Narayan K. Kishor

Business Cycle Synchronization in the Proposed East African Monetary Union: An Unobserved Component Approach

This paper uses the business cycle synchronization criteria of the theory of optimum currency area (OCA) to examine the feasibility of the East African Community (EAC) as a monetary union. We also investigate whether the degree of business cycle synchronization has increased after the 1999 EAC Treaty. We use an unobserved component model to measure business cycle synchronization as the proportion of structural shocks that are common across different countries, and a time-varying parameter model to examine the dynamics of synchronization over time. We find that although the degree of synchronization has increased since 2000 when the EAC Treaty came into force, the proportion of shocks that is common across different countries is still small implying weak synchronization. This evidence casts doubt on the feasibility of a monetary union for the EAC as scheduled by 2012.

What factors drive the price–rent ratio for the housing market? A modified present-value analysis

This paper proposes a modified present-value model that takes into account the fact that movements in the price-rent ratio for housing may not be mean-reverting. Our approach decomposes the price-rent ratio into expected real rent growth, expected housing return and a non-present-value (NPV) component that represents the deviation of the price-rent ratio from its conventional present-value level for the 18 U.S. metropolitan areas and the nation from 1975 through 2012. This NPV component takes into account non-stationarity of the price-rent ratio. To estimate this modified present-value model, we use the unobserved component approach. Our findings suggest that the NPV component is significant and sometimes very large both at the national and the regional level. This is especially true for the MSAs that have experienced frequent booms and busts in the housing market. We also find that the MSAs that display larger deviation from the present-value model are more sensitive to mortgage rate changes. We also compare our results with a recent statistical test for periodically collapsing bubbles. The results from this test and for our model indicate that the MSAs that had large NPV components are also the MSAs that witnessed explosive sub-periods in their price-rent ratios, especially during the 2005-2007 subsample. Our approach also allows us to estimate the correlation between expected rent growth, expected housing return and the NPV component. We find that a shock to expected housing return and a shock to the non-stationary NPV component are highly positively correlated in the pre-2006 sample period, implying that they fed off of each other. This correlation declined significantly in the post-2006 sample period. Our results also show that most of the variation in the present-value component of the price-rent ratio arises due to the variation in expected housing return.We consider which factors determined the price–rent ratio for the housing market in 18 U.S. metropolitan statistical areas (MSAs) and at the national level over the period of 1975–2014. Based on a present-value framework, our proposed empirical model separates the price–rent ratio for a given market into unobserved components related to the expected real rent growth and the expected housing return, but is modified from standard present-value analysis by also including a residual component that captures non-stationary deviations of the price–rent ratio from its present-value level. Estimates for the modified present-value model suggest that the present-value residual (PVR) component is always important and sometimes very large at the national and MSA levels, especially for MSAs that have experienced frequent booms and busts in the housing market. In further analysis, we find that house prices in MSAs that have larger PVR components are more sensitive to mortgage rate changes. These are also the MSAs with less elastic housing supply. Also, comparing our results with a recent statistical test for periodically-collapsing bubbles, we find that MSAs with large estimated PVR components are the same MSAs that test positively for explosive sub-periods in their price–rent ratios, especially during the 2005–2007 subsample. Our approach allows us to estimate the correlation between shocks to expected rent growth, the expected housing return, and the PVR component. We find that the expected housing return and movements in the PVR component are highly positively correlated implying an impact of the expected housing return on house prices that is amplified from what a standard present-value model would imply. Our results also show that most of the variation in the present-value component of the price–rent ratio arises due to the variation in the expected housing return.

The Time-Varying Response of Foreign Stock Markets to U.S. Monetary Policy Surprises: Evidence from the Federal Funds Futures Market

In this paper, we estimate the time-varying response of foreign stock markets to U.S. monetary policy shocks derived from the high-frequency Federal funds futures market. Our results show significant time-variation in the response of the global equity markets to U.S. monetary policy surprises, where an unanticipated interest rate cut leads to an increase in stock returns. Our findings suggest that the foreign stock markets respond more to U.S. monetary policy surprises during the crisis periods. We also find that the stock markets in Europe and the U.S. responded negatively to unanticipated interest rate cuts by the Fed during the recent financial crisis.

Inflation convergence and currency unions: the case of the East African community

Purpose - The purpose of this paper is to investigate inflation convergence within the East African Community (EAC) as it aspires to become a currency union. Design/methodology/approach - An unobserved dynamic factor model was used to decompose the variation in inflation into a component that is common across the countries in the EAC region and a component that is country specific. Convergence was measured by the percentage of variation in inflation that is common across countries. Findings - The estimated results from the dynamic factor model for the pre-EAC Treaty (1981:3 to 2000:2) period and post-EAC Treaty (2000:3 to 2009:1) period suggest that the percentage variation in inflation in the EAC that is explained by the common regional component increased significantly during the post-Treaty period. Research limitations/implications - One of the limitations of this paper is that it does not address the mechanism through which the convergence in a currency union is achieved. Future research should try to examine the link between convergence and different macroeconomic policies. Practical implications - This paper suggests that the push towards forming a currency union in East Africa has led to a greater degree of inflation synchronization across different countries in the region. Originality/value - The main contribution of this paper is to use an unobserved component model to estimate the degree of inflation synchronization in East African countries.

