nep-cba New Economics Papers
on Central Banking
Issue of 2006‒12‒16
forty-nine papers chosen by
Alexander Mihailov
University of Reading

  1. Indeterminacy in a forward-looking regime-switching model By Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
  2. The conquest of South American inflation By Thomas Sargent; Noah Williams; Tao Zha
  3. Managing uncertainty through robust-satisficing monetary policy By Q. Farooq Akram; Yakov Ben-Haim; Øyvind Eitrheim
  4. Comparing Two Variants of Calvo-Type Wage Stickiness By Stephanie Schmitt-Grohe; Martin Uribe
  5. International Reserves Management and the Current Account By Joshua Aizenman
  6. Co-movement in sticky price models with durable goods By Charles T. Carlstrom; Timothy S. Fuerst
  7. Macroeconomic implications of changes in the term premium By Glenn D. Rudebusch; Brian P. Sack; Eric T. Swanson
  8. Deflationary shocks and monetary rules: an open-economy scenario analysis By Douglas Laxton; Papa N'Diaye; Paolo Pesenti
  9. Expectations and exchange rate dynamics: a state-dependent pricing approach By Anthony E. Landry
  10. The Effect of Monetary Policy on Real Commodity Prices By Jeffrey A. Frankel
  11. Trend inflation and inflation persistence in the New Keynesian Phillips curve By Timothy Cogley; Argia M. Sbordone
  12. Incorporating judgement in fan charts By Pär Österholm
  13. Real Time Representations of the Output Gap By Anthony Garratt; Kevin Lee; Emi Mise; Kalvinder Shields
  14. Real Time Representation of the UK Output Gap in the Presence of Trend Uncertainty By Anthony Garratt; Kevin Lee; Emi Mise; Kalvinder Shields
  15. Monetary policy transmission in the euro area:<br />New evidence from micro data on firms and banks By Jean-Bernard Chatelain; Andrea Generale; Philip Vermeulen; Michael Ehrmann; Jorge Martínez-Pagés; Andreas Worms
  16. New Findings on Firm Investment and Monetary Policy Transmission in the Euro Area By Jean-Bernard Chatelain; Andrea Generale; Ignacio Hernando; Philip Vermeulen; Ulf Von Kalckreuth
  17. Inflation measurement By David E. Lebow; Jeremy B. Rudd
  18. Monetary Policy in a Small Open Economy with a Preference for Robustness By Richard Dennis, Kai Leitemo and Ulf Soderstrom
  19. Does Model Uncertainty Lead to Less Central Bank Transparency? By Li Qin; Elefterios Spyromitros; Moïse Sidiropoulos
  20. Is Home Bias in Assets Related to Home Bias in Goods? By Eric van Wincoop; Francis E. Warnock
  21. Monetary policy and rejections of the expectations hypothesis By Ravenna , Federico; Seppälä , Juha
  22. The Nature of Exchange Rate Regimes By Michael W. Klein; Jay C. Shambaugh
  23. World Consistent Equilibrium Exchange Rates By Agnes Benassy-Quere; Amina Lahreche-Revil; Valerie Mignon
  24. Closing open economy models By Martin Bodenstein
  26. A model in which outside and inside money are essential By David C. Mills, Jr.
  27. An estimate of the inflation risk premium using a three-factor affine term structure model By J. Benson Durham
  28. Investing Under Model Uncertainty: Decision Based Evaluation of Exchange Rate and Interest Rate Forecasts in the US, UK and Japan By Anthony Garratt; Kevin Lee
  29. Government Spending and the Taylor Principle By Gisle James Natvik
  30. Changements de régime pour la persistance et la dynamique du taux d'intérêt réel américain By Nicolas Million
  31. In noise we trust? Optimal monetary policy with random targets By Ethan Cohen-Cole; Bogdan Cosmaciuc
  32. The impact of monetary policy signals on the intradaily euro-dollar volatility By Darmoul Mokhtar
  33. Efficiency and coordination of fiscal policy in open economies. By Gilbert KOENIG; Irem ZEYNELOGLU
  34. The Importance of Stock Market Returns in Estimated Monetary Policy Rules. By Jesus Vazquez
  35. Financial market imperfections and the impact of exchange rate movements By Nicolas Berman; Antoine Berthou
  36. Panel Cointegration Tests of the Fisher Effect By Westerlund Joakim
  37. Financial Versus Monetary Mercantilism-Long-run View of Large International Reserves Hoarding By Joshua Aizenman; Jaewoo Lee
  38. A Broad View of Macroeconomic Stability By José Antonio Ocampo
  39. PROPERTIES OF TWO U.S. INFLATION MEASURES (1985-2005) By Eva Vicente Martinez
  40. Price Dispersion By Ed Hopkins
  41. Business cycles: a role for imperfect competition in the banking system By Federico S. Mandelman
  42. Monetary and financial forces in the Great Depression By Satyajit Chatterjee; Dean Corbae
  43. Getting Rid of Keynes ? A reflection on the history of macroeconomics By Michel, DE VROEY
  44. The Emergence of Institutions By Santiago Sanchez-Pages; Stephane Straub
  45. Democracy, Rationality and Morality By Dennis C. Mueller
  46. The Long Term Growth Prospects of the World Economy: Horizon 2050 By Sandra Poncet
  47. How do FOMC actions and U.S. macroeconomic data announcements move Brazilian sovereign yield spreads and stock prices? By Patrice Robitaille; Jennifer E. Roush
  48. Comparison of pricing behaviour of firms in the euro area and Estonia By Aurelijus Dabušinskas; Martti Randveer
  49. QMM A Quarterly Macroeconomic Model of the Icelandic Economy By Ágeir Daníelsson; Lúdvík Elíasson; Magnús F. Gudmundsson; Björn A. Hauksson; Ragnhildur Jónsdóttir; Thorvardur Tjörvi Ólafsson; Thórarinn G. Pétursson

  1. By: Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
    Abstract: This paper is about the properties of Markov-switching rational expectations (MSRE) models. We present a simple monetary policy model that switches between two regimes with known transition probabilities. The first regime, treated in isolation, has a unique determinate rational expectations equilibrium, and the second contains a set of indeterminate sunspot equilibria. We show that the Markov switching model, which randomizes between these two regimes, may contain a continuum of indeterminate equilibria. We provide examples of stationary sunspot equilibria and bounded sunspot equilibria, which exist even when the MSRE model satisfies a generalized Taylor principle. Our result suggests that it may be more difficult to rule out nonfundamental equilibria in MRSE models than in the single-regime case where the Taylor principle is known to guarantee local uniqueness.
