nep-cba New Economics Papers
on Central Banking
Issue of 2006‒09‒03
twenty-two papers chosen by
Alexander Mihailov
University of Essex

  1. Inflation Band Targeting and Optimal Inflation Contracts By Niklas J. Westelius; Frederic S. Mishkin
  2. Imperfect Transparency and Shifts in the Central Bank's Output Gap Target By Niklas J. Westelius
  3. Optimal Monetary Policy with Collateralized Household Debt and Borrowing Constraints By Tommaso Monacelli
  4. International Exchange Rate Systems - Where do we Stand? By Horst Siebert
  5. Conventional and Unconventional Approaches to Exchange Rate Modeling and Assessment By Menzie D. Chinn; Ron Alquist
  6. Modern Macroeconomics in Practice: How Theory is Shaping Policy By Patrick Kehoe; Varadarajan V. Chari
  7. Financial Globalization: A Reappraisal By M. Ayhan Kose; Eswar Prasad; Kenneth S. Rogoff; Shang-Jin Wei
  8. Globalization and Risk Sharing By Jaume Ventura; Fernando A. Broner
  9. The euro as invoicing currency in international trade. By Annette Kamps
  10. Which inflation to target? A small open economy with sticky wages indexed to past inflation. By A. Campolmi
  11. On the Usefulness of the Constrained Planning Problem in a Model of Money By Bhattacharya, Joydeep; Singh, Rajesh
  12. International Evidence on the Efficacy of new-Keynesian Models of Inflation Persistence By Oleg Korenok; Stanislav Radchenko; Norman R. Swanson
  13. Declining valuations and equilibrium bidding in central bank refinancing operations. By Christian Ewerhart; Nuno Cassola; Natacha Valla
  14. The behaviour of the real exchange rate: evidence from regression quantiles. By Kleopatra Nikolaou
  15. Macroeconomic implications of demographic developments in the euro area By Angela Maddaloni; Alberto Musso; Philipp Rother; Melanie Ward-Warmedinger; Thomas Westermann
  16. Sovereign debt restructuring : the Judge, the vultures and creditor rights By Miller, Marcus; Thomas, Dania
  17. Current account composition and sustainability of external debt (I) By G. Rossini; P. Zanghieri
  18. A Survey of the Effects of the Minimum Wage on Prices By Sara Lemos
  19. Money Metrics Welfare Measures in Imperfect Markets under Growth By Li, Chuan Zhong; Löfgren, Karl-Gustaf
  20. Quantifying the impact of structural reforms By Ekkehard Ernst; Gang Gong; Willi Semmler; Lina Bukeviciute
  21. Revisiting the Revolving Door: Capital Flight from Southeast Asia By Edsel L. Beja, Jr.
  22. The Anatomy of a Price Cut: Discovering Organizational Sources of the Costs of Price Adjustment By Mark J. Zbaracki; Mark Bergen; Daniel Levy

  1. By: Niklas J. Westelius (Hunter College); Frederic S. Mishkin (Graduate School of Business Columbia University)
    Abstract: In this paper we examine how target ranges work in the context of a Barro-Gordon (1983) type model, in which the time-inconsistency problem stems from political pressures from the government. We show that target ranges turn out to be an excellent way to cope with the time-inconsistency problem, and achieve many of the benefits that arise under practically less attractive solutions such as the conservative central banker and optimal inflation contracts. Our theoretical model also shows how an inflation targeting range should be set and how it should respond to changes in the nature of shocks to the economy
    Keywords: Inflation Band Targeting, Inflation Contract, Time-inconsistent policy
    JEL: E52 E58
    Date: 2006
  2. By: Niklas J. Westelius (Hunter College)
    Abstract: Despite a drastic increase in transparency in recent years, most central banks remain reluctant to reveal their future intended course of policy. This paper analyzes the case where the central bank’s output gap target is private information. It is assumed that the target is subject to temporary and persistent shocks motivated either by measurement errors of potential output or as a result of political pressure. Under imperfect transparency the public cannot observe the true degree of persistence of the shock to the target and must learn by observing past data. In this setting, the paper shows that the welfare implications of imperfect transparency critically depend on whether monetary policy is characterized by discretion or commitment. Indeed, under discretion imperfect transparency decreases inflation and output gap variability and thus increases welfare. Under commitment, the effect on inflation and output variability is ambiguous and depends on the degree of persistence of the shifts in the output target. Welfare, however, is shown to unambiguously decline under imperfect transparency and commitment.
