nep-cba New Economics Papers
on Central Banking
Issue of 2005‒04‒16
thirty-two papers chosen by
Roberto Santillan

  1. Nominal rigidities and inflation persistence in Luxembourg: a comparison with EU 15 member countries with particular focus on services and regulated prices By Thomas Y. Mathä; Patrick Lünnemann
  2. Monetary Policy Adjustments on the Final Passage towards the Euro By Lucjan T Orlowski
  3. Sobre los Efectos de la Política Monetaria en Colombia By Luis Fernando Melo Velandia; Alvaro José Riascos Villegas
  4. Monetary Policy Shifts, Indeterminacy and Inflation Dynamics By Paolo Surico
  5. The CNB’s Policy Decisions – Are They Priced in by the Markets? By David Navrátil; Viktor Kotlán
  6. Inflation, Central Bank Independence and the Legal System. By Bernd Hayo; Stefan Voigt
  8. "The Transmission Mechanism of Monetary Policy: A Critical Review" By Greg Hannsgen
  9. The Inflation Dynamics of Pegging Interest Rates By David Eagle
  10. "FDIC-Sponsored Self-Insured Depositors: Using Insurance to Gain Market Discipline and Lower the Cost of Bank Funding" By Panos Konstas
  11. Inflation Targeting and Inflation Behavior: A Successful Story? By Marco Vega; Diego Winkelried
  12. Monetary Policy Transparency in the Inflation Targeting By Mariusz Jarmuzek; Lucjan T. Orlowski; Artur Radziwill
  14. Monetary policy and asset prices: the investment channel By Fernando Alexandre; Pedro Bação
  15. Interest Rate Smoothing versus Serially Correlated Errors in Taylor Rules: Testing the Tests By Welz, Peter; Österholm, Pär
  17. Monetary Policy with Incomplete Markets By Gourdel; Triki
  19. Sticky Price Models and Durable Goods By Robert Barsky; Christopher L. House; Miles Kimball
  20. Monetary Convergence of the EU Candidates to the Euro: A Theoretical Framework and Policy Implications By Lucjan T Orlowski
  21. Money Rules For The Eurozone Candidate Countries By Lucjan T Orlowski
  22. Exchange Rate Risk and Convergence to the Euro By Lucjan T Orlowski
  23. Monetary Convergence And Risk Premiums In The EU Candidate Countries By Lucjan T Orlowski
  24. A Dynamic Approach to Inflation Targeting in Transition Economies By Lucjan T Orlowski
  25. Does Monetary Policy Have Asymmetric Effects on Stock Returns? By Shiu-Sheng Chen
  28. A learning hypothesis of the term structure of interest rates By Balázs Romhányi
  29. Money Demand in EU Countries: A Survey By Frank Browne; Gabriel Fagan; Jerome Henry
  30. Monetary policy transmission in the CEECs : revisited results using alternative econometrics. By Jérôme Héricourt
  31. ERM II Membership – the View of the Accession Countries By Luboš Komárek; Zdeněk Čech, Roman Horváth
  32. The dynamics of inflation and currency substitution in a small open economy By Miguel Lebre de Freitas

  1. By: Thomas Y. Mathä; Patrick Lünnemann
    Abstract: This paper analyses the degree of price rigidity and of inflation persistence across different product categories with particular focus on regulated prices and services for the individual EU15 countries, as well as for the EU15 and the euro area aggregates. We show that services and those HICP sub-indices considered being subject to price regulation exhibit larger degrees of nominal price rigidities, with less frequent but larger price index changes as well as stronger asymmetries between price index increases and decreases. With regard to what extent services and regulated prices contribute to the degree of overall inflation persistence, we find that, for most of the EU15 countries as well as for the EU15 and the euro area aggregates, excluding services from the full HICP results in a reduction in the measured degree of inflation persistence; for regulated indices such an effect is also discernible, albeit to a lesser extent.
    Date: 2005–04
  2. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study reviews monetary policy options that are seemingly viable for adopting the euro by the new Member States of the European Union. A fully autonomous direct inflation targeting is believed to be suboptimal for convergence to the euro as it does not incorporate convergence parameters into the central bank reaction function and instrument rules. In an attempt to correct for such deficiency, this study advocates adopting a framework of relative inflation forecast targeting where a differential between the domestic and the eurozone inflation forecasts becomes the main objective of the central bank’s decisions. At the same time, some attention to the exchange rate stability objective becomes necessary for facilitating the monetary convergence process. Foreign exchange market interventions, rather than interest rate adjustments, are viewed as a preferred way of achieving this objective.
