nep-cba New Economics Papers
on Central Banking
Issue of 2007‒01‒13
seventy papers chosen by
Alexander Mihailov
University of Reading

  1. The Unsustainable US Current Account Position Revisited* By Maurice Obstfeld; Kenneth Rogoff
  2. America's Deficit, the World's Problem By Maurice Obstfeld
  3. The Renminbi's Dollar Peg at the Crossroads By Maurice Obstfeld
  4. Implications for the Yen of Japanese Current Account Adjustment By Maurice Obstfeld
  5. External Adjustment By Maurice Obstfeld
  6. Is There More than One Way to be E-Stable? By Joseph Pearlman
  7. Robustifying Learnability By Robert J. Tetlow; Peter von zur Muehlen
  8. Experimental Evidence on the Benefits of Eliminating Exchange Rate Uncertainties and Why Expected Utility Theory causes Economists to Miss Them By Robin Pope; Reinhard Selten; Sebastian Kube; Jürgen von Hagen
  9. International Financial Adjustment By Pierre-Olivier Gourinchas; Hélène Rey
  10. Establishing Credibility: Evolving Perceptions of the European Central Bank By Linda S. Goldberg; Michael W. Klein
  11. Monetary Policy, Endogenous Inattention, and the Volatility Trade-off By William Branch; John Carlson; George W. Evans; Bruce McGough
  12. "On the Determinants of Exporters' Currency Pricing: History vs. Expectations" By Shin-ichi Fukuda; Masanori Ono
  13. General Equilibrium with NonConvexities, Sunspots and Money By Guillaume Rocheteau; Peter Rupert; Karl Shell; Randall Wright
  14. Industry Restructuring, Mark-ups, and Exchange Rate Pass-Through By Beverly Lapham; Danny Leung
  15. A Framework for Identifying the Sources of Local-Currency Price Stability with an Empirical Application By Pinelopi Koujianou Goldberg; Rebecca Hellerstein
  16. Motelling: A Hotelling Model with Money By Dean Corbae; Borghan N. Narajabad
  17. The Time Varying Volatility of Macroeconomic Fluctuations By Giorgio Primiceri; Alejandro Justiniano
  18. Money Illusion and Housing Frenzies By Markus K. Brunnermeier; Christian Julliard
  19. A Model of Money and Credit, with Application to the Credit Card Debt Puzzle By Irina A. Telyukova; Randall Wright
  20. Optimal Monetary Policy in a Channel System of Interest-Rate Control By Aleksander Berentzen; Cyril Monnet
  21. Modeling the Term Structure of Exchange Rate Expectations By Christian Bauer; Sebastian Horlemann
  22. Transactions, Credit, and Central Banking in a Model of Segmented Markets By Stephen D. Williamson
  23. Commodity Money Equilibrium in a Walrasian Trading Post Model: An Example By Ross Starr
  24. Monetary Exchange with Multilateral Matching By Benoit Julien; John Kennes; Ian King
  25. Expectations and Exchange Rate Dynamics: A State-Dependent Pricing Approach By Anthony Landry
  26. Search, Market Power, and Inflation Dynamics By Allen Head; Beverly Lapham
  27. Uncovering the Goodhart's Law: Theory and Evidence By Yosuke Takeda; Atsuko Ueda
  28. Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious? By Carlos Carmona
  29. Price Setting during Low and High Inflation: Evidence from Mexico By Etienne Gagnon
  30. Incomplete markets and the output-inflation tradeoff By Yann Algan; Edouard Challe; Xavier Ragot
  31. Could capital gains smooth a current account rebalancing? By Michele Cavallo; Cedric Tille
  32. Relative Price Distortions and Inflation Persistence By Tatiana Damjanovic; Charles Nolan
  33. The Performance of Trimmed Mean Measures of Underlying Inflation By Andrea Brischetto; Anthony Richards
  34. Component-smoothed Inflation: Estimating the Persistent Component of Inflation in Real Time By Christian Gillitzer; John Simon
  35. Time-Varying U.S. Inflation Dynamics and the New Keynesian Phillips Curve By Kevin J. Lansing
  36. The Returns to Currency Speculation By Craig Burnside; Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo
  37. Monetary Policy Uncertainty: Is There a Difference Between Bank of England and the Bundesbank/ECB? By Iris Biefang-Frisancho Mariscal; Peter Howells
  38. Taking Personalities out of Monetary Policy Decision Making? Interactions, Heterogeneity and Committee Decisions in the Bank of England’s MPC By Arnab Bhattacharjee; Sean Holly
  39. Precautionary Balances and the Velocity of Circulation of Money By Miquel Faig; Belen Jerez
  40. Efficient Propagation of Shocks and the Optimal Return of Money By Ricardo Cavalcanti; Andres Erosa
  41. Can Structural Small Open Economy Models Account for the Influence of Foreign Disturbances? By Alejandro Justiniano; Bruce Preston
  42. Electoral Rules and Government Spending in Parliamentary Democracies By Torsten Persson; Gerard Roland; Guido Tabellini
