nep-cba New Economics Papers
on Central Banking
Issue of 2005‒05‒07
fourteen papers chosen by
Roberto Santillan

  1. Deconstructing the Art of Central Banking By Bayoumi, Tamim; Sgherri, Silvia
  2. Eastern and Southern Africa Monetary Integration: A Structural Vector Autoregression Analysis By Steven K. Buigut; Neven T. Valev
  3. Disinflation Costs Under Inflation Targeting in Small Open Economy Economy By Paulina Restrepo Echavarría
  4. Interest Rate Setting by the ECB: Words and Deeds By Gerlach, Stefan
  5. Welfare-Maximizing Operational Monetary and Tax Policy Rules By Kollmann, Robert
  6. Commodity Money and the Valuation of Trade By Eric Smith; Martin Shubik
  7. Robust Monetary Policy in a Small Open Economy By Kai Leitemo; Ulf Söderstrom
  8. The Impact of Monetary Policy on the Exchange Rate: A Study Using Intraday Data By Jonathan Kearns; Phil Manners
  9. The Variability of Velocity of Money in a Search Model By Weimin Wang; Shouyong Shi
  10. Money, Price Dispersion and Welfare By Brian Peterson; Shouyong Shi
  11. The Effects of Heterogeneity in Price Setting on Price and Inflation Inertia By Carlos Viana de Carvalho
  12. Debt-Deflation: Concepts, and a Stylised Model By Goetz von Peter
  14. Argentina and Inflation Targeting. ¿Can it be implemented? - Some considerations regarding the Brazilian Experience- By juancarlos soldanodeheza

  1. By: Bayoumi, Tamim; Sgherri, Silvia
    Abstract: This Paper proposes a markedly different transmission from monetary policy to the macroeconomy, focusing on how policy changes nominal inertia in the Phillips curve. Using recent theoretical developments, we examine the properties of a small, estimated US monetary model distinguishing four monetary regimes since the late 1950s. We find that changes in monetary policy are linked to shifts in nominal inertia, and that these improvements in supply-side flexibility are indeed the main channel through which monetary policy lowers the volatility of inflation and, even more importantly, output.
    Keywords: inflation; monetary policy; rational expectation models
    JEL: E31 E32
    Date: 2004–10
  2. By: Steven K. Buigut (Andrew Young School of Policy Studies, Georgia State University); Neven T. Valev (Andrew Young School of Policy Studies, Georgia State University)
    Abstract: This paper uses VAR techniques to investigate the potential for forming monetary unions in Eastern and Southern Africa. All countries in the sample are members of various regional economic organizations. Some of the organizations have a monetary union as an immediate objective whereas others consider it as a possibility in the more distant future. Our objective is to sort out which countries are suitable candidates for a monetary union based on the synchronicity of demand and supply disturbances. Although economic shocks are not highly correlated across the entire region, we tentatively identify three sub regional clusters of countries that may benefit from a currency union.
    Keywords: Eastern and Southern Africa Monetary Integration: Structural Vector Analysis
    Date: 2005–02–01
  3. By: Paulina Restrepo Echavarría
    Abstract: Since 1991, inflation in Colombia was reduced from 25% on average to about 6% more recently. Although this performance is in line with a long run inflation target of 3%, some analysts ask whether the Central Bank should continue disinflating. In this paper we present a dynamic stochastic general equilibrium model of inflation targeting for a small open economy to answer this question. We calibrate the model to the Colombian economy and compute the welfare cots and benefits of achieving the long run inflation target. We find that the long run welfare gains are about 4.54% in terms of capital. Furthermore, accounting for the transition the welfare gains are about 1.18% in terms of capital. Our results differ from previous findings because transition costs are introduced and our environment considers the presence of real rigidities (monopolistic competition) and nominal rigidities (sticky information) in a small open economy. We also analyze the sensitivity of the results to some key parameters and conclude that higher price flexibility leads to lower gains from reducing inflation and that a country with markups. The weight given to the inflation gap in the monetary policy rule is important, as a more aggressive Central Bank can improve welfare. Finally, we find that disinflation is more expensive in the case of a closed economy.
    Keywords: Small Open Economy,Inflation Targeting,Compensation;Colombia.
    JEL: E31 E32 E52 F41
  4. By: Gerlach, Stefan
    Abstract: This Paper discusses interest rate setting by the ECB between 1999 and 2004. I develop from the Monthly Bulletins quantitative indicators of the Governing Council’s assessment of inflation, economic activity, and M3 growth, and investigate their impact on its interest rate decisions. I also estimate reaction functions with ordered probit techniques, using the Monthly Bulletins to guide the choice of variables for the analysis. The results show that the ECB reacts strongly to economic sentiment indicators as measures of the state of the real economy. Furthermore, I find statistically significant reactions to inflation and M3 growth.