    Keywords: Monetary convergence, euro adoption, ERM II, new Member States
    JEL: E58 E61 F33 P24
    Date: 2005–03–29
  3. By: Luis Fernando Melo Velandia; Alvaro José Riascos Villegas
    Abstract: En este documento estudiamos algunos canales, mecanismos de amplificación y los efectos cuantitativos de la política monetaria en Colombia. Adicionalmente, sugerimos una metodología completa, consistente teóricamente con la teoría del Equilibrio General y práctica para el análisis de política y pronósticos de variables económicas de interés.En este documento estudiamos algunos canales, mecanismos de amplificación y los efectos cuantitativos de la política monetaria en Colombia. Adicionalmente, sugerimos una metodología completa, consistente teóricamente con la teoría del Equilibrio General y práctica para el análisis de política y pronósticos de variables económicas de interés.En este documento estudiamos algunos canales, mecanismos de amplificación y los efectos cuantitativos de la política monetaria en Colombia. Adicionalmente, sugerimos una metodología completa, consistente teóricamente con la teoría del Equilibrio General y práctica para el análisis de política y pronósticos de variables económicas de interés.En este documento estudiamos algunos canales, mecanismos de amplificación y los efectos cuantitativos de la política monetaria en Colombia. Adicionalmente, sugerimos una metodología completa, consistente teóricamente con la teoría del Equilibrio General y práctica para el análisis de política y pronósticos de variables económicas de interés.En este documento estudiamos algunos canales, mecanismos de amplificación y los efectos cuantitativos de la política monetaria en Colombia. Adicionalmente, sugerimos una metodología completa, consistente teóricamente con la teoría del Equilibrio General y práctica para el análisis de política y pronósticos de variables económicas de interés.En este documento estudiamos algunos canales, mecanismos de amplificación y los efectos cuantitativos de la política monetaria en Colombia. Adicionalmente, sugerimos una metodología completa, consistente teóricamente con la teoría del Equilibrio General y práctica para el análisis de política y pronósticos de variables económicas de interés.En este documento estudiamos algunos canales, mecanismos de amplificación y los efectos cuantitativos de la política monetaria en Colombia. Adicionalmente, sugerimos una metodología completa, consistente teóricamente con la teoría del Equilibrio General y práctica para el análisis de política y pronósticos de variables económicas de interés.En este documento estudiamos algunos canales, mecanismos de amplificación y los efectos cuantitativos de la política monetaria en Colombia. Adicionalmente, sugerimos una metodología completa, consistente teóricamente con la teoría del Equilibrio General y práctica para el análisis de política y pronósticos de variables económicas de interés.
    Date: 2004–02–09
  4. By: Paolo Surico (Bank of England & University of Bari)
    Abstract: The New-Keynesian Phillips curve plays a central role in modern macroeconomic theory. A vast empirical literature has estimated this structural relationship over various postwar full-samples. While it is well know that in a New-Keynesian model a weak central bank response to inflation generates sunspot fluctuations, the consequences of pooling observations from different monetary policy regimes for the estimates of the Phillips curve had not been investigated. Using Montecarlo simulations from a purely forward-looking model, this paper shows that indeterminacy can introduce a sizable persistence in the estimated process of inflation. This persistence however is not an intrinsic feature of the economy; rather it is the result of self full-filling expectations. By neglecting indeterminacy the estimates of the forward- looking term of the Phillips curve are shown to be biased downward. The implications are in line with the empirical evidence for the UK and US.