    Keywords: Transparency, Monetary Policy, Discretion, Commitment
    JEL: E5 E52 E61
    Date: 2006
  3. By: Tommaso Monacelli
    Abstract: We study optimal monetary policy in an economy with nominal private debt, borrowing constraints and price rigidity. Private debt reflects equilibrium trade between an impatient borrower, who faces an endogenous collateral constraint, and a patient saver, who engages in consumption smoothing. Since inflation can positively affect borrower's net worth, monetary policy optimally balances the incentive to offset the price stickiness distortion with the one of marginally relaxing the borrower's collateral constraint. We find that the optimal volatility of inflation is increasing in three key parameters: (i) the borrower's weight in the planner's objective function; (ii) the borrower's impatience rate; (iii) the degree of price flexibility. In general, however, deviations from price stability are small for a small degree of price stickiness. In a two-sector version of our model, in which durable price movements can directly affect the ability of borrowing, the optimal volatility of (non-durable) inflation is more sizeable. In our context, and relative to simple Taylor rules, the Ramsey-optimal allocation entails a partial smoothing of real durable goods prices.
    JEL: E24 E44 E5
    Date: 2006–08
  4. By: Horst Siebert
    Abstract: This paper analyzes institutional arrangements for exchange rate systems and reviews what we know. It looks at the foreign exchange market, different balance of payment situations in which countries find themselves and the necessary exchange rate adjustments. It studies the options that are available to countries in choosing their exchange rate system (type of nominal anchor, nominal anchor versus real target and the degree of sovereignty to be given up) and reviews the historical experience for multilateral options. The actual system is a fragile low-inflation central bank dominated arrangement. Options for the future rest on quite a few idealistic ideas. In addition to choosing the exchange rate system, adopting the right exchange rate is also addressed.
    Keywords: Exchange rate systems, Balance of payments situations, External and internal equilibrium, Choosing the exchange rate system, Unilateral and multilateral arrangements, Options for the future, Universal money
    JEL: E E5 E42 E58 E61 F31 F32 F33
    Date: 2006–08
  5. By: Menzie D. Chinn; Ron Alquist
    Abstract: We examine the relative predictive power of the sticky price monetary model, uncovered interest parity, and a transformation of net exports and net foreign assets. In addition to bringing Gourinchas and Rey’s new approach and more recent data to bear, we implement the Clark and West (forthcoming) procedure for testing the significance of out-of-sample forecasts. The interest rate parity relation holds better at long horizons and the net exports variable does well in predicting exchange rates at short horizons in-sample. In out-of-sample forecasts, we find evidence that our proxy for Gourinchas and Rey’s measure of external imbalances outperforms a random walk at short horizons as do some of other models, although no single model uniformly outperforms the random walk forecast.
    JEL: F31 F47
    Date: 2006–08
  6. By: Patrick Kehoe; Varadarajan V. Chari
    Abstract: Theoretical advances in macroeconomics made in the last three decades have had a major influence on macroeconomic policy analysis. Moreover, over the last several decades, the United States and other countries have undertaken a variety of policy changes that are precisely what macroeconomic theory of the last 30 years suggests. The three key developments that have shaped macroeconomic policy analysis are the Lucas critique of policy evaluation due to Robert Lucas, the time inconsistency critique of discre-tionary policy due to Finn Kydland and Edward Prescott, and the development of quantitative dynamic stochastic general equilibrium models following Finn Kydland and Edward Prescott.
    JEL: E21 E4 E43 E5 E52 E58 E6 E62 E65 H2 H25 H3
    Date: 2006–08
  7. By: M. Ayhan Kose; Eswar Prasad; Kenneth S. Rogoff; Shang-Jin Wei
    Abstract: The literature on the benefits and costs of financial globalization for developing countries has exploded in recent years, but along many disparate channels with a variety of apparently conflicting results. We attempt to provide a unified conceptual framework for organizing this vast and growing literature. This framework allows us to provide a fresh synthetic perspective on the macroeconomic effects of financial globalization, both in terms of growth and volatility. Overall, our critical reading of the recent empirical literature is that it lends some qualified support to the view that developing countries can benefit from financial globalization, but with many nuances. On the other hand, there is little systematic evidence to support widely-cited claims that financial globalization by itself leads to deeper and more costly developing country growth crises.