  43. Optimal monetary policy with imperfect unemployment insurance By Tomoyuki Nakajima
  44. The Valuation Channel of External Adjustment By Fabio Ghironi; Jaewoo Lee; Alessandro Rebucci
  45. Inflation Shocks and Interest Rate Rules By Barbara Annicchiarico; Alessandro Piegallini
  46. The Dynamic (In)efficiency of Monetary Policy by Committee By Alessandro Riboni; Francisco Ruge-Murcia
  47. Divisible money with partially directed search By Dror Goldberg
  48. Equilibrium and Media of Exchange in a Convex Trading Post Economy with transaction Costs By ROSS STARR
  49. Monetary Policy Rules and Exchange Rates:A Structural VAR Identified by No Arbitrage By Sen Dong
  50. Optimal Simple Rules for Fiscal Policy in a Monetary Union By Bernhard Herz; Werner Roeger; Lukas Vogel
  51. The Bank Capital Channel of Monetary Policy By Skander Van den Heuvel
  52. The Other Twins: Currency and Debt Crises By Bernhard Herz; Christian Bauer; Volker Karb
  53. Global Monetary Policy Shocks in the G5: A SVAR Approach By Joao Miguel Sousa; Andrea Zaghini
  54. A Model of Interbank Settlement By Benjamin Lester
  55. Optimal cheating in monetary policy with individual evolutionary learning By Jasmina Arifovic; Olena Kostyshyna
  56. Credit Market Frictions with Costly Capital Reallocation as a Propagation Mechanism By Andre Kurmann; Nicolas Petrosky-Nadeau
  57. Credit Cycles and Macro Fundamentals By Siem Jan Koopman; Roman Kräussl; André Lucas; André Monteiro
  58. (Un)Employment Dynamics: The Case of Monetary Policy Shocks By Helge Braun
  59. Optimal Fiscal Policy over the Business Cycle By Filippo Occhino
  60. International Seigniorage Payments By Benjamin Eden
  61. Changing Patterns of Domestic and Cross-Border Fiscal Policy Multipliers in Europe and the US By Agnes Benassy-Quere; Jacopo Cimadomo
  63. Currency Unions and Irish External Trade By Christine Dwane; Philip R. Lane; Tara McIndoe
  64. The final blow to the Stability Pact? EMU enlargement and government debt By Philipp Paulus
  65. Automatic Stabilizer Feature of Fixed Exchange Rate Regimes in Emerging Markets By Uluc Aysun
  66. Testing for Balance Sheet Effects in Emerging Market Countries By Uluc Aysun
  67. Monetary Policy and Household Mobility: The Effects of Mortgage Interest Rats. By John Quigley
  68. The yield curve as a predictor and emerging economies By Mehl, Arnaud
  69. Monetary and Exchange Rate Stability in South East Asia By Christian Bauer; Bernhard Herz
  70. "Post-crisis Exchange Rate Regimes in ASEAN:A New Empirical Test Based on Intra-daily Data" By Shin-ichi Fukuda; Sanae Ohno

  1. By: Maurice Obstfeld (University of California, Berkeley and CEPR and NBER); Kenneth Rogoff (Harvard University)
    Abstract: Keywords: US current account deficit, external imbalance, net foreign assets, real exchange rate, sustainability JEL Codes: F21, F32, F36, F41ABSTRACT:We show that the when one takes into account the global equilibrium ramifications of an unwinding of the US current account deficit, currently running at more than 6% of GDP, the potential collapse of the dollar becomes considerably larger than our previous estimates (Obstfeld and Rogoff 2000a)--as much as 30% or even higher. It is true that global capital market deepening appears to have accelerated over the past decade (a fact documented by Lane and Milesi-Ferreti (2003, 2004) and recently emphasized by outgoing US Federal Reserve Chairman Alan Greenspan), and that this deepening may have helped allowed the United States to a recordbreaking string of deficits. Unfortunately, however, global capital market deepening turns out to be of only modest help in mitigating the dollar decline that will almost inevitably occur in the wake of global current account adjustment. As the analysis of our earlier papers (2000a,b) showed, and the model of this paper reinforces, adjustments to large current account shifts depend mainly on the flexibility and global integration of goods and factor markets. Whereas the dollar's decline may be benign as in the 1980s, we argue that the current conjuncture more closely parallels the early 1970s, when the Bretton Woods system collapsed. Finally, we use our model to dispel some common misconceptions about what kinds of shifts are needed to help close the US current account imbalance. For example, faster growth abroad helps only if it is relatively concentrated in nontradable goods; faster productivity growth in foreign tradable goods will actually exacerbate the US adjustment problem.
