Macroeconomics and Monetary Policy

Exchange Rate Pass-Through -  Theory, Concepts, Beliefs and Some Evidence

(Malin Adolfson)

Over the recent years many countries have experienced high exchange rate volatility without observing any greater inflationary impulses from fluctuations in the exchange rate. The degree of exchange rate pass-through seems to have declined during the 1990s. At least this is the belief in many inflation targeting countries based on quite simple observations of these economies. So what is the inflationary impulse from an exchange rate movement? This paper discusses what is meant by the concept "exchange rate pass-through" and the theories underlying different definitions. Additionally, the paper explores the links between changes in monetary policy and the degree of exchange rate pass-through. By using data from several inflation targeting countries the paper tries to establish what the degree of pass-through is when applying a careful definition of it, and whether in fact there has been any structural change in the exchange rate pass-through. Are the underlying determinants of the degree of pass-through mainly dependent on other factors than the monetary policy conduct?

Inflation, Financial Stability and Monetary Policy

(Magnus Jonsson; David Domeij, Stockholm School of Economics; Martin Flodén, Stockholm School of Economics).

We study the effects of monetary policy on financial stability and inflation in a dynamic general equilibrium model with heterogenous firms. Firms differ in the amount of equity and their financial situation matters for production. There is a financial intermediary who borrows from households and lends to firms. The central bank follws an interest  ate rule. As measures of financial stability we use bankruptcies of firms and a stock index.

Specification and Estimation of Models Used in Monetary Policy Analysis

(Jesper Lindé)

This project analyzes a variety of important issues when selecting and estimating models that are used in monetary policy analysis. Within the project, the following issues are currently being analyzed:

(1) If the bad fit and parameter instability of purely forward-looking intertemporal AS- and AD-curves relative to purely backward-looking counterparts imply that the underlying economy is backward-looking rather than forward-looking.

(2) Try to find ways to estimate simple structural models (e.g. Phillips- and AD-curves of the New-Keynesian type) on data with measurement errors (preferably in the output gap) while taking into account the influence of the existing monetary policy regime during the estimation period.

(3) Development of a dynamic structural general equilibrium model that may be usable in monetary policy analysis. This work requires identification of empirically relevant channels in the monetary transmission mechanism.

Monetary Policy in an Estimated/Calibrated Model of a Small Open Economy

(Jesper Lindé; Ulf Söderström; Marianne Nessén, Monetary Policy Department)

We develop a theoretical model of a small open economy with gradual exchange rate pass-through and endogenous inertia in inflation and output. We then estimate the model by matching the model impulse responses with those obtained from a VAR model estimated on Swedish data. The model can then used to examine important policy issues for a small open economy, for example (i) the performance of simple policy rules relative to "optimal" policy rules; (ii) the appropriate policy response to different types of shocks; or (iii) the role of the exchange rate in the conduct of monetary policy.

Monetary Policy and the Yield Curve

(Ulf Söderström; Tore Ellingsen, Stockholm School of Economics)

How do market interest rates respond to monetary policy? Ellingsen and Söderström (AER, 2001) suggest that the response of the yield curve to monetary policy shocks depends on the type of information revealed by the policy move. This theory finds strong support in U.S. data. The current project uses an empirical model of the U.S. economy to obtain quantitative predictions of the yield curve response to monetary policy which can be related to the empirical evidence.

Monetary Policy and Exchange Rate Uncertainty

(Ulf Söderström; Kai Leitemo, Norwegian School of Management)

This project analyzes alternative monetary policy strategies in small open economies. In particular we focus on the optimal policy response to movements in the real and nominal exchange rate and the design of monetary policy rules that are robust to uncertainty about the determation of the exchange rate.

Monetary Policy Analysis: A Bayesian VAR Approach

(Mattias Villani; Anders Warne, ECB)

The project has three purposes:

• to develop flexible software for estimating and analyzing structural VAR models, with exogenous variables, using modern Bayesian methods
• to identify effects from monetary policy shocks on e.g. output, unemployment, and inflation in Sweden, and
• to estimate confidence bounds for conditional forecasts under different assumptions about the future short term rate, e.g. fixed at the current value for the next 2 quarters.

The software will be written in MATLAB and compiled for 32-bit x86 computers so that it can be executed on any Windows 9x/NT4/ME/2000 system without the MATLAB software and it's intended to be user friendly, i.e. GUI based.

Financial Markets

Diversification and Delegation in Firms

(Sonja Daltung; Vittoria Cerasi, Università degli Studi di Milano Bicocca)

We study the relationship between the corporate structure, organizational structure, and financial structure of firms. In a context where entrepreneurs have the ability to run projects and improve their future cash flow, there could be rationing of credit due to moral hazard between entrepreneurs and investors. Diversification could mitigate the moral hazard problem. However for a single entrepreneur running many different projects might be increasingly costly due to overload costs. Delegating the running of projects to several managers can not only reduce overload costs, but also the moral hazard problem of external financing. Sometimes delegation is the only way to exploit the gains from diversification when overload costs of diversification are high; delegation thus can be the key ingredient to be able to diversify.

Multiple-Bank Lending Relationships: Diversification and Free-Riding in Monitoring

(Sonja Daltung; Elena Carletti, University of Mannheim; Vittoria Cerasi, Università degli Studi di Milano Bicocca)

We analyse the incentives of a banker to enter in multiple-bank lending relationships. In a context where banks have asymmetric information about its borrowers, diversification can reduce moral hazard. Sharing loans to borrowers with other banks may sometimes be the only way to increase diversification, and may therefore be profitable although it gives rise to free-riding.

Information sharing between banks

(Lars Frisell)

Using a unique data set, this project aims to investigate several claims raised by the theoretical literature on information sharing among lenders, institutionalized in Sweden by the credit bureau "UC". For example, to what extent does information gathered by UC reduce costs of adverse selection and moral hazard? Do the incentives to share information differ between banks?

Dynamic lender-borrower relationships

(Lars Frisell)

Lender-borrower relationships are normally multi-period games, i.e., loans are often renewed or extended. This project analyzes how learning and reputation-building may reduce moral hazard and adverse selection problems in standard debt contracts. The evolution of loans, investments, and expected returns for both borrower and lender are studied.

Credit Risks in the Banking Industry

(Tor Jacobson; Jesper Lindé; Kasper Roszbach; Kenneth Carling, Office of Labour Market Policy Evaluation)

In earlier work we have modelled various aspects of default risks in the consumer credit area. In this project, which will possibly involve several papers, we take on the more challenging task of modelling risks in banks' commercial loans. One reason why commercial loans are of interest is their relative importance on the balance sheets of banks. It might be argued that the credit risks in commercial loans constitute the single most important threat to banks, in particular considering the recent gains in Value-at-Risk-modelling of market risks. We hope to achieve two things; establish a meaningful way of conditioning on macro-economic conditions, this would in all likelihood increase the usefulness of the model for forecasting exercises. Second, for monitoring purposes, an aggregate measure of the stance of financial stability in the form a credit risk measure for the entire Swedish banking industry.