    Date: 2006
  2. By: Thomas Sargent; Noah Williams; Tao Zha
    Abstract: We infer determinants of Latin American hyperinflations and stabilizations by using the method of maximum likelihood to estimate a hidden Markov model that potentially assigns roles both to fundamentals in the form of government deficits that are financed by money creation and to destabilizing expectations dynamics that can occasionally divorce inflation from fundamentals. Our maximum likelihood estimates allow us to interpret observed inflation rates in terms of variations in the deficits, sequences of shocks that trigger temporary episodes of expectations driven hyperinflations, and occasional superficial reforms that cut inflation without reforming deficits. Our estimates also allow us to infer the deficit adjustments that seem to have permanently stabilized inflation processes. Our results show how the available inflation, deficit, and other macroeconomic data had left informed economists like Rudiger Dornbusch and Stanley Fischer undecided about the ultimate sources of inflation dynamics.
    Date: 2006
  3. By: Q. Farooq Akram (Norges Bank (Central Bank of Norway)); Yakov Ben-Haim (Technion - Israel Institute of Technology); Øyvind Eitrheim (Norges Bank (Central Bank of Norway))
    Abstract: We employ information-gap decision theory to derive a robust monetary policy response to Knightian parameter uncertainty. This approach provides a quantitative answer to the question: For a specified policy, how much can our models and data err or vary, without rendering the outcome of that policy unacceptable to a policymaker? For a given acceptable level of performance, the policymaker selects the policy that delivers acceptable performance under the greatest range of uncertainty. We show that such information-gap robustness is a proxy for probability of policy success. Hence, policies that are likely to succeed can be identified without knowing the probability distribution. We adopt this approach to investigate empirically the robust monetary policy response to a supply shock with an uncertain degree of persistence.
    Keywords: Knightian uncertainty, Monetary policy, Info-gap decision theory.
    JEL: E31 E52 E58 E61
    Date: 2006–10–23
  4. By: Stephanie Schmitt-Grohe; Martin Uribe
    Abstract: We compare two ways of modeling Calvo-type wage stickiness. One in which each household is the monopolistic supplier of a differentiated type of labor input (as in Erceg, et al., 2000) and one in which households supply a homogenous labor input that is transformed by monopolistically competitive labor unions into a differentiated labor input (as in Schmitt-Grohe and Uribe, 2006a,b). We show that up to a log-linear approximation the two variants yield identical equilibrium dynamics, provided the wage stickiness parameter is in each case calibrated to be consistent with empirical estimates of the wage Phillips curve. It follows that econometric estimates of New Keynesian models that rely on log-linearizations of the equilibrium dynamics are mute about which type of wage stickiness fits the data better. In the context of a medium-scale macroeconomic model, we show that the two variants of the sticky-wage formulation give rise to the same Ramsey-optimal dynamics, which call for low volatility of price inflation. Furthermore, under both specifications the optimized operational interest-rate feedback rule features a large coefficient on price inflation and a mute response to wage inflation and output.
    JEL: E31 E52
    Date: 2006–12
  5. By: Joshua Aizenman
    Abstract: The paper assesses the costs and benefits of active international reserve management (IRM), shedding light on the question of how intense should IRM be for an emerging market. In principle, an active IRM strategy could lower real exchange rate volatility induced by terms of trade shocks; provide self insurance against sudden stops; reduce the speed of adjustment of the current account; and even allow for higher growth if it fosters exports ("mercantilist" motive). The message of the report is mixed -- management of reserves is not a panacea. The mercantilist case for hoarding international reserves, as an ingredient of an export led growth strategy, is dubious. Done properly, IRM augments macro economic management in turbulent times, mitigating the impact of external adverse shocks and allowing for a smoother current account adjustment. These benefits are especially important for commodity exporting countries, and countries with limited financial development.
    JEL: F15 F32 F36 F4
    Date: 2006–12
  6. By: Charles T. Carlstrom; Timothy S. Fuerst
    Abstract: In an interesting paper Barsky, House, and Kimball (2005) demonstrate that in a standard sticky price model a monetary contraction will lead to a decline in nondurable goods production but an increase in durable goods production, so that aggregate output is little changed. This lack of co-movement between nondurables and durables is wildly at odds with the data and occurs because, by assumption, durable goods prices are relatively more flexible than nondurable goods prices. We investigate possible solutions to this puzzle: nominal wage stickiness and credit constraints. We demonstrate that by adding adjustment costs as in Topel-Rosen, the sticky wage model solves the co-movement puzzle and delivers reasonable volatilities.
    Keywords: Durable goods, Consumer
    Date: 2006
  7. By: Glenn D. Rudebusch; Brian P. Sack; Eric T. Swanson
    Abstract: Linearized New Keynesian models and empirical no-arbitrage macro-finance models offer little insight regarding the implications of changes in bond term premiums for economic activity. We investigate these implications using both a structural model and a reduced-form framework. We show that there is no structural relationship running from the term premium to economic activity, but a reduced-form empirical analysis does suggest that a decline in the term premium has typically been associated with stimulus to real economic activity, which contradicts earlier results in the literature.