    Keywords: US current account deficit, external imbalance, net foreign assets, real exchange rate, sustainability,
    Date: 2006–06–27
  2. By: Maurice Obstfeld (University of California, Berkeley and CEPR and NBER)
    Abstract: The United States deficit on current account, now running at an annual rate of over $700 billion, has reached levels (as a percent of U.S. GDP) not seen since the first decades of the nineteenth century. The deficit is soaking up roughly three-quarters of the world's available external surpluses. Were the deficit to continue at this pace, the U.S. could ultimately converge to an external debt/GDP ratio around 1. Several analyses suggest that a rapid adjustment of the deficit toward balance would require a very sharp real depreciation of the U.S. dollar. This paper reviews the limitations of some optimistic arguments that predict instead a "soft landing" for the dollar. I focus in particular on the view that greater financial globalization allows the U.S. easily to run much bigger deficits for much longer periods. Some simple calculations based on real interest rate differentials suggest that markets could be underestimating the extent of necessary dollar depreciation.
    Keywords: Current account adjustment, international capital flows, exchange rates,
    Date: 2006–06–27
  3. By: Maurice Obstfeld (University of California, Berkeley)
    Abstract: In the face of huge balance of payments surpluses and internal inflationary pressures, China has been in a classic conflict between internal and external balance under its dollar currency peg. Over the longer term, China's large, modernizing, and diverse economy will need exchange rate flexibility and, eventually, convertibility with open capital markets. A feasible and attractive exit strategy from the essentially fixed RMB exchange rate would be a two-stage approach, consistent with the steps already taken since July 2005, but going beyond them. First, establish a limited trading band for the RMB relative to a basket of major trading partner currencies. Set the band so that it allows some initial revaluation of the RMB against the dollar, manage the basket rate within the band if necessary, and widen the band over time as domestic foreign exchange markets develop. Second, put on hold ad hoc measures of financial account liberalization. They will be less helpful for relieving exchange rate pressures once the RMB/basket rate is allowed to move flexibly within a band, and they are best postponed until domestic foreign exchange markets develop further, the exchange rate is fully flexible, and the domestic financial system has been strengthened and placed on a market-oriented basis.
    Keywords: Renminbi, China currency, China balance of payments, fixed exchange rate exit strategy,
    Date: 2006–07–11
  4. By: Maurice Obstfeld (University of California, Berkeley)
    Abstract: This paper presents a quantitative evaluation of the effect on the yen of some alternative scenarios under which Japan reaches current account balance. The analytical framework is a global general-equilibrium model, based closely on Obstfeld and Rogoff (2005a, 2005b), within which relative prices clear the world markets for traded goods as well as the domestic markets for nontraded goods. Depending on assumptions about the critical substitution elasticities underlying the model, the yen could appreciate by as much as 10 per cent for each 1 percent of GDP reduction in its current account surplus. The effect would be smaller if substitution elasticities are larger, or if adjustment is accompanied by an expansion of Japanese nontradable output, the latter presumably implied by a return to a more efficient level of labor utilization.
    Keywords: current account adjustment, international capital flows, exchange rates, external imbalance, net foreign assets, real exchange rate, sustainability,
    Date: 2006–07–11
  5. By: Maurice Obstfeld (University of California, Berkeley)
    Abstract: Gross stocks of foreign assets have increased rapidly relative to national outputs since 1990, and the short-run capital gains and losses on those assets can amount to significant fractions of GDP. These fluctuations in asset values render the national income and product account measure of the current account balance increasingly inadequate as a summary of the change in a country's net foreign assets. Nonetheless, unusually large current account imbalances, especially deficits, should remain high on policymakers' list of concerns, even for the richer and less credit-constrained countries. Extreme imbalances signal the need for large and perhaps abrupt real exchange rate changes in the future, changes that might have undesired political and financial consequences given the incompleteness of domestic and international asset markets. Furthermore, of the two sources of the change in net foreign assets -- the current account and the capital gain on the net foreign asset position -- the former is better understood and more amenable to policy influence. Systematic government attempts to manipulate international asset values in order to change the net foreign asset position could have a destabilizing effect on market expectations.
    Keywords: Current account, external adjustment, balance of payments, foreign asset position, international diversification, capital flows to developing countries,
    Date: 2006–06–27
  6. By: Joseph Pearlman
    Abstract: We initially examine two different methods for learning about parameters in a Rational Expectations setting, and show that there are conflicting E-stability results. We show that this conflict also extends to Minimum State Variable (MSV) representations. One of these methods of learning lends itself to the examination of E-stability for the generic forward-looking rational expectations model. This leads to a completely general relationship between saddlepath stability and E-stability, and a generalization of MSV results.
    Keywords: E-stability, Minimum state variable.
