nep-cba New Economics Papers
on Central Banking
Issue of 2006‒01‒01
thirty-six papers chosen by
Roberto Santillan

  1. Establishing credibility: evolving perceptions of the European Central Bank By Linda S. Goldberg; Michael W. Klein
  2. Optimal Monetary Policy, Commitment, and Imperfect Credibility By A. Hakan Kara
  3. Changes in the Federal Reserve's inflation target: causes and consequences By Peter N. Ireland
  4. Monetary policy with imperfect knowledge By Athanasios Orphanides; John C. Williams
  5. Term structure transmission of monetary policy By Sharon Kozicki; Peter Tinsley
  6. Robustly Optimal Monetary Policy with Near Rational Expectations By Michael Woodford
  7. A Monetary Disequilibrium Model for Turkey : Investigation of a Disinflationary Fiscal Rule and its Implications on Monetary Policy By K. Azim Ozdemir
  8. Monetary Policy Challenges for Turkey in European Union Accession Process By Fatih Ozatay
  9. Optimal Monetary and Fiscal Policy in a Currency Union By Tommaso Monacelli; Jordi Galí
  10. Are there asymmetries in the response of bank interest rates monetary shocks? By Leonardo Gambacorta; Simonetta Iannotti
  11. Heterogeneous beliefs and inflation dynamics: a general equilibrium approach By Fabià Gumbau-Brisa
  12. Central Bank Communication and Policy Effectiveness By Michael Woodford
  13. The Role of Real Wage Rigidity and Labor Market Frictions for Unemployment and Inflation Dynamics By Kai Christoffel; Tobias Linzert
  14. Can U.S. monetary policy fall (again) into an expectation trap? By Roc Armenter; Martin Bodenstein
  15. Importance of Base Money Even When Inflation Targeting By Melike Altinkemer
  16. An inflation goal with multiple reference measures By William Whitesell
  17. Monetary Policy under Imperfect Commitment : Reconciling Theory with Evidence By Hakan Kara
  18. Some benefits of cyclical monetary policy By Ricardo de O. Cavalcanti; Ed Nosal
  19. The Demand for Base Money in Turkey : Implications for Inflation and Seigniorage By K. Azim Ozdemir; Paul Turner
  20. Optimal nonlinear policy: signal extraction with a non-normal prior By Eric T. Swanson
  21. Generalizing the Taylor Principle By Troy Davig; Eric M. Leeper
  22. A Dynamic Model of Central Bank Intervention By Ana Maria Herrera; Pinar Ozbay
  23. The Impact of Firm-Specific Characteristics on the Response to Monetary Policy Actions By Cihan Yalcin; Spiros Bougheas; Paul Mizen
