nep-cba New Economics Papers
on Central Banking
Issue of 2005‒09‒29
twenty-two papers chosen by
Roberto Santillan

  1. Nominal Debt as a Burden on Monetary Policy By Javier Díaz-Giménez; Giorgia Giovannetti; Ramon Marimon; Pedro Teles
  2. Optimal monetary policy, endogenous sticky prices and multiplicity of equilibria By Levon Barseghyan; Riccardo DiCecio
  3. Monetary policy in the presence of asymmetric wage indexation By Giuseppe Diana; Pierre-Guillaume Méon
  4. Optimal policy projections By Lars E.O. Svensson; Robert J. Tetlow
  5. Monetary policy and asset prices: To respond or not? By Gunnar Bårdsen; Q. Farooq Akram; Øyvind Eitrheim
  6. Money and Prices in Models of Bounded Rationality in High Inflation Economies By Albert Marcet; Juan Pablo Nicolini
  7. Monetary Policy and Exchange Rate Volatility in a Small Open Economy By Jordi Galí; Tommaso Monacelli
  8. The effectiveness of monetary policy By Robert H. Rasche; Marcela M. Williams
  9. Latin American Central Bank Reform: Progress and Challenges By Agustin Carstens; Luis I. Jacome H.
  10. Monetary policy predictability in the euro area: An international comparison By Bjørn-Roger Wilhelmsen; Andrea Zaghini
  11. Strategic Delegations in Monetary Unions By V.V. Chari; Larry E. Jones; Ramon Marimon
  12. Recent developments in monetary macroeconomics and U.S. dollar policy By William T. Gavin
  13. The Constitutional Creation of a Common Currency in the U.S., 1748-1811: Monetary Stabilization versus Merchant Rent Seeking By Farley Grubb
  14. Nowcasting GDP and Inflation: The Real Time Informational Content of Macroeconomic Data Releases By Giannone, Domenico; Reichlin, Lucrezia; Small, David
  15. The big problem of large bills: the Bank of Amsterdam and the origins of central banking By Stephen Quinn; William Roberds
  16. The Tobin effect and the Friedman rule By Bhattacharya, Joydeep; Haslag, J; Martin, A
  17. "Transfers Plus Open-Market Purchases: a Remedy for Recession." By Laurence Seidman; Kenneth Lewis
  18. The effectiveness of monetary policy: an assessment By Yi Wen
  19. Nominal rigidities, relative prices and skewness By Mª Ángeles Caraballo Pou; Carlos Dabús
  20. Currency crashes and bond yields in industrial countries By Joseph E. Gagnon
  21. The Exchange Rate Forecasting Puzzle By Francis Vitek
  22. Monetary Equilibria in a Cash-in-Advance Economy with Incomplete Financial Markets By Ingolf Schwarz; Jinhui H. Bai

  1. By: Javier Díaz-Giménez; Giorgia Giovannetti; Ramon Marimon; Pedro Teles
    Abstract: We study the effects of nominal debt on the optimal sequential choice of monetary policy. When the stock of debt is nominal, the incentive to generate unanticipated inflation increases the cost of the outstanding debt even if no unanticipated inflation episodes occur in equilibrium. Without full commitment, the optimal sequential policy is to deplete the outstanding stock of debt progressively until these extra costs disappear. Nominal debt is therefore a burden on monetary policy, not only because it must be serviced, but also because it creates a time inconsistency problem that distorts interest rates. The introduction of alternative forms of taxation may lessen this burden, if there is enough commtiment to fiscal policy. If there is full commitment to an optimal fiscal policy, then the resulting monetary policy is the Friedman rule of zero nominal interest rates.
    Keywords: Time-consistency, monetary policy, debt, recursive equilibrium
    JEL: E40 E52 E61
    Date: 2004–07
  2. By: Levon Barseghyan; Riccardo DiCecio
    Abstract: We analyze optimal monetary policy in an endogenous sticky price model. Similar models with exogenous sticky prices can deliver multiplicity of equilibria. Multiplicity of equilibria is a necessary condition for expectation traps to explain the variation across time and countries of inflation patterns. In our model's equilibrium, profit differentials between sticky price firms and flexible price firms are small. Also, the gain from revising prices for sticky prices firms is increasing in inflation. Depending on the distribution of price revision costs, if enough sticky price firms choose to revise their prices, the monetary authority's benefit from inflation is reduced to the point that the model has a unique, low inflation equilibrium.