    JEL: C6 E00
    Date: 2007–01
  7. By: Robert J. Tetlow (Division of Research and Statistics Federal Reserve Board); Peter von zur Muehlen
    Abstract: In recent years, the learnability of rational expectations equilibria (REE) and determinacy of economic structures have rightfully joined the usual performance criteria among the sought-after goals of policy design. Some contributions to the literature, including Bullard and Mitra (2001) and Evans and Honkapohja (2002), have made significant headway in establishing certain features of monetary policy rules that facilitate learning. However a treatment of policy design for learnability in worlds where agents have potentially misspecified their learning models has yet to surface. This paper provides such a treatment. We begin with the notion that because the profession has yet to settle on a consensus model of the economy, it is unreasonable to expect private agents to have collective rational expectations. We assume that agents have only an approximate understanding of the workings of the economy and that their learning the reduced forms of the economy is subject to potentially destabilizing perturbations. The issue is then whether a central bank can design policy to account for perturbations and still assure the learnability of the model. Our test case is the standard New Keynesian business cycle model. For different parameterizations of a given policy rule, we use structured singular value analysis (from robust control theory) to find the largest ranges of misspecifications that can be tolerated in a learning model without compromising convergence to an REE. In addition, we study the cost, in terms of performance in the steady state of a central bank that acts to robustify learnability on the transition path to REE.
    Keywords: monetary policy, learnability, indeterminacy, robust control
    JEL: C6 E5
    Date: 2006–12–03
  8. By: Robin Pope; Reinhard Selten; Sebastian Kube; Jürgen von Hagen
    Abstract: Conclusions favourable to flexible exchange rates typically accord with expected utility theory in ignoring the costs that exchange rate uncertainty generates for governments, central banks, firms and unions in: (i) choosing among available acts; and (ii) existing until learning the outcome of the chosen act. Allowing for these costs involves the stages of knowledge ahead framework, Pope (1983, 1995, 2005). A laboratory experiment suggests that (i) and (ii) together outweigh the advantages of having a flexible exchange rate as an additional instrument for managing a country’s employment, interest rate, price level and international competitiveness goals
    Keywords: experiment
    JEL: C90
    Date: 2006–10
  9. By: Pierre-Olivier Gourinchas (Economics Department, University of California, Berkeley); Hélène Rey (Department of Economics and Woodrow Wilson School, Princeton University)
    Abstract: The paper proposes a unified framework to study the dynamics of net foreign assets and exchange rate movements. We show that deteriorations in a country's net exports or net foreign asset position have to be matched either by future net export growth (trade adjustment channel) or by future increases in the returns of the net foreign asset portfolio (hitherto unexplored financial adjustment channel). Using a newly constructed data set on US gross foreign positions, we find that stabilizing valuation effects contribute as much as 31% of the external adjustment. Our theory also has asset pricing implications. Deviations from trend of the ratio of net exports to net foreign assets predict net foreign asset portfolio returns one quarter to two years ahead and net exports at longer horizons. The exchange rate affects the trade balance and the valuation of net foreign assets. It is forecastable in and out of sample at one quarter and beyond. A one standard deviation decrease of the ratio of net exports to net foreign assets predicts an annualized 4% depreciation of the exchange rate over the next quarter.
    Keywords: Meese-Rogoff, external adjustment, net foreign assets, valuation,
    Date: 2006–06–27
  10. By: Linda S. Goldberg; Michael W. Klein
    Abstract: The perceptions of a central bank’s inflation aversion may reflect institutional structure or, more dynamically, the history of its policy decisions. In this paper, we present a novel empirical framework that uses high frequency data to test for persistent variation in market perceptions of central bank inflation aversion. The first years of the European Central Bank (ECB) provide a natural experiment for this model. Tests of the effect of news announcements on the slope of yield curves in the euro-area, and on the euro/dollar exchange rate, suggest that the market’s perception of the policy stance of the ECB during its first six years of operation significantly evolved, with a belief in its inflation aversion increasing in the wake of its monetary tightening. In contrast, tests based on the response of the slope of the United States yield curve to news offer no comparable evidence of any change in market perceptions of the inflation aversion of the Federal Reserve.
    Keywords: Central Banking, European Central Bank, Federal Reserve, inflation, exchange rate, monetary policy, credibility, yield curve
    Date: 2007–01–05
  11. By: William Branch (Economics University of California, Irvine); John Carlson; George W. Evans; Bruce McGough
    Abstract: This paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the `Great Moderation' that began in the 1980's
    Keywords: optimal policy, expectations, adaptive learning
    JEL: E52 E31 D83
    Date: 2006–12–03
  12. By: Shin-ichi Fukuda (Faculty of Economics, University of Tokyo); Masanori Ono (Faculty of Economics, Musashi University)
    Abstract: The purpose of this paper is to investigate why the choice of invoice currency under exchange rate uncertainty depends not only on expectations but also on history. The analysis is motivated by the fact that the U.S. dollar has historically been the dominant vehicle currency in developing countries. The theoretical analysis is based on an open economy model of monopolistic competition. When the market is competitive enough, the exporting firms tend to set their prices not to deviate from those of the competitors. As a result, a coordination failure can lead the third currency to be a less efficient equilibrium invoice currency. The role of expectations is important in selecting the equilibrium in the static framework. However, in the dynamic model with staggered price-setting, the role of history becomes another key determinant of the equilibrium currency pricing. The role of history may dominate the role of expectations when the firms are myopic, particularly in the competitive local market. It also becomes dominant in the staggered price setting when a small fraction of the new price setters are backward-looking. The result suggests the importance of history in explaining why the firm tends to choose the US dollar as vehicle currency.