  24. Alternative central bank credit policies for liquidity provision in a model of payments By David C. Mills, Jr.
  25. Oil prices, monetary policy, and counterfactual experiments By Charles T. Carlstrom; Timothy S. Fuerst
  26. An estimate of the measurement bias in the HICP By Mark A. Wynne
  27. Monetary policy analysis with potentially misspecified models By Marco Del Negro; Frank Schorfheide
  28. The Capital Inflows Problem in Selected Asian Economies in the 1990s Revisited: The Role of Monetary Sterilization By Tony Cavoli; Ramkishen S. Rajan
  29. One-sided test for an unknown breakpoint: theory, computation, and application to monetary theory By Arturo Estrella; Anthony P. Rodrigues
  30. The Market of Foreign Exchange Hedge in Brazil: Reactions of Financial Institutions to Interventions of the Central Bank By Fernando N. de Oliveira; Walter Novaes
  31. What Triggers Inflation in Emerging Market Economies? By Ilker Domac; Eray M. Yucel
  32. Semiparametric evidence on the long-run effects of inflation on growth By Andrea Vaona; Stefano Schiavo
  33. Some Evidence on the Irrationality of Inflation Expectations in Turkey By Hakan Kara; Hande Kucuk Tuger
  34. Prospects for Electronic Money : A US - European Comparative Survey By Yuksel Gormez; Forrest Capie
  35. Optimal monetary and fiscal policy under discretion in the new Keynesian model: a technical appendix to "Great Expectations and the End of the Depression" By Gauti B. Eggertsson
  36. Alternative measures of the Federal Reserve banks’ cost of equity capital By Michelle L. Barnes; Jose A. Lopez

  1. By: Linda S. Goldberg; Michael W. Klein
    Abstract: The perceptions of a central bank's inflation aversion may reflect institutional structure or, more dynamically, the history of its policy decisions. In this paper, we present a novel empirical framework that uses high-frequency data to test for persistent variation in market perceptions of central bank inflation aversion. The first years of the European Central Bank (ECB) provide a natural experiment for this model. Tests of the effect of news announcements on the slope of yield curves in the euro area and on the euro-dollar exchange rate suggest that the market's perception of the policy stance of the ECB evolved significantly during the first six years of the Bank's operation, with a belief in its inflation aversion increasing in the wake of its monetary tightening. In contrast, tests based on the response of the slope of the U.S. yield curve to news offer no comparable evidence of any change in market perceptions of the inflation aversion of the Federal Reserve.
    Keywords: Banks and banking, Central ; Inflation (Finance) ; Monetary policy ; European Central Bank
    Date: 2005
  2. By: A. Hakan Kara
  3. By: Peter N. Ireland
    Abstract: This paper estimates a New Keynesian model to draw inferences about the behavior of the Federal Reserve’s unobserved inflation target. The results indicate that the target rose from 1- 1/4 percent in 1959 to over 8 percent in the mid-to-late 1970s before falling back below 2-1/2 percent in 2004. The results also provide some support for the hypothesis that over the entire postwar period, Federal Reserve policy has systematically translated short-run price pressures set off by supply-side shocks into more persistent movements in inflation itself, although considerable uncertainty remains about the true source of shifts in the inflation target.
    Keywords: Inflation (Finance) ; Monetary policy
    Date: 2005
  4. By: Athanasios Orphanides; John C. Williams
    Abstract: We examine the performance and robustness of monetary policy rules when the central bank and the public have imperfect knowledge of the economy and continuously update their estimates of model parameters. We find that versions of the Taylor rule calibrated to perform well under rational expectations with perfect knowledge perform very poorly when agents are learning and the central bank faces uncertainty regarding natural rates. In contrast, difference rules, in which the change in the interest rate is determined by the inflation rate and the change in the unemployment rate, perform well when knowledge is both perfect and imperfect.
    Date: 2005
  5. By: Sharon Kozicki; Peter Tinsley
    Abstract: The sensitivity of bond rates to macro variables appears to vary both over time and over forecast horizons.  The latter may be due to differences in forward rate term premiums and in bond trader perceptions of anticipated policy responses at different forecast horizons.  Determinacy of policy transmission through bond rates requires a lower bound on the average responsiveness of term premiums and anticipated policy responses to inflation.
    Keywords: Monetary policy
    Date: 2005
  6. By: Michael Woodford
    Abstract: The paper considers optimal monetary stabilization policy in a forward-looking model, when the central bank recognizes that private-sector expectations need not be precisely model-consistent, and wishes to choose a policy that will be as good as possible in the case of any beliefs that are close enough to model-consistency. The proposed method offers a way of avoiding the assumption that the central bank can count on private-sector expectations coinciding precisely with whatever it plans to do, while at the same time also avoiding the equally unpalatable assumption that the central bank can precisely model private-sector learning and optimize in reliance upon a precise law of motion for expectations. The main qualitative conclusions of the rational-expectations analysis of optimal policy carry over to the weaker assumption of near-rational expectations. It is found that commitment continues to be important for optimal policy, that the optimal long-run inflation target is unaffected by the degree of potential distortion of beliefs, and that optimal policy is even more history-dependent than if rational expectations are assumed.