    Keywords: indeterminacy, New-Keynesian Phillips curve, Montecarlo, bias, persistence
    JEL: E58 E31 E32
    Date: 2005–04–08
  5. By: David Navrátil (Èeská spoøitelna); Viktor Kotlán (Èeská spoøitelna)
    Abstract: This paper asks to what extent the market prices in the future monetary policy decisions of the Czech National Bank (CNB), how this policy predictability has evolved over time, and whether the change in the central bank’s forecasting methodology in mid-2002 had any impact. Using a sample up to mid-2004, the results are threefold. First, three- quarters of the CNB’s decisions were in line with medium-term money market expectations. Notwithstanding this relatively high predictability of CNB policy, the average mistake in the expectations was biased upwards: over the entire IT period the market has priced in a higher repo rate than has actually turned out to be the case. Second, our analysis shows that the period in which forecasts with an active monetary policy (unconditional forecasts) have been used is characterized by smaller “surprises” of the money market. On the one hand, this may be connected with a change in the CNB’s communication of the forecast, including releases of verbal comments on the interest rate trajectory that is consistent with the outlook. On the other hand, it may reflect a different economic environment in the second stage of IT in the Czech Republic. Third, we analyze whether there is convergence or divergence between the central bank’s forecast-consistent interest rate trajectory and market forward rates. We show that in most cases market rates converged toward the CNB’s interest rate trajectory after the publication of the forecast.
    Keywords: Financial market reaction, inflation targeting, monetary policy predictability, term structure of interest rates.
    JEL: E43 E44 E52
    Date: 2005–03–10
  6. By: Bernd Hayo; Stefan Voigt
    Abstract: We argue that a higher degree of de facto independence of the legal system from the other government branches as well as public trust in the legal system may reduce the average inflation record of countries through a direct and an indirect channel. The direct channel works by affecting potential output, while the indirect channel helps to increase the de facto independence of the central bank. In the empirical section of the paper, we present evidence in favor of both channels in a sample containing both industrial and Third World countries. A model that contains legal trust in addition to de jure central bank independence, checks and balances within government, and openness can explain 60% of the variation in the logarithm of the inflation rate.
    Keywords: Judicial Independence; Legal Trust; Central Bank Independence; Inflation
    JEL: D D H K
    Date: 2005–01
  7. By: stanley c. w. salvary
    Abstract: The view that prediction is the only important concern when policy is to be developed has led to the strict adherence to a money supply rule via the Quantity Theory of Money with its debilitating consequences. The monetarists place the emphasis on the level of the money supply in the determination of price level changes and monetary control is exercised. Along with this line of thinking, statistical elegance transcends empirical reality. Thus, the ensuing consequences of monetary control are not surprising. There are continuous increases in the general level of prices and increasing problems of unemployment, which fuel the flames of business downsizing. In this paper, an alternative to the monetarist explanation of the determination of the price level is advanced. The alternative explanation does not rely on changes in the supply of money but on changes in the composition of aggregate demand and supply. Absent monetary dislocation or revaluation of the currency, change in the general price level is attributed to the net effect of the realignment of relative prices. It is argued that a rethinking of the situation would result in monetary policy that is compatible with the economic setting and not monetary control which crowds out fiscal policy.
    Keywords: endogenous nature of money; general price level; money supply; Quantity Theory; price instability; consumer loans outstanding; Fisher effect; money supply rule.
    JEL: E
    Date: 2005–02–27
  8. By: Greg Hannsgen
    Abstract: Recently, many economists have credited the late-1990s economic boom in the United States for the easy money policies of the Federal Reserve. On the other hand, observers have noted that very low interest rates have had very little positive effect on the chronically weak Japanese economy. Therefore, some theory of how money affects the economy when it is endogenous would be useful. This paper pursues several such explanations, including the effects of interest rate changes on (1) investment; (2) consumer spending; (3) the exchange rate; and (4) financial markets. The theories of such authors as Kalecki, Keynes, Minsky, and J. K. Galbraith are discussed and evaluated, with an emphasis on the role of cash flow. Some of these theories turn out to be stronger than others when subjected to tests of logic and empirical evidence.
    Date: 2004–10
  9. By: David Eagle (Eastern Washington University)
    Abstract: A relatively simple analysis of central banks pegging interest rates applies whenever prices are determined in a price-flexible model where the central bank pursues a singular price-level or nominal-income target. Applying the model empirically in the U.S. and find that prior to 1980, the Federal Reserve would have met its price-level or nominal- income targets best by using the M1 definition of money. However, after 1982, the Federal Reserve would have more effectively met is targets by pegging the interest rate. We also further the analysis in a general- equilibrium, cash-in-advance model with explicit state-contingent securities that complete markets.