    Keywords: Monetary policy ; Prices
    Date: 2005
  3. By: Giuseppe Diana (BETA-theme, Université Louis Pasteur, Strasbourg); Pierre-Guillaume Méon (DULBEA, Université libre de Bruxelles, Brussels)
    Abstract: This paper studies monetary policy in the presence of asymmetric wage indexation. It is found that monetary authorities do not react to small output shocks and that their reaction to large shocks is asymmetric, insofar as they absorb positive shocks more than negative ones. As a consequence, asymmetric wage indexation skews the distribution of output to the left, and can therefore be contractionary. It has ambiguous effects on expected inflation, on the volatility of output and inflation, and on expected welfare, relative to an equivalent symmetric indexation. Optimal symmetric inflation however always outperforms optimal asymmetric indexation.
    Keywords: monetary policy, wage indexation.
    JEL: E30 E50 E61 J30
    Date: 2005–09
  4. By: Lars E.O. Svensson; Robert J. Tetlow
    Abstract: We outline a method to provide advice on optimal monetary policy while taking policymakers' judgment into account. The method constructs optimal policy projections (OPPs) by extracting the judgment terms that allow a model, such as the Federal Reserve Board staff economic model, FRB/US, to reproduce a forecast, such as the Greenbook forecast. Given an intertemporal loss function that represents monetary policy objectives, OPPs are the projections---of target variables, instruments, and other variables of interest---that minimize that loss function for given judgment terms. The method is illustrated by revisiting the economy of early 1997 as seen in the Greenbook forecasts of February 1997 and November 1999. In both cases, we use the vintage of the FRB/US model that was in place at that time. These two particular forecasts were chosen, in part, because they were at the beginning and the peak, respectively, of the late 1990s boom period. As such, they differ markedly in their implied judgments of the state of the world in 1997 and our OPPs illustrate this difference. For a conventional loss function, our OPPs provide significantly better performance than Taylor-rule simulations.
    Date: 2005
  5. By: Gunnar Bårdsen (Bank of Norway and Department of Economics, Norwegian University of Science and Technology); Q. Farooq Akram (Bank of Norway); Øyvind Eitrheim (Bank of Norway)
    Abstract: We investigate whether there is a case for asset prices in interest rates rules within a small econometric model of the Norwegian economy, modeling the interdependence of the real economy, credit and three classes of assets prices: housing prices, equity prices and the nominal exchange rate. We compare the performance of simple and efficient interest rate rules that allow for response to movements in asset prices to the performance of more standard monetary policy rules. We find that including housing prices and equity prices in the policy rules can improve macroeconomic performance in terms of both nominal and real economic stability. In contrast, a response to nominal exchange rate fluctuations can induce excess volatility in general and prove detrimental to macroeconomic stability.
    Keywords: Monetary policy; asset prices; simple interest rate rules; econometric model
    JEL: C51 C52 C53 E47 E52
    Date: 2005–09–15
  6. By: Albert Marcet; Juan Pablo Nicolini
    Abstract: This paper studies the short run correlation of inflation and money growth. We study whether a model of learning can do better than a model of rational expectations, we focus our study on countries of high inflation. We take the money process as an exogenous variable, estimated from the data through a switching regime process. We find that the rational expectations model and the model of learning both offer very good explanations for the joint behavior of money and prices.
    Keywords: Inflation andmoney growth, switching regimes, quasi-rationality
    JEL: D83 E17 E31
    Date: 2005–01
  7. By: Jordi Galí; Tommaso Monacelli
    Abstract: We lay out a small open economy version of the Calvo sticky price model, and show how the equilibrium dynamics can be reduced to simple representation in domestic inflation and the output gap. We use the resulting framework to analyze the macroeconomic implications of three alternative rule-based policy regimes for the small open economy: domestic inflation and CPI-based Taylor rules, and an exchange rate peg. We show that a key difference among these regimes lies in the relative amount of exchange rate volatility that they entail. We also discuss a special case for which domestic inflation targeting constitutes the optimal policy, and where a simple second order approximation to the utility of the representative consumer can be derived and used to evaluate the welfare losses associated with the suboptimal rules.
    Keywords: Small open economy, optimal monetary policy, sticky prices, exchange rate peg, exchange rate volatility
    JEL: E52 F41
    Date: 2004–07
  8. By: Robert H. Rasche; Marcela M. Williams
    Abstract: The analysis addresses changing views of the role and effectiveness of monetary policy, inflation targeting as an "effective monetary policy," monetary policy and short-run (output) stabilization, and problems in implementing a short-run stabilization policy.
    Keywords: Monetary policy
    Date: 2005
  9. By: Agustin Carstens (International Monetary Fund); Luis I. Jacome H. (International Monetary Fund)
    Abstract: This study takes stock of the institutional reform of monetary policy in Latin America since the early 1990s. It argues that strengthening the legal independence of central banks, together with macroeconomic policies, was instrumental in reducing inflation from three-digit annual rates in the 1990s to single-digit territory in 2004. The paper also discusses the main challenges of monetary policy today, namely, achieving price stability, restoring market confidence in domestic currencies, and sticking to policy consistency despite adverse effects of the volatility of capital flows. Finally, recurrent banking crises and lack of fiscal discipline are identified as the main risks for the success of monetary policy in Latin America.
