A MONETARY BUSINESS CYCLE MODEL FOR INDIA

A New Keynesian monetary business cycle model is constructed to study why monetary transmission in India is weak. Our models feature banking and financial sector frictions as well as an informal sector. The predominant channel of monetary transmission is a credit channel. Our main finding is that base money shocks have a larger and more persistent effect on output than an interest rate shock, as in the data. The presence of an informal sector hinders monetary transmission. Contrary to the consensus view, financial repression in the form of a statutory liquidity ratio and administered interest rates, does not weaken monetary transmission. (JEL E31, E32, E44, E52, E63)     

ECONOMIES OF SCALE IN BANKING,INDETERMINACY, AND MONETARY POLICY

This paper investigates economies of scale (ES) in financial intermediation as a source of equilibrium indeterminacy. Financial intermediation is embedded into a standard flexible‐price monetary model, and provides deposits (inside money) that substitute with currency to purchase consumption. The results indicate that equilibrium indeterminacy does not depend on a large degree of ES in intermediation nor a large intermediation sector, but on monetary policy and the determination of nominal interest rates. Monetary policies not targeting nominal rates allow for indeterminacy to arise for any positive degree of ES, while policies targeting nominal rates eliminate indeterminacy for all degrees of ES. (JEL C62, E44, E52)     

THE FISCAL FRAMEWORK OF MONETARY POLICY

This paper i11ustrates the importance of the fiscal framework for monetary analysis by discussing three separate issues. I begin by examining how the fiscal framework changes the macroeconomic equilibrium associated with different steady state rates of money growth. This includes a summary of research that I have presented elsewhere and comments on several additional aspects of the way in which the fiscal structure destroys the neutrality of monetary policy.
The second section deals with the short-run impact of changes in monetary policy. Here again the fiscal structure complicates the economy's response to monetary policy.
The final section looks at the effect of the fiscal structure on the central banks choice of monetary policies. Fiscal structures are likely to influence the policies adopted because they affect the costs and benefits of monetary policies.     

STOP‐GO MONETARY POLICY

We propose and estimate several discrete choice models of monetary policy decision‐making that feature time‐varying inertia. The models permit us to account for three stylized facts characterizing monetary policymaking in the United States: (1) target interest rates are gradually adjusted in small discrete movements, (2) there are some long stretches of time in which rates are repeatedly moved, and (3) there are other long stretches in which the policy rate does not change. The models are used to account for delayed monetary policy responses to the recession of 2001 and to the housing‐driven expansion of 2003–2006. (JEL E52, E58, E65)     

CENTRAL BANK SECRECY, INTEREST RATES, AND MONETARY CONTROL

We construct a dynamic rational expectations model of the federal funds and deposit market that provides a rationale for central bank secrecy about current monetary aggregate objectives. In this analysis, the Trading Desk values secrecy because it reduces the influence of monetary control policy on interest rates. We then examine actual U.S. experience with monetary control and determine that the reserve bias predicted by the model is present in the data from 1978 to 1985. Finally, we demonstrate that central bank secrecy may not lower the value of commercial banks.     

LENDING RELATIONSHIPS AND MONETARY POLICY

Financial intermediation and bank spreads are the important elements in the analysis of business cycle transmission and monetary policy. We present a simple framework that introduces lending relationships, a relevant feature of financial intermediation that has been so far neglected in the monetary economics literature, into a dynamic stochastic general equilibrium model with staggered prices and cost channels. Our main findings are (a) banking spreads move countercyclically generating amplified output responses, (b) spread movements are important for monetary policymaking even when a standard Taylor Rule is employed, (c) modifying the policy rule to include a banking spread adjustment improves stabilization of shocks and increases welfare when compared to rules that only respond to output gap and inflation, and finally (d) the presence of strong lending relationships in the banking sector can lead to indeterminacy of equilibrium forcing the Central Bank to react to spread movements. (JEL E44, E52, G21)     

MONETARY POLICY SHOCKS,EXPECTATIONS, AND INFORMATION RIGIDITIES

This paper contributes to the literature by assessing expectation effects from monetary policy for G7 economies. We rely on expectation data from Consensus Economics and a panel vector autoregression framework, which accounts for international spillovers and time‐variation. We analyze whether monetary policy has changed the degree of information rigidity after the emergence of the subprime crisis and estimate effects of interest rate changes on expectations, disagreements, and forecast errors. We find strong evidence for information rigidities and identify higher forecast errors by professionals after monetary policy shocks. Our results suggest that the international transmission of monetary policy shocks introduces noisy information and partly increases disagreement among forecasters. (JEL E31, E52)     

DISEQUILIBRIUM EXCHANGE IN BARTER AND MONETARY ECONOMIES

This article compares the relative performances of barter and monetary arrangements at fixed disequilibrium prices. The decentralized functioning of the two systems is described, and their "fix-price" equilibria compared. It is shown that, while the fix-price equilibria will be more difficult to obtain in the barter economy, they are more efficient than in the monetary economy where disequilibrium "effective demand failures" appear.     

