nep-cba New Economics Papers
on Central Banking
Issue of 2006‒03‒25
38 papers chosen by
Roberto Santillan

  1. Robustifying learnability By Robert J. Tetlow; Peter von zur Muehlen
  2. Sunspots and Monetary Policy By Jagjit S. Chadha; Luisa Corrado
  3. Forecasting economic aggregates by disaggregates By David F. Hendry; Kirstin Hubrich
  4. Consistent Targets and Optimal Monetary Policy: A Note By Stephen M. Miller; Huiping Yuan
  5. The Making of Optimal and Consistent Policy: An Analytical Framework for Monetary Models By Huiping Yuan; Stephen M. Miller; Langnan Chen
  6. The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy By Huiping Yuan; Stephen M. Miller
  7. The Dynamic (In)efficiency of Monetary Policy by Committee By RIBONI, Alessandro; RUGE-MURCIA, Francisco
  8. Does Monetary Policy Help Least Those Who Need It Most? By Michael S. Hanson; Erik Hurst; Ki Young Park
  9. Macroeconomic Instability in the European Monetary System? By Amalia Morales Zumaquero; Simón Sosvilla Rivero
  10. Measuring the Impact of Intervention on Exchange Market Pressure By Pierre L. Siklos; Diana N. Weymark
  11. Rational inattention, inflation developments and perceptions after the euro cash changeover By Michael Ehrmann
  12. Non-linear dynamics in the euro area demand for M1 By Alessandro Calza; Andrea Zaghini
  13. Investigating M3 Money Demand in the Euro Area : New Evidence Based on Standard Models By Christian Dreger; Jürgen Wolters
  14. Wage Indexation, Inflation Inertia, and the Cost of Disinflation - New version By Javier Gómez
  15. Dutch households' perceptions of economic growth and inflation By Céline Christensen; Peter van Els; Maarten van Rooij
  16. Cointegration in panel data with breaks and cross-section dependence By Anindya Banerjee; Josep Lluís
  17. Forecasting inflation with an uncertain output gap By Hilde C. Bjørnland; Leif Brubakk; Anne Sofie Jore
  18. Impulse Response Confidence Intervals for Persistent Data: What Have We Learned? By Pesavento, Elena; Rossi, Barbara
  19. Determinants of business cycle synchronisation across euro area countries By Uwe Böwer; Catherine Guillemineau
  20. Implied volatility of foreign exchange options: is it worth tracking? By Áron Gereben; Klára Pintér
  21. Intra-Daily FX Optimal Portfolio Allocation By Luc, BAUWENS; Walid, BEN OMRANE; Erick, Rengifo
  22. Arbitrage in the Foreign Exchange Market: Turning on the Microscope By Akram, Q. Farooq; Rime, Dagfinn; Sarno, Lucio
  23. Fiscal Shocks, the Current Account, and the Exchange Rate By Faik Koray; W. Douglas McMillin
  24. Credit Cycles and Macro Fundamentals By Siem Jan Koopman; Roman Kraeussl; Andre Lucas; Andre Monteiro
  25. Worst Case Portfolio Optimization and HJB-Systems By Ralf Korn; Mogens Steffensen
  26. Output and Inflation in Models of the Business Cycle with Nominal Rigidities: Some Counterfactual Evidence By Páez-Farrell, Juan
  27. Assessing Sticky Price Models Using the Burns and Mitchell Approach By Páez-Farrell, Juan
  28. Escape Dynamics: A Continuous—Time Approximation By Dmitri Kolyuzhnov; Anna Bogomolova; Sergey Slobodyan
  29. Uncertainty Determinants of Corporate Liquidity By Christopher F. Baum, Mustafa Caglayanm, Andreas Stephan and Oleksandr Talavera
  30. Banks and Innovation: Microeconometric Evidence on Italian Firms By Luigi Benfratello; Fabio Schiantarelli; Alessandro Sembenelli
  31. A Dynamic Model of Settlement By Thorsten Koeppl; Cyril Monnet; Ted Temzelides
  32. Artificial Neural Networks in Financial Modelling By Crescenzio Gallo; Giancarlo De Stasio; Cristina Di Letizia
  33. Estonia’s Accession to the EMU By Mart Sõrg
  34. Maximising Seigniorage and Inflation Tax: The Case of Belarus By D r. (elect.) Julia Korosteleva
  35. Crédito, Represión Financiera y Flujos de Capitales en Colombia 1974-2003 By Leonardo Villar Gómez; David M. Salamanca Rojas; Andrés Murcia Pabón
  36. Monetary Policy and Financial Sector Reform For Employment Creation and Poverty Reduction in Ghana By Gerald Epstein; James Heintz
  37. Fiscal competition, revenue sharing, and policy-induced agglomeration By Jean, HINDRIKS; Susana , PERALTA; Sholmo , WEBER
  38. Social Choice: Recent Developments By BOSSERT, Walter; WEYMARK, J.A.

  1. By: Robert J. Tetlow (Federal Reserve Board, 20th and C Streets, NW, Washington, D.C. 20551, USA.); Peter von zur Muehlen (von zur Muehlen & Associates, Vienna, VA 22181, USA.)