    Keywords: Central banks independence, monetary policy, inflation, Latin America
    JEL: E42 E52 E58
    Date: 2005–09–15
  10. By: Bjørn-Roger Wilhelmsen (Norges Bank); Andrea Zaghini (Banca d’Italia)
    Abstract: The paper evaluates the ability of market participants to anticipate monetary policy decisions in the euro area and in 13 other countries. First, by looking at the magnitude and the volatility of the changes in the money market rates we show that the days of policy meetings are special days for financial markets. Second, we find that the predictability of the ECB’s monetary policy is fully comparable (and sometimes slightly better) to that of the FED and the Bank of England. Finally, an econometric analysis of the ability of market participants to incorporate in the current money rates the expected changes in the key policy rate shows that in the euro area policy decisions are anticipated well in advance.
    Keywords: Monetary policy, Predictability, Money market rates
    JEL: E4 E5 G1
    Date: 2005–09–02
  11. By: V.V. Chari; Larry E. Jones; Ramon Marimon
    Abstract: In monetary unions, monetary policy is typically made by delegates of the member countries. This procedure raises the possibility of strategic delegation - that countries may choose the types of delegates to influence outcomes in their favor. We show that without commitment in monetary policy, strategic delegation arises if and only if three conditions are met: shocks affecting individual countries are not perfectly correlated, risk-sharing across countries is imperfect, and the Phillips Curve is nonlinear. Moreover, inflation rates are inefficiently high. We argue that ways of solving the commitment problem, including the emphasis on price stability in the agreements constituting the European Union are especially valuable when strategic delegation is a problem.
    Keywords: Strategic delegation, monetary union, time-consistency, monetary policy
    JEL: E58 E61
    Date: 2004–04
  12. By: William T. Gavin
    Abstract: This paper summarizes recent developments in the theory and practice of monetary policy in a closed economy and explains what these developments mean for U.S. Dollar policy. There is no conflict between what is appropriate U.S. monetary policy at home or abroad because the dollar is the world's key currency country. Both at home and abroad, the main problem for U.S. policymakers is to provide an anchor for the dollar. Recent experience in other countries suggests that a solution is evolving in the use of inflation targets.
    Keywords: Dollar, American ; Monetary policy
    Date: 2005
  13. By: Farley Grubb (Department of Economics,University of Delaware)
    Keywords: Monetary Policy
    JEL: N1
    Date: 2004
  14. By: Giannone, Domenico; Reichlin, Lucrezia; Small, David
    Abstract: This paper formalizes the process of updating the nowcast and forecast on output and inflation as new releases of data become available. The marginal contribution of a particular release for the value of the signal and its precision is evaluated by computing 'news' on the basis of an evolving conditioning information set. The marginal contribution is then split into what is due to timeliness of information and what is due to economic content. We find that the Federal Reserve Bank of Philadelphia surveys have a large marginal impact on the nowcast of both inflation variables and real variables and this effect is larger than that of the Employment Report. When we control for timeliness of the releases, the effect of hard data becomes sizeable. Prices and quantities affect the precision of the estimates of GDP while inflation is only affected by nominal variables and asset prices.
    Keywords: factor model; forecasting; large datasets; monetary policy; news; real time data
    JEL: C33 C53 E52
    Date: 2005–08
  15. By: Stephen Quinn; William Roberds
    Abstract: This paper outlines a model of the first true central bank, the Bank of Amsterdam, founded in 1609. Employing a variant of the Freeman (1996) model of money and payments, we first analyze the problematic monetary situation in the Netherlands prior to the founding of the Bank. We then use the model to describe how the Bank could remedy this situation by creating a stable medium for the settlement of commercial obligations.
    Date: 2005
  16. By: Bhattacharya, Joydeep; Haslag, J; Martin, A
    Abstract: This paper studies a overlapping generations economy with capital where limited communication and stochastic relocation create an endogenous transactions role for fiat money. We assume a production function with a knowledge-externality (Romer-style) that nests economies with endogenous growth (AK form) and those with no long run growth (the Diamond model). With logarithmic utility, the Friedman rule is optimal (stationary welfare maximizing) irrespective of whether there is long run growth or not. Under the more general CRRA form of preferences, we find that a sufficient condition for the Friedman rule to be optimal is that the ‘anti-Tobin effect’ is operative. Also, contrary to models with a storage technology, zero inflation is not optimal (except for a set of parameters which has measure zero in the parameter space). These results are in sharp contrast to the received wisdom about the suboptimality of the Friedman rule in overlapping generation models.