    Keywords: ECB; empirical reaction functions; ordered probit
    JEL: E43 E52 E58
    Date: 2004–12
  5. By: Kollmann, Robert
    Abstract: This Paper computes welfare-maximizing monetary and tax policy feedback rules, in a calibrated dynamic general equilibrium model with sticky prices. The government makes exogenous final good purchases, levies a proportional income tax, and issues nominal one-period bonds. A quadratic approximation method is used to solve the model, and to compute household welfare. Optimized policy has a strong anti-inflation stance and implies persistent fluctuations of the tax rate and of public debt. Very simple optimized policy rules, under which the interest rate just responds to inflation and the tax rate just responds to public debt, yield a welfare level very close to that generated by richer rules.
    Keywords: fiscal policy; monetary policy; welfare
    JEL: E50 E60 H60
    Date: 2004–12
  6. By: Eric Smith (Sante Fe Institute); Martin Shubik (Cowles Foundation, Yale University)
    Abstract: In a previous essay we modeled the enforcement of contract, and through it the provision of money and markets, as a production function within the society, the scale of which is optimized endogenously by labor allocation away from primary production of goods. Government and a central bank provided fiat money and enforced repayment of loans, giving fiat a predictable value in trade, and also rationalizing the allocation of labor to government service, in return for a fiat salary. Here, for comparison, we consider the same trade problem without government or fiat money, using instead a durable good (gold) as a commodity money between the time it is produced and the time it is removed by manufacture to yield utilitarian services. We compare the monetary value of the two money systems themselves, by introducing a natural money-metric social welfare function. Because labor allocation both to production and potentially to government of the economy is endogenous, the only constraint in the society is its population, so that the natural money-metric is labor. Money systems, whether fiat or commodity, are valued in units of the labor that would produce an equivalent utility gain among competitive equilibria, if it were added to the primary production capacity of the society.
    Keywords: Bureaucracy, Contract enforcement, Taxes, Money
    JEL: C7 D5 H5 K42
    Date: 2005–04
  7. By: Kai Leitemo; Ulf Söderstrom
    Abstract: This paper studies how a central bank’s preference for robustness against model misspecification affects the design of monetary policy in a New-Keynesian model of a small open economy. Due to the simple model structure, we are able to solve analytically for the optimal robust policy rule, and we separately analyze the effects of robustness against misspecification concerning the determination of inflation, output and the exchange rate. We show that an increased central bank preference for robustness makes monetary policy respond more aggressively or more cautiously to shocks, depending on the type of shock and the source of misspecification.
  8. By: Jonathan Kearns (Reserve Bank of Australia); Phil Manners (Reserve Bank of Australia)
    Abstract: This paper uses intraday data to estimate the effect of changes in monetary policy on the exchange rate. We use an event study with carefully selected sample periods for four countries (Australia, Canada, New Zealand and the United Kingdom) to ensure that the change in monetary policy is exogenous to the exchange rate. Intraday data allow us to use a short event window, which improves the accuracy of estimates, and demonstrates that the change in policy is rapidly incorporated into the exchange rate. On average, an unanticipated tightening of 25 basis points is found to appreciate the exchange rate by around 0.35 per cent, with estimates for the individual countries ranging from ¼–½ of a per cent. The estimation indicates that monetary policy changes account for only a small part of the observed variability of exchange rates in these countries. We also find that changes in monetary policy have substantially different effects on the exchange rate depending on how they alter expectations regarding future policy. Surprises that cause expectations of future policy to be revised by the full amount of the surprise are found to have a larger impact on the exchange rate (around 0.4 per cent) than surprises that only bring forward an anticipated change in policy and do not change expectations of future policy (around 0.2 per cent).
    Keywords: exchange rates; monetary policy; intraday data
    JEL: F31 G14
    Date: 2005–04
  9. By: Weimin Wang; Shouyong Shi
    Abstract: We construct a dynamic equilibrium model where there is costly search in the goods market and the labor market. Incorporating shocks to money growth and productivity, we calibrate the model to the US time series data to examine the model's quantitative predictions on aggregate variables and, in particular, on the variability of consumption velocity of money. Despite the fact that money is the only asset, the model captures most of the variability of velocity in the data. It also generates realistic predictions on the moments of other variables and provides peresistent propagation of the shocks. The model generates these results largely because costly search gives an important role to the extensive margin of trade.
    JEL: E40 E30 D83
  10. By: Brian Peterson; Shouyong Shi
    Abstract: We introduce heterogeneous preferences into a tractable model of monetary search to generate price dispersion, and then examine the effects of money growth on price dispersion and welfare. With buyers' search intensity fixed, we find that money growth increases the range of (real) prices and lowers welfare as agents shift more of their consumption to less desirable goods. When buyers' search intensity is endogenous, multiple equilibria are possible. In the equilibrium with the highest welfare level, money growth reduces welfare and increases the range of prices, while having ambiguous effects on search intensity. However, there can be a welfare-inferior equilibrium in which an increase in money growth increases search intensity, increases welfare, and reduces the range of prices.
