Monetary Policy Implementation in the Interbank Market

The liquidity crisis that swept through the financial markets in 2007 triggered multi-billion losses and forced buyouts of some large banks. The resulting credit crunch is sometimes compared to the great recession in the early twentieth century. But the crisis also serves as a reminder of the significance of the interbank market and of proper central bank policy in this market. This thesis deals with implementation of monetary policy in the interbank market and examines how central bank tools affect commercial banks' decisions. I answer the following questions: • What is the relationship between the policy setup and interbank interest rate volatility? (averaging reserve requirement reduces the volatility) • What can explain a weak relationship between market liquidity and the interest rate? (high reserve requirement buffer) • What determines banks' decisions on when to satisfy the reserve requirement? (market frictions) • How did the liquidity crisis that began in 2007 affect interbank market behaviour? (resulted in higher credit risk and trading frictions as well as expected liquidity shortage)

Monetary Policy, Stock Price Misalignments and Macroeconomic Instability

Perhaps the most fundamental prediction of financial theory is that the expected returns on financial assets are determined by the amount of risk contained in their payoffs. Assets with a riskier payoff pattern should provide higher expected returns than assets that are otherwise similar but provide payoffs that contain less risk. Financial theory also predicts that not all types of risks should be compensated with higher expected returns. It is well-known that the asset-specific risk can be diversified away, whereas the systematic component of risk that affects all assets remains even in large portfolios. Thus, the asset-specific risk that the investor can easily get rid of by diversification should not lead to higher expected returns, and only the shared movement of individual asset returns – the sensitivity of these assets to a set of systematic risk factors – should matter for asset pricing. It is within this framework that this thesis is situated. The first essay proposes a new systematic risk factor, hypothesized to be correlated with changes in investor risk aversion, which manages to explain a large fraction of the return variation in the cross-section of stock returns. The second and third essays investigate the pricing of asset-specific risk, uncorrelated with commonly used risk factors, in the cross-section of stock returns. The three essays mentioned above use stock market data from the U.S. The fourth essay presents a new total return stock market index for the Finnish stock market beginning from the opening of the Helsinki Stock Exchange in 1912 and ending in 1969 when other total return indices become available. Because a total return stock market index for the period prior to 1970 has not been available before, academics and stock market participants have not known the historical return that stock market investors in Finland could have achieved on their investments. The new stock market index presented in essay 4 makes it possible, for the first time, to calculate the historical average return on the Finnish stock market and to conduct further studies that require long time-series of data.

Monetary policy rules and estimated reaction functions for the European Central Bank

This thesis studies the interest-rate policy of the ECB by estimating monetary policy rules using real-time data and central bank forecasts. The aim of the estimations is to try to characterize a decade of common monetary policy and to look at how different models perform at this task.The estimated rules include: contemporary Taylor rules, forward-looking Taylor rules, nonlinearrules and forecast-based rules. The nonlinear models allow for the possibility of zone-like preferences and an asymmetric response to key variables. The models therefore encompass the most popular sub-group of simple models used for policy analysis as well as the more unusual non-linear approach. In addition to the empirical work, this thesis also contains a more general discussion of monetary policy rules mostly from a New Keynesian perspective. This discussion includes an overview of some notable related studies, optimal policy, policy gradualism and several other related subjects. The regression estimations are performed with either least squares or the generalized method of moments depending on the requirements of the estimations. The estimations use data from both the Euro Area Real-Time Database and the central bank forecasts published in ECB Monthly Bulletins. These data sources represent some of the best data that is available for this kind of analysis. The main results of this thesis are that forward-looking behavior appears highly prevalent, but that standard forward-looking Taylor rules offer only ambivalent results with regard to inflation. Nonlinear models are shown to work, but on the other hand do not have a strong rationale over a simpler linear formulation. However, the forecasts appear to be highly useful in characterizing policy and may offer the most accurate depiction of a predominantly forward-looking central bank. In particular the inflation response appears much stronger while the output response becomes highly forward-looking as well.

Experimental approach for studying structural changes in axonal membrane upon nerve excitation

The Hodgkin and Huxley (HH) model of action potential has become a central paradigm of neuroscience. Despite its ability to predict action potentials with remarkable accuracy, it fails to explain several biophysical findings related to the initiation and propagation of the nerve impulse. The isentropic heat release and optical phenomena demonstrated by various experiments suggest that action potential is accompanied by a transient phase change in the axonal membrane. In this study a method was developed for preparing a giant axon from the crayfish abdominal cord for studying the molecular mechanisms of action potential simultaneously by electrophysiological and optical methods. Also an alternative setup using a single-cell culture of an Aplysia sensory neuron is presented. In addition to the description of the method, the preliminary results on the effect of phloretin, a dipole potential lowering compound, on the excitability of a crayfish giant axon are presented.

Forest sector simulation models as methodological tools in forest policy analysis.