    Keywords: Interest rates ; Economic forecasting ; Econometric models
    Date: 2006
  8. By: Douglas Laxton; Papa N'Diaye; Paolo Pesenti
    Abstract: The paper considers the macroeconomic transmission of demand and supply shocks in an open economy under alternative assumptions about whether the zero interest rate floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy relative to the rest of the world. Negative demand shocks have more prolonged and conspicuous effects on the economy when the ZIF is binding than when it is not binding. Positive supply shocks can actually extend the period of time over which the ZIF may be expected to bind. Economies that are more open hit the ZIF for a shorter period of time, and with less harmful effects. The implications of deflationary supply shocks depend on whether the shocks are concentrated in the tradables or the nontradables sector. Price-level-path targeting rules are likely to provide better guidelines for monetary policy in a deflationary environment, and have desirable properties in normal times when the ZIF is not binding.
    Keywords: Economic forecasting ; Monetary policy ; Interest rates ; Macroeconomics
    Date: 2006
  9. By: Anthony E. Landry
    Abstract: We introduce elements of state-dependent pricing and strategic complementarity into an otherwise standard New Open Economy Macroeconomics (NOEM) model. Relative to previousNOEM works, there are new implications for the dynamics of real and nominal economic activity: complementarity in the timing of price adjustment alters an open economy's response to monetary disturbances. Using a two-country Producer-Currency-Princing environment, our framework replicates key international features following a domestic monetary expansion: (i) a delayed surge in inflation across countries, (ii) a delayed overshooting of exchange rates, (iii)a J-curve dynamic in the domestic trade balance, and (iv) a high international output correlation relative to consumption correlation. Overall, the model is consistent with many emperical aspects of international economic fluctuations, while stressing pricing behavior and exchange rate effects highlighted in traditional Keynesian works.>
    Date: 2006
  10. By: Jeffrey A. Frankel
    Abstract: Commodity prices are back. This paper looks at connections between monetary policy, and agricultural and mineral commodities. We begin with the monetary influences on commodity prices, first for a large country such as the United States, then smaller countries. The claim is that low real interest rates lead to high real commodity prices. The theory is an analogy with Dornbusch overshooting. The relationship between real interest rates and real commodity prices is also supported empirically. One channel through which this effect is accomplished is a negative effect of interest rates on the desire to carry commodity inventories. The paper concludes with a consideration of implications for monetary policy.
    JEL: E4 E5 F3 Q0
    Date: 2006–12
  11. By: Timothy Cogley; Argia M. Sbordone
    Abstract: The New Keynesian Phillips curve (NKPC) asserts that inflation depends on expectations of real marginal costs, but empirical research has shown that purely forward-looking versions of the model generate too little inflation persistence. In this paper, we offer a resolution of the persistence problem. We hypothesize that inflation is highly persistent because of drift in trend inflation, a feature that many versions of the NKPC neglect. We derive a version of the NKPC as a log-linear approximation around a time-varying inflation trend and examine whether it explains deviations of inflation from that trend. We estimate the NKPC parameters jointly with those that define the inflation trend by estimating a vector autoregression with drifting coefficients and volatilities; the autoregressive parameters are constrained to satisfy the restrictions imposed by the NKPC. Our results suggest that trend inflation has been historically quite volatile and that a purely forward-looking model that takes these fluctuations into account approximates well the short-run dynamics of inflation.
    Keywords: Phillips curve ; Inflation (Finance)
    Date: 2006
  12. By: Pär Österholm
    Abstract: Within a decision-making group, such as the monetary-policy committee of a central bank, group members often hold differing views about the future of key economic variables. Such differences of opinion can be thought of as reflecting differing sets of judgement. This paper suggests modelling each agent's judgement as one scenario in a macroeconomic model. Each judgement set has a specific dynamic impact on the system, and accordingly, a particular predictive density - or fan chart - associated with it. A weighted linear combination of the predictive densities yields a final predictive density that correctly reflects the uncertainty perceived by the agents generating the forecast. In a model-based environment, this framework allows judgement to be incorporated into fan charts in a formalised manner.
    Date: 2006
  13. By: Anthony Garratt (School of Economics, Mathematics & Statistics, Birkbeck); Kevin Lee; Emi Mise; Kalvinder Shields
    Abstract: Methods are described for the appropriate use of data obtained and analysed in real time to represent the output gap. The methods employ cointegrating VAR techniques to model real time measures and realisations of output series jointly. The model is used to mitigate the impact of data revisions; to generate appropriate forecasts that can deliver economically-meaningful output trends and that can take into account the end-of-sample problems associated with the use of the Hodrick-Prescott filter in measuring these trends; and to calculate probability forecasts that convey in a clear way the uncertainties associated with the gap measures. The methods are applied to data for the US 1965q4-2004q4 and the improvements over standard methods are illustrated.
    Keywords: Output gap measurement, real time data, data revision, HP end-points, probability forecasts.
    JEL: E52 E58
    Date: 2006–12
  14. By: Anthony Garratt (School of Economics, Mathematics & Statistics, Birkbeck); Kevin Lee; Emi Mise; Kalvinder Shields
    Abstract: This paper describes an approach that accommodates in a coherent way three types of uncertainty when measuring the output gap. These are trend uncertainty (associated with the choice of model and de-trending technique), estimation uncertainty (with a given model) and data uncertainty (associated with the reliability of data). The approach employs VAR models to explain real time measures and realisations of output series jointly along with Bayesian-style ‘model averaging’ procedures. Probability forecasts provide a comprehensive representation of the output gap and the associated uncertainties in real time. The approach is illustrated using a real time dataset for the UK over 1961q2 — 2005q4.
    Keywords: Output gap, real time data, revisions, Hodrick-Prescott trend, exponential smoothing trend, moving average trend, model uncertainty, probability forecasts.
