The euro system and the federal reserve system compared: Facts and challenges

This paper compares the Federal Reserve System and the Eurosystem in four aspects. These are the institutional level, the monetary policy instruments, the operational framework and the monetary policy strategy applied. It highlights the similarities and the differences as well as the efficiency of the different settings. --

The supply and demand for Eurosystem deposits - The first 18 months

This paper describes the demand and supply factors affecting the amounts of deposits held by banks with the Eurosystem in the first 18 months of Stage Three of EMU and differences to the years before. The paper starts from the methodology adopted in a recent study by James Hamilton on 'The supply and demand for Federal Reserve deposits'. While the treatment of the autonomous liquidity factors is in principle similar, the modelling of open market operations and of the recourse to standing facilities diverge. These differences stem from different institutional settings, but also from somewhat different views on the accurate model. In a second part, the paper turns to prices by providing a simple econometric model capturing a large part of the variability of the difference between the EONIA rate (the price for daily funds) and the rate charged for the main refinancing operations JEL Classification: E52, E58

Household money holdings in the euro area: An explorative investigation

In this paper we analyse household holdings of the broad monetary aggregate M3 in the euro area from 1991 until 2009. We develop four models, two in nominal, two in real terms, with satisfactory economic and statistical properties. The main determinants are a transactions variable, wealth considerations, opportunity costs and uncertainty. The models are robust to different estimation strategies, samples considered and a multitude of mis-specification tests. The exercise also provides insights that go beyond the portfolio allocation decision of households. According to our analysis, it is quite apparent that in equilibrium, households jointly determine consumption and broad money holdings both influenced by wealth as well as interest rates. JEL Classification: E41, C23, C32, D21cointegrated VARs, households, Money demand

Simple interest rate rules with a role for money

The paper analyses the performance of simple interest rate rules which feature a response to noisy observations of inflation, output and money growth. The analysis is based on a small empirical model of the hybrid New Keynesian type which has been estimated on euro area data by Stracca (2007). To assess the magnitude of the measurement problems regarding the feedback variables, we draw upon the real-time data set for Germany compiled by Gerberding et al. (2004). We find that interest rate rules which include a response to money growth outperform both Taylor-type rules and speed limit policies once real-time output gap uncertainty is accounted for. One reason is that targeting money growth introduces history dependence into the policy rule which is desirable when private agents are forward-looking. The second reason is that money growth contains information on the "true" growth rate of output which can only be measured imperfectly. --Monetary policy rules,euro area,data uncertainty

Explaining the US Bond Yield Conundrum

We analyze if and to what extent fundamental macroeconomic factors, temporary influences or more structural factors have contributed to the low levels of US bond yields over the last few years. For that purpose, we start with a general model of interest rate determination. The empirical part consists of a cointegration analysis with an error correction mechanism. We are able to establish a stable long-run relationship and find that the behavior of bond yields, even during the last two years, can well be explained. Alongside the more traditional macroeconomic determinants like core inflation, monetary policy and the business cycle, we also include foreign holdings of US Treasuries. The latter should capture the frequently mentioned structural effects on long-term interest rates. Finally, our bond yield equation outperforms a random walk model in different forecasting exercises.bond yields; interest rates; cointegration; inflation; forecasting

Money-based interest rate rules: lessons from German data

The paper derives the monetary policy reaction function implied by money growth targeting. It consists of an interest rate response to deviations of the inflation rate from target, to the change in the output gap, to money demand shocks and to the lagged interest rate. In the second part, it is shown that this type of inertial interest rate rule characterises the Bundesbank's monetary policy from 1979 to 1998 quite well. This result is robust to the use of real-time or ex post data and to the consideration of serially correlated errors. The main lesson is that, in addition to anchoring long-term inflation expectations, monetary targeting introduces inertia and history-dependence into the monetary policy rule. This is advantageous when private agents have forward-looking expectations and when the level of the output gap is subject to persistent measurement errors. --Monetary policy,Taylor rule,money growth targets,history dependence

The demand for euro area currencies: past, present and future

The present paper analyses currency in circulation in the euro area since the beginning of the 1980s. After a comprehensive literature review on this topic we present some stylised facts on currency holdings in the euro area countries as well as at an aggregate euro area level. The next chapter develops a theoretical model, which extends traditional money demand models to also incorporate arguments for the informal economy and foreign demand for specific currencies. In the empirical sections we first estimate the demand for euro legacy currencies in total and for small and large denominations within a cointegration framework. We find significant differences between the determinants of holdings of small and large denominations as well as overall currency demand. While small-value banknotes are mainly driven by domestic transactions, the demand for large-value banknotes depends on a short-term interest rate, the exchange rate of the euro as a proxy for foreign demand and inflation variability. Large-value banknotes seem to be therefore used to an important extent as a store of value domestically and abroad. As monetary policy is mainly interested in getting information on the demand for currency used for domestic transactions we also try several approaches in this direction. All the methods applied result in rather low levels of transaction balances used within the euro area of around 25% to 35% of total currency. After this we deal with possibly changing cost-benefit-considerations of the use of cash due to the introduction of euro notes and coins. Overall, there seems no evidence so far of a substantial decline of the demand for currency in the euro area. JEL Classification: E41, E52, E58cointegration, currency in circulation, purposes of holding currency

Forecasting real GDP: what role for narrow money?

JEL Classification: E41, E52, E58business cycle, forecast comparison, Money, VAR models

Coin migration within the euro area

This paper analyses how many euro coins outflow from Germany and which composition of coins is to be expected in the long run. To this end, a simple mathematical model is formulated and calibrated for €1 coins. The introduction of the euro coins in 2002 presented a unique opportunity to analyse the cross-border migration and the mixing process of coins in different euro-area countries. Based on research by Stoyan and depending on growth assumptions, the annual outflow of German €1 coins is calculated to lie somewhere between 4% and 5%. In the long run, the ratio of German €1 coins in Germany is likely to converge to around 50%. --Euro coins,coin volumes,mixing process

Narrow Money and the Business Cycle: Theoretical aspects and euro area evdence

This paper analyses the information content of M1 for euro area real GDP since the beginning of the 1980s. After a literature review on the empirical results in individual euro area countries we review some theoretical arguments why real narrow money growth might be an important determinant of cyclical developments in real GDP beyond effects already captured by short-term interest rates. In the empirical part we first present some preliminary evidence on the M1-GDP connection against the background of the situation in the US, based on an approach developed by Hamilton and Kim 2002. This test suggests that compared with the U.S., in the euro area, M1 has better and more robust forecasting properties than the term spread. These properties are also maintained when looking at a broader set of non-monetary indicator variables. Narrow money therefore seems crucial for cyclical developments. We also evaluate the relative out-of-sample forecasting performance of different classes of VAR models comprising real M1, GDP and further potential leading indicator variables against a univariate benchmark model. As a result, once the information from narrow money is taken into account, what matters more for the forecast performance, is the model class rather than the selection of additional indicators. While within the class of VARs in levels, Bayesian VARs are the best performing models, they are not capable of outperforming the benchmark. Specifically, only VARs in first differences are able to outperform the benchmark model.Money; business cycle; forecast comparison; VAR models