    JEL: F2 F3 F4 G1
    Date: 2006–08
  8. By: Jaume Ventura; Fernando A. Broner
    Abstract: This paper presents a theoretical study of the e¤ects of globalization on risk sharing and welfare. We model globalization as a gradual and exogenous increase in the fraction of goods that are tradable. In the absence of frictions, globalization opens new goods markets and raises welfare. We assume, however, that countries cannot commit to pay their debts. Unlike the previous literature, and motivated by changes in the institutional setup of emerging-market borrowing, we also assume that countries cannot discriminate between domestic and foreign creditors when paying their debts. Although globalization still opens new goods markets, we find that it can also open or close some asset markets. The net e¤ect on risk sharing and welfare of this process of creation and destruction of markets might be either positive or negative depending on a variety of factors that the theory highlights.
    JEL: E24 F34 F36 G15
    Date: 2006–08
  9. By: Annette Kamps (Kiel Institute for the World Economy, Düsternbrooker Weg 120, 24105 Kiel, Germany.)
    Abstract: This paper investigates the determinants of currency invoicing in international trade. Although the currency of invoicing is central for the transmission of monetary policy, empirical research on this topic is scarce due to a lack of data. With a new extensive invoicing dataset and a panel model analysis this paper shows that a country’s membership or prospective membership of the EU plays a decisive role in the choice of the euro as invoicing currency. The role of the euro as vehicle currency is increasing but still limited when compared to the U.S. dollar. Monetary instability and low product differentiation favour vehicle pricing in U.S. dollar. An increase of euro invoicing due to higher exchange rate volatility supports the role of the euro as vehicle currency, however. High market power defined as the share of a country’s total exports to world exports and membership of the euro area make invoicing in the home currency (euro) more likely. JEL Classification: F41, F42, L11.
    Keywords: International trade, currency invoicing, panel data.
    Date: 2006–08
  10. By: A. Campolmi
    Date: 2005
  11. By: Bhattacharya, Joydeep; Singh, Rajesh
    Abstract: In this paper, we study a decentralized monetary economy with a specified set of markets, rules of trade, an equilibrium concept, and a restricted set of policies and derive a set of equilibrium (monetary) allocations. Next we set up a simpler constrained planning problem in which we restrict the planner to choose from a set that contains the set of equilibrium allocations in the decentralized economy. If there is a government policy that allows the decentralized economy to achieve the constrained planner's allocation, then it is the optimal policy choice. To illustrate the power of such analyses, we solve such planning problems in three monetary environments with limited communication. The upshot is that solving constrained planning problems is an extremely "efficient" (easy and quick) way of deriving optimal policies for the corresponding decentralized economies.
    Keywords: planning problems, overlapping generations, random relocation model
    JEL: E4
    Date: 2006–08–23
  12. By: Oleg Korenok (Department of Economics, VCU School of Business); Stanislav Radchenko (Department of Economics, University of North Carolina at Charlotte); Norman R. Swanson (Department of Economics, Rutgers University)
    Abstract: In this paper we take an agnostic view of the Phillips curve debate, and carry out an empirical investigation of the relative and absolute efficacy of Calvo sticky price (SP), sticky information (SI), and sticky price with indexation models (SPI), with emphasis on their ability to mimic inflationary dynamics. In particular, we look at evidence for a group of 13 OECD countries, and we consider three alternative measures of inflationary pressure, including the output gap, labor share, and unemployment. We find that the Calvo SP and the SI models essentially perform no better than a strawman constant inflation model, when used to explain inflation persistence. Indeed, virtually all inflationary dynamics end up being captured by the residuals of the estimated versions of these models. We find that SPI model is preferable because it captures the type of strong inflationary persistence that has in the past characterized the economies of the countries in our sample. However, two caveats to this conclusion are that improvement in performance is driven mostly by the time series part of the model (i.e. lagged inflation) and that the SPI model overemphasizes inflationary persistence. Thus, there appears to be room for improvement via either modified versions of the above models, or via development of new models, that better "track" inflation persistence.
    Keywords: sticky price, sticky information, empirical distribution, model selection
    JEL: E12 E3 C32
    Date: 2006–06
  13. By: Christian Ewerhart (Institute for Empirical Research in Economics (IEW), Winterthurerstrasse 30, CH-8006 Zurich, Switzerland.); Nuno Cassola (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Natacha Valla (Banque de France, 39, rue Croix-des-Petits-Champs, F-75049 Paris Cedex 01, France.)
