Rial vis-a-vis the US$) on prices using an updated time series from 2004 to 2018. It addresses the limitations of the previous studies, which found no strong relationship between the exchange rate and inflation rate in the Iranian context. One of these limitations was using the CPI, as the only price index.

Distortionary effects of economic crises on policy coordination in Turkey: Threshold GMM approach

This study investigates the interaction between fiscal and monetary policies and how crises affect the coordination between policymakers in Turkey. This study’s novelty is that a nonlinear Taylor rule indicating monetary policy response function is estimated based on the Threshold Generalized Method of Moments (Threshold GMM) methodology over the period January 2006—March 2020. The empirical findings reveal that when fiscal policy has an expansionary stage, especially in crises times, the policy interest rate does not react significantly to the inflation gap, output gap and real effective exchange rate gap in expansionary periods. On the contrary the policy interest rate gives statistically important responses to these variables during contractionary fiscal policy periods. Thus, the effectiveness of the Taylor rule appears in a period of contractionary fiscal policy. This situation gives rise to the significant policy implication that the monetary policymaker’s success in controlling inflation increases with the contractionary fiscal policy. Finally, it has been observed that effective coordination between monetary and fiscal policies did not occur during crisis periods, but compatible coordination was achieved in other periods.

On the Use of Current or Forward-Looking Data in Monetary Policy: A Behavioural Macroeconomic Approach

We analyse the use of current and forward-looking data in the setting of monetary policy (Taylor rule). We answer the question of whether the use of forward-looking data is to be preferred over the use of current data. We use a behavioural macroeconomic model that generates periods of tranquillity alternating with crisis periods characterized by fat tails in the distribution of output gap. We find that the answer to our question depends on the nature of the monetary policy regime. In general, in a strict inflation targeting regime the use of forward-looking data leads to a lower quality of monetary policymaking than in a dual mandate monetary policy regime. Finally, nowcasting tends to improve the quality of monetary policy especially in a strict inflation targeting regime.

Central Bank Policy and the Concentration of Risk: Empirical Estimates

Before the 2008 crisis, the cross-sectional skewness of banks' leverage went up and macro risk concentrated in the balance sheets of large banks. Using a model of profit-maximizing banks with heterogeneous Value-at-Risk constraints, we extract the distribution of banks' risk-taking parameters from balance sheet data. The time series of these estimates allow us to understand systemic risk and its concentration in the banking sector over time. Counterfactual exercises show that (1) monetary policymakers confront the trade-off between stimulating the economy and financial stability, and (2) macroprudential policies can be effective tools to increase financial stability.

Real interest rate convergence and monetary policy independence in CEE countries

In this paper we provide new empirical evidence relevant for discussions on monetary policy independence in the context of euro adoption in three Central and Eastern European (CEE) countries: Czechia, Hungary and Poland. Unlike many other authors, in this paper we focus on real and not nominal interest rates as real interest rates are at the hearth of modern macroeconomic and monetary policy theory. In the paper we employ several methodologies to test the convergence of real interest rates between these countries and the euro area and to determine the main drivers of real interest rates. Based on the unit root analysis we find evidence of convergence of real interest rates in these countries, thus confirming the real interest rate parity (RIRP) hypothesis. Next, using principle component analysis (PCA) we show that common factor extracted from the sample of CEE countries and individual euro area countries can explain high proportion of real interest rate developments in these countries. Finally, results of our newly proposed analytical framework for the analysis of determinants of real interest rates in small open economies, based on a Bayesian VAR model with block exogeneity, show that external shocks have non-negligible effect on real interest rate developments in selected CEE countries. Thus, our results indicate that real interest rates in CEE depend on factors that are beyond the scope of domestic monetary policy makers. In this sense we can conclude that (conventional) monetary policy independence in these countries is limited. Thus, we see the loss of monetary policy independence as overly emphasized argument in discussions on the euro adoption in these countries. However, we are aware that national central banks in CEE started to rely more on non-conventional measures recently, which gives them a higher degree of flexibility (and autonomy).

