The Fiscal Theory of the Price Level (FTPL) is the claim that, in a popular class of theoretical models, the price level is sometimes determined by fiscal policy rather than monetary policy. The models where this claim has been established assume that all decisions are made by an infinitely-lived representative agent. We present an alternative, arguably more realistic model, populated by sixty-two generations of people. We calibrate our model to an income profile from U.S. data and we show that the FTPL breaks down. In our model, the price level and the real interest rate are indeterminate, even when monetary and fiscal policy are both active. Our findings challenge established views about what constitutes a good combination of fiscal and monetary policies.
The yen is an important barometer for the Japanese economy. Depreciations are typically associated with favorable economic developments such as increased corporate profits, rising equity prices, and upward pressure on domestic consumer prices. On the other hand, large and sharp appreciations run the risk of lowering actual and expected inflation, squeezing corporate profits, generating a negative wealth effect through depressed equity prices, and reducing confidence in the Bank of Japan’s efforts to reflate the domestic economy and achieve the inflation target. This paper takes a closer look at underlying drivers of rapid yen appreciations, highlighting the key role of carry-trade and the zero lower bound as important amplifiers.
Mr. Mario Catalan, Alexander W. Hoffmaister, and Cicilia Anggadewi Harun
This paper studies the transmission of bank capital shocks to loan supply in Indonesia. A
series of theoretically founded dynamic panel data models are estimated and find nonlinear
effects of capital on loan growth: the response of weaker banks to changes in their capital
positions is larger than that of stronger banks. This non-linearity implies that not only the
level of capital but also its distribution across banks in the financial system affects the
transmission of shocks to aggregate lending. Likewise, the effects of bank recapitalization on
loan growth depend on banks’ starting capital positions and the size of capital injections.
Mr. Calixte Ahokpossi, Pilar Garcia Martinez, and Laurent Kemoe
We estimate the latent factors that underlie the dynamics of the sovereign bond yield curve in
Morocco during 2004–14 based on the Dynamic Nelson-Siegel model. On this basis, we
explore the interaction between macroeconomic variables and the yield curve, which is of
direct relevance to macroeconomic policy-making. In Morocco’s context, we find that tighter
monetary policy increases short-end maturities, and that the impact is small and short-lived.
Economic activity is also briefly but significantly impacted, suggesting that even under a
pegged exchange rate, monetary policy autonomy and effectiveness can be increased through
greater central bank independence. Fiscal improvements significantly lower yield levels. Policy
conclusions are that improvement in the fiscal and monetary policy frameworks, as well as
greater financial sector development and inclusion, could benefit Morocco and strengthen the
transmission mechanisms and effectiveness of macroeconomic policies.
Mr. Paul Cashin, Mr. Kamiar Mohaddes, and Mr. Mehdi Raissi
China's GDP growth slowdown and a surge in global financial market volatility could both
adversely affect an already weak global economic recovery. To quantify the global
macroeconomic consequences of these shocks, we employ a GVAR model estimated for 26
countries/regions over the period 1981Q1 to 2013Q1. Our results indicate that (i) a one percent
permanent negative GDP shock in China (equivalent to a one-off one percent growth shock) could
have significant global macroeconomic repercussions, with world growth reducing by 0.23
percentage points in the short-run; and (ii) a surge in global financial market volatility could
translate into a fall in world economic growth of around 0.29 percentage points, but it could also
have negative short-run impacts on global equity markets, oil prices and long-term interest rates.
This paper develops a structural macroeconometric model of the world economy, disaggregated into forty national economies. This panel dynamic stochastic general equilibrium model features a range of nominal and real rigidities, extensive macrofinancial linkages, and diverse spillover transmission channels. A variety of monetary policy analysis, fiscal policy analysis, spillover analysis, and forecasting applications of the estimated model are demonstrated. These include quantifying the monetary and fiscal transmission mechanisms, accounting for business cycle fluctuations, and generating relatively accurate forecasts of inflation and output growth.
This paper constructs a financial conditions index for Poland to explore the link between financial conditions and real economic activity. The index in constructed by applying two complementary approaches—factor analysis and vector auto-regression approach. We evaluate the index’s forecasting performance against a composite leading indicator developed by the OECD. We found that the FCI is highly correlated with GDP growth, attesting to the importance of financial sector in Poland’s economy. In-sample and out-of-sample forecasting exercises indicate that the FCI can outperform the CLI in predicting near-term GDP growth.
This paper uses the Global VAR (GVAR) model proposed by Pesaran et al. (2004) to study cross-country linkages among euro area countries, other advanced European countries (including the Nordics, the UK, etc.), and the Central, Eastern and Southeastern European (CESEE) countries. An innovative feature of the paper is the use of combined trade and financial weights (based on BIS reporting banks’ external position data) to capture the very close trade and financial ties of the CESEE countries with the advanced Europe countries. The results show strong co-movements in output growth and interest rates but weaker linkages bewteen inflation and real credit growth within Europe. While the euro area is the dominant source of economic influences, there are also interesting subregional linkages, e.g. between the Nordic and the Baltic countries, and a small but notable impact of CESEE countries on the rest of the Europe.
This paper quantifies the economic impact of uncertainty shocks in the UK using data that span the recent Great Recession. We find that uncertainty shocks have a significant impact on economic activity in the UK, depressing industrial production and GDP. The peak impact is felt fairly quickly at around 6-12 months after the shock, and becomes statistically negligible after 18 months. Interestingly, the impact of uncertainty shocks on industrial production in the UK is strikingly similar to that of the US both in terms of the shape and magnitude of the response. However, unemployment in the UK is less affected by uncertainty shocks. Finally, we find that uncertainty shocks can account for about a quarter of the decline in industrial production during the Great Recession.