    Keywords: interest-rate targeting, price-level targeting, nominal-income targeting, cash-in-advance models, monetary economics, price determinism
    JEL: E
    Date: 2005–02–25
  10. By: Panos Konstas
    Abstract: Insured depositors have no reason to care how their banks perform or how safe they are.  Only uninsured depositors have that incentive.  This paper offers a plan to replace some insured deposits with uninsured deposits.  The plan: the FDIC would guarantee loan contracts if the loan takers deposited the proceeds exclusively in uninsured deposits and backed those deposits with equity. This would ensure that the loan takers could share the likely costs if any of their depositories failed.  The loans made under FDIC guarantee would only require interest at the risk-free rate.  Thus the loan takers could offer the proceeds at lower rates than the rates paid on current deposits.  Accordingly, funding by banks would shift to the new deposits, and since the new “self-insured” depositors would have equity at stake, they would have no choice but to duly monitor their banks and impose rate premiums based on each bank’s indigenous risk.  With these reforms, some very costly imperfections of current deposit insurance would be eliminated: the FDIC would now have in place a program that would dissuade banks from moral hazard and high risk and set the foundation for better disciplined, safer, and more cost-efficient banking.
    Date: 2005–03
  11. By: Marco Vega (Central Bank of Peru & London School of Economics); Diego Winkelried (Cambridge University)
    Abstract: This paper estimates the effects of inflation targeting (IT) adoption over inflation dynamics using a wide control group. We contribute to the current IT evaluation literature by considering the adoption of IT by a country as a treatment, just as in the program evaluation literature. Hence, we perform propensity score matching to determine suitable counterfactuals to the actual inflation targeters. With this approach we find that IT has helped in reducing the level and volatility of inflation in the countries that adopted it. This result is robust to alternative definitions of treatment and control groups. We also find that the e ect of IT in the persistence of inflation is rather weak and not as categorical as the one associated with the mean and volatility of inflation.
    Keywords: Inflation Targeting, matching methods
    JEL: E
    Date: 2005–02–16
  12. By: Mariusz Jarmuzek (CASE Center for Social & Economic Research); Lucjan T. Orlowski (Sacred Heart University); Artur Radziwill (CASE Center for Social & Economic Research)
    Abstract: This paper quantifies transparency of monetary policy in the three EU New Member States that have adopted direct inflation targeting strategy. Two measures of transparency are applied. The institutional measure reflects the extent to which a central bank discloses information that is related to the policymaking process. The behavioural measure reflects the clarity among the financial market participants about the true course of monetary policy. The paper shows an ambiguous association between the two measures of transparency, which may be attributed to the active exchange rate management policy that undermines the actual transparency proxied by the behavioural measure.
    Keywords: monetary policy, institutional and behavioural transparency, direct inflation targeting, EU New Member States, European Monetary Union
    JEL: E52 E58 P52
    Date: 2005–02–12
  13. By: Edgar L. Feige (University of Wisconsin-Madison); M. Parkin (University of Manchester); R Avery (University of Wisconsin-Madison); C. Stones (University of Manchester)
    Abstract: What is the optimum quantity of money in a society? This paper answers this question both from the perspective of a utility maximizing model with real balances in the utility function, and employing an inventory theoretic model which focuses attention on the costs of transacting in different markets and on the storage costs of holding money. We find that socially optimal transactions patterns and inventory holdings can be induced by paying interest on money and bonds equal to the net rate of return on capital. This conclusion is however only valid if it is costless for the society to institute and operate such an interest payment mechanism. In a world where it is costly to institute and operate an interest payment mechanism, a social optimum requires that the rate of return on money and bonds must equal the net rate of return on capital minus the social cost of inducing individuals to hold optimal quantities of financial assets. It is therefore necessary to take account of both the potential gains in welfare from instituting interest payments on money and the real potential costs of such a policy. Reference: Economica, November, 1973 pp. 416-431
    JEL: E41 E50 E59 E52 E31 G11
    Date: 2005–01–30
  14. By: Fernando Alexandre (Universidade do Minho - NIPE and Birkbeck College); Pedro Bação (Universidade de Coimbra)
    Abstract: The role of monetary policy during periods of asset price volatility has been the subject of discussion among economists and policymakers at least since the 1920s and the Great Depression that followed. In this paper we survey the recent and rapidly growing literature on this topic, with an emphasis on the investment channel. We present a detailed discussion of the hypotheses that have been used to justify, or criticise, a response to asset prices. These hypotheses concern imperfections in financial markets, bubbles in asset prices, and the information on which firm managers and central banks base their decisions.