    Abstract: In recent years, the learnability of rational expectations equilibria (REE) and determinacy of economic structures have rightfully joined the usual performance criteria among the sought-after goals of policy design. Some contributions to the literature, including Bullard and Mitra (2001) and Evans and Honkapohja (2002), have made significant headway in establishing certain features of monetary policy rules that facilitate learning. However a treatment of policy design for learnability in worlds where agents have potentially misspecified their learning models has yet to surface. This paper provides such a treatment. We begin with the notion that because the profession has yet to settle on a consensus model of the economy, it is unreasonable to expect private agents to have collective rational expectations. We assume that agents have only an approximate understanding of the workings of the economy and that their learning the reduced forms of the economy is subject to potentially destabilizing perturbations. The issue is then whether a central bank can design policy to account for perturbations and still assure the learnability of the model. Our test case is the standard New Keynesian business cycle model. For different parameterizations of a given policy rule, we use structured singular value analysis (from robust control theory) to find the largest ranges of misspecifications that can be tolerated in a learning model without compromising convergence to an REE. In addition, we study the cost, in terms of performance in the steady state of a central bank that acts to robustify learnability on the transition path to REE.
    Keywords: monetary policy; learning, E-stability; learnability; robust control.
    JEL: C6 E5
    Date: 2006–02
  2. By: Jagjit S. Chadha; Luisa Corrado
    Abstract: A monetary economy subject to expectational sunspots is prone to instability, in the sense of multiple rational expectations equilibria. We show how to modify the policy rule to guarantee stability in the presence of expectational sunspots. The policy-maker must co-ordinate inflation dynamics by targeting each of lagged, current and expected inflation. We show that this solution maps directly into the timeless perspective by Woodford. Finally, we trace the responses in an artificial sunspot economy to the adoption of our rule and illustrate the extent to which macroeconomic persistence is reduced.
    Keywords: Sunspots; Indeterminacy; Monetary Policy Rules; Expectation Based Timeless Perspective.
    JEL: C63 C62 E00
    Date: 2006–01
  3. By: David F. Hendry (Department of Economics, Oxford University, Manor Road Building, Manor Road, Oxford, OX1 3UQ, United Kingdom); Kirstin Hubrich (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: We suggest an alternative use of disaggregate information to forecast the aggregate variable of interest, that is to include disaggregate information or disaggregate variables in the aggregate model as opposed to first forecasting the disaggregate variables separately and then aggregating those forecasts or, alternatively, using only lagged aggregate information in forecasting the aggregate. We show theoretically that the first method of forecasting the aggregate should outperform the alternative methods in population. We investigate whether this theoretical prediction can explain our empirical findings and analyse why forecasting the aggregate using information on its disaggregate components improves forecast accuracy of the aggregate forecast of euro area and US inflation in some situations, but not in others.
    Keywords: Disaggregate information; predictability; forecast model selection; VAR; factor models
    JEL: C51 C53 E31
    Date: 2006–02
  4. By: Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas); Huiping Yuan (Xiamen University)
    Abstract: Kydland and Prescott (1977) develop a simple model of monetary policy making, where the central bank needs some commitment technique to achieve optimal monetary policy over time. Although not their main focus, they illustrate the difference between consistent and optimal policy in a sequential-decision one-period world. We employ the analytical method developed in Yuan and Miller (2005), whereby the government appoints a central bank with consistent targets or delegates consistent targets to the central bank. Thus, the central bank s welfare function differs from the social welfare function, which cause consistent policy to prove optimal.
    JEL: E42 E52 E58
    Date: 2005–12
  5. By: Huiping Yuan (Xiamen University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas); Langnan Chen (Sun Yat-sen University)
    Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the central bank should adopt a loss function that differs from the social loss function. Carefully designing the central bank s loss function with consistent targets can harmonize optimal and consistent policy. This desirable result emerges from two observations. First, the social loss function reflects a normative process that does not necessarily prove consistent with the structure of the microeconomy. Thus, the social loss function cannot serve as a direct loss function for the central bank. Second, an optimal loss function for the central bank must depend on the structure of that microeconomy. In addition, this paper shows that control theory provides a benchmark for institution design in a game-theoretical framework.
    JEL: E42 E52 E58
    Date: 2006–02
  6. By: Huiping Yuan (Xiamen University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the social loss function cannot serve as a direct loss function for the central bank. Accordingly, we employ implementation theory to design a central bank loss function (mechanism design) with consistent targets, while the social loss function serves as a social welfare criterion. That is, with the correct mechanism design for the central bank loss function, optimal policy and consistent policy become identical. In other words, optimal policy proves implementable (consistent).