XVIII IUFRO World Congress, Ljubljana 1986.

Factors affecting farmland prices in Finland

The purpose of the study was to analyse factors affecting the differences in land prices between regions. The key issue was to find out the policy effects on farmland prices. In addition to comprehensive literature review, a theoretical analysis as well as modern panel and spatial econometric techniques were utilized. The study clearly pointed out the importance of taking into account the possible spatial dependence. The data were exceptionally large, comprising more than 6 000 observations. Thus, it allowed a thorough econometric estimation including the possibility to take into account the spatial nature of the data. This study supports the view that there are many other factors that affect farmland prices besides pure agricultural returns. It was also found that the support clearly affects land prices. However, rather than assuming the discount rates for support and market returns to be similar, the rough analysis refers to the discount rate for support being a little lower. If this were true it would indicate that farmers rely more on support income than market returns. The results support the view presented in literature that land values are more responsive to government payments when these payments are perceived to be permanent. An important result of this study is that the structural differences between regions and the structural change in agriculture seemed to have a considerable role in affecting land prices. Firstly, the present structure affects the competition in the land market: the more dense farms are in the region the more there are potential buyers, and the land price increases. Secondly, the change in farm structure (especially in animal husbandry) connected to the policy changes that increase area-based support affects land prices. The effect comes from two sources. Growing farms need more land for the manure, and the proportion of retiring farmers may be lower. The introduction of the manure density variable proved to be an efficient way to aggregate the otherwise very difficult task of taking into account the environmental pressure caused by structural change in animal husbandry. Finally, infrastructure also has a very important role in determining the price level of agricultural land. If other industries are prospering in the surrounding area, agricultural viability also seems to improve. The non-farm opportunities offered to farm families make continuing and developing farming more tempting.

Essays on macroeconomic effects of fiscal policy rules

Economic and Monetary Union can be characterised as a complicated set of legislation and institutions governing monetary and fiscal responsibilities. The measures of fiscal responsibility are to be guided by the Stability and Growth Pact, which sets rules for fiscal policy and makes a discretionary fiscal policy virtually impossible. To analyse the effects of the fiscal and monetary policy mix, we modified the New Keynesian framework to allow for supply effects of fiscal policy. We show that defining a supply-side channel for fiscal policy using an endogenous output gap changes the stabilising properties of monetary policy rules. The stability conditions are affected by fiscal policy, so that the dichotomy between active (passive) monetary policy and passive (active) fiscal policy as stabilising regimes does not hold, and it is possible to have an active monetary - active fiscal policy regime consistent with dynamical stability of the economy. We show that, if we take supply-side effects into ac-count, we get more persistent inflation and output reactions. We also show that the dichotomy does not hold for a variety of different fiscal policy rules based on government debt and budget deficit, using the tax smoothing hypothesis and formulating the tax rules as difference equations. The debt rule with active monetary policy results in indeterminacy, while the deficit rule produces a determinate solution with active monetary policy, even with active fiscal policy. The combination of fiscal requirements in a rule results in cyclical responses to shocks. The amplitude of the cycle is larger with more weight on debt than on deficit. Combining optimised monetary policy with fiscal policy rules means that, under a discretionary monetary policy, the fiscal policy regime affects the size of the inflation bias. We also show that commitment to an optimal monetary policy not only corrects the inflation bias but also increases the persistence of output reactions. With fiscal policy rules based on the deficit we can retain the tax smoothing hypothesis also in a sticky price model.

Dynamics of inflation expectations in the euro area

The present study examines empirically the inflation dynamics of the euro area. The focus of the analysis is on the role of expectations in the inflation process. In six articles we relax rationality assumption and proxy expectations directly using OECD forecasts or Consensus Economics survey data. In the first four articles we estimate alternative Phillips curve specifications and find evidence that inflation cannot instantaneously adjust to changes in expectations. A possible departure of expectations from rationality seems not to be powerful enough to totally explain the persistence of euro area inflation in the New Keynesian framework. When expectations are measured directly, the purely forward-looking New Keynesian Phillips curve is outperformed by the hybrid Phillips curve with an additional lagged inflation term and the New Classical Phillips curve with a lagged expectations term. The results suggest that the euro area inflation process has become more forward-looking in the recent years of low and stable inflation. Moreover, in low inflation countries, the inflation dynamics have been more forward-looking already since the late 1970s. We find evidence of substantial heterogeneity of inflation dynamics across the euro area countries. Real time data analysis suggests that in the euro area real time information matters most in the expectations term in the Phillips curve and that the balance of expectations formation is more forward- than backward-looking. Vector autoregressive (VAR) models of actual inflation, inflation expectations and the output gap are estimated in the last two articles.The VAR analysis indicates that inflation expectations, which are relatively persistent, have a significant effect on output. However,expectations seem to react to changes in both output and actual inflation, especially in the medium term. Overall, this study suggests that expectations play a central role in inflation dynamics, which should be taken into account in conducting monetary policy.

