nep-cba New Economics Papers
on Central Banking
Issue of 2006‒09‒30
forty-one papers chosen by
Alexander Mihailov
University of Reading

  1. A Comparison of Five Federal Reserve Chairmen: Was Greenspan the Best? By Ray C. Fair
  2. The danger of inflating expectations of macroeconomic stability: heuristic switching in an overlapping generations monetary model By Alex Brazier; Richard Harrison; Mervyn King; Tony Yates
  3. A Structuralist Model of the Small Open Economy in the Short, Medium and Long Run By Hian Teck Hoon; Edmund S Phelps
  4. UK monetary regimes and macroeconomic stylised facts By Luca Benati
  5. Monetary Cooperation in the North American Economy By David Laidler
  6. The New Keynesian Phillips Curve for a Small Open Economy By Pål Boug, Ådne Cappelen and Anders Rygh Swensen
  7. The New Keynesian Phillips Curve in the United States and the euro area: aggregation bias, stability and robustness By Bergljot Barkbu; Vincenzo Cassino; Aileen Gosselin-Lotz; Laura Piscitelli
  8. Empirical Phillips Curves in OECD Countries: Has There Been A Common Breakdown? By Doyle, Matthew
  9. Misperceptions and monetary policy in a New Keynesian model By Jarkko J""skel"; Jack McKeown
  10. Monetary policy and private sector misperceptions about the natural level of output By Jarkko J""skel"; Jack McKeown
  11. Monetary policy and data uncertainty By Jarkko J""skel"; Tony Yates
  12. Forecasting using Bayesian and information theoretic model averaging: an application to UK inflation By George Kapetanios; Vincent Labhard; Simon Price
  13. Financial Structure and its Impact on the Convergence of Interest Rate Pass-through in Europe. A Time-varying Interest Rate Pass-through Model By Schwarzbauer, Wolfgang
  14. Foreign exchange market interventions as monetary policy By Post, Erik
  15. Why are federal central banks more activist? By Hein Roelfsema
  16. The price puzzle: fact or artefact? By Efrem Castelnuovo; Paolo Surico
  17. Bank capital, asset prices and monetary policy By David Aikman; Matthias Paustian
  18. What Drives Heterogeneity in Foreign Exchange Rate Expectations : Deep Insights from a New Survey By Christian Dreger; Georg Stadtmann
  19. Real and Nominal UK Interest Rates, ERM Membership and Inflation Targeting By Reschreiter, Andreas
  20. Pricing-to-market, sectoral shocks and gains from monetary cooperation By Bastiaan Verhoef
  21. Panel Cointegration and the Neutrality of Money By Westerlund, Joakim; Costantini, Mauro
  22. The Euro Changeover and its Effects on Price Transparency and Inflation. By Giovanni Mastrobuoni; Wioletta Dziuda
  23. Will it float? The New Keynesian Phillips curve tested on OECD panel data By Roger Bjørnstad and Ragnar Nymoen
  24. Supply shocks and currency crises : the policy dilemma reconsidered By García-Fronti, Javier; Miller, Marcus; Zhang, Lei
  25. 'Real-world' mortgages, consumption volatility and the low inflation environment By Sebastian Barnes; Gregory Thwaites
  26. Real Exchange Rate Dynamics With Endogenous Distribution Costs By Mulraine, Millan L. B.
  27. Wealth and consumption: an assessment of the international evidence By Vincent Labhard; Gabriel Sterne; Chris Young
  28. What caused the early millennium slowdown? Evidence based on vector autoregressions By Gert Peersman
  29. Accounting for the source of exchange rate movements: new evidence By Katie Farrant; Gert Peersman
  30. Resolving banking crises - an analysis of policy options By Misa Tanaka; Glenn Hoggarth
  31. What do current account reversals in OECD countries tell us about the US case? By Leo de Haan; Hubert Schokker; Anastassia Tcherneva
  32. The welfare benefits of stable and efficient payment systems By Stephen Millard; Matthew Willison
  33. Are Output Growth-Rate Distributions Fat-Tailed? Some Evidence from OECD Countries By Giorgio Fagiolo; Mauro Napoletano; Andrea Roventini