    JEL: E42 E52 E58
    Date: 2006–02
  7. By: RIBONI, Alessandro; RUGE-MURCIA, Francisco
    Abstract: This paper develops a model where the value of the monetary policy instrument is selected by a heterogenous committee engaged in a dynamic voting game. Committee members differ in their institutional power and, in certain states of nature, they also differ in their preferred instrument value. Preference heterogeneity and concern for the future interact to generate decisions that are dynamically ineffcient and inertial around the previously-agreed instrument value. This model endogenously generates autocorrelation in the policy variable and provides an explanation for the empirical observation that the nominal interest rate under the central bank’s control is infrequently adjusted.
    Keywords: Committees, status-quo bias, interest-rate smoothing, dynamic voting
    JEL: E58
    Date: 2006
  8. By: Michael S. Hanson (Economics Department, Wesleyan University); Erik Hurst (University of Chicago GSB, and NBER); Ki Young Park (University of Chicago)
    Abstract: We estimate the impact of U.S. monetary policy on the cross-sectional distribution of state economic activity for a 35-year panel. Our results indicate that the effects of policy have a significant history dependence, in that relatively slow growth regions contract more following contractionarymonetary shocks. Moreover, policy is asymmetric, in that expansionary shocks have less of a beneficial impact upon relatively slow growth areas. As a result, we conclude that monetary policy on average widens the dispersion of growth rates among U.S. states, and those locations initially at the low end of the cross-sectional distribution benefit least from any given change inmonetary policy.
    Keywords: Monetary policy, asymmetric effects, state dependence, regional business cycles
    JEL: E32 E59 R10
    Date: 2006–01
  9. By: Amalia Morales Zumaquero (Universidad de Málaga); Simón Sosvilla Rivero (FEDEA, UCM)
    Abstract: This paper analyses the impact of the establishment of the European Monetary System (EMS) on a number of macroeconomic variables, such as exchange rates, money, interest rates and prices for member countries participating in the Exchange Rate Mechanism (ERM). We examine the instability in terms of multiple structural breaks in the variance of the series. To that end, we employ two procedures: the OLS-based tests to detect multiple structural breaks, proposed by Bai and Perron (1998, 2003) and several procedures based on Information Criterion joint with the so called sequential procedure suggested by Bai and Perron (2003). Results indicate that there is some evidence of structural breaks in volatility across investigated variables, playing the realignments in the ERM a significant role in the reduction of volatility in some countries and sub-periods. In this sense, the results tend to support the hypothesis that the EMS has contributed to reduce the macroeconomic volatility of the member countries.
    Keywords: European Monetary System, multiple structural breaks, volatility
    JEL: C12 C22 F31 F33
    Date: 2006
  10. By: Pierre L. Siklos (Department of Economics and Viessmann Research Centre, Wilfrid Laurier University); Diana N. Weymark (Department of Economics, Vanderbilt University)
    Abstract: In this article, we introduce an index of ex ante exchange market pressure (EMP) that can be used as a benchmark against which to measure the effectiveness of sterilized intervention. Ex ante EMP is the change in the exchange rate that would have been observed if the policy authority had refrained from intervening and this policy decision had been correctly anticipated by rational agents. Ex post EMP measures the exchange market pressure under the policy actually implemented by the policy authority. We use a ratio of these two EMP measures to assess the effectiveness of sterilized intervention in Canada and Australia.
    Keywords: Exchange market pressure, exchange rate policy, foreign exchange intervention, Bank of Canada policy, Reserve Bank of Australia policy
    JEL: F31
    Date: 2006–03
  11. By: Michael Ehrmann (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: This paper uses the euro cash changeover to test theories of finite informationprocessing capacities on the side of consumers. It argues that the denomination of prices in a new currency has increased the information-processing requirements for consumers by more than for sellers, a wedge that can lead to price increases. The size of the wedge should depend on the complexity of the currency conversion rates. In line with this theory, the paper finds that the evolution of prices for food products around the cash changeover varied across countries, depending on the complexity of conversion rates. These changeover effects are found in particular for goods with prices below one euro sold in mid-priced stores. The paper also finds that cross-country differences in the mismatch of perceived and actual inflation in the aftermath of the cash changeover are linked to differences in the complexity of conversion rates.
    Keywords: rational inattention; perceived inflation; euro cash changeover
    JEL: D84 E31 E58 L11
    Date: 2006–02
  12. By: Alessandro Calza (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.); Andrea Zaghini (Banca d’Italia, Servizio Studi, Via Nazionale 91, 00184 Rome, Italy.)
    Abstract: This paper investigates possible non-linearities in the dynamics of the euro area demand for the narrow aggregate M1. A long-run money demand relationship is firstly estimated over a sample period covering the last three decades. While the parameters of the relationship are jointly stable, there are indications of non-linearity in the residuals of the error-correction model. This non-linearity is explicitly modelled using a fairly general Markov switch- ing error-correction model with satisfactory results. The empirical findings of the paper are consistent with theoretical predictions stemming from "buffer stock" and "target-threshold" models and with analogous empirical evidence for European countries and the US.