    JEL: D81 D84 E52
    Date: 2005–12
  7. By: K. Azim Ozdemir
  8. By: Fatih Ozatay
  9. By: Tommaso Monacelli; Jordi Galí
    Abstract: We lay out a tractable model for fiscal and monetary policy analysis in a currency union, and analyze its implications for the optimal design of such policies. Monetary policy is conducted by a common central bank, which sets the interest rate for the union as a whole. Fiscal policy is implemented at the country level, through the choice of government spending level. The model incorporates country-specific shocks and nominal rigidities. Under our assumptions, the optimal monetary policy requires that inflation be stabilized at the union level. On the other hand, the relinquishment of an independent monetary policy, coupled with nominal price rigidities, generates a stabilization role for fiscal policy, one beyond the efficient provision of public goods. Interestingly, the stabilizing role for fiscal policy is shown to be desirable not only from the viewpoint of each individual country, but also from that of the union as a whole. In addition, our paper offers some insights on two aspects of policy design in currency unions: (i) the conditions for equilibrium determinacy and (ii) the effects of exogenous government spending variations.
  10. By: Leonardo Gambacorta (Bank of Italy, Economic Research Department); Simonetta Iannotti (Bank of Italy, Supervision and Regulation Department)
    Abstract: This paper examines the velocity and asymmetry in the response of bank interest rates to monetary policy shocks. Using an Asymmetric Vector Error Correction Model (AVECM), it analyses the pass-through of changes in the money market rates to retail bank interest rates in Italy in the period 1985-2002. The main results of the paper are: 1) the speed in adjustment of bank interest rates to monetary policy changes have significantly increased after the introduction of the 1993 Consolidated Law on Banking; 2) interest rate adjustment, in response to positive and negative shocks, are asymmetric in the short run, but not in the long run; 3) banks adjust their loan (deposit) rate at a faster rate during period of monetary tightening (easing); 4) this asymmetry has almost vanished since the nineties.
    Keywords: monetary policy transmission, interest rates, asymmetries, liberalization
    JEL: E43 E44 E52
    Date: 2005–11
  11. By: Fabià Gumbau-Brisa
    Abstract: This paper looks at the implications of heterogeneous beliefs for inflation dynamics. Following a monetary policy shock, inflation peaks after output, is inertial, and can be characterized by a Hybrid Phillips Curve. It presents a novel channel through which systematic monetary policy can affect the degree of inflation persistence. It does so by altering the effective extent of strategic complementarities in pricing, and hence the role of higher-order expectations in the equilibrium. In particular, stronger inflation targeting reduces the impact of uncertainty on the economy and therefore the degree of inertia. It is possible to calibrate at around 25 percent the fraction of relevant information processed every period by the private sector. The imperfect common knowledge framework does not require any exogenous shocks to create heterogeneity. Despite the fact that prices can be adjusted at no cost in every period, there are nominal rigidities, and monetary policy has real effects.
    Keywords: Inflation (Finance)
    Date: 2005
  12. By: Michael Woodford
    Abstract: A notable change in central banking over the past 15 years has been a world-wide movement toward increased communication by central banks about their policy decisions, the targets that they seek to achieve through those decisions, and the central bank's view of the economy's likely future evolution. This paper considers the role of such communication in the successful conduct of monetary policy, with a particular emphasis on an issue that remains controversial: to what extent is it desirable for central banks to comment on the likely path of short-term interest rates? After reviewing general arguments for and against central-bank transparency, the paper considers two specific contexts in which central banks have been forced to consider how much they are willing to say about the future path of interest rates. The first is the experiment with policy signaling by the FOMC in the U.S., using the statement released following each Committee meeting, since August 2003. The second is the need to make some assumption about future policy when producing the projections (for future inflation and other variables) that are central to inflation-forecast targeting procedures, of the kind used by the Bank of England, the Swedish Riksbank, the Reserve Bank of New Zealand, and others. In both cases, it is argued that increased willingness to share the central bank's own assumptions about future policy with the public has increased the predictability of policy, in ways that are likely to have improved central bank's ability to achieve their stabilization objectives.
