nep-cba New Economics Papers
on Central Banking
Issue of 2005‒08‒13
sixteen papers chosen by
Roberto Santillan

  1. Money Supply and the Implementation of Interest Rate Targets By Schabert, Andreas
  2. Policy Uncertainty, Symbiosis, and the Optimal Fiscal and Monetary Conservativeness By Giovanni Di Bartolomeo; Francesco Giuli; Marco manzo
  3. Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models By Andrew T. Levin; Alexei Onatski; John C. Williams; Noah Williams
  4. On Stability of the Demand for Money in a Developing OECD By Ferda HALICIOGLU; Mehmet UGUR
  5. Monetary Policy in the Euro Area: Lessons from Five Years of ECB and Implications for Turkey By Canova, Fabio; Favero, Carlo A
  6. Voting Transparency in a Monetary Union By Gersbach, Hans; Hahn, Volker
  7. Is There a Change in the Trade-Off Between Output and Inflation at Low or Stable Inflation Rates?: Some Evidence in the Case of Japan By Hideyuki Ibaragi; Annabelle Mourougane
  8. Uncertainty, Wage Setting and Decision Making in a Monetary Union By Carsten Hefeker
  9. Systematic monetary policy and persistence By Luca Bindelli
  10. Alice Through the Looking Glass: Monetary and Fiscal Policy Interaction in a Liquidity Trap By Sanjit Dhami; Ali al-Nowaihi
  11. Long-Run Determinants of Inflation Differentials in a Monetary Union By Altissimo, Filippo; Benigno, Pierpaolo; Rodriguez Palenzuela, Diego
  12. Unions, fiscal policy and central bank transparency By Giuseppe Ciccarone; Giovanni Di Bartolomeo; Enrico Marchetti
  13. Sources of Inflation Persistence in the Euro Area By Boris Cournède; Alexandra Janovskaia; Paul Van den Noord
  14. Wealth Effects on Money Demand in EMU: Econometric Evidence By Laurence Boone; Fanny Mikol; Paul Van den Noord
  15. Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency? By Menzie Chinn; Jeffrey Frankel
  16. One Money, One Cycle? Making Monetary Union a Smoother Ride By Christine de la Maisonneuve; Claude Giorno; Peter Hoeller

  1. By: Schabert, Andreas
    Abstract: In this paper, we analyze the relation between interest rate targets and money supply in a (bubble-free) rational expectation equilibrium of a standard cash-in-advance model. We examine contingent monetary injections aimed to implement interest rate sequences that satisfy interest rate target rules. An interest rate target with a positive inflation feedback in general corresponds to money growth rates rising with inflation. When prices are not completely flexible, this implies that a non-destabilizing money supply cannot implement a forward-looking and active interest rate rule. This principle also applies for an alternative model version with an interest elastic money demand. The implementation of a Taylor rule then requires a money supply that leads to explosive or oscillatory equilibrium sequences. In contrast, an inertial interest rate target can be implemented by a non-destabilizing money supply, even if the inflation feedback exceeds one, which is often found in interest rate rule regressions.
    Keywords: contingent money supply; interest rate inertia; interest rate rules; macroeconomic stability; policy equivalence
    JEL: E32 E41 E52
    Date: 2005–06
  2. By: Giovanni Di Bartolomeo (Department of Public Economics, University of Rome 'La Sapienza'); Francesco Giuli (Department of Public Economics, University of Rome 'La Sapienza'); Marco manzo (Department of Public Economics, University of Rome 'La Sapienza')
    Abstract: This paper extends the stabilization game between monetary and fiscal authorities to the case of multiplicative (model) uncertainty. In this context, the “symbiosis assumption”, i.e. fiscal and monetary policy share the same ideal targets, no longer guarantees the achievement of ideal output and inflation, unless the ideal output is equal to its natural level. A time consistency problem arises.
    Keywords: Monetary-fiscal policy interactions, uncertainty, symbiosis.
    JEL: E61 E63
    Date: 2005–08–05
  3. By: Andrew T. Levin; Alexei Onatski; John C. Williams; Noah Williams
    Abstract: We use a micro-founded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data, and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably robust to uncertainty about the model parameters and to various assumptions regarding the nature and incidence of the innovations. However, the characteristics of optimal policy are very sensitive to the specification of the wage contracting mechanism, thereby highlighting the importance of additional research regarding the structure of labor markets and wage determination.