The Finnish Competition State and Entrepreneurial Policies in the Helsinki Region

The thesis examines the intensification and characteristics of a policy that emphasises economic competitiveness in Finland during the 1990s and early 2000s. This accentuation of economic objectives is studied at the level of national policy-making as well as at the regional level through the policies and strategies of cities and three universities in the Helsinki region. By combining the analysis of state policies, urban strategies and university activities, the study illustrates the pervasiveness of the objective of economic competitiveness and growth across these levels and sheds light on the features and contradictions of these policies on a broad scale. The thesis is composed of five research articles and a summary article. At the level of national policies, the central focus of the thesis is on the growing role of science and technology policy as a state means to promote structural economic change and its transformation towards a broader, yet ambivalent concept of innovation policy. This shift brings forward a tension between an increasing emphasis on economic aspects – innovations and competitiveness – as well as the expanding scope of issues across a wide range of policy sectors that are being subsumed under this market- and economy oriented framework. Related to science and technology policy, attention is paid to adjustments in university policy in which there has been increasing pressure for efficiency, rationalisation and commercialisation of academic activities. Furthermore, political efforts to build an information society through the application of information and communication technologies are analysed with particular attention to the balance between economic and social objectives. Finally, changes in state regional policy priorities and the tendency towards competitiveness are addressed. At the regional level, the focus of the thesis is on the policies of the cities in Finland’s capital region as well as strategies of three universities operating in the region, namely the University of Helsinki, Helsinki University of technology and Helsinki School of Economics. As regards the urban level, the main focus is on the changes and characteristics of the urban economic development policy of the City of Helsinki. With respect to the universities, the thesis examines their attempts to commercialise research and thus bring academic research closer to economic interests, and pays particular attention to the contradictions of commercialisation. Related to the universities, the activities of three intermediary organisations that the universities have established in order to increase cooperation with industry are analysed. These organisations are the Helsinki Science Park, Otaniemi International Innovation Centre and LTT Research Ltd. The summary article provides a synthesis of the material presented in the five original articles and relates the results of the articles to a broader discussion concerning the emergence of competition states and entrepreneurial cities and regions. The main points of reference are Bob Jessop’s and Neil Brenner’s theses on state and urban-regional restructuring. The empirical results and considerations from Finland and the Helsinki region are used to comment on, specify and criticise specific parts of the two theses.

Medicalising Prohibition : Harm reduction in Finnish and International Drug Policy

The increase in drug use and related harms in the late 1990s in Finland has come to be referred to as the second drug wave. In addition to using criminal justice as a basis of drug policy, new kinds of drug regulation were introduced. Some of the new regulation strategies were referred to as "harm reduction". The most widely known practices of harm reduction include needle and syringe exchange programmes for intravenous drug users and medicinal substitution and maintenance treatment programmes for opiate users. The purpose of the study is to examine the change of drug policy in Finland and particularly the political struggle surrounding harm reduction in the context of this change. The aim is, first, to analyse the content of harm reduction policy and the dynamics of its emergence and, second, to assess to what extent harm reduction undermines or threatens traditional drug policy. The concept of harm reduction is typically associated with a drug policy strategy that employs the public health approach and where the principal focus of regulation is on drug-related health harms and risks. On the other hand, harm reduction policy has also been given other interpretations, relating, in particular, to human rights and social equality. In Finland, harm reduction can also be seen to have its roots in criminal policy. The general conclusion of the study is that rather than posing a threat to a prohibitionist drug policy, harm reduction has come to form part of it. The implementation of harm reduction by setting up health counselling centres for drug users with the main focus on needle exchange and by extending substitution treatment has implied the creation of specialised services based on medical expertise and an increasing involvement of the medical profession in addressing drug problems. At the same time the criminal justice control of drug use has been intensified. Accordingly, harm reduction has not entailed a shift to a more liberal drug policy nor has it undermined the traditional policy with its emphasis on total drug prohibition. Instead, harm reduction in combination with a prohibitionist penal policy constitutes a new dual-track drug policy paradigm. The study draws on the constructionist tradition of research on social problems and movements, where the analysis centres on claims made about social problems, claim-makers, ways of making claims and related social mobilisation. The research material mainly consists of administrative documents and interviews with key stakeholders. The doctoral study consists of five original articles and a summary article. The first article gives an overview of the strained process of change of drug policy and policy trends around the turn of the millennium. The second article focuses on the concept of harm reduction and the international organisations and groupings involved in defining it. The third article describes the process that in 1996 97 led to the creation of the first Finnish national drug policy strategy by reconciling mutually contradictory views of addressing the drug problem, at the same as the way was paved for harm reduction measures. The fourth article seeks to explain the relatively rapid diffusion of needle exchange programmes after 1996. The fifth article assesses substitution treatment as a harm reduction measure from the viewpoint of the associations of opioid users and their family members.