    JEL: E52 E58
    Date: 2005–12
  13. By: Kai Christoffel (European Central Bank); Tobias Linzert (European Central Bank and IZA Bonn)
    Abstract: In this paper we incorporate a labor market with matching frictions and wage rigidities into the New Keynesian business cycle model. In particular, we analyze the effect of a monetary policy shock and investigate how labor market frictions affect the transmission process of monetary policy. The model allows real wage rigidities to interact with adjustments in employment and hours affecting inflation dynamics via marginal costs. We find that the response of unemployment and inflation to an interest rate innovation depends on the degree of wage rigidity. Generally, more rigid wages translate into more persistent movements of aggregate inflation. Moreover, the impact of a monetary policy shock on unemployment and inflation depends also on labor market fundamentals such as bargaining power and the flows in and out of employment.
    Keywords: monetary policy, matching models, labor market search, inflation persistence, real wage rigidity
    JEL: E52 J64 E32 E31
    Date: 2005–12
  14. By: Roc Armenter; Martin Bodenstein
    Abstract: We provide a tractable model to study monetary policy under discretion. We restrict our analysis to Markov equilibria. We find that for all parametrizations with an equilibrium inflation rate of about 2 percent, there is a second equilibrium with an inflation rate just above 10 percent. Thus, the model can simultaneously account for the low and high inflation episodes in the United States. We carefully characterize the set of Markov equilibria along the parameter space and find our results to be robust, suggesting that expectation traps are more than just a theoretical curiosity.
    Keywords: Equilibrium (Economics) ; Inflation (Finance) ; Rational expectations (Economic theory) ; Monetary policy
    Date: 2005
  15. By: Melike Altinkemer
  16. By: William Whitesell
    Abstract: Most inflation-targeting central banks express their inflation objective in terms of a range for a single official inflation measure but generally have not clarified the meaning of the ranges and their implications for policy responses. In formulating policy, all central banks monitor multiple inflation indicators. This paper suggests an alternative approach to communicating an inflation goal: announcing point-values, rather than ranges, for a few key reference measures of inflation that are used in making policy. After reviewing and extending relevant theoretical and empirical studies, the paper argues that the alternative approach could more accurately reflect the concerns of policymakers and provide a better accountability structure for monetary policy performance.
    Date: 2005
  17. By: Hakan Kara
  18. By: Ricardo de O. Cavalcanti; Ed Nosal
    Abstract: In this paper, we present a simple random-matching model in which different seasons translate into different propensities to consume and produce. We find that the cyclical creation and destruction of money is beneficial for welfare under a wide variety of circumstances. Our model of seasons can be interpreted as providing support for the creation of the Federal Reserve System, with its mandate of supplying an elastic currency for the nation.
    Keywords: Monetary policy ; Money supply
    Date: 2005
  19. By: K. Azim Ozdemir; Paul Turner
  20. By: Eric T. Swanson
    Abstract: The literature on optimal monetary policy typically makes three major assumptions: (1) policymakers' preferences are quadratic, (2) the economy is linear, and (3) stochastic shocks and policymakers' prior beliefs about unobserved variables are normally distributed. This paper relaxes the third assumption and explores its implications for optimal policy. The separation principle continues to hold in this framework, allowing for tractability and application to forward-looking models, but policymakers' beliefs are no longer updated in a linear fashion, allowing for plausible nonlinearities in optimal policy. We consider in particular a class of models in which policymakers' priors about the natural rate of unemployment are diffuse in a region around the mean. When this is the case, it is optimal for policy to respond cautiously to small surprises in the observed unemployment rate, but become increasingly aggressive at the margin. These features of optimal policy match statements by Federal Reserve officials and the behavior of the Fed in the 1990s.