    Keywords: Investment; Asset Prices; Inflation Targeting; Fundamentals.
    Date: 2005
  15. By: Welz, Peter (Department of Economics); Österholm, Pär (Department of Economics)
    Abstract: This paper contributes to the recent debate about the estimated high partial adjustment coefficient in dynamic Taylor rules, commonly interpreted as deliberate interest rate smoothing on the part of the monetary authority. We argue that a high coefficient on the lagged interest rate term may be a consequence of an incorrectly specified central bank reaction function. Focusing on omitted variables, our Monte Carlo study first generates the well-known fact that all coefficients in the misspecified equation are biased in such cases. In particular, if relevant variables are left out from the estimated equation, a high partial adjustment coefficient is obtained even when it is in fact zero in the data generating process. Misspecification also leads to considerable size distortions in two tests that were recently proposed by English, Nelson, and Sack (2003) in order to distinguish between interest rate smoothing and serially correlated disturbances. Our results question the common interpretation of very slow partial adjustment as interest rate smoothing in estimated dynamic Taylor rules.
    Keywords: Monetary policy; Taylor rule; Interest rate smoothing; Serially correlated error term; Omitted variables
    JEL: C12 C15 E52
    Date: 2005–03–31
  16. By: Jaan Masso; Karsten Staehr
    Abstract: The paper seeks to explain the inflationary dynamics in the Baltic countries since the mid-1990s. While single-equation estimations generally yield poor results, panel data estimations provide statistically and economically satisfactory findings. Our main result is that the observed gradual disinflation can to a large extent be explained by adjustment to international prices. Stringent fixed exchange rate systems have exerted downward pressure on inflation both directly and via expectations of future inflation. Measures of excess capacity in the labour market have no effect on inflation, while industrial output gaps have some explanatory power. Real oil price shocks have an immediate but short-lived impact on inflation.
    Keywords: Inflation, exchange rates, Phillips curve
    JEL: E31 E42 P24
    Date: 2005
  17. By: Gourdel (CERMSEM); Triki (CERMSEM)
    Abstract: We consider an extension of a general equilibrium model with incomplete markets that considers cash-in-advance constraints. The total amount of money is supplied by an authority, which produces at no cost and lends money to agents at short term nominal rates of interest, meeting the demand. Agents have initial nominal claims, which in the aggregate, are the counterpart of an initial public debt. The authority covers its expenditures, including initial debt, through public revenues which consists of taxes and seignorage, and distributes its eventual budget surpluses through transfers to individuals, while no further instruments are available to correct eventual budget deficits. We define a concept of equilibrium in this extended model, and prove that there exists a monetary equilibrium with no transfers. Moreover, we show that if the price level is high enough, a monetary equilibrium with positive transfers exists.
    Keywords: Cash-in-advance constraints, incomplete markets, nominal assets, monetary equilibrium, money, nominal interest rate, transfers, price levels
    JEL: C62 D52 E40 E50 G10
    Date: 2005–03–29
  18. By: Jerome Henry (ECB); Jens Weidmann (Bundesbank)
    Abstract: We investigate the consequences of the 1992-1993 EMS crises, which resulted in the widening of the exchange rate bands, on the long-run linkages between the daily 1-month-Eurorates on German Mark, US-Dollar and French Franc. First, within a Gaussian VAR, both the US Eurorate and the French-German Eurorate differential are found stationary between December 1990 and December 1993. Second, using various GARCH models to account for heteroskedasticity show that Gaussian models can be misleading as to the interpretation of the linkages. Third, the estimated variance parameters are stable and the July 1993 episode is not linked to especially high a volatility. Finally, focusing on the French rate, we find asymmetry in the stochastic volatility, positive shocks being more persistent.