    Keywords: Price dispersion; Search; Efficiency
    JEL: E31 D60
  11. By: Carlos Viana de Carvalho (Princeton University)
    Abstract: This paper analyzes the implications of heterogeneity in price setting for both price and inflation inertia. Standard models based on Taylor- or Calvo-style price setting usually assume ex-ante identical firms, while Calvo's approach implies only ex-post heterogeneity. While it is known that these models have different implications in terms of the dynamic effects of monetary shocks, the role of heterogeneity has not yet been properly explored. In a simple framework, this paper provides analytical results which suggest that ex-ante heterogeneity should have a role in models which attempt to understand the persistence of real effects of monetary shocks.
    Keywords: heterogeneity, price-setting, inflation persistence
    JEL: E
    Date: 2005–04–30
  12. By: Goetz von Peter (Bank for International Settlements)
    Abstract: This paper proposes a model of how agents adjust their asset holdings in response to losses in general equilibrium. By emphasising the relation between deflation and financial distress, we capture some original features of the early debt-deflation literature, such as distress selling, instability, and endogenous monetary contraction. The agents affected by a shock sell off assets to prevent their debt from crowding out consumption. But their distress-selling causes a decline in equilibrium prices, and the resulting losses elicit reactions by all agents. This activates several channels of debt-deflation. Yet we show that this process remains stable, even in the presence of large shocks, high indebtedness, and wide-spread default. What keeps the asset market stable is the presence of agents without prior debt or losses, who borrow to exploit the expected asset price recovery. By contrast, debt-deflation becomes unstable when agents try to contain their indebtedness, or when a credit crunch interferes with the accommodation necessary for stability.
    Keywords: Debt-Deflation, Leverage, Refinancing, Losses, Financial Distress, Distress Selling, Asset Prices, Credit, Inside Money.
    JEL: E31 E51 G33 G21 G18
    Date: 2005–05–02
  13. By: Valery Chernookiy
    Abstract: This paper discusses the econometric model of inflation processes in the Republic of Belarus which makes it possible to explain major factors determining the dynamics of the GDP deflator, consumer price index and producer price index during the period 1994 - 2003. For estimation of the model the author used the statistical tools of nonstationary time series econometrics: cointegration analysis and error-correction models. The model has good statistical properties, it demonstrates stability of the coefficients and enables one to conduct analysis of the various choices in the field of monetary and foreign exchange policies, as well as in the area of labour remuneration, prices and tariffs.
    Keywords: inflation, GDP deflator, consumer price index, producer price index, Belarus, cointegration
    JEL: E31 C32 P24
    Date: 2005–05–02
  14. By: juancarlos soldanodeheza
    Abstract: Countries use different type of “anchors” with who intend to make the agents expectations to converge to a specified level of inflation. Those anchors could be either based on the exchange rate or some kind of monetary policy. Modern trend is to use Inflation Targeting rather than the traditional monetary aggregates. Countries that adopt Inflation Targeting could be classified as EIT (Eclectic Inflation Targeters), FFIT (Full Fledge Inflation Targeters) and ITL (Inflation Targeting Light). Argentina, if it walks through an IT regime, would be a very particular case, since there is no background that a country in default, with its financial system almost destroyed and a very low degree of credibility on its institutions, have had the capability of successfully implemented this kind of policies. A first issue that should be considered to adopt this monetary regime is to obtain a level of fiscal equilibrium that will allow the agents to believe in the long term solvency of the country. A second issue is reconstruction of credibility of the agents in the monetary authority, in such a way that its analysis would tend to a convergence of expectations and minimize doubts on the reasons the Central Bank should make interventions in the market. A third issue is the creation of an area of economic studies in the Central Bank that will allow the monetary authority to analyze the transmition mechanisms of monetary policy to prices. A fourth issue is renegotiating the public services contracts in which the definition of a new model for adjusting tariffs could be a good idea to avoid linking them to price indexes, but to link them to the cost structure of the companies, due to their impact on the structure of the price indexes usually used as reference for IT. A last issue that cannot be forgiven is that the argentine economy is, in fact, partially dollarized, because currency used for major transactions is US dollar, and also operate, at least with a majority of sectors linked to goods production, a foreign currency standard (US dollar price adjustment) in commercial contracts. The first three issues show us that Argentina seems to be very far of implementing a FFIT policy and with some difficulties to be considered an ITL. It seems that it does not seem an advantage to make public yet the new anchor to avoid consequences of a hypothetically change of system. The fourth issue introduces the need of a difficult and complex negotiation on public services prices in terms of its technical aspects that also has an extreme political sensitiveness. Finally, the last issue shows that it could be necessary to introduce into the predictive models an à la Peru bias, where the economy works under a heavily dollarized component, which is quite more superior than what it happens in Brazil.
    JEL: E
    Date: 2005–05–03

This nep-cba issue is ©2005 by Roberto Santillan. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.