Distributional changes in oil price and inflation in the net oil exporting countries in Africa

The debate on oil price changes and inflation has attracted considerable empirical investigations among policy makers over the years. Most of the empirical literature so far studies disregard the likelihood that oil price changes may influence inflation along various consumer price index distribution. The paper employs a quantile regression model piloted by Koenker and Xiao (2004) to examine the distributional changes in oil price and their impact on inflation of the net oil exporting countries in Africa. By analyzing the behaviour of inflation in a wide range of quantiles, the technique allows us to capture possible variation and inflation distribution towards to its long-run equilibrium. Our results reveal that negative and positive changes in oil price impacts inflation negatively for majority of the quantiles. The paper also reveals significant disparity in magnitude and sign of the parameters. The result of the quantile regression shows an insignificant negative relationship between positive oil price and inflation across the quantiles at 5% level of significance. However, the opposite is the case when we modeled the negative oil price. It turns out to be a significantly negative coefficient at the lower quantile of 0.50 to higher levels of 0.90. The paper suggests that in order to stabilize the price, stakeholders must continue to monitor impending inflation volatility and take counteractive actions to sustain inflation potentials. The finding also implies that monetary policy makers have the ability to suppress the effects of hostile oil price changes on inflation

The Challenges of Reforming the International Monetary System in the Post COVID-19 World

AbstractThe paper analyzes if the international monetary system calls for reform and whether China and the renminbi will play a decisive role in the post COVID-19 world. It also evaluates the main scenarios and trends that is being discussed since the global crisis – selecting the relevant authors, journals, institutions and opinions – examines present conditions and tries to extrapolate into future trends. Opting for a nontechnical approach, the article could be a good insight into the international monetary system, for academics, non-experts and policy makers. The paper concludes that if the 2008 crisis has induced the growth of the China role in the international monetary governance and the increase of the renminbi internationalization, the COVID-19 pandemic and post crisis reconstruction could generate a deeper reform of the international monetary system, in which the Chinese currency will strengthen its global position alongside the US dollar and the euro.

The communication effects on inflation forecast errors: Empirical evidence from Colombia

The purpose of this article is to explore the central bank?s ability to management inflation forecast errors in Colombia. We present empirical evidence based on the Colombian experience with data from the period of 2008 to 2020. The communication channel selected for analysis is the press releases. The empirical evidence is divided into three steps: (i) regression analysis using an EGARCH model; (ii) use of VAR models; and (iii) variance decomposition analysis. The communications effects are significant for several months and that close to half of the forecast error variance can be explained by innovations in central bank communication. The results obtained allow monetary policymakers to develop more efficient strategies for anchoring expectations and strengthening the central bank credibility.

Monetary policy uncertainty and stock market returns: influence of limits to arbitrage and the economic cycle

PurposeThis paper aims to examine the impact that monetary policy uncertainty (MPU) has on stock market returns by taking into account limits to arbitrage and the economic cycle.Design/methodology/approachUsing four news-based MPU measures, regression models have been applied in this study over a sample period from January 1985 to March 2020. The limits to arbitrage have been considered by taking Russell 1000 Value, Russell 1000 Growth, Russell 2000 Value and Russell 2000 Growth indices, and business cycles were established following the National Bureau of Economic Research.FindingsA negative MPU impact on stock returns has been found. In particular, the most subjective and difficult to arbitrate stocks have been more sensitive to MPU. However, it could not be concluded that MPU has a greater or lesser impact on stock returns depending on the economic cycle.Practical implicationsThe findings obtained are particularly useful for monetary policymakers showing the importance and need for greater control over the transparency of their decisions to maintain the stability of financial markets. The findings obtained are also useful for investors when selecting their investment assets at times of the highest MPU.Originality/valueTo the best of the authors’ knowledge, this is one of the few studies investigating the effect of MPU on stock market returns, and the first to analyse this relationship taking into account the economic cycle and limits to arbitrage.

Democracy and Money: Lessons for Today from Athens in Classical Times

The authors of this book argue that post-war fiscal and monetary policies in the U.S. are prone to more frequent and more destabilizing domestic and international financial crises. So, in the aftermath of the one that erupted in 2008, they propose that now we are sleepwalking into another, which under the prevailing institutional circumstances could develop into a worldwide financial Armageddon. Thinking ahead of such a calamity, this book presents for the first time a model of democratic governance with privately produced money based on the case of Athens in Classical times, and explains why, if it is conceived as a benchmark for reference and adaptation, it may provide an effective way out from the dreadful predicament that state managed fiat money holds for the stability of Western-type democracies and the international financial system. As the U.S. today, Athens at that time reached the apex of its military, economic, political, cultural, and scientific influence in the world. But Athens triumphed through different approaches to democracy and fundamentally different fiscal and monetary policies than the U.S. Thus the readers will have the opportunity to learn about these differences and appreciate the potential they offer for confronting the challenges contemporary democracies face under the leadership of the U.S. The book will find audiences among academics, university students, and researchers across a wide range of fields and subfields, as well as legislators, fiscal and monetary policy makers, and economic and financial consultants.