    Date: 2006–10
  13. By: Guillaume Rocheteau (Federal Reserve Bank of Cleveland public); Peter Rupert; Karl Shell; Randall Wright
    Abstract: We study general equilibrium with nonconvexities. In these economies there exist sunspot equilibria without the usual assumptions needed in convex economies, and they have good welfare properties. Moreover, in these equilibria, agents act as if they have quasi-linear utility. Hence wealth effects vanish. We use this to construct a new model of monetary exchange. As in Lagos-Wright, trade occurs in both centralized and decentralized markets, but while that model requires quasi-linearity, we have general preferences. Given our specification looks much like the textbook Arrow-Debreu model, we think this constitutes progress on the classic problem of integrating money and general equilibrium theory. We also use the model to discuss another classic issue: the relation between inflation and unemployment
    Keywords: Money, Indivisibilities, Sunspots.
    JEL: E40 E50
    Date: 2006–12–03
  14. By: Beverly Lapham (Queen's University); Danny Leung
    Abstract: Consumer prices are not very responsive to movements in nominal exchange rates and their response has fallen considerably in Canada since the mid 1980s. This paper explores two of the most likely explanations for this decline in exchange rate pass-through to consumer prices: (1) lower inflation and (2) restructuring in the retail sector. We believe that both explanations are important but our focus in this paper is the latter explanation. We first present estimates which suggest that mark-ups in the retail sector in Canada have decreased while concentration has increased over this time period. We also discuss other trends in Canadian retailing which suggest considerable restructuring in this sector which have led to changes in the nature of competition. Based on this evidence, we argue that it is important to examine pass-through in industrial organization models with strategic elements. We present such a model which generates lower mark-ups, higher concentration, and lower exchange rate pass-through simultaneously.
    Keywords: Exchange Rate Pass-Through, Strategic Pricing
    JEL: F31 F12
    Date: 2006–12–03
  15. By: Pinelopi Koujianou Goldberg; Rebecca Hellerstein (International Research Federal Reserve Bank of New York)
    Abstract: The inertia of the local-currency prices of traded goods in the face of exchange-rate changes is a well-documented phenomenon in International Economics.This paper develops a frame-work for identifying the sources of local-currency price stability at each stage of the distribution chain. The empirical approach exploits manufacturers’ and retailers’ first-order conditions in conjunction with detailed information on the frequency of price adjustments in response to exchange-rate changes, in order to quantify the relative importance of nominal price rigidities, local-cost non-traded components, and markup adjustment by manufacturers and retailers in the incomplete transmission of exchange-rate changes to prices. The approach is applied to microdata from the beer market
    Keywords: menu costs; nominal rigidities; local-currency price stability
    JEL: F1 F2 F3 F4
    Date: 2006–12–03
  16. By: Dean Corbae (University of Texas); Borghan N. Narajabad
    Abstract: We apply a mechanism design approach to a trading post environment where the household type space (tastes over variety) is continuous and it is costly to set up shops that trade differentiated goods. In this framework, we address Hotelling's <cite>Hot</cite> venerable question about where shops will endogenously locate in variety space across environments with and without money. Money has a role in our environment due to anonymity. Our specific question is whether monetary exchange leads to more product variety than an environment without money (i.e. a barter economy). We show that an efficient monetary mechanism does in fact lead to more product variety available to households provided the discount factor is sufficiently high, costs of operating shops are sufficiently low, and there is sufficient heterogeneity in tastes and abilities. We then show how this allocation can be implemented in a trading post economy with money. The paper is an attempt to integrate monetary theory and industrial organization
    Keywords: Matching Models of Money, Trading Posts
    JEL: E4
    Date: 2006–12–03
  17. By: Giorgio Primiceri; Alejandro Justiniano (Board of Governors of the Federal Reserv public)
    Abstract: In this paper we investigate the sources of the important shifts in the volatility of U.S. macroeconomic variables in the postwar period. To this end, we propose the estimation of DSGE models allowing for time variation in the volatility of the structural innovations. We apply our estimation strategy to a large-scale model of the business cycle and …nd that investment speci…c technology shocks account for most of the sharp decline in volatility of the last two decades
    Keywords: Great Moderation, Stochastic Volatility, Investment Specific Technology Shock, Relative Price of Investment, DSGE Models
    JEL: E32 C32
    Date: 2006–12–03
  18. By: Markus K. Brunnermeier; Christian Julliard
    Abstract: A reduction in inflation can fuel run-ups in housing prices if people suffer from money illusion. For example, investors who decide whether to rent or buy a house by simply comparing monthly rent and mortgage payments do not take into account that inflation lowers future real mortgage costs. We decompose the price-rent ratio in a rational component -- meant to capture the proxy effect and risk premia -- and an implied mispricing. We find that inflation and nominal interest rates explain a large share of the time-series variation of the mispricing, and that the tilt effect is unlikely to rationalize this finding.