    Keywords: Friedman rule, Tobin effect, monetary policy
    JEL: E4
    Date: 2005–09–15
  17. By: Laurence Seidman (Department of Economics,University of Delaware); Kenneth Lewis (Department of Economics,University of Delaware)
    Abstract: This paper simulates the use of transfers to households plus central-bank open-market purchases to generate a recovery of a low-interest-rate economy from a negative demand shock. Transfers to households are automatically triggered in recession; the prescribed anti-recession transfer ratio is proportional to the unemployment gap. Three alternative complementary monetary policies that the Federal Reserve might decide to implement are considered: standard, moderate, and aggressive. The simulations suggest that transfers plus open market purchases are likely to be an effective remedy for such a recession while limiting potential adverse impacts on inflation and government debt held by the non-central-bank public.
    Keywords: Macroecomics; Recession
    Date: 2004
  18. By: Yi Wen
    Abstract: When monetary policies are endogenous, the conventional VAR approach for detecting the effect of monetary policies is powerless. This paper proposes to test the implication of monetary policies along a different dimension. That implication is to exploit the policy induced exogeneity of endogenous variables that are the source of monetary non-neutrality. We illustrate the idea by constructing a new Keynesian sticky wage model with capital accumulation and then testing the implications of optimal monetary policies for nominal wages under both complete and incomplete information. Econometric test using post war US data suggests that the nominal wage is exogenous with respect to lagged macro variables. Such exogeneity is consistent with new Keynesian models in which the monetary authority pursues active monetary policy based on information with a lag.
    Keywords: Monetary policy
    Date: 2005
  19. By: Mª Ángeles Caraballo Pou (Universidad de Sevilla); Carlos Dabús (CONICET y Universidad Nacional del Sur (Argentina))
    Abstract: The menu costs model developed by Ball and Mankiw (BM)(1994,1995) predicts that inflation is positively related to the skewness of price changes distribution. We test this prediction in different inflationary contexts: Spain (1975-2002) and Argentina (1960-1989). We find a positive inflation-skewness relationship in both countries at low inflation, even though the mean annual inflation rates were very different: 2,2% for Spain and 23% for Argentina. Therefore, the threshold of low inflation under which the menu costs model is suitable is determined endogenously, and it depends on the inflationary experience of each economy. In the higher inflation periods skewness is not significant. Finally, our results suggest that the menu-costs model is not suitable beyond certain threshold of inflation.
    Keywords: menu costs, skewness, relative prices, inflation regimes
    JEL: E31
    Date: 2005
  20. By: Joseph E. Gagnon
    Abstract: This paper examines episodes of sudden large exchange rate depreciations (currency crashes) in industrial countries and characterizes the behavior of government bond yields during and after these crashes. The most important determinant of changes in bond yields appears to be inflationary expectations. When inflation is high and rising at the time of a currency crash, bond yields tend to rise. Otherwise--and in every currency crash since 1985--bond yields tend to fall. Over the past 20 years, inflation rates have been remarkably stable in industrial countries after currency crashes.
    Keywords: Balance of payments ; Inflation (Finance) ; Foreign exchange rates
    Date: 2005
  21. By: Francis Vitek (University of British Columbia)
    Abstract: We survey and update the empirical literature concerning the predictability of nominal exchange rates using structural macroeconomic models over the recent floating exchange rate period. In particular, we consider both flexible and sticky price versions of the monetary model of nominal exchange rate determination. In agreement with the existing empirical literature, we find that nominal exchange rate movements are difficult to forecast, with a random walk generally dominating the monetary model in terms of predictive accuracy conditional on observed monetary fundamentals at all horizons.
    Keywords: Exchange rate forecasting; Monetary model
    JEL: F31
    Date: 2005–09–14
  22. By: Ingolf Schwarz (Max-Planck-Institute for Research on Collective Goods); Jinhui H. Bai (Yale University, Department of Economics)
    Abstract: The general equilibrium model with incomplete financial markets (GEI) is extended by adding fiat money, fiscal and monetary policy and a cash-in-advance constraint. The central bank either pegs the interest rate or money supply while the fiscal authority sets a Ricardian or a non-Ricardian fiscal plan. We prove the existence of equilibria in all four scenarios. In Ricardian economies, the conditions required for existence are not more restrictive than in standard GEI. In non-Ricardian economies, the sufficient conditions for existence are more demanding. In the Ricardian economy, neither the price level nor the equivalent martingale measure are determinate.
    Keywords: Money, Incomplete Markets, Fiscal Policy, Indeterminacy
    JEL: D52 E40 E50
    Date: 2005–09

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