WHAT IS DRIVING FINANCIAL DOLLARIZATION IN TRANSITION ECONOMIES? A DYNAMIC FACTOR ANALYSIS

This paper investigates the impact of institutions on the dollarization of the domestic banking system by using a unique policy experiment: the accession process of countries to the European Union (EU). Using a dynamic factor model, we decompose fluctuations in financial dollarization for 24 transition economies into a world factor, an EU factor, and country-specific factors. The EU factor, which proxies for improvements in institutions under the set criteria for eventual membership, reveals the importance of institutions for the extent of …nancial dollarization over time. The results also indicate the asymmetric impact of improved institutions on the domestic bank’s balance sheets by inducing higher loan dollarization and lower deposit dollarization. The relative importance of the EU factor to the financial dollarization of a country is associated with the degree of comovement of its business cycle with that of the EU.

The Instability in the Monetary Policy Reaction Function and the Estimation of Monetary Policy Shocks

This paper uses the conventional wisdom about the shift in the monetary policy stance in 1979 to compute monetary policy shocks by estimating different monetary policy reaction functions for the pre-1979 and post-1979 time periods. We use the information from the internal forecasts of the Federal Reserve to derive monetary policy shocks. The results in this paper show that a monetary policy shock in the pre-1979 period affects output and prices much more strongly and quickly than what has been reported in the literature for the full sample. Our findings suggest that the dynamic response of output and prices to a monetary policy shock declined significantly between 1980-2001. We argue that this diminished response to the monetary policy shock is the result of a successful monetary policy that has led to a less volatile economy.

Does federal funds futures rate contain information about the treasury bill rate

In this article, we use high-frequency daily data to examine the dynamic relationship between the federal funds futures rate and the 3-month treasury (T)-bill rate. Our results show that 1-month federal funds futures rate is co-integrated with the 3-month T-bill rate, and thus move together in the long run. We find that any deviation of the 1-month federal funds futures rate and the T-bill rate from their long-run equilibrium is corrected by the subsequent movements in both federal funds futures rate and T-bill rate. Decomposing the federal funds futures rate and the T-bill rate into a trend and cycle using the multivariate Beveridge–Nelson methodology, we find that there was a big positive cycle in the federal funds futures rate before 2008 implying a future downward movement in federal funds futures rate. We also find a negative cycle in T-bill market during the financial crisis implying that the yield on T-bill was below the long-run trend.

Exploring the Dynamic Relationship in the Shadow Banking System

In this paper, we study the dynamic relationship in the shadow banking system by examining the short-run and the long-run relationship among the financial assets of the money market fund, the commercial paper, and the repurchase agreement market. The evidence suggests that there exists a common long-term cointegrating trend among these three components of the shadow banking system for 1985-2013 sample period. Any disequilibrium in this long-run relationship among these variables is corrected by movement in the financial assets of the money market funds. The trend-cycle decomposition from the estimated cointegrating relationship shows that the cyclical component in the money market funds is large and captures the huge swings in these markets during the financial crisis. Our results are also robust to the exclusion of the financial crisis, and it reveals the changing role of the commercial paper and the repurchase agreement market in the shadow banking system.

The roles of inflation expectations, core inflation, and slack in real-time inflation forecasting

Using state-space modeling, we extract information from surveys of long-term inflation expectations and multiple quarterly inflation series to undertake a real-time decomposition of quarterly headline PCE and GDP-deflator inflation rates into a common long-term trend, common cyclical component, and high-frequency noise components. We then explore alternative approaches to real-time forecasting of headline PCE inflation. We find that performance is enhanced if forecasting equations are estimated using inflation data that have been stripped of high-frequency noise. Performance can be further improved by including an unemployment-based measure of slack in the equations. The improvement is statistically significant relative to benchmark autoregressive models and also relative to professional forecasters at all but the shortest horizons. In contrast, introducing slack into models estimated using headline PCE inflation data or conventional core inflation data causes forecast performance to deteriorate. Finally, we demonstrate that forecasting models estimated using the Kishor-Koenig (2012) methodology-which mandates that each forecasting VAR be augmented with a flexible state-space model of data revisions-consistently outperform the corresponding conventionally estimated forecasting models.

CONSUMPTION AND EXPECTED ASSET RETURNS: AN UNOBSERVED-COMPONENT APPROACH

This paper proposes an unobserved-component approach to estimate expected returns on household assets and expected growth rates of excess consumption (consumption in excess of labor income) within a present-value model of consumption. The present-value model of consumption implies that the excess-consumption–assets ratio can be expressed as a function of the present discounted value of expected excess-consumption growth rate and expected asset returns. Because expected returns and expected excess-consumption growth rate are unobserved variables, we use an unobserved-component approach to extract them from the observed history of realized returns and excess-consumption growth rate. Our results suggest that both filtered returns and filtered excess-consumption growth rate are significant and better predictors of realized returns and realized excess-consumption growth rate than the one obtained by the lagged excess-consumption–assets ratio.