    JEL: G12 R2
    Date: 2006–12
  19. By: Irina A. Telyukova; Randall Wright
    Abstract: Many individuals simultaneously have significant credit card debt and money in the bank. The so-called credit card debt puzzle is, given high interest rates on credit cards and low interest rates on bank accounts, why not pay down this debt? Economists have gone to some lengths to explain this. As an alternative, we present a natural extension of the standard model in monetary economics to incorporate consumer debt, which we think is interesting in its own right, and which shows that the coexistence of debt and money in the bank is no puzzle
    Keywords: Money, credit, monetary search models, credit card debt puzzle
    JEL: E44 E51
    Date: 2006–12–03
  20. By: Aleksander Berentzen (University of Basel); Cyril Monnet
    Abstract: This paper studies optimal interest-rate policies when the central bank operates a channel system of interest-rate control. We conduct our analysis in a dynamic general equilibrium model with infinitely-lived agents who are subject to idiosyncratic trading shocks which generate random liquidity needs. In response to these shocks agents either borrow against collateral or deposit money at the central bank at the specified rates. We show that it is optimal to have a strictly positive interest-rate corridor if the opportunity cost of holding collateral is strictly positive and that the optimal corridor is strictly decreasing in the collateral's real return
    Keywords: Optimal Monetary Policy, Channel System, Interest Rate Rule, Essential Money
    JEL: E4 E5
    Date: 2006–12–03
  21. By: Christian Bauer; Sebastian Horlemann
    Abstract: Recent approaches in international finance on exchange rates explicitly account for the maturity of interest rates. We integrate the interest parity idea into a modern microstructure model of foreign exchange and national bond markets and develop a model of the term structure of exchange rate expectations. The reaction function of the spot rate on changes of the basic economic variables such as the interest rate is generalized. This capital market model is able to reproduce standard results (e.g. overshooting) without reference to macroeconomic variables like rigid prices. In addition, the semi-elasticity of the spot exchange rate on interest rate changes depends on both the term structure of interest rates in both countries and determinants of the financial markets. The effects of interest rate changes on the spot exchange rate are diminished, if the exchange rate expectations for short and for long horizons have opposite signs. Finally, we show that there are several rational methods of building expectations which are not mutually consistent. This ambiguity of rational expectation building might contribute to explanations of the diversity of empirical results in the literature known as UIP puzzle.
    Keywords: exchange rates, expectation, term structure, interest parity
    JEL: F31 D84 E43
  22. By: Stephen D. Williamson (Department of Economics University of Iowa)
    Abstract: A segmented markets model is constructed in which transactions are conducted using credit and currency. Goods market segmentation plays an important role, in addition to the role played by conventional segmentation of asset markets. An important novelty of the paper is to show how the diffusion of a money injection by the central bank depends not only on the interaction of agents in exchanging money for goods, but on the arrangements for clearing and settlement of credit instruments. The model permits open market operations, daylight overdrafts, reserve-holding, and overnight lending and borrowing, allowing us to consider a rich array of central banking arrangements and their implications
    Keywords: Money, Segmented Markets, Credit, Central Banking
    JEL: E4
    Date: 2006–12–03
  23. By: Ross Starr (University of California, San Diego)
    Abstract: This paper posits an example of Walrasian general competitive equilibrium in an exchange economy with commodity-pairwise trading posts and transaction costs. Budget balance is enforced for each transaction at each trading post separately. Commodity-denominated bid and ask prices at each post allow the post to cover transaction costs through the bid/ask spread. In the absence of double coincidence of wants, the lower transaction-cost commodity (with the narrowest bid/ask spread) becomes the common medium of exchange, commidty money. Selection of the monetary commodity and adoption of a monetary pattern of trad results from price-guided equilibrium without central direction, fiat, or government
    Keywords: Transaction cost, bid/ask spread, money, Arrow-Debreu general equilibrium,
    Date: 2006–06–01
  24. By: Benoit Julien (Economics Australian Graduate School of Management); John Kennes; Ian King
    Abstract: This paper analyzes monetary exchange in a search model allowing for multilateral matches to be formed, according to a standard urn-ball process. We consider three physical environments: indivisible goods and money, divisible goods and indivisible money, and divisible goods and money. We compare the results with Kiyotaki and Wright (1993), Trejos and Wright (1995), and Lagos and Wright (2005) respectively. We …nd that the multilateral matching setting generates very simple and intuitive equilibrium allocations that are similar to those in the other papers, but which have important di¤erences. In particular, sur- plus maximization can be achieved in this setting, in equilibrium, with a positive money supply. Moreover, with ‡exible prices and directed search, the …rst best allocation can be attained through price posting or through auctions with lotteries, but not through auctions without lotteries. Finally, analysis of the case of divisible goods and money can be performed without the assumption of large families (as in Shi (1997)) or the day and night structure of Lagos and Wright (2005)