    Keywords: Euro area; cointegration; non-linear error correction; demand for money.
    JEL: E41 C22
    Date: 2006–02
  13. By: Christian Dreger; Jürgen Wolters
  14. By: Javier Gómez
    Abstract: A Statement of the Colombian Consitutional Court has mandated wage indexation on the basis of past inflation. A simple model with a wage price system, a real block, and an inflation targeting interest rule is calibrated to resemble price setting in the colombian economy and to analize the differing slope of the output inflation trade off for diferent specifications of wage indexation. The disinflation experiments show that backward looking indexation increases inflation inertia, decreases the effect of monetary policy, and increases the cost of disinflation. Shorter wage contracts and more frequent wage negotiations do not appear to have important effects on the cost of disinflation. Higher central bank credibility and the use of forward looking inflation expectations in wage negotiations decrease the cost of disinflation and may eventually lead to a boom.
    JEL: E1 E17 E52 E27 J30
  15. By: Céline Christensen; Peter van Els; Maarten van Rooij
    Abstract: This paper analysis the results of a survey on qualitative and quantitative perceptions and expectations of past, current and future macroeconomic developments among a representative household panel (DNB Household Survey). Perceptions of economic growth and inflation show a large dispersion. For the median respondents, however, the quantitative perceptions were found to be quite accurate. There is some evidence that the concept of economic growth is a more abstract notion for the general public than inflation. The results on qualitative and quantitative perceptions of current inflation could be interpreted as the Dutch public having a high level of inflation aversion. Those who have declared themselves more knowledgeable are also more actively involved in dealing with financial issues. The empirical evidence seems to corroborate that individuals with higher self-assessed knowledge levels are better informed indeed and have more accurate quantitative perceptions of economic growth and inflation. The survey also provides further insights on the connection between perceptions of current and past economic developments on the one hand, and expectations of future developments on the other. At the individual level there is a strong and robust correlation between expected growth and inflation for the next year and the perceptions of the current situation (rule of thumb behavior). But short-term expectations are also influenced by the views individuals hold on longer-term developments. Moreover, the results confirm the observed persistence in annual acroeconomic growth and inflation figures.
    Keywords: individual consumer perceptions and expectations; empirical knowledge of inflation and economic growth; rule of thumb behavior; DNB Household survey
    JEL: D12 D84 E30
    Date: 2006–03
  16. By: Anindya Banerjee (European University Institute, Department of Economics, Villa San Paolo, Via della Piazzuola 43, 50133 Florence, Italy.); Josep Lluís (University of Barcelona, Department of Econometrics, Statistics and Spanish Economy, Av. Diagonal 690, 08034 Barcelona, Spain.)
    Abstract: The power of standard panel cointegration statistics may be affected by misspecification errors if proper account is not taken of the presence of structural breaks in the data. We propose modifications to allow for one structural break when testing the null hypothesis of no cointegration that retain good properties in terms of empirical size and power. Response surfaces to approximate the finite sample moments that are required to implement the statistics are provided. Since panel cointegration statistics rely on the assumption of cross-section independence, a generalisation of the tests to the common factor framework is carried out in order to allow for dependence among the units of the panel.
    Keywords: Panel cointegration; structural break; common factors; cross-section dependence
    JEL: C12 C22
    Date: 2006–02
  17. By: Hilde C. Bjørnland (University of Oslo and Norges Bank (Central Bank of Norway)); Leif Brubakk (Norges Bank (Central Bank of Norway)); Anne Sofie Jore (Norges Bank (Central Bank of Norway))
    Abstract: The output gap (measuring the deviation of output from its potential) is a crucial concept in the monetary policy framework, indicating demand pressure that generates inflation. The output gap is also an important variable in itself, as a measure of economic fluctuations. However, its definition and estimation raise a number of theoretical and empirical questions. This paper evaluates a series of univariate and multivariate methods for extracting the output gap, and compares their value added in predicting inflation. The multivariate measures of the output gap have by far the best predictive power. This is in particular interesting, as they use information from data that are not revised in real time. We therefore compare the predictive power of alternative indicators that are less revised in real time, such as the unemployment rate and other business cycle indicators. Some of the alternative indicators do as well, or better, than the multivariate output gaps in predicting inflation. As uncertainties are particularly pronounced at the end of the calculation periods, assessment of pressures in the economy based on the uncertain output gap could benefit from being supplemented with alternative indicators that are less revised in real time.