  34. A model of bank capital, lending and the macroeconomy: Basel I versus Basel II By Lea Zicchino
  35. Determinants of long-term interest rates in the Scandinavian countries By Suzan Hol
  36. Modelling the cross-border use of collateral in payment systems By Mark J Manning; Matthew Willison
  37. Stratégie monétaire des économies émergentes : les écueils de la dollarisation By Jean-François Ponsot
  38. Finland`s Experiences and Challenges in the Euro Zone By Markku Kotilainen
  39. Reflexiones sobre la política cambiaria en México By Guerrero, Carlos; Urzúa, Carlos M.
  40. What Affects the Remittances of Turkish Workers : Turkish or German Output? By Sule Akkoyunlu; Konstantin A. Kholodilin
  41. Monetary reform in times of Charles II (1679-1686): Aspects concerning the issued dispositions. By Cecilia Font de Villanueva

  1. By: Ray C. Fair
    Date: 2006–09–22
  2. By: Alex Brazier; Richard Harrison; Mervyn King; Tony Yates
    Abstract: The volatility of inflation and output has fallen in most advanced economies in the 1990s and 2000s. We use a monetary overlapping generations model to discuss the cause and durability of this macroeconomic change. In that model, agents' decision rules require them to make forecasts of future inflation, which, because of shocks to productivity, is uncertain. Agents make forecasts of inflation using two rules of thumb or 'heuristics'. One is based on lagged inflation, the other on an inflation target announced by the central bank. They switch between those heuristics based on an imperfect assessment of how each has performed in the past. The way the economy propagates productivity shocks into inflation depends on the proportion of agents using each. Movements in that proportion generate fluctuations in small sample measures of economic volatility. We use this simple model of heuristic switching to contrast the performance of monetary policy rules. We find that, relative to the rule that would be optimal under rational expectations, a rule that responds to both productivity shocks and inflation expectations better stabilises the economy but does not prevent agents switching between heuristics. Finally, we study the impact of introducing an explicit inflation target, which can be used by agents as a simple heuristic, into an economy that did not previously have one. Depending on the heuristics agents have access to before the introduction of the target, this can result in reduced inflation volatility.
  3. By: Hian Teck Hoon (School of Economics and Social Sciences, Singapore Management University); Edmund S Phelps (Columbia University)
    Abstract: Open-economy macroeconomics contains a monetary model in the Keynesian tradition that is deemed serviceable for analyzing the short run and a nonmonetary neoclassical model thought capable of handling the long run. But do the Keynesian and neoclassical models meet the challenges thrown out by the main events of the past few decades—the ’80s shock to Europe from the sharp increase of external real interest rates; the kind of speculative shock experienced in the U.S. and parts of northern Europe in the second half of the ’90s: the prospect of new industries emerging in the future with needs for new capital; and what may have been an important shock in the U.S.: the large Kennedy cut in income taxes in 1964? We first indicate that the effects of these shocks on the open economy are not well captured by either the standard Keynesian model or the standard neoclassical theory. Next we provide a careful development of a nonmonetary model of the equilibrium path of the real exchange rate, share price level,as well as natural output, employment and interest that contains “trading frictions” of the customer-market type. We then examine its implications for the above kinds of shocks not only over the medium run but over the short run and the long run as well. The structuralist model we develop also provides an explanation for the dollar’s weakening and accompanying decline in U.S. employment from early 2002 to late 2004 (and prediction of subsequent recovery) resting on belated apprehensions over the scheduled explosion over future decades of Medicare and Social Security outlays for the baby boomers and alarm over the large tax cuts enacted in spite of this prospect.
    Keywords: structuralist model; share price; real exchange rate; employment
    JEL: E24 F3 F4
    Date: 2005–05
  4. By: Luca Benati
    Abstract: We exploit the marked changes in UK monetary arrangements since the metallic standards era to investigate continuity and changes across monetary regimes in key macroeconomic stylised facts in the United Kingdom. We find that, historically, inflation persistence has been the exception, rather than the rule, with inflation estimated to have been highly persistent only during the period between the floating of the pound, in June 1972, and the introduction of inflation targeting, in October 1992. As a corollary, our results clearly reject Mishkin's explanation for time variation in the extent of the Fisher effect, favouring instead Barsky's theory. We document a remarkable stability across regimes in the correlation between inflation and the rates of growth of both narrow and broad monetary aggregates at the very low frequencies, thus countering the Whiteman-McCallum criticism of Lucas. The post-1992 inflation-targeting regime appears to have been characterised, to date, by the most stable macroeconomic environment in recorded UK history, with the volatilities of the business-cycle components of real GDP, national accounts aggregates, and inflation measures having been, post-1992, systematically lower than for any of the pre-1992 monetary regimes/historical periods, often markedly so, as in the case of inflation and real GDP. The Phillips correlation between inflation and unemployment was flattest under the gold standard, steepest between 1972 and 1992. In line with Ball, Mankiw and Romer, evidence points towards a positive correlation between mean inflation and the steepness of the trade-off. We show how Keynes, in his dispute with Dunlop and Tarshis on real wage cyclicality, was entirely right: during the inter-war period, real wages were strikingly countercyclical. By contrast, under inflation targeting they have been, so far, strongly procyclical.
  5. By: David Laidler (University of Western Ontario)
    Abstract: The economic integration of North America, unlike that of Europe, has no parallels on the political front, and U.S. economic and political interests are world-wide, while those of Canada and Mexico are predominantly regional. These facts have important implications for the degree of policy integration, not least in monetary matters, that is feasible within NAFTA. Each member has an interest in the monetary stability of the others, but a common currency -- even a pegged exchange rate system -- is not desirable without a significantly greater degree of labour market integration than currently exists, and without a willingness on the part of the U.S. authorities to subordinate national to regional interests in their policy making. Absent these preconditions, monetary stability within NAFTA is best achieved by each country pursuing its own domestic stability, while maintaining the current high degree of formal and informal communications about economic conditions and policy intentions implicit in current arrangements.