    Keywords: Matching, Money, Directed Search
    JEL: C78 D44 E40
    Date: 2006–12–03
  25. By: Anthony Landry (Economics Federal Reserve Bank of Dallas)
    Abstract: We introduce elements of state-dependent pricing and strategic complementarity into an otherwise standard New Open Economy Macroeconomics (NOEM) model. Relative to previous NOEM work, there are striking new implications for the dynamics of real and nominal economic activity: complementarity in the timing of price adjustment dramatically alters an open economy's response to monetary disturbances. Using a two-country Producer-Currency-Pricing environment, our framework replicates key international features following a domestic monetary expansion: (i) a high international output correlation relative to consumption correlation, (ii) a delayed overshooting of exchange rates, (iii) a J-curve dynamic in the domestic trade balance, and (iv) a delayed surge in inflation across countries. Overall, the model is consistent with many empirical aspects of international economic fluctuations, while stressing pricing behavior and exchange rate effects highlighted in the traditional work of Mundell, Fleming, and Dornbusch
    Keywords: international monetary policy transmission
    JEL: F41 F42
    Date: 2006–12–03
  26. By: Allen Head (Department of Economics Queen's University); Beverly Lapham
    Abstract: The short-run non-neutrality of money and its implications for inflation dynamics are examined in a monetary search economy with heterogeneous agents. Lump-sum money injections affect the distribution of money holdings in equilibrium and thus generate short-run non-neutrality. The response of prices and inflation to shocks of this type depends on the changes in households' search intensity that they induce. Monetary shocks change the distribution of prices in equilibrium and thus alter the returns to search. The resulting changes in optimal search intensity affect sellers' profit maximizing markups and thus may result in sluggish price adjustment and persistent inflation despite the absence of restrictions of sellers; ability to set prices in every period
    Keywords: Price Dispersion, Inflation, Mark-ups, Dynamics
    JEL: E31 D43 E41
    Date: 2006–12–03
  27. By: Yosuke Takeda (Sophia University public); Atsuko Ueda
    Abstract: This paper addresses the Goodhart's Law in a cash-in-advance economy with monetary policy regime switching. Using the Japanese data of the money velocity, we found that although our cash-credit model fails to generate a downward trend in the actual velocity, the model succeeds in terms of velocity's variation and correlations with money growth rates or nominal interest rates, with procyclicality of velocity unpredictable.
    Keywords: Goodhart' Law; velocity of money; Taylor rule; Markov regime swiching; cash-credit model
    JEL: E41 E52
    Date: 2006–12–03
  28. By: Carlos Carmona (University of California, San Diego)
    Abstract: Inflation forecasts of the Federal Reserve systematically under-predicted inflation before Volcker and systematically over-predicted it afterward. Furthermore, under quadratic loss, commercial forecasts have information not contained in those forecasts. To investigate the cause, this paper recovers the loss function implied by Federal Reserve's forecasts. It finds that the cost of having inflation above an implicit time-varying target was larger than the cost of having inflation below it for the period since Volcker, and that the opposite was true for the pre-Volcker era. Once these asymmetries are taken into account, the Federal Reserve is found to be rational. (JEL C53, E52)
    Keywords: Inflation Forecasts, Asymmetric Loss, Federal Reserve,
    Date: 2005–07–01
  29. By: Etienne Gagnon (Economics Northwestern University)
    Abstract: This paper provides new insight into the relationship between inflation and consumer price setting by examining a large data set of Mexican consumer prices covering episodes of both low and high inflation, as well as the transition between the two. The overall portrait is one in which the economy shares several characteristics of time dependent models when the annual inflation rate is low (below 10-15%), while displaying strong state dependence when inflation is high (above 10-15%). At low inflation levels, the aggregate frequency of price changes responds little to movements in inflation because movements in the frequency of price decreases partly offset movements in the frequency of price increases. When the annual inflation rate is above 10-15 percent, however, there are no longer enough price decreases to counterbalance price increases, making the frequency of price changes much more responsive to inflation. In this case, a 1-percent increase in the annual inflation rate is associated with a 0.40-0.45-percentage-points increase in the monthly frequency of price changes for consumer goods.
    Keywords: Price setting, consumer prices, frequency of price changes, time-dependent pricing, state-dependent pricing.
    JEL: E31 D40 C23
    Date: 2006–12–03
  30. By: Yann Algan; Edouard Challe; Xavier Ragot
    Abstract: This paper analyses the short-run effect of inflation shocks in an economy with incomplete markets, idiosyncratic unemployment risk, and fully flexible prices. Inflation shocks redistribute wealth from the cash-rich employed to the cash-poor unemployed, thereby forcing the former to work more in order to maintain their desired levels of consumption and precautionary savings. The reduced-form dynamics of the model is a textbook "output-inflation trade-off" equation where inflation shocks raise output contemporaneously, the effect being stronger the higher is idiosyncratic unemployment risk. We find that the data provides support for this short-run non-neutrality mechanism based on incomplete markets.