    JEL: E52 E58
    Date: 2006–12
  15. By: Jean-Bernard Chatelain (PSE - Paris-Jourdan Sciences Economiques - [CNRS : UMR8545] - [Ecole des Hautes Etudes en Sciences Sociales][Ecole Nationale des Ponts et Chaussées][Ecole Normale Supérieure de Paris], EconomiX - [CNRS : UMR7166] - [Université de Paris X - Nanterre]); Andrea Generale (Banca d´Italia - [Banca d´Italia]); Philip Vermeulen (ECB - European Central Bank - [European Central Bank]); Michael Ehrmann (ECB - European Central Bank - [European Central Bank]); Jorge Martínez-Pagés (Bank of Spain - [Bank of Spain]); Andreas Worms (Bundesbank - [Bundesbank])
    Abstract: This paper presents an overview of the results of a research project on monetary transmission pursued by the Eurosystem, which has analysed micro data on firms and banks in several countries of the euro area in great detail. There is strong empirical support for an interest rate channel working through firm investment. Furthermore, a credit channel can be identified with firm micro data. On the bank side, there is evidence that lending reacts differently to monetary policy according to bank balance sheet characteristics. In particular, banks that have a less liquid asset composition show a stronger loan supply response. This finding may be due to banks drawing on their liquid assets to cushion the effects of monetary policy on their loan portfolio, which is in line with the existence of close relationships between banks and their loan customers.
    Keywords: monetary policy transmission, interest rate channel, credit channel, euro area
    Date: 2006–12–11
  16. By: Jean-Bernard Chatelain (PSE - Paris-Jourdan Sciences Economiques - [CNRS : UMR8545] - [Ecole des Hautes Etudes en Sciences Sociales][Ecole Nationale des Ponts et Chaussées][Ecole Normale Supérieure de Paris], EconomiX - [CNRS : UMR7166] - [Université de Paris X - Nanterre]); Andrea Generale (Banca d´Italia - [Banca d´Italia]); Ignacio Hernando (Bank of Spain - [Bank of Spain]); Philip Vermeulen (ECB - European Central Bank - [European Central Bank]); Ulf Von Kalckreuth (Bundesbank - [Bundesbank])
    Abstract: In this paper we present comparable results on the determinants of firms' investment and their link to monetary policy. The results have been obtained by the Eurosystem Monetary Transmission Network. This network has produced a series of papers in which the use of micro data permits estimating and quantifying the relevance of two channels of monetary policy transmission: the nterest rate and the broad credit channel. The research findings provide evidence of an operative interest rate channel in all countries examined. Moreover, the results indicate that variables which proxy firms' financial conditions play a role. Firms characterised by weaker balance sheets<br />show higher liquidity sensitivity.
    Keywords: investment, monetary transmission, user cost of capital
    Date: 2006–12–11
  17. By: David E. Lebow; Jeremy B. Rudd
    Abstract: Inflation measurement is the process through which changes in the prices of individual goods and services are combined to yield a measure of general price change. This paper discusses the conceptual framework for thinking about inflation measurement and considers practical issues associated with determining an inflation measure's scope; with measuring individual prices; and with combining these individual prices into a measure of aggregate inflation. We also discuss the concept of "core inflation," and summarize the implications of inflation measurement for economic theory and policy.
    Date: 2006
  18. By: Richard Dennis, Kai Leitemo and Ulf Soderstrom
    Abstract: We use robust control techniques to study the effects of model uncertainty on monetary policy in an estimated, semi-structural, small-open-economy model of the U.K. Compared to the closed economy, the presence of an exchange rate channel for monetary policy not only produces new trade-offs for monetary policy, but it also introduces an additional source of specification errors. We find that exchange rate shocks are an important contributor to volatility in the model, and that the exchange rate equation is particularly vulnerable to model misspecification, along with the equation for domestic inflation. However, when policy is set with discretion, the cost of insuring against model misspecification appears reasonably small.
  19. By: Li Qin; Elefterios Spyromitros; Moïse Sidiropoulos
    Abstract: This paper discusses the problem of monetary policy transparency in a simple static robust control framework. In this framework, we identify two sources of monetary policy uncertainty. First, we identify the uncertainty about the central bank’s inflation stabilization preferences, which affects the private sector’s inflation expectations and therefore the realized inflation and output. On the other hand, uncertainty means that central bank is unsure about its model, in the sense that there is a group of approximate models that it also considers as possibly true and its objective is to choose a rule that will work under a range of different model specifications. We find that robustness reveals the emergence of a precautionary behaviour of the central bank in the case of unstructured model uncertainty, reducing thus central bank’s willingness to choice a high degree of monetary policy transparency.
    Keywords: central bank transparency, min-max policies, model uncertainty, robust control.
    JEL: E50 E52 E58
    Date: 2006
  20. By: Eric van Wincoop; Francis E. Warnock
    Abstract: Obstfeld and Rogoff (2000) have reinvigorated an old literature on the link between home bias in the goods market and home bias in the asset market by arguing that trade costs in the goods market can account for the observed portfolio home bias. The key link between home bias in the two markets is the real exchange rate. Home bias in consumption implies a different expenditure allocation across countries, which leads to different inflation rates when measured in the same currency. This leads investors from different countries to choose different portfolios to hedge against inflation uncertainty. An older partial equilibrium literature argued that such hedge portfolios are not large enough to produce substantial home bias. We link the general equilibrium and partial equilibrium literatures and show that in both the resulting home bias in the equity market depends on a covariance-variance ratio: the covariance between the real exchange rate and the excess return on home relative to foreign equity, divided by the variance of the excess return. Empirical evidence shows that this ratio and the implied home bias are close to zero, casting significant doubt on a meaningful link between home bias in the goods and asset markets. General equilibrium models that conclude otherwise imply a covariance-variance ratio that is at odds with the data.