    Keywords: Output gap, real time indicators, forecasting, Phillips curve
    JEL: C32 E31 E32 E37
    Date: 2006–03–17
  18. By: Pesavento, Elena; Rossi, Barbara
    Abstract: This paper is a comprehensive comparison of existing methods for constructing confidence bands for univariate impulse response functions in the presence of high persistence. Monte Carlo results show that Kilian (1998a), Wright (2000), Gospodinov (2004) and Pesavento and Rossi (2005) have favorable coverage properties, although they differ in terms of robustness at various horizons, median unbiasedness, and reliability in the possible presence of a unit or mildly explosive root. On the other hand, methods like Runkle’s (1987) bootstrap, Andrews and Chen (1994), and regressions in levels or first differences (even when based on pre-tests) may not have accurate coverage properties. The paper makes recommendations as to the appropriateness of each method in empirical work.
    Keywords: Local to unity asymptotics, persistence, impulse response functions
    JEL: C1 C2
    Date: 2006
  19. By: Uwe Böwer (University of Munich, Munich Graduate School of Economics, Kaulbachstr. 45, 80539 Munich, Germany.); Catherine Guillemineau (The Conference Board, 845 Third Avenue, New York, NY 10022-6679, USA)
    Abstract: We investigate the key factors underlying business cycle synchronisation in the euro area applying the extreme-bounds analysis. We examine both traditional determinants and new, EMU-specific policy and structural indicators over the past 25 years. Our evidence seems to support the endogeneity hypothesis of the optimum currency area criteria. The implementation of the single market intensified bilateral trade across euro area countries and contributed to higher business cycle symmetry. The introduction of the single currency led to an intensification of intra-industry trade which has become the main driving force ensuring the coherence of business cycles. In addition, the set of robust determinants of business cycle synchronisation has varied over time, depending on the difference phases of the European construction, with fiscal policy, in addition to industrial and financial structures, playing a greater role during the completion of the Single Market, while short-term interest rate differentials and cyclical services have become more determinant since Economic and Monetary Union.
    Keywords: business cycle synchronisation; extreme-bounds analysis; Economic and Monetary Union; trade.
    JEL: C21 E32 F15
    Date: 2006–02
  20. By: Áron Gereben (Magyar Nemzeti Bank); Klára Pintér (Magyar Nemzeti Bank)
    Abstract: Market analysts and central banks often use the implied volatility of FX options as an indicator of expected exchange rate uncertainty. The aim of our study is to investigate the limits of this statistic. We present some key factors that may deviate the value of implied volatility from the exchange rate variability expected by the market. These biasing factors are linked to the simplifying assumptions of the Black-Scholes option pricing model. Our empirical results show that forint/euro implied volatilities carry useful information about future exchange rate uncertainty when the forecast horizon is shorter than one month. However, implied volatility provides a biased estimate, and does not encompass the information included in other (GARCH, ARMA) predictors of volatility calculated from historical exchange rate data. These results are in line with the findings of similar analyses of other currency pairs.
    Keywords: option, volatility, exchange rate.
    JEL: G13
    Date: 2005
  21. By: Luc, BAUWENS (UNIVERSITE CATHOLIQUE DE LOUVAIN, Center for Operations Research and Econometrics (CORE)); Walid, BEN OMRANE (UNIVERSITE CATHOLIQUE DE LOUVAIN, Center for Operations Research and Econometrics (CORE)); Erick, Rengifo
    Abstract: We design and implement optimal foreign exchange portfolio allocations. An optimal allocation maximizes the expected return subject to a Value-at-Risk (VaR) constraint. Based on intradaily data, the optimization procedure is carried out at regular time intervals. For the estimation of the conditional variance from which the VaR is computed, we use univariate and multivariate GARCH models. The result for each model is given by the best intradaily investment recommendations in terms of the optimal weights of the currencies in the risk portfolio.
    Keywords: Optimal portfolio selection; Value-at-risk; GARCH models; Foreign exchange markets
    JEL: C32 C53 G11
    Date: 2006–02–16
  22. By: Akram, Q. Farooq (The Central Bank of Norway); Rime, Dagfinn (The Central Bank of Norway); Sarno, Lucio (University of Warwick and CEPR)
    Abstract: This paper investigates the presence and characteristics of arbitrage opportunities in the foreign exchange market using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency, obtained from Reuters on special order. We provide evidence on the frequency, size and duration of round-trip and one-way arbitrage opportunities in real time. The analys is unveils the existence of numerous short-lived arbitrage opportunities, whose size is economically significant across exchange rates and comparable across different maturities of the instruments involved in arbitrage. The duration of arbitrage opportunities is, on average, high enough to allow agents to exploit deviations from the law of one price, but low enough to explain why such opportunities have gone undetected in much previous research using data at lower frequency.