CAPITAL CONTROLS,MONETARY POLICY,AND BALANCE SHEETS IN A SMALL OPEN ECONOMY

We develop a small open economy, New Keynesian model that incorporates a financial accelerator in combination with liability dollarization. Applying a Ramsey‐type analysis, we compare the welfare implications of an optimal monetary policy under flexible exchange rates and an optimal capital control policy under fixed exchange rates. In an economy without the financial accelerator, an optimal monetary policy under flexible exchange rates is superior to an optimal capital control policy under fixed exchange rates. In contrast, in an economy with the financial accelerator, an optimal capital control under fixed exchange rates yields higher welfare than an optimal monetary policy under flexible exchange rates.(JEL E44, E52, F32, F38, F41)     

RULES AND DISCRETION WITH NONCOORDINATED MONETARY AND FISCAL POLICIES

The time inconsistency of optimal monetary policy is due to the effects of tax distortions. Thus the issue of how to improve upon the time-consistent suboptimal monetary policy is related to that of the coordination of monetary and fiscal policy. We present a model with three players (the central bark, the fiscal authority, and wage setters) in which distortionary taxes are explicitly modelled. We show that binding commitments to monetary rules are not necessarily welfare improving if monetary and fiscal policy are not coordinated. We also examine the effects of different degrees of independence of the central bank.     

THE RELATION BETWEEN NARRATIVE AND MONEY MARKET INDICATORS OF MONETARY POLICY

This paper studies the relation between narrative-based indicators of monetary policy and widely used money market indicators of monetary policy. Three principal findings emerge. First, changes in monetary policy, as measured by the narrative-based policy indices, are associated with persistent changes in the levels of M2 and the monetary base. In contrast, changes in the narrative policy indicators lead to transitory changes in short-term interest rates, nonborrowed reserves, and the spread between the six-month commercial paper rate and the three-month treasury bill rate. Third, these findings are generally robust across different narrative-based policy indices.     

THE FINANCIAL AND TAX EFFECTS OF MONETARY POLICY ON INTEREST RATES

Standard analysis of monetary policy effects on interest rates in terms of liquidity, income, and expectations effects is incomplete. After a change in monetary policy, substitution among securities will increase as time elapses and so reduce or eliminate financial effects caused by short-run financial market segmentation. Also, the standard expectations effect omits the transfer of income tax liability on that part of the interest payment representing a return of real capital. So a 1 percentage point increase in the expected inflation rate should increase the nominal interest rate by 1/(1 —τ) percentage points, τ being the marginal tax rate.     

THE COMPOSITION AND CONSTRUCTION OF MONETARY AGGREGATES

An economic monetary aggregate is composed from a set of monetary goods that are at least weakly separable from other goods in the optimizing agent's utility function. We construct such an aggregate using a Divisia index number. We demonstrate that through the middle of the 1980s forecasts of the inflation rate based on our economic monetary aggregate are superior to forecasts based on the simple sum monetary aggregates M1 or M2.     

THE INCOME EFFECTS OF THE SOURCES OF MONETARY CHANGE: AN HISTORICAL APPROACH*

This paper attempts to answer the question – does the way in which the quantity of money is introduced into the economic system matter or only the amount introduced? The question of the importance of the sources of monetary change has become a key issue between Monetarists and Neo-Keynesians. The approach of the paper is to compare different periods in U. S. monetary history over the time span 1834–1914, which exhibited different sources of monetary change, to see whether the source of monetary change significantly affected the relationship between money and income between these periods, as well as within them. In the majority of cases examined, the income effects of the sources of monetary change were found to be insignificant.     

A LONG-RUN VIEW OF GERMAN DOMINANCE AND THE DEGREE OF POLICY CONVERGENCE IN THE EMS

A preliminary for European monetary union is convergence of the European Monetary System's members' policies. Using a cointegration framework with short-term interest rates and monetary bases as monetary policy measures, we find policy convergence has not occurred. Nor, contrary to popular belief, does the Bundesbank dominate other members' policies. Although the Bundesbank is influential, substantial policy interaction occurs among almost all the EMS countries examined. Finally, the "credibility" argument, that pegged exchange rate systems constrain and discipline monetary policymakers behavior, is undermined by our findings.     