    Keywords: NAFTA; economic integration; currency unions; exchange rate regimes; monetary policy; inflation targets
    JEL: E41 E58 E61 F15 F33 F42
    Date: 2006
  6. By: Pål Boug, Ådne Cappelen and Anders Rygh Swensen (Statistics Norway)
    Abstract: The New Keynesian Phillips Curve (NKPC) has become the benchmark model for understanding inflation in modern monetary economics. One reason for the popularity is the microfoundation of the model, which decomposes agents' behaviour into price adjustments and deviations of the price level from its target. The empirical relevance of the NKPC is, however, a matter of debate as recent studies reveal that some supportive evidence depends crucially on the econometric methods applied. We show how to evaluate the features of the model using cointegration techniques and tests based on both single-behavioural equations and cointegrated VAR models. Our results indicate that the forward-looking part of the NKPC is most likely at odds with Norwegian data. By contrast, we establish a well-specified dynamic model interpreted as a standard backward-looking mark-up price equation. We also demonstrate that the dynamic mark-up model forecasts well post-sample and during a major change in the monetary policy regime, which certainly is strong evidence in favour of this model. Consequently, we conclude that taking account of forward-looking behaviour when modelling consumer price inflation in Norway seems unnecessary to arrive at a well-specified model by econometric criteria.
    Keywords: The New Keynesian Phillips Curve; mark-up pricing; single-equation estimation methods; encompassing tests; cointegrated vector autoregressive models and equilibrium correction models.
    JEL: C51 C52 E31 F31
    Date: 2006–05
  7. By: Bergljot Barkbu; Vincenzo Cassino; Aileen Gosselin-Lotz; Laura Piscitelli
    Abstract: In the recent past, the empirical literature on the New Keynesian Phillips Curve (NKPC) has grown rapidly. The NKPC has been shown to describe satisfactorily the relationship between inflation and marginal cost both for the United States and the euro area. However, little attention has been given so far to the stability and robustness of the parameters in the estimated NKPC. In this paper, we aim to help fill this gap. After estimating hybrid NKPCs on US and euro-area data using the generalised method of moments and having found that our results are broadly in line with previous findings, we subject our estimated NKPCs to a thorough stability analysis. We find that the estimated coefficients for the United States are stable, whereas those for the euro area are considerably less stable. We then investigate the possible reasons for this instability. One explanation, explored using the Andrews' test, is the presence of structural breaks. Another possibility is the presence of an aggregation bias, which we investigate by estimating NKPCs for the three largest euro-area economies: Germany, France and Italy. At this disaggregated level, the fit of the NKPC improves, but the coefficients are still unstable. Furthermore, the disaggregated analysis indicates the presence of structural breaks in the three largest euro-area economies.
  8. By: Doyle, Matthew
    Abstract: Recent work on U.S. data calls into question the ability of simple Phillips curve models to forecast inflation. This paper asks whether there is similar evidence of a breakdown in the forecasting ability of Phillips curve models in other OECD countries. The results suggests that the ability of a Phillips curve to out-forecast simpler models has deteriorated in many OECD countries. The evidence is less clear as to whether this breakdown can be attributed to structural breaks in the parameters of the Phillips curve
    Keywords: Phillips curve, structural breaks, forecast breakdown
    JEL: E3
    Date: 2006–09–25
  9. By: Jarkko J""skel"; Jack McKeown
    Abstract: This paper studies the consequences for the monetary policy design of information shortages on the part of the private sector. We model these shortages as exogenous shocks to expected output, which through an IS curve, disturb demand and output themselves. We constrain policymakers to follow Taylor-like rules but allow them to optimise coefficients: we find that the presence of misperceptions makes the optimised Taylor rule respond more aggressively to inflation and the output gap. We also find that if the policymaker is uncertain about misperceptions, then it is less costly to assume they are pervasive when they are not than the reverse. In other words, setting policy on the basis that the private sector is subject to misperceptions is a 'robust' policy
  10. By: Jarkko J""skel"; Jack McKeown
    Abstract: In this paper we illustrate, using a simple model of monetary policy, the welfare costs of the private sector and/or the central bank being uncertain about the natural level of output. It turns out that monetary policy strategies that put less weight on output stabilisation can offset some of these welfare costs.
  11. By: Jarkko J""skel"; Tony Yates
    Abstract: One of the problems facing policymakers is that recent releases of data are liable to subsequent revisions. This paper discusses how to deal with this, and is in two parts. In the normative part of the paper, we study the design of monetary policy rules in a model that has the feature that data uncertainty varies according to the vintage. We show how coefficients on lagged variables in optimised simple rules for monetary policy increase as the relative measurement error in early vintages of data increases. We also explore scenarios when policymakers are uncertain by how much measurement error in new data exceeds that in old data. An optimal policy can then be one in which it is better to assume that the ratio of measurement error in new compared to old data is larger, rather than smaller. In the positive part of the paper, we show that the response of monetary policy to vintage varying data uncertainty may generate evidence of apparent interest rate smoothing in interest rate reaction functions: but we suggest that it may not generate enough to account for what has been observed in the data.