    Keywords: Interest rates, cointegration, heteroskedasticity, GARCH, EMS, Asymmetry in the ERM
    JEL: F3 F4
    Date: 2005–03–30
  19. By: Robert Barsky (University of Michigan); Christopher L. House (University of Michigan); Miles Kimball (University of Michigan)
    Abstract: This paper shows that there are striking implications that stem from including durable goods in otherwise conventional sticky price models. The behavior of these models depends heavily on whether durable goods are present and whether these goods have sticky prices. If long-lived durables have sticky prices, then even small durables sectors can cause the model to behave as though most prices were sticky. Conversely, if durable goods prices are flexible then the model exhibits unwelcome behavior. Flexibly priced durables contract during periods of economic expansion. The tendency towards negative comovement is very robust and can be so strong as to dominate the aggregate behavior of the model. In an instructive limiting case, money has no effects on aggregate output even though most prices in the model are sticky.
    Keywords: Sticky prices, Durables, Comovement, Neutrality
    JEL: E21 E30 E31 E32
    Date: 2005–01–27
  20. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: A flexible approach to direct inflation targeting is a viable monetary policy choice for transition economies that is believed to facilitate both the economic transition and the monetary convergence to the euro. Following this assumption, an analytical model investigating the link between the inflation process and monetary variables in transition economies is advanced in this study. The empirical testing is conducted for Poland, the Czech Republic and Hungary. The analysis recommends that the monetary convergence begins with inflation targeting and concludes with a full-fledged euroization. It further advocates the application of flexible benchmarks of monetary convergence that would accommodate various non-monetary factors affecting inflation in transition economies.
    Keywords: transition economies, European Union candidate countries, inflation targeting, inflation targeting, monetary convergence
    JEL: E32 E52 P33
    Date: 2005–01–28
  21. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study proposes the adoption of money growth rules as indicator variables of monetary policies by the countries converging to a common currency system, in particular, by the eurozone candidate countries. The analytical framework assumes an inflation target as the ultimate policy goal. The converging countries act in essence as “takers” of the inflation target, which, in this case, is the eurozone’s inflation forecast. The study advances a forward-looking money growth model that might be applied to aid monetary convergence to the eurozone. However, feasibility of adopting money growth rules depends on stable relationships between money and target variables, which are low inflation and stable exchange rate. Long-run interactions between these variables are examined for Poland, Hungary and the Czech Republic by employing a Johansen cointegration test, along with short-run effects assessed with a vector error correction procedure.
    Keywords: common currency system, eurozone, monetary convergence, money growth rules, inflation targeting.
    JEL: E42 E52 F36 P24
    Date: 2005–01–28
  22. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This paper proposes a new monetary policy framework for effectively navigating the path to adopting the euro. The proposed policy is based on relative inflation forecast targeting and incorporates an ancillary target of declining exchange rate risk, which is suggested as a key criterion for evaluating the currency stability. A model linking exchange rate volatility to differentials over the euro zone in both inflation (target variable) and interest rate (instrument variable) is proposed. The model is empirically tested for the Czech Republic, Poland and Hungary, the selected new Member States of the EU that use direct inflation targeting to guide their monetary policies. The empirical methodology is based on the TARCH(p,q,r)-M model.
    Keywords: exchange rate risk, inflation targeting, monetary convergence, euro area, new EU Member States
    JEL: E42 E52 F36 P24
    Date: 2005–01–28
  23. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study examines the link between various monetary policy regimes and the ability to manage inflation and exchange rate risk premiums in the EU candidate countries as they undergo monetary convergence to the eurozone. The underlying hypothesis is that a system of 'flexible inflation targeting' may be an optimal policy choice for managing these two categories of risk. A model of inflation and exchange rate risk premiums within the context of inflation targeting is proposed. Recent trends in these risk premiums in Hungary, the Czech Republic and Poland are tested by using the GARCH(1,1) methodology.
    Keywords: inflation risk premium, exchange rate risk premium, inflation targeting, monetary convergence, transition economies
    JEL: E32 E52 P33
    Date: 2005–01–31
  24. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study views inflation targeting as a viable regime for more advanced transition economies. A dynamic approach to the trajectory of disinflation and the flexibility of direct inflation targeting is presented in the context of achieving monetary convergence to the EU/EMU. The candidate countries are advised to begin from strict inflation targeting and to follow with a more flexible inflation targeting regime before they establish a necessary 'foundational credibility' and monetary stability. These steps, ultimately followed by the euro-peg, are necessary in preparing for accession to the eurozone. The early experiences of the Czech Republic and Poland with inflation targeting are examined.