    JEL: F21 F41 G11
    Date: 2006–12
  21. By: Ravenna , Federico (Department of Economics, University of California); Seppälä , Juha (Department of Economics, University of Illinois)
    Abstract: We study the rejection of the expectations hypothesis within a New Keynesian business cycle model. Earlier research has shown that the Lucas general equilibrium asset pricing model can account for neither sign nor magnitude of average risk premia in forward prices, and is unable to explain rejection of the expectations hypothesis. We show that a New Keynesian model with habit-formation preferences and a monetary policy feedback rule produces an upward-sloping average term structure of interest rates, procyclical interest rates, and countercyclical term spreads. In the model, as in U.S. data, inverted term structure predicts recessions. Most importantly, a New Keynesian model is able to account for rejections of the expectations hypothesis. Contrary to earlier work, we identify systematic monetary policy as a key factor behind this result. Rejection of the expectation hypothesis can be entirely explained by the volatility of just two real shocks which affect technology and preferences.
    Keywords: term structure of interest rates; monetary policy; sticky prices; habit formation; expectations hypothesis
    JEL: E43 E44 E52 G12
    Date: 2006–12–14
  22. By: Michael W. Klein; Jay C. Shambaugh
    Abstract: The impermanence of fixed exchange rates has become a stylized fact in international finance. The combination of a view that pegs do not really peg with the "fear of floating" view that floats do not really float generates the conclusion that exchange rate regimes are, in practice, unimportant for the behavior of the exchange rate. This is consistent with evidence on the irrelevance of a country's choice of exchange rate regime for general macroeconomic performance. Recently, though, more studies have shown the exchange rate regime does matter in some contexts. In this paper, we attempt to reconcile the perception that fixed exchange rates are only a "mirage" with the recent research showing the effects of fixed exchange rates on trade, monetary autonomy, and growth. First we demonstrate that, while pegs frequently break, many do last and those that break tend to reform, so a fixed exchange rate today is a good predictor that one will exist in the future. Second, we study the exchange rate effect of fixed exchange rates. Fixed exchange rates exhibit greater bilateral exchange rate stability today and in the future. Pegs also display somewhat lower multilateral volatility.
    JEL: F33 F41
    Date: 2006–12
  23. By: Agnes Benassy-Quere; Amina Lahreche-Revil; Valerie Mignon
    Abstract: This paper proposes a systematic analysis of the problem of world consistency when deriving equilibrium exchange rates. World inconsistency can arise for two reasons. First, real effective misalignments of currencies out of the considered sample are implicitly assumed to be the mirror image of those of the currencies under review. Second, only N ? 1 independent bilateral equilibrium exchange rates can be derived from a set of N effective rates. Here we measure the extent of these two problems by estimating equilibrium exchange rates for 15 countries of the G20 in effective as well as bilateral terms and by varying the assumptions concerning the rest of the world and the numeraire currency. Our results show that the way the rest of the world is tackled has a major impact on the calculation of effective misalignments and especially bilateral misalignments.
    Keywords: Equilibrium exchange rates; BEER approach; world consistency; models; panel
    JEL: F31 C23
    Date: 2006–12
  24. By: Martin Bodenstein
    Abstract: Several methods have been proposed to obtain stationarity in open economy models. I find substantial qualitative and quantitative differences between these methods in a two-country framework, in contrast to the results of Schmitt-Grohé and Uribe (2003). In models with a debt elastic interest rate premium or a convex portfolio cost, both the steady state and the equilibrium dynamics are unique if the elasticity of substitution between the domestic and the foreign traded good is high. However, there are three steady states if the elasticity of substitution is sufficiently low. With endogenous discounting, there is always a unique and stable steady state irrespective of the magnitude of the elasticity of substitution. Similar to the model with convex portfolio costs or a debt elastic interest rate premium, though, there can be multiple convergence paths for low values of the elasticity.
    Date: 2006
  25. By: Martin Menner
    Abstract: Shouyong Shi(1998) presents a general equilibrium model which shows a persistent monetary propagation mechanism. There the high persistence is obtained by a combination of search frictions in the goods and labor markets and the presence of final goods inventories. The present paper addresses the question of robustness of these results, especially, how sensitive are Shi's results to parameter changes and to different model specifications. Calibration of the parameters to intervals is used to perform a global sensitivity analysis. The calibration exercise reveals that the model is quite robust to changes in parameters. Comparing different model versions - including a CIA model which appears as a special case when buyers and sellers match always - we can disentangle and quantify the contributions of the various frictions in accounting for the persistent propagation. Search-frictions in the goods market and inventory holdings are necessary for persistent propagation of monetary shocks. Labor market frictions are not crucial but prolong the output responses and reduce their magnitude.
    Date: 2006–11
  26. By: David C. Mills, Jr.
    Abstract: I present an environment for which both outside and inside money are essential as means of payment. The key model feature is that there is imperfect monitoring of issuers of inside money. I use a random matching model of money where some agents have private trading histories and others have trading histories that can be publicly observed only after a lag. I show via an example that for lags that are neither too long nor too short, there exist allocations that use both types of money that cannot be duplicated when only one type is used. Inside money provides liquidity that increases the frequency of trades, but incentive constraints restrict the amount of output that can be traded. Outside money is immune to such constraints and can trade for higher levels of output.
    Date: 2006
  27. By: J. Benson Durham
    Abstract: This paper decomposes nominal Treasury yields into expected real rates, expected inflation rates, real risk premiums, and inflation risk premiums by separately calibrating a three-factor affine term structure model to the nominal Treasury and TIPS yield curves. Although this particular application seems to produce expected real short rates and inflation rates that are somewhat static, there are theoretical advantages to calibrating the model to nominal and real yields separately. Moreover, the estimates correlate positively with back-of-the-envelope measures of the inflation risk premium. With respect to the current environment, monetary policy uncertainty does not seem to have contributed to the apparent increase in the inflation risk premium since the beginning of 2006. Also, in purely nominal terms, the increase in term premiums thus far this year might be just as much a global as a domestic phenomenon, given that nominal term premiums have also increased in Germany and the United Kingdom.