  12. By: George Kapetanios; Vincent Labhard; Simon Price
    Abstract: In recent years there has been increasing interest in forecasting methods that utilise large data sets, driven partly by the recognition that policymaking institutions need to process large quantities of information. Factor analysis is a popular way of doing this. Forecast combination is another, and it is on this that we concentrate. Bayesian model averaging methods have been widely employed in this area, but a neglected alternative approach employed in this paper uses information theoretic based weights. We consider the use of model averaging in forecasting UK inflation with a large data set from this perspective. We find that an information theoretic model averaging scheme can be a powerful alternative both to the more widely used Bayesian model averaging scheme and to factor models.
  13. By: Schwarzbauer, Wolfgang (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)
    Abstract: So far studies concerned with the interest pass-through of monetary policy have not taken into account one central issue that arose in Europe in the late 1990s: the importance of financial structure for the convergence of monetary transmission. This study addresses this shortcoming. We estimate a time varying interest pass-through allowing us to test for the importance of financial structure and its impact on the convergence of the effects of monetary policy. We find convergence in banks' reaction to money market movements, which is additionally reduced in groups of countries with similar financial structure. Furthermore, there is a significant impact of financial structure on the extent of transmission of monetary policy impulses within the same month. Thus, differences in financial structure between countries must not be ignored when considering convergence of monetary transmission in Europe.
    Keywords: Convergence, Interest rate pass-through, EMU, Financial structure, Money and bank interest rates, Transmission mechanism
    JEL: E43 G21 E52
    Date: 2006–09
  14. By: Post, Erik (Department of Economics)
    Abstract: This paper sets up a simple model for interventions and interest rate setting assuming that the policy maker cares about deviations in inflation from a target level. Under a quadratic cost of interest rate adjustments and interventions the policy maker should use a combination of interest rate adjustment and interventions. According to the model interventions (purchases of foreign currency) will be negatively correlated with interest rate deviations from the steady state level but positively correlated with interest rate deviations pertaining to non-stabilizing motives or a binding zero lower bound. The model also predicts that interventions will be decreasing in inflation expectations and in the real exchange rate but increasing the expected interventions. Interventions are shown to be positively serially correlated if the policy maker cares about the future. Following the theoretical model closely two sets of regression results are presented using both Two Stage Least Squares and an Ordered Probit model. The empirical analysis uses daily intervention data for Australia, Japan and Sweden. Overall, the predictions of the model is supported in most dimensions indicating that interventions have been used in a way that is consistent with monetary policy considerations.
    Keywords: foreign exchange interventions; monetary policy; central banks
    JEL: E52 E58 F31
    Date: 2006–09–26
  15. By: Hein Roelfsema
    Abstract: This paper analyzes monetary policy making by a committee of regional representatives in a currency union with asymmetric shocks. By considering strategic delegation of monetary policy making, we show that regional representatives in a federal policy making committee may be more activist than the average citizen in their district. Hence, in our model federal central banks such as the ECB and the FED respond more aggressively to output shocks when compared to individual central banks.
    Keywords: Central Banking, Asymmetric Shocks, Federations, Strategic Delegation
    JEL: F33 F53 E58
    Date: 2006–09
  16. By: Efrem Castelnuovo; Paolo Surico
    Abstract: This paper re-examines the empirical evidence on the price puzzle and proposes a new theoretical interpretation. Using structural VARs and two different identification strategies based on zero restrictions and sign restrictions, we find that the positive response of prices to a monetary policy shock is historically limited to the subsamples associated with a weak central bank response to inflation. These subsamples correspond to the pre-Volcker period for the United States and the period prior to the introduction of the inflation targeting framework for the United Kingdom. Using a micro-founded New Keynesian monetary policy model for the US economy, we then show that the structural VARs are capable of reproducing the price puzzle from artificial data only when monetary policy is passive and hence multiple equilibria arise. In contrast, this model never generates on impact a positive inflation response to a policy shock. The omission in the VARs of a variable capturing the high persistence of expected inflation under indeterminacy is found to account for the price puzzle observed in actual data.
  17. By: David Aikman; Matthias Paustian
    Abstract: We study a general equilibrium model in which informational frictions impede entrepreneurs' ability to borrow and banks' ability to intermediate funds. These financial market frictions are embedded in an otherwise-standard dynamic New Keynesian model. We find that exogenous shocks have an amplified and more persistent effect on output and investment, relative to the case of perfect capital markets. The chief contribution of the paper is to analyse how these financial sector imperfections - in particular, those relating to the banking sector - modify our understanding of optimal monetary policy. Our main finding is that optimal monetary policy tolerates only a very small amount of inflation volatility. Given that similar results have been reported for models that abstract from banks, we conclude that assigning a non-trivial role for banks need not materially affect the properties of optimal monetary policy.
