Monetary Aggregates, Asset Prices and Real Outcomes

Paying close attention to money, credit, and asset prices shall improve the IWH's macroeconomic policy work, especially in terms of forecasting macroeconomic developments and risks, but also in terms of assessing the stance of monetary policy. To this end, it is necessary to understand the relationship between monetary and financial developments, on the one hand, and macroeconomic dynamics and stability, on the other hand. Money and credit are important determinants of the macroeconomic performance of a market economy. Research in this group contributes to the literature on quantitative macroeconomic models to be applied for forecasting and policy analysis that incorporate monetary and financial aspects.

Research Cluster
Macroeconomic Dynamics and Stability

Your contact

Professor Boreum Kwak, PhD
Professor Boreum Kwak, PhD
Mitglied - Department Macroeconomics
Send Message +49 345 7753-851


01.2017 ‐ 12.2017

Effects of exchange rate changes on production and inflation

Deutsche Bundesbank

Professor Dr Oliver Holtemöller

Refereed Publications


On the Low-frequency Relationship Between Public Deficits and Inflation

Martin Kliem Alexander Kriwoluzky Samad Sarferaz

in: Journal of Applied Econometrics, No. 3, 2016


We estimate the low-frequency relationship between fiscal deficits and inflation and pay special attention to its potential time variation by estimating a time-varying vector autoregression model for US data from 1900 to 2011. We find the strongest relationship neither in times of crisis nor in times of high public deficits, but from the mid 1960s up to 1980. Employing a structural decomposition of the low-frequency relationship and further narrative evidence, we interpret our results such that the low-frequency relationship between fiscal deficits and inflation is strongly related to the conduct of monetary policy and its interaction with fiscal policy after World War II.

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Nested Models and Model Uncertainty

Alexander Kriwoluzky Christian A. Stoltenberg

in: Scandinavian Journal of Economics, No. 2, 2016


Uncertainty about the appropriate choice among nested models is a concern for optimal policy when policy prescriptions from those models differ. The standard procedure is to specify a prior over the parameter space, ignoring the special status of submodels (e.g., those resulting from zero restrictions). Following Sims (2008, Journal of Economic Dynamics and Control 32, 2460–2475), we treat nested submodels as probability models, and we formalize a procedure that ensures that submodels are not discarded too easily and do matter for optimal policy. For the United States, we find that optimal policy based on our procedure leads to substantial welfare gains compared to the standard procedure.

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The Diablo 3 Economy: An Agent Based Approach

Makram El-Shagi Gregor von Schweinitz

in: Computational Economics, No. 2, 2016


Designers of MMOs such as Diablo 3 face economic problems much like policy makers in the real world, e.g. inflation and distributional issues. Solving economic problems through regular updates (patches) became as important to those games as traditional gameplay issues. In this paper we provide an agent framework inspired by the economic features of Diablo 3 and analyze the effect of monetary policy in the game. Our model reproduces a number of features known from the Diablo 3 economy such as a heterogeneous price development, driven almost exclusively by goods of high quality, a highly unequal wealth distribution and strongly decreasing economic mobility. The basic framework presented in this paper is meant as a stepping stone to further research, where our evidence is used to deepen our understanding of the real-world counterparts of such problems. The advantage of our model is that it combines simplicity that is inherent to model economies with a similarly simple observable counterpart (namely the game environment where real agents interact). By matching the dynamics of the game economy we can thus easily verify that our behavioral assumptions are good approximations to reality.

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Monetary Policy and the Transaction Role of Money in the US

Alexander Kriwoluzky Christian A. Stoltenberg

in: The Economic Journal, No. 587, 2015


The declining importance of money in transactions can explain the well-known fact that US interest rate policy was passive in the pre-Volcker period and active after 1982. We generalise a standard cashless new Keynesian model (Woodford, 2003) by incorporating an explicit transaction role for money. In the pre-Volcker period, we estimate that money did play an important role and determinacy required a passive interest rate policy. However, after 1982, money no longer played an important role in facilitating transactions. Correspondingly, the conventional view prevails and an active policy ensured equilibrium determinacy.