    JEL: C11 C22 E31 E52 E61 E63
    Date: 2005–08
  4. By: Ferda HALICIOGLU (The University of Greenwich); Mehmet UGUR (The University of Greenwich)
    Abstract: This paper empirically analyses the stability of the narrow money demand function (M1) in Turkey for the period 1950-2002. As part of the IMF-sponsored stabilisation programme, Turkey has been pursuing base money targets. To ascertain whether this policy framework satisfies the necessary condition for effectiveness, we estimate and test for the stability of Turkish M1 by employing a recent single cointegration procedure proposed by Pesaran et al. (2001) along with the CUSUM and CUSUMSQ stability tests. We demonstrate that there is a stable money demand function and it could be used as an intermediate target of monetary policy in Turkey.
    Keywords: co-integration, money demand, stability, Turkey
    JEL: E41 E52
    Date: 2005–08–01
  5. By: Canova, Fabio; Favero, Carlo A
    Abstract: We examine monetary policy in the euro area from both theoretical and empirical perspectives. We discuss what theory tells us the strategy of Central banks should be and contrasts it with the one employed by the ECB. We review accomplishments (and failures) of monetary policy in the euro area and suggest changes that would increase the correlation between words and actions; streamline the understanding that markets have of the policy process; and anchor expectation formation more strongly. We examine the transmission of monetary policy shocks in the euro area and in some potential member countries and try to infer the likely effects occurring when Turkey joins the EU first and the euro area later. Much of the analysis here warns against having too high expectations of the economic gains that membership to the EU and euro club will produce.
    Keywords: communication; EU newcomers; pillars; transmission
    JEL: C11 E12 E32 E62
    Date: 2005–06
  6. By: Gersbach, Hans; Hahn, Volker
    Abstract: We examine whether the central bank council of a monetary union should publish its voting records when members are appointed by national politicians. We show that the publication of voting records lowers overall welfare if the private benefits of holding office are sufficiently low. High private benefits of central bankers lower overall welfare under opacity, as they induce European central bankers to care more about being re-appointed than about beneficial policy outcomes. We show that opacity and low private benefits jointly guarantee the optimal welfare level. Moreover, we suggest that non-renewable terms for national central bankers and delegating the appointment of all council members to a European agency would be desirable.
    Keywords: central banks; transparency voting
    JEL: D70 E58
    Date: 2005–07
  7. By: Hideyuki Ibaragi; Annabelle Mourougane
    Abstract: <P>This paper examines the relationship between the output gap and inflation in Japan by estimating Phillips curves and testing for changes since the advent of low inflation and/or the stabilisation of the rate of change of inflation. The work provides empirical support for the hypothesis of a change in the relationship between output and inflation in an environment of low inflation for Japan. In particular, there is evidence that the slope of the Phillips curve becomes flatter when the inflation rate is below ½ per cent (quarter-on-quarter, non-annualised) and also that there has been a break in the relationship between demand pressures and inflation in Japan since the beginning of the 1990s. Evidence is also found that the relationship changes when the inflation rate is either rising rapidly or falling sharply. At such times, changes in demand pressure have stronger effects on inflation. These results are robust to a wide range of specifications, including corrections for the ...</P> <P>La relation entre indicateurs de demande et inflation change-t-elle dans un contexte de basse ou de stabilité de l’inflation? <P>Cette étude examine la relation entre l’écart de croissance et l’inflation au Japon en estimant des courbes de Phillips et teste si cette relation se modifie dans un contexte d’inflation basse et/ou de stabilité de l’inflation. Les estimations présentées constituent un support empirique relativement détaillé de l’hypothèse d’un changement dans la relation entre indicateur de demande et inflation dans un environnement de basse inflation pour le Japon. En particulier, la pente de la courbe de Phillips s’aplatit quand le taux d’inflation est en dessous d’½ pour cent (taux trimestriel, non annualisé) et il existe un break dans la relation entre indicateur de demande et inflation au Japon au début des années 90. La relation apparaît aussi se modifier quand le taux d’inflation augmente ou baisse rapidement. Durant de telles périodes, les mouvements dans les indicateurs de demande ont un effet plus fort sur l’inflation. Les résultats obtenus sont robustes à la correction des hausses de ...</P>
    Keywords: Japan, Japon, Phillips curves, asymmetry, low inflation environment, Courbes de Phillips, asymétrie, environnement de basse inflation
    JEL: C22 E31
    Date: 2004–02–02
  8. By: Carsten Hefeker
    Abstract: The enlargement of the European Monetary Union is likely to lead to an increase in uncertainty regarding the transmission of monetary policy for the larger union. Adding new members to the central bank council will in addition imply that the policy reaction of the enlarged council will be uncertain in the initial period. The paper considers the influence of both types of uncertainty on wage-setting behavior in the larger monetary union and its effects on unemployment. In light of these effects, I also derive implications for the adequate structure of the central bank.
