Q. Farooq Akram

Model Selection for Monetary Policy Analysis: How Important is Empirical Validity?*

We investigate the economic significance of trading off empirical validity of models against other desirable model properties. Our investigation is based on three alternative econometric systems of the supply side, in a model that can be used to discuss optimal monetary policy in Norway. Our results caution against compromising empirical validity when selecting a model for policy analysis. We also find large costs from basing policies on the robust model, or on a suite of models, even when it contains the valid model. This confirms an important role for econometric modelling and evaluation in model choice for policy analysis.

Macro Effects of Capital Requirements and Macroprudential Policy

I investigate macro effects of higher bank capital requirements on the Norwegian economy and their use as a macroprudential policy instrument under Basel III. To this end, I develop a macroeconometric model where the capital adequacy ratio, lending rates, asset prices and credit interact with each other and with the real economy. The empirical results suggest that changes in capital requirements are primarily transmitted via lending rates to the other variables in the model. The proposed increases in capital requirements under Basel III are found to have significant effects especially on house prices and credit. I also derive optimal paths for the countercyclical capital buffer in response to various shocks. The buffer is found to equal its imposed ceiling of 2.5% in response to most of the shocks considered while its duration varies in the range of 1-12 quarters depending on the shock and its persistence.

Non-linear dynamics in output, real exchange rates and real money balances: Norway, 1830-2003

We characterise the behaviour of Norwegian output, the real exchange rate and real money balances over a period of almost two centuries. The empirical analysis is based on a new annual data set that has recently been compiled and covers the period 1830-2003. We apply multivariate linear and smooth transition regression models proposed by Terasvirta (1998) to capture broad trends, and take into account non-linear features of the time series. We particularly investigate and characterise the form of the relationship between output and monetary policy variables. It appears that allowance for statedependent behaviour and response to shocks increases the explanatory powers of the models and helps bring forward new aspects of the dynamic behaviour of output, the real exchange rate and real money balances.

Time-Varying Dynamics of the Norwegian Economy

We use time‐varying parameter vector autoregressive models to investigate possible changes in the time‐series properties of key Norwegian macroeconomic variables since the 1980s. Notably, we find that inflation persistence falls during the inflation targeting period, while the volatility of inflation and nominal exchange rates increases. The observed time‐variation in the correlations between the interest rates and the macro variables largely reflects the prevailing monetary policy regimes. An increase in the correlations between oil prices and other macro variables over time is also documented. Using a counterfactual analysis, we discuss the observed time‐varying dynamics of the Norwegian economy in the light of monetary policy and oil price shocks.

Pricing in the Norwegian Interbank Market – The Effects of Liquidity and Implicit Government Support

We investigate the effects of central bank liquidity and possible implicit government guarantees against default on Norwegian overnight interbank interest rates. We conduct an econometric study of these interest rates over the period 2006-2009, which includes the sharp fall in interbank trading during the financial crisis. Our findings suggest relatively lower funding costs for banks of systemic importance, particularly for banks with many and valuable linkages to other banks. Moreover, interest rates are found to depend not only on overall liquidity in the interbank market, but on its distribution among banks as well. There is also evidence of stronger effects on interest rates of systemic importance, creditworthiness and liquidity demand and supply factors during the financial crisis.

Policy Analysis in Real Time Using IMF's Monetary Model

We investigate to what extent estimated relationships of the IMF’s monetary model and their policy implications are sample dependent. This model constitutes the core of the IMF’s financial programming models for developing and emerging economies. We observe that estimates of the model’s key parameters and model-based measures of macroeconomic disequilibria are highly dependent on data vintage employed. Changes in parameter estimates solely due to data revisions are found to be much smaller than those owing to parameter instability, which may be due to model misspecification. Moreover, instability in parameter estimates contributes to more uncertainty in evaluations of macroeconomic excesses than data revisions. It is shown that analyses based on a version of the model in difference form are more robust across data vintages than those based on the model with variables in levels. Well specified models that take into account known data revisions may also have relatively stable parameter estimates and hence more robust policy implications.