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The Quantity Theory Revisited: A New Structural Approach

Makram El-Shagi Sebastian Giesen

in: Macroeconomic Dynamics, No. 1, 2015


We propose a unified identification scheme to identify monetary shocks and track their propagation through the economy. We combine three approaches dealing with the consequences of monetary shocks. First, we adjust a state space version of the P-star type model employing money overhang as the driving force of inflation. Second, we identify the contemporaneous impact of monetary policy shocks by applying a sign restriction identification scheme to the reduced form given by the state space signal equations. Third, to ensure that our results are not distorted by the measurement error exhibited by the official monetary data, we employ the Divisia M4 monetary aggregate provided by the Center for Financial Stability. Our approach overcomes one of the major difficulties of previous models by using a data-driven identification of equilibrium velocity. Thus, we are able to show that a P-star model can fit U.S. data and money did indeed matter in the United States.

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Working Papers


Sovereign Default Risk, Macroeconomic Fluctuations and Monetary-Fiscal Stabilisation

Markus Kirchner Malte Rieth

in: IWH Discussion Papers, No. 22, 2020


This paper examines the role of sovereign default beliefs for macroeconomic fluctuations and stabilisation policy in a small open economy where fiscal solvency is a critical problem. We set up and estimate a DSGE model on Turkish data and show that accounting for sovereign risk significantly improves the fit of the model through an endogenous amplication between default beliefs, exchange rate and inflation movements. We then use the estimated model to study the implications of sovereign risk for stability, fiscal and monetary policy, and their interaction. We find that a relatively strong fiscal feedback from deficits to taxes, some exchange rate targeting, or a monetary response to default premia are more effective and efficient stabilisation tools than hawkish inflation targeting.

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Exchange Rates and the Information Channel of Monetary Policy

Oliver Holtemöller Alexander Kriwoluzky Boreum Kwak

in: IWH Discussion Papers, No. 17, 2020


We disentangle the effects of monetary policy announcements on real economic variables into an interest rate shock component and a central bank information shock component. We identify both components using changes in interest rate futures and in exchange rates around monetary policy announcements. While the volatility of interest rate surprises declines around the Great Recession, the volatility of exchange rate changes increases. Making use of this heteroskedasticity, we estimate that a contractionary interest rate shock appreciates the dollar, increases the excess bond premium, and leads to a decline in prices and output, while a positive information shock appreciates the dollar, decreases prices and the excess bond premium, and increases output.

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The Evolution of Monetary Policy in Latin American Economies: Responsiveness to Inflation under Different Degrees of Credibility

Stefan Gießler

in: IWH Discussion Papers, No. 9, 2020


This paper investigates the forward-lookingness of monetary policy related to stabilising inflation over time under different degrees of central bank credibility in the four largest Latin American economies, which experienced a different transition path to the full-fledged inflation targeting regime. The analysis is based on an interest rate-based hybrid monetary policy rule with time-varying coefficients, which captures possible shifts from a backward-looking to a forward-looking monetary policy rule related to inflation stabilisation. The main results show that monetary policy is fully forward-looking and exclusively reacts to expected inflation under nearly perfect central bank credibility. Under a partially credible central bank, monetary policy is both backward-looking and forward-looking in terms of stabilising inflation. Moreover, monetary authorities put increasingly more priority on stabilising expected inflation relative to actual inflation if central bank credibility tends to improve over time.

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Why is Unemployment so Countercyclical?

Lawrence J. Christiano Martin S. Eichenbaum Mathias Trabandt

in: NBER Working Paper No. 26723, 2020


We argue that wage inertia plays a pivotal role in allowing empirically plausible variants of the standard search and matching model to account for the large countercyclical response of unemployment to shocks.

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Resolving the Missing Deflation Puzzle

Jesper Lindé Mathias Trabandt

in: CEPR Discussion Papers 13690, 2019


We propose a resolution of the missing deflation puzzle. Our resolution stresses the importance of nonlinearities in price- and wage-setting when the economy is exposed to large shocks. We show that a nonlinear macroeconomic model with real rigidities resolves the missing deflation puzzle, while a linearized version of the same underlying nonlinear model fails to do so. In addition, our nonlinear model reproduces the skewness of inflation and other macroeconomic variables observed in post-war U.S. data. All told, our results caution against the common practice of using linearized models to study inflation and output dynamics.

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