    Keywords: Monetary policy ; Econometric models
    Date: 2005
  21. By: Troy Davig; Eric M. Leeper
    Abstract: Recurring change in a monetary policy function that maps endogenous variables into policy choices alters both the nature and the efficacy of the Taylor principle---the proposition that central banks can stabilize the macroeconomy by raising their interest rate instrument more than one-for-one in response to higher inflation. A monetary policy process is a set of policy rules and a probability distribution over the rules. We derive restrictions on that process that satisfy a long-run Taylor principle and deliver unique equilibria in two standard models. A process can satisfy the Taylor principle in the long run, but deviate from it in the short run. The paper examines three empirically plausible processes to show that predictions of conventional models are sensitive to even small deviations from the assumption of constant-parameter policy rules.
    JEL: E52 E62
    Date: 2005–12
  22. By: Ana Maria Herrera; Pinar Ozbay
  23. By: Cihan Yalcin; Spiros Bougheas; Paul Mizen
  24. By: David C. Mills, Jr.
    Abstract: I explore alternative central bank policies for liquidity provision in a model of payments. I use a mechanism design approach so that agents' incentives to default are explicit and contingent on the credit policy designed. In the first policy, the central bank invests in costly enforcement and charges an interest rate to recover costs. I show that the second best solution is not distortionary. In the second policy, the central bank requires collateral. If collateral does not bear an opportunity cost, then the solution is first best. Otherwise, the second best is distortionary because collateral serves as a binding credit constraint.
    Date: 2005
  25. By: Charles T. Carlstrom; Timothy S. Fuerst
    Abstract: Recessions are associated with both rising oil prices and increases in the federal funds rate. Are recessions caused by the spikes in oil prices or by the sharp tightening of monetary policy? This paper discusses the difficulties in disentangling these two effects.
    Keywords: Petroleum products - Prices ; Monetary policy ; Business cycles
    Date: 2005
  26. By: Mark A. Wynne
    Abstract: This paper provides an estimate of the measurement bias in the Harmonised Index of Consumer Prices (HICP) that the European Central Bank uses to define price stability in the euro area. The estimate is based on a comparison of the rate of increase in consumer prices as measured by the HICP and the responses to a question about recent changes in the cost of living on the European Commission’s monthly Harmonised Consumer Survey (HCS). I find that the HICP may overstate the true rate of inflation by about 1.0 to 1.5 percentage points a year.
    Keywords: Euro ; Inflation (Finance)
    Date: 2005
  27. By: Marco Del Negro; Frank Schorfheide
    Abstract: The paper proposes a novel method for conducting policy analysis with potentially misspecified dynamic stochastic general equilibrium (DSGE) models and applies it to a New Keynesian DSGE model along the lines of Christiano, Eichenbaum, and Evans (JPE 2005) and Smets and Wouters (JEEA 2003). We first quantify the degree of model misspecification and then illustrate its implications for the performance of different interest rate feedback rules. We find that many of the prescriptions derived from the DSGE model are robust to model misspecification.
    Date: 2005
  28. By: Tony Cavoli (School of Economics, University of Adelaide); Ramkishen S. Rajan (School of Public Policy, George Mason University)
    Abstract: This paper develops a simple model to examine the reasons behind the capital inflow surges into selected Asian economies in the 1990s prior to the financial crisis of 1997-98. The simple analytical model reveals that persistent uncovered interest differentials and consequent capital inflows may be a consequence of complete sterilization, perfect capital mobility, sluggish response of interest rates to domestic monetary disequilibrium, or some combination of all three. Using the model as an organizing framework, the paper undertakes a series of related simple empirical tests of the dynamic links between international capital flows and the extent to which they are sterilized and uncovered interest rate differentials (UIDs) in the five crisis-hit economies (Indonesia, Korea, Malaysia, the Philippines and Thailand) over the period 1990:1 to 1997:5.
