The Interaction between Mortgage Financing and Housing Prices in Greece

Although the close empirical relationship between the evolution of mortgage lending and housing prices is well established in the literature, the direction of causation is less clear from a theoretical standpoint. We apply multivariate cointegration techniques in order to address this issue empirically for the Greek economy. Our results, based on a cointegration relationship that we identify as a mortgage loan demand equation, indicate that housing prices do not adjust to disequilibria in the market for housing loans. This suggests that in the long run the causation does not run from mortgage lending to housing prices. In the short run we find evidence of a contemporaneous bi-directional dependence.Housing loans; Housing prices; Multivariate cointegration

Market power, innovative activity and exchange rate pass-through in the euro area

This paper examines exchange rate pass-through in the euro area by accounting for the impact of exchange rate changes on exporting firms’ market power, cost structure and competitiveness. An international oligopoly model where exporting firms simultaneously decide on their pricing and innovation strategies is used as the basis for the econometric analysis. The estimations are carried out on data for manufacturing imports of three large euro area countries (Germany, France, Netherlands) from three major non-euro area import suppliers (US, Japan, UK). The results show that exporting firms’ price and innovation decisions in each source country are jointly determined and that total pass-through to euro area import prices is low. There are also indications that other factors, such as interactions with domestic producers, may be important for the determination of pass-through. Finally, euro area import prices are found to be sticky in local currency in the short run. JEL Classification: E43, E44, E58euro exchange rate, Exchange Rate Pass-Through, innovative activity, market power, multivariate cointegration

Changes in Financial Structure and Asset Price Substitutability: A Test of the Bank Lending Channel

In this paper we develop a method for testing the implications of the Bernanke-Blinder model for monetary policy transmission. Multivariate cointegration techniques are used in a sample that includes six major industrial countries with data covering the last 25 years. Moreover, we examine whether changes in financial markets affected the degree of asset substitutability and thus the potency of the lending channel. We find that in the US and the UK, representing the “Anglo-Saxon type” of financial market structure, the lending channel is inoperative, while in Japan it is still important for monetary transmission. The other three European countries examined – Germany, France, Italy – are in between, with the lending channel losing its potency in the last decade.Monetary transmission mechanism; bank lending channel; financial structure;multivariate cointegration

Forward-Looking Information in VAR Models and the Price Puzzle

In this paper we suggest a VAR specification that proves to be successful in resolving the price puzzle featuring in VARs used for monetary policy analysis. We show that augmenting a standard VAR with a small number of variables that have forward-looking informational content is capable of producing theory-consistent responses to monetary policy shocks. The VAR is estimated for the US with data covering the period 1989-2001, which is characterized by a relatively homogeneous monetary policy regime and a pronounced price puzzle in standard VAR specifications. Most important among these forward-looking variables are the federal funds rate future reflecting expectations of future monetary policy and a leading composite indicator providing information about near-term developments in economic activity. In view of the increasing ability of financial markets to better predict monetary policy movements, financial asset prices, such as the federal funds rate futures, are ideal candidates for incorporating parsimoniously a large amount of information into a lowdimension VAR.Monetary transmission mechanism; VAR models; Fed funds futures; price puzzle

Monetary Policy Rules under Heterogeneous Inflation Expectations

This paper evaluates the role of inflation-forecast heterogeneity in US monetary policy making. The deviation between private and central bank inflation forecasts is identified as a factor increasing inflation persistence and thus calling for a policy reaction. An optimal policy rule is derived by the minimization under discretion of a standard central bank loss function subject to a Phillips curve, modified to include the forecast deviation, and a forward-looking aggregate demand equation. This rule, which itself includes the forecast deviation as an additional argument, is estimated for the period 1974-1998, covering the Chairmanships of Arthur Burns, Paul Volcker and Alan Greenspan, by using real-time forecasts of inflation and the output gap obtained from the FOMC’s Greenbook and the Survey of Professional Forecasters. The estimated rule remains remarkably stable over the whole sample period, challenging the conventional view of a structural break following Volcker’s appointment as Chairman of the Fed. Finally, the substantial decline in the significance of the interest-rate smoothing term in the rule indicates that monetary policy inertia may, to a large extent, be an artifact of serially correlated inflation-forecast errors that feed into policy decisions in real time.Forward-looking model; Monetary policy reaction function; Expectations formation; Inflation expectations

Market Power, Innovative Activity and Exchange Rate Pass-Through

This paper considers an international oligopoly where firms simultaneously choose both the amount of output produced and the proportion of R&D investment to output. The model captures the links between the exchange rate, market power, innovative activity and price, which are important for the determination of the optimal degree of exchange rate pass-through. It is found that in the long run the pass-through elasticity can be less than, equal to or greater than one depending on R&D effectiveness but in any case it is higher than in models that do not endogenise innovation decisions. The empirical implications of the model are tested using data for Japanese firms exporting to the US market and applying the Johansen multivariate cointegration technique. Particular attention is given to the estimation and identification of the equilibrium price and R&D-intensity equations. The empirical results indicate that price-setting and R&D-intensity decisions of firms are jointly determined in the long run. This interdependence must be taken into account if an accurate estimate of the exchange rate pass-through is to be obtained.Exchange rate pass-through; market power; innovative activity; multivariate cointegration

Bank heterogeneity and monetary policy transmission

Heterogeneity in the response of banks to a change in monetary policy is an important element in the transmission of this policy through banks. This paper examines the role of bank liquidity, capitalization and market power as internal factors influencing banks’ reaction in terms of lending and risk-taking to monetary policy impulses. The ultimate impact of a monetary policy change on bank performance is also considered. The empirical analysis, using large panel datasets for the United States and the euro area, elucidates the sources of differences in the response of banks to changes in policy interest rates by disaggregating down to the individual bank level. This is achieved by the use of a Local GMM technique that also enables us to quantify the degree of heterogeneity in the transmission mechanism. It is argued that the extensive heterogeneity in banks’ response identifies overlooked consequences of bank behavior and highlights potential monetary sources of the current financial distress. JEL Classification: E44, E52, G21, C14Bank heterogeneity, bank performance, monetary policy, Risk-taking

Market Conduct, Price Interdependence and Exchange Rate Pass-Through

This paper develops an international oligopoly model where foreign and domestic firms simultaneously choose their pricing strategies under the assumption of non-zero conjectural variations. The model captures the links between domestic and foreign producers’ prices and establishes a relationship between the price of domestically produced goods and the exchange rate, which appears to be important for the determination of exchange rate pass-through. It is also found that the equilibrium pass-through elasticity can be less than, equal to or greater than one depending on exporting and domestic firms’ conjectural variations. The empirical implications of the model are tested with the Johansen multivariate cointegration technique using data for Japanese firms’ exports to the US market. The results indicate that US producer prices are indeed influenced by the prices of their Japanese competitors and that the pass-through elasticity is less than one.Money demand; Exchange rate pass-through; Conjectural variations; Translog expenditure function; Multivariate cointegration

Bank-Level Estimates of Market Power

The aim of this study is to provide an empirical methodology for the estimation of market power of individual banks. The new method employs the well-known model of Panzar and Rosse (1987) and proposes its estimation using the local regression technique. Thus, a number of restrictive assumptions regarding the properties of the production function of banks are relaxed, while the method proves successful in providing reasonable estimates of bank-level market power when applied to a large panel of banks of transition countries. The empirical results suggest that many banks in the sample deviate significantly from competitive practices and that market power varies substantially across banks in each country. Country averages of the bank-level results exhibit a very close relationship with standard, industry-level Panzar-Rosse estimates.Bank output; Market power; bank-level; local regression