  18. By: Christian Dreger; Georg Stadtmann
    Abstract: Foreign exchange rate expectations play a central role in virtually all monetary models for the open economy. Therefore, it is extremely important to gain empirical insights into the expectations formation process. In this paper, we use a unique disaggregated data set to model the expectations of the Yen/USD exchange rate of about 50 leading foreign exchange rate professionals. The survey includes not only forecasts of the exchange rate, but also for macroeconomic fundamentals, like GDP growth, inflation, and interest rates. Different expectations of fundamentals might lead to different views of exchange rate dynamics. Using panel models, we are able to confirm the het-erogeneity of exchange rate expectations often detected by former authors. More impor-tant, we provide strong evidence regarding the likely source of heterogeneity. In line with forward looking models for the exchange rate, expected fundamentals have a sub-stantial impact on exchange rate expectations, thereby challenging the backward look-ing evidence of previous studies. However, the heterogeneity in the expectations of macroeconomic fundamentals is not sufficient to explain the heterogeneity in exchange rate expectations.
    Keywords: Exchange rate expectations, heterogeneity of expectations, expected fundamentals
    JEL: F31 F37 C23
    Date: 2006
  19. By: Reschreiter, Andreas (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)
    Abstract: This paper models the time-varying mean of the UK real and nominal short-term interest rate. Both rates mean revert to a time-varying central tendency in continuous-time interest rate models. Before and during British membership in the ERM, the mean of the real and nominal short rate have a strong negative correlation. Afterwards, when the UK implemented an inflation targeting policy, the mean of the real and nominal short rate are no longer negatively correlated, but instead have a strong positive correlation. The paper also reports empirical evidence of a relationship between the mean of the real and nominal short rate and inflation in the period before the departure from the ERM.
    Keywords: ERM, Inflation targeting, Nominal and real rates, Term structure model, UK
    JEL: E52 F33 G12
    Date: 2006–09
  20. By: Bastiaan Verhoef
    Abstract: Recent literature states that international monetary cooperation results in substantial welfare gains in an environment with imperfectly correlated sectoral shocks and with prices only set in firms (domestic) currency. However, empirical studies provide evidence that firms not only set their prices in their own currency, but in foreign currency as well. The question is whether the result of substantial welfare gains due to imperfectly correlated sector-specific shocks applies to the case where firms in the tradable sector apply pricing-to-market, i.e. prices are set in both domestic and foreign currency. This paper finds that this is not the case. For imperfectly correlated sectoral shocks and local currency pricing, welfare benefits of international monetary cooperation are fairly small.
    Keywords: nominal rigidities; international cooperation; local currency pricing
    JEL: E31 E52 F42
    Date: 2006–08
  21. By: Westerlund, Joakim (Department of Economics, Lund University); Costantini, Mauro (Department of Public Economics)
    Abstract: Most econometric methods for testing the proposition of long-run monetary neutrality rely on the assumption that money and real output do not cointegrate, a result that is usually supported by the data. This paper argues that these results can be attributed in part to the low power of univariate tests, and that a violation of the noncointegration assumption is likely to result in a nonrejection of the neutrality proposition. To alleviate this problem, two new and more powerful panel cointegration tests are proposed that can be used under very general conditions. The tests are then applied to a panel covering 10 countries between 1870 and 1986. The results suggest money and real output are cointegrated, and that the neutrality proposition therefore must be rejected.
    Keywords: Monetary Neutrality; Panel Cointegration Testing
    JEL: C12 C22 C23 E30 E50
    Date: 2006–08–09
  22. By: Giovanni Mastrobuoni; Wioletta Dziuda
    Abstract: Despite the expectations of economists that the euro changeover would have no effect on prices, we show that European consumers perceived the contrary. The data indicate that consumers based their perceptions about inflation on goods that are cheaper and more frequently purchased. We use this insight to develop and estimate a model of imperfect information that explains why these goods were subject to higher price growth after the changeover. The data indicate that some retailers, aware of the consumers' diffculties in adopting the new currency, used the changeover to increase profits by increasing prices. We also propose an explanation of why this effect was smaller in more concentrated retail markets.
    Keywords: euro, currency changeover, imperfect information, search costs, price setting.
    JEL: D83 F33 L11
    Date: 2005
  23. By: Roger Bjørnstad and Ragnar Nymoen (Statistics Norway)
    Abstract: Galí, Gertler and Lòpez-Salido (2005), GGL, assert that the hybrid New Keynesian Phillips curve, NPC, is robust to different choices of estimation procedure and so some forms of specification bias. Specifically, the dominance of forward-looking behavior is robust according to GGL. We assess the NPC on a panel data set from OECD countries and find that the forward rate of inflation dominates also on the panel data set. However, when variables consistent with alternative inflation models are introduced in the models, the forward term is no longer significant. Such an outcome is predicted by the incomplete competition model of inflation, ICM, meaning that the ICM encompasses the NPC. The opposite does not apply. The non-robustness of the OECD panel data NPC is in alignment with a previous encompassing test on euro-area data, as well as tests on data from the UK and from Norway. GGL on their part do not test the robustness of the NPC features with respect to existing inflation models.