    Abstract: It is argued that bidders in liquidity-providing central bank operations should typically possess declining marginal valuations. Based on this hypothesis, we construct an equilibrium in central bank refinancing operations organised as variable rate tenders. In the case of the discriminatory pricing rule, bid shading does not disappear in large populations. The predictions of the model are shown to be consistent with the data for the euro area. JEL Classification: D44, E52.
    Keywords: Open market operations, uniform price auction, discriminatory auction, Eurosystem.
    Date: 2006–08
  14. By: Kleopatra Nikolaou (Warwick Business School, Finance Group, Univeristy of Warwick, Coventry, CV32 7AL, United Kingdom.)
    Abstract: We test for mean reversion in real exchange rates using a recently developed unit root test for non-normal processes based on quantile autoregression inference in semi-parametric and non-parametric settings. The quantile regression approach allows us to directly capture the impact of different magnitudes of shocks that hit the real exchange rate, conditional on its past history, and can detect asymmetric, dynamic adjustment of the real exchange rate towards its long run equilibrium. Our results suggest that large shocks tend to induce strong mean reverting tendencies in the exchange rate, with half lives less than one year in the extreme quantiles. Mean reversion is faster when large shocks originate at points of large real exchange rate deviations from the long run equilibrium. However, in the absence of shocks no mean reversion is observed. Finally, we report asymmetries in the dynamic adjustment of the RER. JEL Classification: F31.
    Keywords: Real exchange rate,purchasing power parity, quantile regression.
    Date: 2006–08
  15. By: Angela Maddaloni (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alberto Musso (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Philipp Rother (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Melanie Ward-Warmedinger (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Thomas Westermann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper examines the macroeconomic consequences of future demographic trends for economic growth, financial markets and public finances. It shows that in the absence of reforms and responses by economic agents, the currently projected demographic trends imply a decline in average real GDP growth and a severe burden in terms of pay-as-you-go pension and health care systems. Population ageing will change the financial landscape, with a potentially larger role for financial intermediaries and asset prices. All this points to a need to closely monitor demographic change also from a monetary policy perspective. While population projections are surrounded by considerable uncertainty and the effects of demographic change tend to be drawn out, the magnitude of the potential effects calls for an early recognition of this issue. This paper provides some input to the examination of possible policy issues.
    Date: 2006–08
  16. By: Miller, Marcus (Department of Economics, CEPR and CSGR, University of Warwick); Thomas, Dania (CSGR, University of Warwick)
    Abstract: What role did the US courts play in the Argentine debt swap of 2005? What implications does this have for the future of creditor rights in sovereign bond markets? The judge in the Argentine case has, it appears, deftly exploited creditor heterogeneity – between holdouts seeking capital gains and institutional investors wanting a settlement – to promote a swap with a supermajority of creditors. Our analysis of Argentine debt litigation reveals a ‘judge-mediated’ sovereign debt restructuring, which resolves the key issues of Transition and Aggregation - two of the tasks envisaged for the IMF’s still-born Sovereign Debt Restructuring Mechanism. For the future, we discuss how judge-mediated sovereign debt restructuring (together with creditor committees) could complement the alternative promoted by the US Treasury, namely collective action clauses in sovereign bond contracts
    Keywords: Sovereign debt crises ; debt restructuring ; holdout creditors ; collective action clauses
    JEL: F34 K41 K49
    Date: 2006
  17. By: G. Rossini; P. Zanghieri
    Date: 2006
  18. By: Sara Lemos
    Abstract: It is well established in the literature that minimum wage increases compress the wage distribution. Firms respond to these higher labour costs by reducing employment, reducing profits, or raising prices. While there are hundreds of studies on the employment effect of the minimum wage, there are merely a handful of studies on its profit effects, and only a couple of dozen studies on its price effects. Furthermore, a comprehensive survey on minimum wage price effects is not available in the literature. Given the policy relevance of this neglected issue, in this paper we summarise and critically compare the available evidence on the effects of minimum wages on prices.