    Date: 2006
  28. By: Anthony Garratt (School of Economics, Mathematics & Statistics, Birkbeck); Kevin Lee
    Abstract: We evaluate the forecast performance of a range of theory-based and atheoretical models explaining exchange rates and interest rates in US, UK and Japan. The decision-making environment is fully described for an investor who optimally allocates portfolio shares to domestic and foreign assets. Methods necessary to compute and use forecasts in this context are proposed, including the means of combining density forecasts to deal with model uncertainty. An out-of-sample evaluation exercise covering the 1990’s is described, comparing statistical criteria with decision-based criteria. The theory-based models are found to perform relatively well when their forecasts are judged by their economic value.
    Keywords: Model Averaging, Buy and Hold, Exchange rate and interest rate forecasts.
    JEL: C32 C53 E17
    Date: 2006–12
  29. By: Gisle James Natvik (University of Oslo and Norges Bank (Central Bank of Norway))
    Abstract: This paper explores how government size affects the scope for equilibrium indeterminacy in a New Keynesian economy where part of the population live hand-to-mouth. I find that in this framework, a larger public sector may widen the scope for self-fulfilling prophecies to occur. This takes place even though taxes serve to reduce swings in current income. In general, government provision of goods that are Edgeworth substitutes for private consumption tend to narrow the scope for indeterminacy, while government goods that are Edgeworth complements for private consumption increase the problem of indeterminacy. Hence monetary policy should be conducted with an eye to the amount and composition of government consumption.
    Keywords: Public expenditures, Taylor principle, Fiscal policy rules, Rule- of-thumb consumers.
    JEL: E32 E52 E63
    Date: 2006–12–11
  30. By: Nicolas Million (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I])
    Abstract: Dans cet article, nous analysons le taux d'intérêt réel pour les bons du Trésor américain à trois mois par l'intermédiaire d'une représentation SETAR (Self Exciting Threshold AutoRegressive). Dans le but de distinguer la non linéarité de la non-stationnarité, nous utilisons des tests très récents d'intégration à seuil contre une alternative stationnaire et non linéaire. Une innovation de ce travail réside dans l'introduction de ruptures structurelles dans la partie déterministe. Cela implique que la valeur du paramètre de seuil estimée par le modèle varie après un changement de structure du modèle. Les résultats empiriques des tests de linéarité soutiennent l'hypothèse d'un processus de retour à la moyenne non linéaire pour le taux d'intérêt réel américain sur les cinquante dernières années. Cependant, l'application des tests de racine unitaire ne sont pas si définitifs par rapport à l'hypothèse de stationnarité : le taux d'intérêt réel semble stationnaire uniquement pour le régime bas, défini par le paramètre de seuil estimé.
    Keywords: SETAR Model, structural break, real interest rate, switching regime.
    Date: 2006–12–07
  31. By: Ethan Cohen-Cole; Bogdan Cosmaciuc
    Abstract: We show that a monetary policy in which the central bank commits to a randomized inflation target allows for potentially faster-expectations convergence than with a fixed target. The randomized target achieves faster convergence in particular in transition environments: those demonstrating either particularly high or low inflation.
    Keywords: Monetary policy
    Date: 2006
  32. By: Darmoul Mokhtar (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I])
    Abstract: In this paper, we investigate the impact of monetary policy signals stemming from the ECB Council and the FOMC on the intradaily Euro-dollar volatility, using high-frequency data (five minutes frequency). For that, we estimate an AR(1)-GARCH(1,1) model, which integrates a polynomials structure depending on signal variables, starting from the deseasonalized exchange rate returns series. This structure allows us to test the signals persistence one hour after their occurence and to reveal a dissymmetry between the effect of the ECB and Federal Reserve signals on the exchange rate volatility.
    Keywords: Exchange rates, official interventions, monetary policy, GARCH models.
    Date: 2006–12–06
  33. By: Gilbert KOENIG; Irem ZEYNELOGLU
    Abstract: In this paper, we use a two country stochastic “new open economy macroeconomics” model with sticky wages and imperfect competition where public spending and private consumption appear in a non-separable way in individual preferences. We use this setup to define optimal fiscal policy in the face of a productivity shock and to analyze the efficiency of this optimal fiscal policy as a stabilization tool. We also consider strategic games between fiscal authorities in the two countries in order to see if there are additional gains from fiscal cooperation. We find that optimal fiscal policy consists of a deviation in the same direction as the deviation of the shock and that this type of reaction reduces the negative effects of the shock. We find also that fiscal cooperation generates a higher level of welfare than under Nash. However, the gain from cooperation is very likely to be negligible.
    Keywords: Fiscal policy, policy coordination, stabilization, new open economy macroeconomics.
    JEL: E62 F41 F42
    Date: 2006
  34. By: Jesus Vazquez (Universidad del Pais Vasco)
    Abstract: This paper estimates a standard version of the New Keynesian Monetary (NKM) model augmented with financial variables in order to analyze the relative importance of stock market returns and term spread in the estimated U.S. monetary policy rule. The estimation procedure implemented is a classical structural method based on the indirect inference principle. The empirical results show that the Fed seems to respond to the macroeconomic outlook and to the stock market return but does not seem to respond to the term spread. Moreover, policy inertia and persistent policy shocks are also significant features of the estimated policy rule.
    Keywords: NKM model, stock market returns, policy rule
    JEL: C32 E44 E52
    Date: 2006–01–01
  35. By: Nicolas Berman (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I]); Antoine Berthou (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I])
    Abstract: This paper analyses empirically the role of financial market imperfections in the way countries' exports react to a currency depreciation. Using quarterly data for 27 developed and developing countries over the period 1990-2005, we find that the impact of a depreciation on exports will be less positive - or even negative - for a country if : (i) firms borrow in foreign currency ; (ii) they are credit constrained ; (iii) they are specialized in industries that require more external capital ; (iv) the magnitude of depreciation or devaluation is large. This last result emphasizes the existence of a non-linear relationship between an exchange rate depreciation and the reaction of a country's exports when financial imperfections are observed. This offers a new explanation for the consequences of recent currency crises in middle income countries.