    Keywords: New Keynesian Phillips Curve; forward looking price setting; panel data model; encompassing
    JEL: C23 C52 E12 E31
    Date: 2006–07
  24. By: García-Fronti, Javier (University of Warwick and CSGR, University of Warwick); Miller, Marcus (University of Warwick, Centre for Economic Policy Research and CSGR, University of Warwick); Zhang, Lei (University of Warwick and CSGR, University of Warwick)
    Abstract: The stylised facts of currency crises in emerging markets include output contraction coming hard on the heels of devaluation, with a prominent role for the adverse balance-sheet effects of liability dollarisation. In the light of the South East Asian experience, we propose an eclectic blend of the supply-side account of Aghion, Bacchetta and Banerjee (2000) with a demand recession triggered by balance sheet effects (Krugman, 1999). This sharpens the dilemma facing the monetary authorities - how to defend the currency without depressing the economy. But, with credible commitment or complementary policy actions, excessive output losses can, in principle, be avoided.
    Keywords: Supply and demand shocks ; financial crises ; contractionary devaluation ; Keynesian recession
    JEL: E12 E4 E51 F34 G18
    Date: 2006
  25. By: Sebastian Barnes; Gregory Thwaites
    Abstract: This paper considers the interaction between the microeconomic decisions facing households and the macroeconomic environment in a setting where households have `real-world' mortgage contracts. In particular, we consider the possible consequences of the important changes in the framework for setting monetary policy in the United Kingdom in recent decades that have coincided with a more stable and low inflation environment. We set a model of households with 'real-world' mortgages in a partial equilibrium overlapping generations framework calibrated to UK data. We find that the welfare gains of the change of regime would have been considerable. However, the baseline calibration of the model implies that the volatility of aggregate consumption growth would actually be higher in the steady state in the more stable environment of the 1990s regime. This is due to greater synchrony in the response of households to shocks, offsetting the smaller magnitude of macroeconomic shocks. This effect is amplified by higher levels of debt in the 1990s. The result that aggregate consumption volatility could be higher in the current regime suggests that the observed fall in aggregate consumption volatility cannot necessarily be attributed to the more stable macroeconomic environment and the role of mortgage debt. If this result applies, this would suggest that the observed fall in volatility may be due either to other factors or may be a transitional phenomenon rather than a feature of the new steady state.
  26. By: Mulraine, Millan L. B.
    Abstract: The importance of distribution costs in generating the deviations from the law of one price has been well documented. In this paper we show that a two-country flexible price dynamic general equilibrium model driven by exogenous innovations to technology, and with a localized distribution services sector can replicate the key dynamic features of the real exchange rate. In doing so, the paper identifies the importance of two key channels for real exchange rate dynamics. That is, we show: (i) that shocks in the real sector are important contributors to movements in the real exchange rate, and (ii) that the endogenous wedge created by distribution costs of traded goods is a significant source of fluctuation for the real exchange rate, and the overall macro-economy as a whole. The evidence presented here demonstrates that this model - without any nominal rigidities, can account for up to 89% of the relative volatility in the real exchange rate.
    Keywords: Distribution costs; Real exchange rate dynamics; Law of one price
    JEL: E32 F41 E37
    Date: 2006–09
  27. By: Vincent Labhard; Gabriel Sterne; Chris Young
    Abstract: The main objective of this paper is to offer a critique of the existing literature on the link between wealth and consumption, as captured by the long-run marginal propensity to consume from financial wealth (mpcw). The international evidence suggests that the mpcw varies considerably across countries, and new estimates are presented, based on structural vector autoregressions (VARs) for eleven OECD countries, which tend to confirm this finding. It is argued that there is little theoretical rationale for a wide cross-country dispersion of the mpcw, and that the cross-country differences in empirical estimates may in fact reflect difficulties in the measurement of wealth across countries and a failure to account for the shocks causing changes in both consumption and wealth. Using a suitable panel technique, it is found that the hypothesis of a common long-run mpcw across countries cannot be rejected consistently, and a plausible estimate is obtained for the cross-section of eleven OECD countries. This estimate is a little over 6%, broadly consistent with estimates used in a wide range of policy models.
  28. By: Gert Peersman
    Abstract: This paper uses a number of simple VAR models for the industrialised world, the United States and the euro area respectively to analyse the underlying shocks that may have caused the recent slowdown. The results of two identification strategies are compared. One is based on traditional zero restrictions and, as an alternative, an identification scheme based on more recent sign restrictions is proposed. The main conclusion is that the recent slowdown was caused by a combination of several shocks: a negative aggregate supply and aggregate spending shock, the increase of oil prices in 1999, and restrictive monetary policy in 2000. These shocks were more pronounced in the United States than the euro area. The results are somewhat different depending on the identification strategy. It is illustrated that traditional zero restrictions can have an influence on the estimated impact of certain shocks.
  29. By: Katie Farrant; Gert Peersman
    Abstract: This paper analyses the role of the real exchange rate in a structural vector autoregression framework for the United Kingdom, euro area, Japan and Canada versus the United States. A new identification strategy is proposed building on sign restrictions. The results are compared to the benchmark conventional approach of Clarida and Gali based on long-run zero restrictions. Although the restrictions are derived from the same theoretical model, the results are strikingly different. In contrast to the benchmark model, an important role for nominal shocks in explaining real exchange rate fluctuations is found.