    Keywords: minimum wage; employment; labour costs; cost shock; pass-through
    JEL: J38
    Date: 2006–05
  19. By: Li, Chuan Zhong (Uppsala University, Box 513); Löfgren, Karl-Gustaf (Department of Economics, Umeå University)
    Abstract: This paper shows how utility based welfare measures in dynamic general equilibrium under imperfect markets can be transferred into a money metrics. In order to do this, we need to price forward looking components measured in units of utility. The typical comprehensive quasi-static welfare measure contains a core that looks like a comprehensive (green) NNP component, as well as additional consumer surplus terms for both consumption goods and the externality. In addition, it contains a forward looking component with the discounted value of the marginal externality as the function to be integrated over time is also required. To accomplish this, we need a price index that is independent of the market basket, or to assume that the marginal utility of income is constant over time. With respect to local welfare measures it turn out that growth in traditional NNP will surprisingly work, provided that we condition on a positive average marginal rate of return of investment, and use an augmented genuine saving concept.
    Keywords: Welfare measurement under growth; imperfect markets; utility versus money metrics
    JEL: D61 D91 Q01
    Date: 2006–08–28
  20. By: Ekkehard Ernst (Corresponding author: OECD, Economics Department, 2, Rue André Pascal, 75775 Paris Cedex 16, France.); Gang Gong (School of Economics and Management, Tsinghua University, Beijing 100084, China.); Willi Semmler (New School and SCEPA, New York, and CEM, Bielefeld University. Contacts: The New School for Social Research, 65 Fifth Avenue, New York, NY 10003, USA.); Lina Bukeviciute (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We estimate a dynamic intertemporal model with non-clearing markets that mimics features of European labour markets, such as sticky nominal wages and sluggish adjustment of employment to shocks for 15 OECD countries. The estimates include a measure for the degree of labour market sluggishness that compares well with standard indicators of product and labour market regulation. Calibration of the model on a selected country sample confirms its explanatory power in comparison with the standard competitive markets model. In a second step, the measure for labour market sluggishness is used as a policy variable and model variants are simulated in order to assess the extent to which the countries would have performed better with more flexible labour markets. These policy experiments show that an increase in labour market flexibility reduces the volatility of consumption relative to production, improves intertemporal efficiency but entails higher employment risk for households. JEL Classification: E32, C61.
    Keywords: Nominal and real rigidities, non-clearing labour markets, business cycles, labour market reforms in OECD countries.
    Date: 2006–08
  21. By: Edsel L. Beja, Jr.
    Abstract: The paper revisits hypothesized direct linkages between external borrowing and capital flight. It reviews the cases of Indonesia, Malaysia, the Philippines and Thailand to see if such linkages exist. The results indicate that, indeed, large sums of capital flowed in and out of these four countries in a revolving door process. Thus, the results lend support to the need for: better domestic management of external debt, sound macroeconomic management and solid macro-organizational foundations (with the government at the centre of policy making), active management of capital flows, and effective domestic and international involvement and coordination in capital flows.
    Keywords: capital flight, external debt, revolving door, Southeast Asia
    JEL: F20 F30 O57
    Date: 2006–08
  22. By: Mark J. Zbaracki; Mark Bergen; Daniel Levy
    Abstract: The fact that organizations find it hard to change in response to shocks in the environment is a crucial feature of the economy. Yet we know little about why it is so difficult for organizations to adjust, and where these limitations come from. In an effort to discover some of these reasons we ground ourselves in the context of price adjustment, and present a qualitative analysis of an intensive ethnographic field study of the pricing practices at a one-billion dollar Midwestern industrial manufacturing firm and its customers. We go into depth on a specific episode, a price cut, which most vividly exemplifies the themes that emerged from our data. In the specific situation, market forces clearly dictate that the firm should cut prices, and everyone in the firm agrees with this assessment, suggesting a fairly straightforward price adjustment decision. Yet when we look deeper, and dissect how the firm implemented the price cut, we uncover a rich tapestry of frictions hidden within the organization. At their core, these frictions relate to how managers, in the context of an organization, attempt to apply the fundamental elements of economic theory. Essentially they face a series of constraints that make sense in the context of an organization trying to make these adjustments, but constraints that are rarely articulated or incorporated into economic understanding of price adjustment. We discover that the largest barriers to price adjustment are related to disputes arising from collisions between "partial models" used by different organizational participants as they confront fundamental economic issues. Often, these issues have not been settled and exist in a tenuous truce within the organization – and adjustment requires the organization to deal with them in order to react to these changes.
    Date: 2006–08

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