    Keywords: International trade, exchange rate movements, balance-sheets effects, financial market imperfections.
    Date: 2006–12–06
  36. By: Westerlund Joakim (METEOR)
    Abstract: Most empirical evidence suggest that the Fisher effect, stating that inflation and nominal interest rates should cointegrate with a unit slope on inflation, does not hold, a finding at odds with many theoretical models. This paper argues that these results can be attributed in part to the low power of univariate tests, and that the use of panel data can generate more powerful tests. For this purpose, we propose two new panel cointegration tests that can be applied under very general conditions, and that are shown by simulation to be more powerful than other existing tests. These tests are applied to a panel of quarterly data covering 20 OECD countries between 1980 and 2004. The evidence suggest that the Fisher effect cannot be rejected once the panel evidence on cointegration has been taken into account.
    Keywords: econometrics;
    Date: 2006
  37. By: Joshua Aizenman; Jaewoo Lee
    Abstract: The sizable hoarding of international reserves by several East Asian countries has been frequently attributed to a modern version of monetary mercantilism -- hoarding international reserves in order to improve competitiveness. Taking a long-run perspective, we point out that manufacturing exporters in East Asia frequently used financial mercantilism -- subsidizing the cost of capital -- during decades of high growth. The switches to sizable hoarding of international reserves happened when growth floundered or deep crises erupted, exacerbating financial fragility as the legacy of past financial mercantilism. As financial fragility may lead to currency crises, the rise of non-performing loans provides impetus for the precautionary hoarding of international reserves, making it harder to disentangle the monetary mercantilism from precautionary response to the heritage of past financial mercantilism. Monetary mercantilism also raises the prospects of competitive hoarding -- exporters of competing manufacturing goods to third markets would adopt a similar hoarding policy, in order to mitigate their deteriorating competitiveness following the adoption of monetary mercantilism by a competitor. Competitive hoarding, owing to the negative externalities associated with it, can dissipate competitiveness gains and result in excess reserves. It may also encourage the formation of institutions like regional funds, in an attempt to curb these adverse externalities.
    JEL: F15 F31 F43 F51
    Date: 2006–12
  38. By: José Antonio Ocampo
    Abstract: This paper recommends a broad concept of macroeconomic stability, whereby “sound macroeconomic frameworks” include not only price stability and sound fiscal policies, but also a well-functioning real economy, sustainable debt ratios and healthy public and private sector balance sheets. These multiple dimensions imply using multiple policy instruments. The paper elaborates a framework for developing countries that involves active use of counter-cyclical macroeconomic policies (exchange rate, monetary and fiscal), together with capital management techniques (capital account regulations and prudential rules incorporating macroeconomic dimensions). It also explores the role of international financial institutions in facilitating developing countries’ use of counter-cyclical macroeconomic policies.
    Keywords: macroeconomic stability, capital account volatility, counter-cyclical macroeconomic policies, capital management techniques, capital account regulations.
    JEL: E44 E61 E63 F41
    Date: 2005–10
  39. By: Eva Vicente Martinez
    Abstract: Analyses are presented of 84 quarterly observations 1/85-4/05 on two U.S. index numbers of nominal prices often employed to measure inflation. Analyses are designed to answer two key questions of interest to macroeconomists. Is inflation stationary (I(0)) or stochastically non-stationary (I(1))? If it is I(1), is it scalar or multivariate? Both measures of inflation are found clearly to be I(1) and, for these measures, inflation is found clearly to be scalar. The paper also illustrates univariate analysis procedures (and report standards) considered to be more effective and convincing than those found in the existing literature on inflation measures.
    Date: 2006–12
  40. By: Ed Hopkins
    Abstract: A brief survey of the economics of price dispersion, written for the New Palgrave Dictionary of Economics, 2nd Edition.
    JEL: C72 D43 D82 D83
  41. By: Federico S. Mandelman
    Abstract: This paper studies the cyclical pattern of ex post markups in the banking system using balance-sheet data for a large set of countries. Markups are strongly countercyclical even after controlling for financial development, banking concentration, operational costs, inflation, and simultaneity or reverse causation. The countercyclical pattern is explained by the procyclical entry of foreign banks, which occurs mostly at the wholesale level and signals the intention to spread to the retail level. My hypothesis is that wholesale entry triggers incumbents' limit-pricing strategies, which are aimed at deterring entry into retail niches and which, in turn, dampen bank markups. In the second part of the paper, I develop a general equilibrium model that accounts for these features of the data. I find that this monopolistic behavior in the intermediary financial sector increases the volatility of real variables and amplifies the business cycle. I interpret this bank-supply channel as an extension of the credit channel pioneered by Bernanke and Blinder (1988).
    Date: 2006
  42. By: Satyajit Chatterjee; Dean Corbae
    Abstract: What caused the worldwide collapse in output from 1929 to 1933? Why was the recovery from the trough of 1933 so protracted for the U.S.? How costly was the decline in terms of welfare? Was the decline preventable? These are some of the questions that have motivated economists to study the Great Depression. In this paper, the authors review some of the economic literature that attempts to answer these questions.