DO CAPITAL ADEQUACY REQUIREMENTS MATTER FOR MONETARY POLICY?

Central bankers and financial supervisors can have conflicting goals. While monetary policymakers work to ensure sufficient lending activities as a foundation for high and stable economic growth, supervisors may limit banks’ lending capacities in order to prevent excessive risk taking. We show that, in theory, central bankers can avoid this potential conflict by adopting an interest rate strategy that takes accounts of capital adequacy requirements. Empirical evidence suggests that while policymakers at the Federal Reserve have adjusted their interest rate to neutralizing the procyclical impact of bank capital requirements, those in Germany and Japan have not. (JEL E52, E58, G21)     

MONETARY FACTORS IN SOUTH AFRICA'S POST-WAR DEVELOPMENT

During the period 1949–60 the Government encouraged development of the money market. This, coupled with increased gold production, encouraged a “liquidity boom.” The only serious monetary crisis during the period was political, and the fact that this coincided with a strong upward movement in gold production largely explains how the crisis was handled without a major monetary adjustment, such as devaluation. The marked increase in gold production prevented any serious balance of payments deficits during years of sharply increased business activity. There was also sufficient gold to support marked credit expansion by the growing banking system. Indeed, except for the political crisis period 1960-61, the chief concern of the Government since the early 1960's has been excess liquidity in the monetary system. Prior to 1960, the Government's attitude was that cyclical fluctuations (and their varying effects on liquidity) could be effectively handled by the usual monetary, fiscal and trade controls available up to that date. The Severe crisis of 1960-61 led to an investigation of the monetary system and the passage of new laws aiming at greater equity as between banking institutions, more effective allocation of resources, protection of bank customers, and more effective control of excess liquidity and inflation. In 1964, inflation accelerated. The banking amendments came into effect almost immediately thereafter. During the past 3 years, the Government has made strenuous efforts to curb inflation. These efforts stressed monetary, fiscal, and import controls. Consumer credit controls have been used more effectively since 1965, but evasion of these controls has continued to be somewhat of a problem [25]. Apparently there has been some reluctance to use an “incomes policy” [3, p. 91. A device not widely used until recently was the so-called “credit directive” which was in the form of a ceiling on private credit. Initially, it was not entirely effective, but towards the end of 1967 there was evidence that the authorities' efforts to curb infiation were having some success, as the rate of price increase in the first half of 1968 has been less than in 1967, which in turn was less than the increase in 1966. The real growth rate in 1967 was nearly 7 percent, which was higher than the average of the preceding several years, but was attributable in considerable part to increased agricultural production which benefited greatly from u n d y good weather conditions [15, March 1968, p. 61.] several of the years immediately preceding 1967 were poor ones from the point of view of agriculture [6, p. 131).     

MONETARY NEUTRALITY UNDER EVOLUTIONARY DOMINANCE OF BOUNDED RATIONALITY

We provide evolutionary game‐theoretic microfoundations to a dynamic complete nominal adjustment in response to a monetary shock by introducing a novel analytical notion that we call boundedly rational inattentiveness. We investigate the behavior of the general price level in a context where a firm can either pay a cost (featuring a random component) to update its information set and establish the optimal price (Nash strategy) or freely use non‐updated information and establish a lagged optimal price (bounded rationality strategy). We devise evolutionary microdynamics (with and without mutation) that, by interacting with the dynamics of the aggregate variables, determines the coevolution of the frequency distribution of information‐updating strategies in the population of firms and the extent of the nominal adjustment of the general price level to a monetary shock. As it turns out, evolutionary learning dynamics take the information‐updating process to a long‐run equilibrium configuration in which, albeit either most or even all firms play the bounded rationality strategy, the general price level is the symmetric Nash equilibrium price and the monetary shocks have persistent, although not permanent, impacts on real output. (JEL E31, C73, D83)     

MONETARY POLICY AND ENDOWMENT RISK IN A LIMITED PARTICIPATION MODEL

A limited participation model is constructed to study the risk‐sharing role of monetary policy. A fraction of households exchange money for interest‐bearing government nominal bonds in the asset market and the government injects money through open market operations. In equilibrium, money is nonneutral and monetary policy redistributes consumption across households. Without idiosyncratic endowment risk, monetary policy becomes a perfect risk‐sharing tool, but with idiosyncratic endowment risk, it is not. The Friedman rule is not optimal in general. (JEL E4, E5)