  30. By: Misa Tanaka; Glenn Hoggarth
    Abstract: This paper develops a dynamic model to examine the ex-ante and ex-post implications of five policy options for resolving bank failures when the authorities cannot observe the level of non-performing loans (NPLs) held by individual banks. Under asymmetric information, we show that the first-best outcome is achievable when the authorities can close all banks that fail to raise a minimum level of new capital. But when the authorities cannot close banks and must rely on financial incentives to induce banks to liquidate their NPLs, recapitalisation using equity (Tier 1 capital) would be the second-best policy, whereas recapitalisation using subordinated debt (Tier 2 capital) is suboptimal. If the authorities do not wish to hold an equity stake in a bank, they should subsidise the liquidation of non-performing loans rather than inject subordinated debt. We also show that the cost of this subsidy can be reduced if it is offered in a menu that includes equity injection.
  31. By: Leo de Haan; Hubert Schokker; Anastassia Tcherneva
    Abstract: This study examines macro-economic developments around reversals in current account deficits in 29 OECD countries over four decades and draws some inferences for the present US deficit. Estimates of a probit model indicate that the deepness of the deficit itself, absence of spare production capacity and a beginning real depreciation are factors that increase the likelihood of a current account reversal in the following year. For the US each of these three indicators of a reversal are now on, making a near reversal probable. Over the past 40 years half of the current account deficit reversals in the OECD area were followed by a recession in the countries concerned.
    Keywords: Current account adjustment; US; forecasting reversals
    JEL: F32 F47
    Date: 2006–08
  32. By: Stephen Millard; Matthew Willison
    Abstract: The Bank of England's second core purpose is to maintain the stability of the financial system. Payment systems, by supporting transactions, are a key aspect of this. In this paper, we examine the importance of smoothly functioning payment systems to the economy by extending a recently developed theoretical model of banks. In the model the risk of theft implies a cost to using cash. This risk can be avoided by depositing cash in banks and transferring money through an interbank payment system. However, agents are then exposed to the risk that the payment system is unreliable. Agents will use a payment system (rather than cash) to make transactions if the system is sufficiently cheap to use and/or it is sufficiently reliable. We show that the introduction of a payment system that buyers and producers choose to use unambiguously increases social welfare if it expands the number of trades occurring in the economy. This is more likely the more reliable is the payment system. When the introduction of a payment system does not increase the number of trades, social welfare may increase or decrease depending on the trade-off between the risk of using cash and the risk that the payment system is unreliable. We again show that the more reliable is the payment system, the more likely welfare is increased by its introduction and we illustrate how this benefit might be quantified.
  33. By: Giorgio Fagiolo; Mauro Napoletano; Andrea Roventini
    Abstract: This work explores some distributional properties of aggregate output growth-rate time series. We show that, in the majority of OECD countries, output growth-rate distributions are well-approximated by symmetric exponential-power densities with tails much fatter than those of a Gaussian. Fat tails robustly emerge in output growth rates independently of: (i) the way we measure aggregate output; (ii) the family of densities employed in the estimation; (iii) the length of time lags used to compute growth rates. We also show that fat tails still characterize output growth-rate distributions even after one washes away outliers, autocorrelation and heteroscedasticity.
    Keywords: Output Growth-Rate Distributions, Normality, Fat Tails, Time Series, Exponential-Power Distributions, Laplace Distributions, Output Dynamics.
    Date: 2006–09–21
  34. By: Lea Zicchino
    Abstract: The revised framework for capital regulation of internationally active banks (known as Basel II) introduces risk-based capital requirements. This paper analyses the relationship between bank capital, lending and macroeconomic activity under the new capital adequacy regime. It extends a model of the bank-capital channel of monetary policy - developed by Chami and Cosimano - by introducing capital constraints . la Basel II. The results suggest that bank capital is likely to be less variable under the new capital adequacy regime than under the current one, which is characterised by invariant asset risk-weights. However, bank lending is likely to be more responsive to macroeconomic shocks.
  35. By: Suzan Hol (Statistics Norway)
    Abstract: The financial markets in a small open economy like the Scandinavian countries are influenced by international economic developments, especially in their major trading partners. This paper investigates to which degree nominal long-term interest rates in Norway, Sweden and Denmark are determined by fundamental domestic macroeconomic variables and by international economic conditions. Relating the level of interest rates to international macroeconomic variables also sheds some light on the degree of financial marketintegration. In Norway the currency risk, exchange rate regime, international debt and unemployment in Europe are significant in explaining the interest rate differential. In Sweden domestic and US inflation are important, while for Denmark domestic debt, domestic and US money stock, and less significantly US inflation are determinants of the interest rate differential. In these three countries with quite different economies the expectations hypothesis, the effect of domestic growth and unemployment and of international growth are not supported as determinants of long-term interest rate differentials.