    Keywords: monetary policy uncertainty, wage setting, European Central Bank, Euro area, accession countries
    JEL: D72 E58
    Date: 2005
  9. By: Luca Bindelli
    Abstract: Woodford (1999 and 2003) has raised the theoretical possibility that in a standard, forward looking sticky price model, an independent channel of inertia might arise as a result of policy behavior. We analyze this assertion empirically, and estimate a standard model, in which the monetary authority is assumed to commit to an optimal rule. We contribute to the existing literature by identifying the purely policy induced persistence present in the model. We also analyze the role of the structural parameters reflecting policy preferences and price flexibility in altering the policy induced, as well as the overall persistence properties of the model. We find that such a model is able to replicate most of the data's moments. In constrast to previous empirical literature, lagged terms in both modelled Phillips and IS curves are found to be either insignificant or very small. Commitment policy alone can explain a substantial part of output persistence. While the pricing mechanism at the heart of this model helps transfer output persistence into inflation persistence, commitment policy manages to undo this link by undershooting the inflation target following a positive 'cost push' shock so that inflation persistence is slightly reduced compared to the discretionary policy case.
    Keywords: persistence; optimal monetary policy; supply shock; Kalman filter
    JEL: E52 E58
    Date: 2005–05
  10. By: Sanjit Dhami; Ali al-Nowaihi
    Abstract: In a liquidity trap the nominal interest rate hits its zero floor. Hence, to reduce the real interest rate, and affect an economic recovery, inflationary expectations must increase. If the economy turns out not to be liquidity trapped, the Treasury has an incentive to renege on its promise of high inflation because inflation is costly. Hence, under discretion, a rational private sector keeps its inflation expectations low and the real interest rate remains too high. We suggest an institutional solution that has two main components. First, an inflation target given to an independent Central Bank who has sole control over monetary policy. This provides a commitment to the ‘necessary’ inflation level when the economy is not in a liquidity trap. Second, the Treasury, who retains control of fiscal policy, is given something like a ‘Taylor rule’, which penalizes deviations of output from an output target and inflation from the inflation target. This ensures that fiscal policy is ‘appropriately’ expansionary in a liquidity trap. Overall, this type of delegation keeps inflationary expectations ‘suffi- ciently’ high and achieves the optimal mix of monetary and fiscal policy. We prove that this arrangement achieves the optimal rational expectations (precommitment) solution. It is tempting to conclude that the huge welfare losses associated with the Japanese experience might have been mitigated by the institutional setup suggested here.
    Keywords: liquidity trap; monetary-fiscal coordination; optimal inflation and output targets; the Japanese experience
    JEL: E63 E52 E58 E61
    Date: 2005–07
  11. By: Altissimo, Filippo; Benigno, Pierpaolo; Rodriguez Palenzuela, Diego
    Abstract: This paper analyses the long-run determinants of inflation differentials in a monetary union. First, we aim at establishing some stylized facts relating the regional dispersion in headline inflation rates in the euro area as well as in the main components of the consumer price index. We find that a relatively large proportion of it occurs in the Service category of the EU’s harmonized consumer price index (HICP). We then lay out a model of a monetary union with fully flexible prices, the long-run properties of which are analysed. Our model departs in several respects from the Balassa-Samuelson hypotheses. Our results are in contrast with the result that movements in the real exchange rate are mainly driven by regionally asymmetric productivity shocks in the traded sectors. Our results point instead to relative variations in productivity in the non-traded sector as the primary cause of price and inflation differentials, with shocks to productivity in the traded sector being largely absorbed by movements in the terms of trade in the regional economies. These shocks are also found to largely drive the variability of real wages at the country level.