    JEL: E32 E52 P33
    Date: 2005–01–31
  25. By: Shiu-Sheng Chen (Department of Economics, National Taiwan University)
    Abstract: This paper investigates whether monetary policy has asymmetric effects on stock returns using Markov-switching models. Different measures of the stance of monetary policy are adopted. Empirical evidence from monthly returns on the standard & Poor 500 (S&P 500) price index suggests that monetary policy has larger effects on stock returns in bear markets. Furthermore, it has been shown that contractionary monetary policy leads to a higher probability of switching to a recession in stock markets.
    Keywords: Monetary Policy, Stock Returns, Markov-switching
    JEL: E52 E32 G10
    Date: 2005–02–01
  26. By: Edgar L. Feige (University of Wisconsin-Madison)
    Abstract: This paper examines the problem of appropriately specifying and estimating the money demand function in the presence of adaptive expectations and partial adjustment mechanisms. The paper demonstrates the difficulty of interpreting distributed lag reduced form representations of the monetary sector when both expectation and adjustment mechanisms are present. It finally presents and empirically estimates an identified model of the monetary sector with partial adjustment mechanisms and multiple expectation formation mechanisms and finds that the elasticity of adjustment appears to be unity, and the adaptive expectation elasticity of income conforms to that proposed by Friedman’s permanent income hypothesis. Reference: American Economic Review, Vol. LVII, No. 2 May, 1967, pp. 462-473.
    Keywords: money demand, expectations, adjustments, distributed lags, identification, adaptive expectations, pasrtial adjustments, permanent income.
    JEL: E41 E42 C1 C3 D84
    Date: 2005–02–01
  27. By: Stanley C. W. Salvary
    Abstract: Perceptions of money do influence monetary policy, and monetary policy does have an impact on the functioning of the economy. For instance, a high interest rate policy usually entails high levels of bankruptcies and unemployment. Also, given a loss of confidence in the issuing authority (monetary dislocation), paper money can and does fail in all its functions as a medium of exchange, a unit of account, and a store of nominal value. In a money economy in which nominal money is the medium of exchange, nominal money prices reflect the underlying exchange ratios of the various commodities that are produced and exchanged for nominal money. In the absence of monetary dislocation (monetary revaluation or devaluation), any change in the nominal price of a commodity reflects a change in its purchasing power (a change in its exchange ratio vis-a-vis other commodities). Monetary policy prescriptions, which ignore this reality, result in significant displacement costs to members of society. A ‘pure science’ approach to economic research engenders policy prescriptions based upon assumptions of the economic system which are not aligned with the empirical reality. Hence, to avoid severe social costs, the ‘pure science’ approach to economics needs to be modified to deal with social reality.
    Keywords: monetary policy decisions; economic policy; federal funds target range; purchasing power uncertainty; interest rate targeting; reserves targeting; instruments for the prediction of observable phenomena.
    JEL: E
    Date: 2005–02–28
  28. By: Balázs Romhányi (Hungarian Ministry of Finance)
    Abstract: Recent empirical results about the US term structure are difficult to reconcile with the classical hypothesis of rational expectations even if time-varying but stationary term premia are allowed for. A hypothesis of rational learning about the conditional variance of the log pricing kernel is put forward. In a simple, illustrative consumption-based asset pricing model the long-term interest rate turns out to have an economic meaning distinct from both price stability and full employment, namely to measure the market perception of aggregate level of future risk in the economy. Implications for economic modeling and monetary policy are explored.