    Keywords: long-term interst rates; expectation hypothesis; international macroeconomic influence; crowding out
    JEL: E43 E44
    Date: 2006–08
  36. By: Mark J Manning; Matthew Willison
    Abstract: Banks often rely on collateralised intraday liquidity from the central bank in order to be able to effect payments in a real-time gross settlement (RTGS) payment system. If a bank is holding insufficient eligible collateral in a particular country, and therefore cannot obtain credit from the local central bank, it may have to delay payments. This constitutes a liquidity risk to the system. Furthermore, a bank operating in multiple systems may face a mismatch between the location of its collateral holdings and liquidity needs. In this paper, we examine the extent to which the liquidity risk arising from such a mismatch may be mitigated by allowing cross-border use of collateral. We develop a two-country, two-bank model in which risk-neutral banks minimise expected costs with respect to their collateral choice in each country. In our baseline model, in which each bank faces a liquidity need in only one country, we find that liquidity risk is indeed reduced by cross-border use of collateral. This result holds despite the fact that banks may find it optimal to economise on their total holdings of collateral. However, when we extend the model to allow for the possibility that a bank faces liquidity needs in both countries simultaneously, the total quantum of collateral held is important. Indeed, when a bank finds it optimal to reduce its total holdings, there may be an increase in liquidity risk in at least one country when simultaneous liquidity demands are realised.
  37. By: Jean-François Ponsot (LEPII - Laboratoire d'Economie de la Production et de l'Intégration Internationale - [CNRS : FRE2664] - [Université Pierre Mendès-France - Grenoble II])
    Abstract: Cette recherche vise à dégager les implications d'un arrangement monétaire particulier -la dollarisation officielle et intégrale- à partir de l'étude du cas équatorien. Elle montre comment la dollarisation officielle et intégrale a introduit une stabilisation monétaire artificielle et instauré deux niveaux de fragilisation : (1) une insécurité macroéconomique, en raison d'une dynamique des taux d'intérêt et du crédit défavorable aux petites et moyennes entreprises ; (2) une insécurité financière liée à l'absence théorique de marges de manoeuvre sur la gestion de la liquidité et le prêt en dernier ressort. L'évolution des prérogatives de la Banque centrale est soulignée, notamment sur la question des mécanismes imaginés par les autorités équatoriennes pour limiter l'influence de l'insécurité macroéconomique et financière. L'impact de ces deux niveaux de fragilisation sur la croissance demeure néanmoins modeste, compte tenu d'un environnement favorable à l'accumulation de pétrodollars. Tant que les recettes d'exportation de pétrole demeureront élevées, les tendances déflationnistes du régime de dollarisation seront atténuées.
    Keywords: monnaie ; politique monétaire ; prêt ; banque centrale ; taux d'intérêt ; système financier ; dollar ; Equateur
    Date: 2006–09–25
  38. By: Markku Kotilainen
    Keywords: Economic and Monetary Union, EMU, Finland
    JEL: E30 E32 E42 E52 F33 F41 F42
    Date: 2006–09–27
  39. By: Guerrero, Carlos (Tecnológico de Monterrey, Campus Ciudad de México); Urzúa, Carlos M. (Tecnológico de Monterrey, Campus Ciudad de México)
    Abstract: El documento pasa revista a cinco posibles alternativas cambiarias que podrían contemplar las autoridades en el momento actual. La primera es seguir con el actual status quo. Una segunda alternativa es la dolarización unilateral. La tercera es dar más mandatos al Banco de México. Una cuarta alternativa es la fijación de una tasa de inflación socialmente óptima. Y una quinta alternativa, que nos parece la más razonable, es que la Comisión de Cambios establezca un régimen que permita la restauración de la competitividad del tipo de cambio.
    Keywords: México, política cambiaria, política monetaria, autonomía del banco central, tipo de cambio real
    JEL: E52 E58 F31 F41
    Date: 2006–03
  40. By: Sule Akkoyunlu; Konstantin A. Kholodilin
    Abstract: In this paper we examine the interactions between the remittances of the Turkish workers in Germany and the output both in Turkey and in Germany. In our analysis we use the new data set provided by the German monetary authorities, which was never before employed in the literature and which we consider as a more reliable source than the data sets used in the other studies. We show that the remittances positively respond to the changes in the German output and do not react at all to the changes in Turkish output. This finding is consistent with the "remittance maximization" and "inheritance" motives of the migrants' behavior.
    Keywords: Migration, remittances, Turkey, Germany
    JEL: F22 J61 E32
    Date: 2006
  41. By: Cecilia Font de Villanueva
    Abstract: During the reign of Carlos II drastic monetary reform was carried out, which once and for all ended the tremendous monetary instability that took place in Castile throughout the whole Seventeenth century. Between 1680 and 1686, six monetary rules were adopted. The path chosen to attain the stability was not easy due to the state of the coinage. The reform tried to provide the Kingdom with a currency properly valued for which it was later decreed the devaluation and then the subsequent removal of the circulating copper coins. Simultaneously, along with the gathered metal, new purely copper made coins were ordered with adjusted value. Once the stability of the lesser value coinage was obtained, the reach of the reform was extended to the gold and silver pieces to equate them to the new monetary values.
    Date: 2006–09

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