    Keywords: Exchange rates; arbitrage; foreign exchange microstructure
    JEL: F31 F41 G14 G15
    Date: 2006–02–15
  23. By: Faik Koray; W. Douglas McMillin
    Abstract: This paper investigates empirically, using a VAR model, the response of the exchange rate and the current account to fiscal policy shocks for the U.S. economy during the period 1981:3-2005:3. The results indicate that positive shocks to real government purchases generate a persistent increase in the budget deficit, a transitory expansionary effect on output, and a long-lived positive effect on the price level, but reduce the real interest rate. Simultaneously, and consistent with interest parity, the real exchange rate depreciates, and the current account improves. Negative shocks to net taxes also generate a persistent increase in the budget deficit, and the effects on the model variables are generally in the same direction, but are almost never significant. Our results indicate it is inappropriate to attribute rising current account deficits to expansionary fiscal policy shocks, even though these shocks generate long-lived increases in the budget deficit.
  24. By: Siem Jan Koopman (Vrije Universiteit Amsterdam); Roman Kraeussl (Vrije Universiteit Amsterdam); Andre Lucas (Vrije Universiteit Amsterdam); Andre Monteiro (Vrije Universiteit Amsterdam)
    Abstract: We study the relation between the credit cycle and macro-economic fundamentals in an intensity-based framework. Using rating transition and default data of U.S. corporates from Standard and Poor’s over the period 1980—2005 we directly estimate the credit cycle from the micro rating data. We relate this cycle to the business cycle, bank lending conditions, and financial market variables. In line with earlier studies, these variables appear to explain part of the credit cycle. As our main contribution, we test for the correct dynamic specification of these models. In all cases, the hypothesis of correct dynamic specification is strongly rejected. Moreover, if we account for the dynamic mis-specification, many of the variables thought to explain the credit cycle, turn out to be insignificant. The main exceptions are GDP growth, and to some extent stock returns and stock return volatilities. Their economic significance appears low, however. This raises the puzzle of which macro-economic fundamentals explain default and rating dynamics.
    Keywords: Credit cycles; Business cycles; Bank lending conditions; Unobserved component models; Intensity models
    JEL: G11 G21
    Date: 2006–03–08
  25. By: Ralf Korn (Fachbereich Mathematik, Universität Kaiserslautern); Mogens Steffensen (Department of Applied Mathematics and Statistics, University of Copenhagen)
    Abstract: We formulate a portfolio optimization problem as a game where the investor chooses a portfolio and his opponent, the market, chooses some market crashes. The asymmetry of the opponents' decision processes leads to a new and delicate generalization of the classical Hamilton-Jacob-Bellman equation in stochastic control. We characterize the optimal controls in general and specify them further in the cases of HARA, logarithmic, and exponential utility of the investor.
    Keywords: continuous-time game; asymmetric decisions; market crash; utility optimization
  26. By: Páez-Farrell, Juan (Cardiff Business School)
    Abstract: This paper examines the relationship between cyclical output and inflation in models commonly used for monetary policy analysis. This includes models that incorporate the New Keynesian, Fuhrer-Moore and backward-looking Phillips curves. The main finding is that these models imply a strong negative relationship between inflation and output, a result that is at odds with the data. The fact that New Keynesian models yield counterfactual implications is not new; the novelty of the paper lies in the fact that the finding extends to the other variants, such as the backward-looking Phillips Curve, which has been put forward as displaying superior dynamics.
    Keywords: nominal rigidities; monetary policy; Phillips Curve; Output; Inflation; Correlation
    JEL: E20 E31 E32 E52 E61
    Date: 2006–03
  27. By: Páez-Farrell, Juan (Cardiff Business School)
    Abstract: This paper evaluates sticky-price models using the methods proposed by Burns and Mitchell, focusing on the monetary aspects of the business cycle. Recent research has emphasised the responses of models to shocks at the expense its systematic component. Whereas sticky-price models have been successful at replicating impulse response functions from VARs, this paper highlights that they are unable to mimic the data for nominal variables. Moreover, the results are robust to the specification of the Phillips curve, including its backward-looking variant; calibrated values and the inclusion of fiscal policy shocks. Since being able to mimic the data is the lowest hurdle a model must pass, these results pose a challenge for New Keynesian-type models.
    Keywords: New Keynesian Models; Business Cycles; Correlations; Burns and Mitchell
    JEL: E32 E52 E58
    Date: 2006–03
  28. By: Dmitri Kolyuzhnov; Anna Bogomolova; Sergey Slobodyan
    Abstract: We extend a continuous—time approach to the analysis of escape dynamics in economic models with adaptive learning with constant gain. This approach is based on applying results of continuous—time version of large deviations theory to the diffusion approximation of the original discrete—time dynamics under learning. We characterize escape dynamics by analytically deriving the most probable escape point and mean escape time. The continuous—time approach is tested on the Phelps problem of a government controlling inflation while adaptively learning the approximate Phillips curve, studied previously by Sargent (1999) and Cho, Williams and Sargent (2002) (henceforth, CWS). We compare the results with simulations and the results obtained by CWS. We express reservations regarding applicability of escape dynamics theory to characterization of mean escape time for economically plausible values of constant gain in the model of CWS.We show that for these values of the gain simple considerations and formulae generate much better mean escape time results than the large deviations theory. We explain it by insufficient averaging near the point of self—confirming equilibrium for relatively large gains and suggest two changes which might help the approaches based on large deviation theory to work better in this gain interval.