    Keywords: term structure; interest rate; learning; uncertainty; monetary policy
    JEL: D8 E4 E5 G12
    Date: 2005–03–02
  29. By: Frank Browne (EMI); Gabriel Fagan (EMI); Jerome Henry (EMI)
    Abstract: Money demand is probably one of the most extensively studied economic relationship in applied economics. While useful surveys of existing literature are available, much of the attention has focused on the US. However, a considerable number of papers have recently been produced dealing with the situation in the EU, both at a country and at an area- wide level, with much of this research being carried out at EU central banks. Therefore, it appears useful to also examine this recent work, both in order to assess the current situation, and to guide future research. The first part of the paper covers a range of general issues arising such as the theoretical models, the specifications, the variables employed, and estimation techniques that have been used. It is emphasised that the basis of all these papers appears to be a benchmark model, in which money is a function of a scale variable, of interest rates and, when necessary, of variables accounting for financial innovation. The second part of the paper focuses on the estimated equations for the individual countries, paying particular attention to the case of Germany. A reasonable summary of the results obtained in general is that money demand equations perform fairly well in EU countries. Estimated parameters have the signs, if not always the magnitudes, predicted by economic theory. In most cases, the evidence points to the existence of the long-run equilibrium relation between money and a few determinant variables (real income, prices and interest rates) although the size of the adjustment coefficients indicate that deviations from the steady state may be of long duration. The next section provides a review of empirical evidence of aggregate money demand in grouping of EU countries taken together, an area in which interest is increasing as EMU approaches. In this strand of the literature, there seems to be a consensus that EU-wide equations yield satisfactory results, with area-wide equations often performing better than comparable national equations. Some reasons underlying this result are also examined.
    Keywords: Money demand, Cross-country comparisons, European union
    JEL: E41 E52
    Date: 2005–03–07
  30. By: Jérôme Héricourt (TEAM)
    Abstract: This paper aims at providing better supported results regarding monetary policy transmission in Central and Eastern European countries (CEECs). In the general frame of VAR models, our study differs from previous research in two main respects. Firstly, we provide estimations that do not rely on the hypothesis of cointegration usually exploited in the related literature, but economically meaningless over less than ten years spans and statistically very fragile. Secondly, we present another set of results, relying on real GDP monthly data that have been rebuilt using the Chow and Lin (1971) method; this allows for an alternative to the traditional industrial production data, a partial and highly unstable proxy variable for output. These original methodological insights lead to results emphasizing the general prevalence of exchange rate and domestic credit channels for monetary policy transmission across the studied countries, despite some persistent national specificity. The empirical evidence also incites to be reasonably optimistic regarding the relevancy of a close integration of these countries into euro area.
    Keywords: Monetary policy transmission, VAR models, CEECs
    JEL: E52 E58 F47
    Date: 2005–03
  31. By: Luboš Komárek; Zdeněk Čech, Roman Horváth
    Abstract: With EU accession looming, a new chapter has been opened in the debate about the candidate countries’ exchange rate strategies. A heated discussion has arisen in relation to ERM2 membership. The experience of the present eurozone members with ERM/ERM2 membership shows that none of them faced a significant challenge in the two-year “evaluation†period in terms of the exchange rate stability convergence criterion. This could also be attributable to the stability policies prescribed by the Maastricht Treaty. However, for catching-up countries in the run-up to joining the eurozone, given the existing functioning of the mechanism, the ERM2 appears be of little help for ensuring exchange rate stability. The mechanism should be viewed rather as a tool for “persuading†the markets of the appropriateness of the euro-locking rate. Since the Maastricht rules do not allow downward adjustment of the central parity within the ERM2 for two years before introduction of the euro, the authorities should be familiar with the preferred real exchange rate path prior to entering the mechanism. We conclude that countries could face large costs if they fail to do so.
    Keywords: EU/eurozone, convergence, exchange rate, transition.
    JEL: E58 E52 E32 F42 F33
    Date: 2003–12
  32. By: Miguel Lebre de Freitas (Departamento de Economia e Gestão Industrial, Universidade de Aveiro)
    Abstract: In this paper, we analyse the relationship between money and inflation in a small open economy where domestic and foreign currencies are perfect substitutes as means of payment. It is shown that, if the path of domestic money supply is such that individuals find it optimal to change the currency in which transactions are settled, there will be an adjustment period during which domestic inflation adjusts so as to equalise the foreign inflation rate. In the case of a disinflation program, it is shown that the foreign currency is not necessarily abandoned as means of payment. The results obtained are consistent with both dollarisation hysteresis and reversibility, without requiring the specification of dollarisation costs.
    Keywords: currency substitution, dollarisation, money-demand and hysteresis
    JEL: E41 E52 F41
    Date: 2003–08

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