    Keywords: Depressions
    Date: 2006
  43. By: Michel, DE VROEY (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics)
    Abstract: The aim of this paper is to give an account of the unfolding of macroeconomic from Keynes to the present day. To this end I shall use a grid of analyses resulting from the combination of two distinctions. The first is the Marshall-Walras divide, the second is the distinction between Keynesianism viewed as a conceptual apparatus and Keynesianism viewed as a policy cause. On the basis of these distinctions, I construct two box diagrams. Box diagram No.1 has complex general equilibrium and simple general equilibrium (I.e. macroeconomics) models as its columns, and the Marshallian and Walrasian approaches as its rows. Box diagram No.2 has the Keynesian policy cause (justifying demand activation) and the anti-Keynesian policy cause (a defence of laissez-faire) as its columns, and the Marshallian and Walrasian conceptual apparatuses as it rows. This framework allows me to recount the history of macroeconomics as if it were a matter of filling in, step by step, the different slots in my two box diagrams. One of the claims made in the paper is that the rise of new classical macroeconomics can be encapsulated as the replacement of Marshallian by Walrasian macroeconomics, on the one hand, and, on the other hand, as the emergence of models that are anti-Keynesian on the score of both their analytical apparatus and their policy cause.
    Date: 2006–10–15
  44. By: Santiago Sanchez-Pages; Stephane Straub
    Abstract: This paper analyzes how institutions aimed at coordinating economic interactions may appear. We build a model in which agents play a prisoners’ dilemma game in a hypothetical state of nature. Agents can delegate the task of enforcing cooperation in interactions to one of them in exchange for a proper compensation. Two basic commitment problems stand in the way of institution formation. The first one is the individual commitment problem that arises because an agent chosen to run the institution may prefer to renege ex post. The second one is a “collective commitment” problem linked to the lack of binding agreements on the fee that will be charged by the centre once it is designated. This implies first that a potentially socially efficient institution may fail to arise because of the lack of individual incentives, and second that even if it arises, excessive rent extraction by the institution may imply a sub-optimal efficiency level, explaining the heterogeneity of observed institutional arrangements. An institution is less likely to arise in small groups with limited endowments, but also when the underlying commitment problem is not too severe. Finally, we show that the threat of secession by a subset of agents may endogenously solve part of the second commitment problem.
    Keywords: Institution, Coordination, State of nature, Secession.
    JEL: C72 D02 O17 Z13
  45. By: Dennis C. Mueller
    Abstract: The fundamental, underlying assumption in economics, public choice, and increasingly in political science and other branches of the social sciences is that individuals are rational actors. Many people have questioned the realism of this assumption, however, and considerable experimental evidence seems to refute it. This paper builds on recent findings from the field of evolutionary psychology to discuss the evolution of rational behavior in humans. It then goes on to relate this evolutionary process to the evolution of political institutions and in particular of democratic institutions. Length 58 pages
    Date: 2006–11
  46. By: Sandra Poncet
    Abstract: This study develops long-term forecasts for world economic growth, based on a production function according to which an economy can grow by (1) deploying more inputs (labor and capital inputs) to production and/or by (2) becoming more efficient, i.e. producing more output per unit of input. An econometric analysis of past performance is carried out to describe the process by which physical capital accumulates over time and to estimate the parameters of a catch-up model of technology diffusion. We moreover account for the modification of real exchange rates against the US dollar. The results suggest that today’s advanced economies are to become a shrinking part of the world economy: in less than 50 years, China and India together could match the size of the US in current dollars (26.6 against 26.9% of the world GDP in 2050). China and India will stand out as an engine of new demand growth and spending, their GDP will grow at yearly average rate of 4.6 and 4.5%, respectively between 2005 and 2050. The largest economies in the world (by GDP) may no longer be the richest (in terms of income per capita).
    Keywords: Growth projections; emerging countries; human capital; technology diffusion; convergence
    JEL: O10 O40
    Date: 2006–10
  47. By: Patrice Robitaille; Jennifer E. Roush
    Abstract: This paper provides a robust structural identification of the effects of U.S. interest rates on an emerging economy’s asset values. Using newly available intraday data, we investigate how surprises associated with U.S. macro data and FOMC announcements affectmove on intra-daily movements in the yield spread on a benchmark Brazilian government dollar-denominated bond and (the C-bond) as well as onthe Brazilian broad stock price index. Our study covers the period February 1999 to April 2005. We find that FOMC announcements that lead to an increase in U.S. interest rates are associated with a systematic increase in Brazil’s C-bond spread and a systematic decline in the Bovespa stock price index. Several U.S. macro data surprises, including for nonfarm payrolls and the CPI, prompt an increase in the Brazilian C-bond yield spread and a fall in Brazilian share prices. These combined findings suggest that, for Brazil during this period, the financial risks of higher U.S. interest rates rates in response to positive news about the U.S. economy dominated any benefits through trade or other channels in the determination of Brazilian asset valuations.
    Date: 2006
  48. By: Aurelijus Dabušinskas; Martti Randveer
    Abstract: In this paper, we review the price setting survey of Estonian firms and compare our findings with the results of similar research in the euro area summarized by Fabiani et al. (2005). Generally, the price setting patterns that emerge from our survey are quite similar to those in the euro zone. There is some evidence, however, that price setting may be somewhat more flexible in Estonia. The findings that suggest more price flexibility in Estonia are as follows: the incidence of time-dependent pricing is lower, the share of firms that are price takers is larger, price changes are more frequent, and, finally, the speed of price adjustments to shocks is higher
    Keywords: price setting, nominal rigity, inflation persistence, price survey
    JEL: E30 D40
    Date: 2006–12–10
  49. By: Ágeir Daníelsson; Lúdvík Elíasson; Magnús F. Gudmundsson; Björn A. Hauksson; Ragnhildur Jónsdóttir; Thorvardur Tjörvi Ólafsson; Thórarinn G. Pétursson
    Abstract: This paper documents and describes the new Quarterly Macroeconomi Model of the Central Bank of Iceland (qmm). qmm and the underlying quar terly database have been under construction since 2001 at the Research and Forecasting Division of the Economics Department at the Bank. qmm is used by the Bank for forecasting and various policy simulations and therefore play a key role as an organisational framework for viewing the medium-term futur when formulating monetary policy at the Bank. This paper is mainly focused on the short and medium-term properties of qmm. Analysis of the steady state properties of the model are currently under way and will be reported in a separate paper in the near future.
    Date: 2006–12

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