    Keywords: currency area; PPP; Real Exchange Rate
    JEL: E31 F41
    Date: 2005–07
  12. By: Giuseppe Ciccarone (Department of Public Economics, University of Rome 'La Sapienza'); Giovanni Di Bartolomeo (Department of Public Economics, University of Rome 'La Sapienza'); Enrico Marchetti (Department of Public Economics, University of Rome 'La Sapienza')
    Abstract: In a unionised economy with supply-side fiscal policy transparency has two contrasting effects on economic performance. Uncertainty on central bank's preferences induces unions to reduce wages but also produces a fully-anticipated expansionary fiscal policy which favours the setting of higher wages. Even if the net effect depends on the preference parameters of public entities and on the effectiveness of fiscal policy on aggregate supply: (i) the positive effects of opacity in unionised economies without fiscal policy are confirmed when the central bank is populist; (ii) if it is instead sufficiently conservative, transparency reduces inflation and the output gap, but at the cost of higher macroeconomic volatility.
    Keywords: Central bank transparency, Inflation, uncertainty
    JEL: E58
    Date: 2005–08–05
  13. By: Boris Cournède; Alexandra Janovskaia; Paul Van den Noord
    Abstract: In recent years, inflation in the euro area has failed to decelerate decisively while cyclical slack built up in the economy. Is this phenomenon more than a peculiarity in recent data? Is it related to structural policy settings? Econometric analysis conducted on two decades of quarterly data covering 17 countries yields a yes on both counts. First, inflation is shown to respond significantly more weakly to cyclical slack in the euro area than in countries such as the United Kingdom, the United States or Canada. Secondly, this lack of responsiveness is found to be related in a statistically significant way to more rigid structural policy settings. The results pass a wide range of robustness checks. This Working Paper relates to the 2005 OECD Economic Survey of the euro area ( <P>Les causes de la persistance de l'inflation dans la zone euro Au cours des dernières années, l’inflation ne s’est pas ralentie de manière sensible au sein de la zone euro alors même que l’écart de production y devenait de plus en plus négatif. Ce phénomène est-il plus profond qu’une bizarrerie des statistiques économiques récentes ? Y a-t-il un lien avec les caractéristiques structurelles de la zone euro ? L’analyse économétrique de deux décennies de données trimestrielles pour dix-sept pays conduit à répondre oui à chacune de ces questions. Premièrement, il apparaît que, pour un même écart de production négatif, l’inflation ralentit moins dans la zone euro que dans des pays comme le Royaume-Uni, les États-Unis ou le Canada. Deuxièmement, il existe un lien statistiquement significatif entre ce manque de réactivité et une plus grande rigidité des politiques structurelles. La robustesse de ces résultats est confirmée par un large éventail de tests. Ce Document de travail se rapporte à l'Etude économique de l'OCDE de la zone euro, 2005 (
    Keywords: monetary policy, Economic and Monetary Union, Union Économique et Monétaire, politique monetaire, inflation, inflation
    JEL: E31 E32 E52 E58
    Date: 2005–07–20
  14. By: Laurence Boone; Fanny Mikol; Paul Van den Noord
    Abstract: <P>This paper investigates the determinants of money demand (M3) in the euro area. It specifically examines the potential impact of financial and housing wealth on money demand. It tests the hypothesis, whether wealth associated with increases in asset prices is used to finance liquidity holdings in a standard portfolio context. Regressing velocity on interest rates and a wealth variable (a composite of residential property and stocks) within an error-correction framework provides evidence of positive wealth effects from financial and housing assets on money demand in the long run, but no significant impact in the short run. Tests suggests that the long-run and dynamic money demand equations are stable and have not been disrupted by the adoption of the euro on 1 January 1999, while the impact of wealth on money demand may have increased ...</P> <P>Les effets de richesse sur la demande de monnaie dans l'union économique et monétaire : une analyse économétrique <P>Cet article étudie les facteurs qui déterminent la demande de monnaie (M3) dans la zone euro. Il examine de manière explicite quels sont les effets de richesse liés aux avoirs mobiliers et immobiliers sur la demande de monnaie. Il teste l'hypothèse selon laquelle, dans un contexte classique de choix de portefeuille, la richesse résultant d'une hausse des prix des actifs est employée pour financer la détention de liquidités. Un modèle à correction d'erreur est mis en oeuvre pour effectuer une régression économétrique de la vitesse de circulation de la monnaie sur les taux d'intérêt et sur une variable composite de richesse (qui agrège immeubles et actions), faisant apparaître des effets de richesse liés aux actifs mobiliers et immobiliers sur la demande de monnaie qui sont significatifs à long terme mais non à court terme. Différents tests suggèrent que les équations de demande de monnaie, tant dynamiques que de long terme, sont stables et n'ont pas été perturbées par l'adoption de ...</P>