    Keywords: Constant gain adaptive learning, E—stability, recursive least squares, large deviations theory.
    JEL: C62 C65 D83 E10 E17
    Date: 2006–01
  29. By: Christopher F. Baum, Mustafa Caglayanm, Andreas Stephan and Oleksandr Talavera
    Abstract: This paper investigates the link between the optimal level of non- financial firms’ liquid assets and uncertainty. We develop a partial equilibrium model of precautionary demand for liquid assets showing that firms change their liquidity ratio in response to changes in either macroeconomic or idiosyncratic uncertainty. We test this proposition using a panel of non-financial US firms drawn from the COMPUSTAT quarterly database covering the period 1993–2002. The results indicate that firms increase their liquidity ratios when macroeconomic uncertainty or idiosyncratic uncertainty increases.
    JEL: C23 D8 D92 G32
  30. By: Luigi Benfratello (University of Turin); Fabio Schiantarelli (Boston College and IZA Bonn); Alessandro Sembenelli (University of Turin)
    Abstract: In this paper we investigate the effect of local banking development on firms’ innovative activities, using a rich data set on innovation for a large number of Italian firms over the 1990’s. There is evidence that banking development affects the probability of process innovation, particularly for small firms and for firms in high(er) tech sectors and in sectors more dependent upon external finance. The evidence for product innovation is weaker. There is also some evidence that banking development reduces the cash flow sensitivity of fixed investment spending, particularly for small firms, and that it increases the probability they will engage in R&D.
    Keywords: banks, financial development, innovation, R&D, investment
    JEL: D24 G21 G38 O31 O33
    Date: 2006–03
  31. By: Thorsten Koeppl (Department of Economics, Queen's University); Cyril Monnet (DG Research, European Central Bank); Ted Temzelides (Department of Economics, University of Pittsburgh)
    Abstract: We investigate the role of settlement in a dynamic model of a payment system where the ability of participants to perform certain welfare-improving transactions is subject to random and unobservable shocks. In the absence of settlement, the full information first-best allocation cannot be supported due to incentive constraints. In contrast, this allocation is supportable if settlement is introduced. This, however, requires that settlement takes place with a sufficiently high frequency.
    Keywords: Payment Systems, Settlement, Mechanism Design
    JEL: E40 D82 C73
    Date: 2006–02
  32. By: Crescenzio Gallo; Giancarlo De Stasio; Cristina Di Letizia
    Abstract: The study of Artificial Neural Networks derives from first trials to translate in mathematical models the principles of biological “processing”. An Artificial Neural Network deals with generating, in the fastest times, an implicit and predictive model of the evolution of a system. In particular, it derives from experience its ability to be able to recognize some behaviours or situations and to “suggest” how to take them into account. This work illustrates an approach to the use of Artificial Neural Networks for Financial Modelling; we aim to explore the structural differences (and implications) between one- and multi- agent and population models. In one-population models, ANNs are involved as forecasting devices with wealth-maximizing agents (in which agents make decisions so as to achieve an utility maximization following non-linear models to do forecasting), while in multipopulation models agents do not follow predetermined rules, but tend to create their own behavioural rules as market data are collected. In particular, it is important to analyze diversities between one-agent and one-population models; in fact, in building one-population model it is possible to illustrate the market equilibrium endogenously, which is not possible in one-agent model where all the environmental characteristics are taken as given and beyond the control of the single agent.
    Keywords: artificial neural network, financial modelling, population model, market equilibrium.
    JEL: C53 C69 C90 D58
    Date: 2006–01
  33. By: Mart Sõrg (Institute of Finance and Accounting, University of Tartu)
    Abstract: CEE countries have passed the process of transition to market economy and eight of them, including Estonia, joined the European Union in 2004. Estonia has been very successful in the transition process, mainly owing to the currency board-based monetary system, which serves as a signal of commitment to prudent monetary policy and as a guarantee of sound money during the transition period. The current paper discusses the thirteen years of experience in operating the currency board-based monetary system in Estonia. Estonia’s accession to the European Union will soon be accompanied by membership of the Economic and Monetary Union (EMU). Here it is also explained why Estonia wants to join the EMU as fast as possible and what the prospects are to do it on time, at the beginning of 2007.
    Keywords: monetary systems, monetary policy, Economic and Monetary Union
    JEL: E42 E5 F33
    Date: 2005
  34. By: D r. (elect.) Julia Korosteleva
    Abstract: While most Central European countries, realising the inflationary potential of money creation, had by the mid-1990s switched to market instruments based monetary policy, Belarus continued to use money emission, so gaining seigniorage and inflation tax. The productivity of the inflation tax can be analysed by comparing the revenue actually raised from inflation tax with the revenue that could be raised if the quantity of money had risen at a constant rate. The present paper, based on Cagan’s (1956) seminal work ‘Monetary Dynamics of Hyperinflation’, analyses the effect of inflation on seigniorage revenue in Belarus and draws conclusions about the effectiveness of monetary policy in 1995-2002, and about the consequences of inflationary financing.