    Keywords: Capital flows, East Asia, interest rates, monetary sterilization, reserves
    JEL: F30 F32 F41
  29. By: Arturo Estrella; Anthony P. Rodrigues
    Abstract: The econometrics literature contains a variety of two-sided tests for unknown breakpoints in time-series models with one or more parameters. This paper derives an analogous one-sided test that takes into account the direction of the change for a single parameter. In particular, we propose a sup t statistic, which is distributed as a normalized Brownian bridge. The method is illustrated by testing whether the reaction of monetary policy to inflation has increased since 1959.
    Keywords: Time-series analysis ; Monetary policy ; Inflation (Finance)
    Date: 2005
  30. By: Fernando N. de Oliveira (IBMEC Business School - Rio de Janeiro and Central Bank of Brazil); Walter Novaes (PUC/RJ)
    Abstract: Between 1999 and 2002, Brazil's Central Bank sold expressive amounts of dollar indexed debt and foreign exchange swaps. This paper shows that in periods of high volatility of the exchange rate, first semester of 1999 and second semester of 2002, the Central Bank of Brazil increased the foreign exchange hedge, but the financial institutions used this to reduce their foreign exchange exposure. In contrast, increases in foreign hedge during periods of low volatility of the exchange rate were transferred to the productive sector.
    Keywords: foreign exchange swaps, central bank interventions, foreign exchange risk
    JEL: E58 E52 F31
    Date: 2005–12–15
  31. By: Ilker Domac; Eray M. Yucel
  32. By: Andrea Vaona; Stefano Schiavo
    Abstract: Two major findings of the empirical literature on the connec- tion between inflation and output growth is that their relationship is non linear and that there exists a threshold inflation level be- low which inflation has a positive impact on growth and above which inflation has a negative impact on growth. In this paper we adopt a semiparametric estimator and we show that the first finding holds true even dropping the specification assumptions typical of parametric models. We also show that a threshold level does exist and it is around 10% for developed countries and 15% for developing ones. However, below the threshold level inflation does not appear to have a positive impact on growth, rather it does not have any substantial effect on it.
    Keywords: Inflation, Growth
    JEL: E31 O49 C14
    Date: 2005
  33. By: Hakan Kara; Hande Kucuk Tuger
  34. By: Yuksel Gormez; Forrest Capie
  35. By: Gauti B. Eggertsson
    Abstract: This paper details the microfoundations of the model presented in Staff Report no. 234, "Great Expectations and the End of the Depression." It defines the Markov perfect equilibrium formally in the nonlinear model, discusses in some detail the approximation method used and the order of accuracy of this approximation, and gives proofs of two propositions not proved in Staff Report no. 234. In addition, this paper states a proposition that shows the equivalence between the linear quadratic approximation in Staff Report no. 234 and a first order approximation to the exact nonlinear conditions of the government in the Markov perfect equilibrium defined here.
    Keywords: Econometric models ; Equilibrium (Economics) ; Rational expectations (Economic theory) ; Price levels
    Date: 2005
  36. By: Michelle L. Barnes; Jose A. Lopez
    Abstract: The Monetary Control Act of 1980 requires the Federal Reserve System to provide payment services to depository institutions through the twelve Federal Reserve Banks at prices that fully reflect the costs a private-sector provider would incur, including a cost of equity capital (COE). Although Fama and French (1997) conclude that COE estimates are “woefully” and “unavoidably” imprecise, the Reserve Banks require such an estimate every year. We examine several COE estimates based on the Capital Asset Pricing Model (CAPM) and compare them using econometric and materiality criteria. Our results suggest that the benchmark CAPM applied to a large peer group of competing firms provides a COE estimate that is not clearly improved upon by using a narrow peer group, introducing additional factors into the model, or taking account of additional firm-level data, such as leverage and line-of-business concentration. Thus, a standard implementation of the benchmark CAPM provides a reasonable COE estimate, which is needed to impute costs and set prices for the Reserve Banks’ payments business.
    Keywords: Capital assets pricing model ; Payment systems
    Date: 2005

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