    Keywords: wealth, richesse, Money demand, inflation, demande de monnaie, inflation
    JEL: E41 E52
    Date: 2004–11–09
  15. By: Menzie Chinn; Jeffrey Frankel
    Abstract: Might the dollar eventually follow the precedent of the pound and cede its status as leading international reserve currency? Unlike ten years ago, there now exists a credible competitor: the euro. This paper econometrically estimates determinants of the shares of major currencies in the reserve holdings of the world’s central banks. Significant factors include: size of the home country, inflation rate (or lagged depreciation trend), exchange rate variability, and size of the relevant home financial center (as measured by the turnover in its foreign exchange market). We have not found that net international debt position is an important determinant. Network externality theories would predict a tipping phenomenon. Indeed we find that the relationship between currency shares and their determinants is nonlinear (which we try to capture with a logistic function, or else with a dummy “leader” variable for the largest country). But changes are felt only with a long lag (we estimate a weight on the preceding year’s currency share around .9). The advent of the euro interrupts the continuity of the historical data set. So we estimate parameters on pre-1999 data, and then use them to forecast the EMU era. The equation correctly predicts a (small) narrowing in the gap between the dollar and euro over the period 1999-2004. Whether the euro might in the future rival or surpass the dollar as the world’s leading international reserve currency appears to depend on two things: (1) do the United Kingdom and enough other EU members join euroland so that it becomes larger than the US economy, and (2) does US macroeconomic policy eventually undermine confidence in the value of the dollar, in the form of inflation and depreciation. What we learn about functional form and parameter values helps us forecast, contingent on these two developments, how quickly the euro might rise to challenge the dollar. Under two important scenarios the remaining EU members, including the UK, join EMU by 2020 or else the recent depreciation trend of the dollar persists into the future the euro may surpass the dollar as leading international reserve currency by 2022.
    JEL: F02 F31 F33
    Date: 2005–08
  16. By: Christine de la Maisonneuve; Claude Giorno; Peter Hoeller
    Abstract: <P>In recent years the euro area has shown less resilience to the negative and largely OECD-wide common shocks than the English-speaking countries, but most of the smaller euro area countries have fared better than the large ones. This paper reviews policy issues that are important in fostering a speedy adjustment to shocks. We argue that the small countries are well placed to adjust swiftly to asymmetric shocks, because they are well integrated with the rest of the area. An activist fiscal policy is not needed and also not powerful enough to smooth the cycle. However, asset bubbles are a cause of concern as their limited weight means that the common monetary policy is more likely to be out of line with their cyclical position. Large countries are less well placed to cope with shocks and sluggish adjustment can be expected. Reforms should focus on raising trade linkages via the completion of the single market, on improving wage and price flexibility and on making their housing markets ...</P> <P>Même monnaie, même cycle ? Rendre plus souple le fonctionnement de l'union monétaire <P>Au cours des dernières années, la zone euro a fait preuve d'une moindre résistance que les pays nglo-saxons aux chocs négatifs qui ont affecté dans une large mesure l'OCDE dans son ensemble; mais la lupart des plus petits pays de la zone ont mieux tirer leur épingle du jeux que les grands. Cet article passe n revue les questions de politique économique qui sont importantes afin de favoriser un ajustement rapide ux chocs. Nous défendons l'idée que les petits pays sont mieux armés pour s'ajuster promptement à des hocs asymétriques du fait de leur bonne intégration avec le reste de la zone. Une politique budgétaire ctiviste n'est pas nécessaire ni suffisamment puissante pour amortir le cycle. Néanmoins, l'apparition de ulles spéculatives est une source de préoccupation dans leur cas en raison de leur poids limité, lequel mplique que la politique monétaire commune est susceptible d'être plus fréquemment incohérente avec eur position cyclique. Les grands pays sont moins bien armés pour ...</P>
    Keywords: taxation, fiscalité, fiscal policy, politique budgétaire, Business cycles, cycles économiques, Economic and Monetary Union, Union Économique et Monétaire
    JEL: E3 E6 H2 H6
    Date: 2004–09–16

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