    JEL: C12 C22 E42 E52 G28
  35. By: Leonardo Villar Gómez; David M. Salamanca Rojas; Andrés Murcia Pabón
    Abstract: Este trabajo analiza los vínculos entre crédito doméstico, flujos externos de capital y regulación financiera en Colombia en el período comprendido entre 1974 y 2003. Para ese propósito se incluye una visión histórica sobre la evolución de las variables y se hacen análisis cuantitativos sobre los determinantes del grado de profundización financiera, utilizando métodos de descomposición contable y ejercicios econométricos sencillos. Se observa que los ciclos en el crédito doméstico al sector privado en Colombia han coincidido con ciclos en la misma dirección en los flujos externos de capital. Ese comportamiento procíclico del crédito ha sido reforzado además por la política de regulación financiera. Entre 1974 y 1991, la prociclicidad de la política surgió fundamentalmente del comportamiento de los coeficientes de encaje requerido. En el período más reciente, esos coeficientes se movieron en forma menos procíclica. Durante la crisis que se inició en 1998, incluso, la política de encajes fue abiertamente contracíclica. En esta última etapa, sin embargo, la introducción del impuesto a las transacciones financieras actuó en la dirección contraria y reforzó la caída en el crédito. El resultado neto es que el grado de profundización financiera en Colombia a finales de 2003 se ubicaba por debajo de los niveles que tenía en 1974. Esos niveles son extremadamente bajos en comparación con los de economías desarrolladas o con los de economías en desarrollo exitosas.
  36. By: Gerald Epstein; James Heintz
    Abstract: This report summarizes the findings of a UNDP-sponsored study on the structure of the financial sector, central bank policy, and employment outcomes in Ghana. The financial sector is the primary conduit through which monetary policy affects real economic outcomes, and monetary policy determines the resources available to financial institutions. Therefore, monetary policy must be coordinated with financial sector reforms in order to improve employment opportunities, reduce poverty and support human development. The report develops a critique of financial programming and inflation targeting, presents a series of empirical estimates on the impact of monetary policy variables in Ghana, and describes the elements of an alternative monetary policy. In addition, the report documents the institutional and structural constraints currently operating in the financial system which prevent the sector from facilitating investment, growth, and improved employment opportunities. Econometric estimates of the determinants of investment explicitly link financial variables to real economic activity. The report summarizes a series of financial sector reforms that would improve the financial sector's capacity to move Ghana onto an employment-intensive growth path.
    Keywords: Monetary policy, financial programming, inflation-targeting, financial reform, Ghana, employment
    JEL: E22 E24 E52 E58 O11
    Date: 2006
  37. By: Jean, HINDRIKS (UNIVERSITE CATHOLIQUE DE LOUVAIN, Center for Operations Research and Econometrics (CORE)); Susana , PERALTA; Sholmo , WEBER
    Abstract: Revenue sharing can be used to discourage low tax regions from competing for capital and firms with high tax regions. However, with heterogeneous regions, revenue sharing involves net transfers across regions and creates a “moral-hazard” problem - that is, regions may want to invest less in market fostering public good when the benefits are shared across nations. This paper analyzes these costs and benefits of revenue sharing. When asymmetric regions compete in capital income taxes only, we show that revenue sharing can be desirable for the high tax region if it is pushed far enough (i.e., J-curve effect), while tax harmonization is always harmful for the low tax region. When regions also compete through public investments, we find that tax competition distorts (downards) public investments. While revenue sharing discourages public investments due to moral-hazard effect, it remains beneficial in most cases. Moreover, there are new agglomeration forces resulting from public investments because the inflow of capital raises the incentive for public investments which in turn attract more capital. This leads to the possibility of policy-induced agglomeration (which is different from the classical agglomeration forces in the New Economic geography).
    Keywords: Heterogeneous Regions; Fiscal Federalism; Revenue Sharing; Moral Hazard; Agglomeration
    JEL: C72 H23 H70
    Date: 2005–12–15
  38. By: BOSSERT, Walter; WEYMARK, J.A.
    Abstract: In the past quarter century, there has been a dramatic shift of focus in social choice theory, with structured sets of alternatives and restricted domains of the sort encountered in economic problems coming to the fore. This article provides an overview of some of the recent contributions to four topics in normative social choice theory in which economic modelling has played a prominent role: Arrovian social choice theory on economic domains, variable-population social choice, strategy-proof social choice, and axiomatic models of resource allocation.
    Keywords: Social Choice, Arrow’s Theorem, Gibbard–Satterthwaite Theorem, Strategy-oofness, Fairness, Axiomatic Models of Resource Allocation
    JEL: D63
    Date: 2006

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