    Date: 2006
  31. By: Michele Cavallo; Cedric Tille (Federal Reserve Bank of New York)
    Abstract: A narrowing of the U.S. current account deficit through exchange rate movements is likely to entail a substantial depreciation of the dollar, as stressed in research by Obstfeld and Rogoff. We assess how the adjustment is affected by the high degree of financial integration in the world economy. A growing body of research emphasizes the increasing leverage in international financial positions, with industrialized economies holding substantial and growing financial claims on each other. Exchange rate movements then lead to valuation effects as the currency composition of a country's assets and liabilities are not matched. In particular, a dollar depreciation generates valuation gains for the United States by boosting the dollar value of much of its foreign-currency-denominated assets. We consider an adjustment scenario in which the U.S. net external debt is held constant. The key finding is that as the current account moves into balance, the pace of adjustment is smooth. Intuitively, the valuation gains from the depreciation of the dollar allow the United States to finance ongoing, albeit shrinking, current account deficits. We find that the smooth pattern of adjustment is robust to alternative scenarios, although the ultimate movements in exchange rates will vary under different conditions
    Keywords: current account, exchange rates, global imbalances
    JEL: F31 F32 F41
    Date: 2006–12–03
  32. By: Tatiana Damjanovic; Charles Nolan
    Abstract: Many sticky-price models suggest that relative price distortion is one of the major costs of inflation. We show that this resource misallocation is costly even at quite low rates of inflation. This is because inflation strongly affects price dispersion which in turn has an impact on the economy qualitatively similar to, and of the order of magnitude of, a negative shift in productivity. Similarly, the utility cost of price dispersion is large. We incorporate price dispersion in a linearized model. This radically affects how shocks are transmitted through the economy. Notably, a contractionary nominal shock has a persistent, negative hump-shaped impact on inflation, but may have a positive hump-shaped impact on output. Observed persistence in the policy rate is not due to the policy rule per se.
    Keywords: Price stickiness; optimal fiscal and monetary policies; price dispersion.
    JEL: E52 E61 E63
    Date: 2006–11
  33. By: Andrea Brischetto (Reserve Bank of Australia); Anthony Richards (Reserve Bank of Australia)
    Abstract: This paper uses data for Australia, the United States, Japan and the euro area to examine the relative performance of the headline CPI, exclusion-based ‘cores’, and trimmed means as measures of underlying inflation. Overall, we find that trimmed means tend to outperform headline and exclusion measures on a range of different criteria, indicating that they can be thought of as having better signal-to-noise ratios. We also find that there is a wide range of trims that perform well. One innovation for the United States is to break up the large implicit rent component in the US CPI into four regional components, which improves the performance of trimmed means, especially large trims such as the weighted median. The results lend support to the use of trimmed means as useful measures of underlying inflation at the current juncture where the growth of China and other emerging markets is having two offsetting effects on global inflation. Whereas some central banks have tended to focus on headline inflation and others have focused more on exclusion measures, our results provide some justification for a middle path, namely using trimmed mean measures which deal with outliers at both ends of the distribution of price changes in a symmetric manner.
    Keywords: underlying inflation; core inflation; trimmed means; Australia; United States; Japan; euro area
    JEL: E31 E52 E58
    Date: 2006–12
  34. By: Christian Gillitzer (Reserve Bank of Australia); John Simon (Reserve Bank of Australia)
    Abstract: This paper presents a new measure of underlying inflation: component-smoothed inflation. It approaches the problem of determining underlying inflation from a different direction than previous methods. Rather than excluding or trimming out volatile CPI items, it smoothes components of the CPI based on their volatility – CPI expenditure weights are maintained for all items. Items such as rent are smoothed a little, if at all, while volatile series such as fruit, vegetables and automotive fuel are smoothed a lot. This removes much of the temporary volatility in the CPI while retaining most of the persistent signal. Because our underlying inflation measure includes all CPI items at all times, it is robust to sustained relative price changes and is unbiased in the long run. A potential cost of this approach is that, unlike other measures, it places weight on lagged as well as contemporaneous prices for volatile series. An evaluation of the balance between the costs and benefits of this approach remains an open question.
    Keywords: CPI; core inflation; underlying inflation; Australia; United States
    JEL: E31 E52
    Date: 2006–12
  35. By: Kevin J. Lansing
    Abstract: This paper introduces a form of boundedly-rational expectations into an otherwise standard New-Keynesian Phillips curve. The representative agent's forecast rule is optimal (in the sense of minimizing mean squared forecast errors), conditional on a perceived law of motion for inflation and observed moments of the inflation time series. The perceived law of motion allows for both temporary and permanent shocks to inflation, the latter intended to capture the possibility of evolving shifts in the central bank's inflation target. In this case, the agent's optimal forecast rule defined by the Kalman filter coincides with adaptive expectations, as shown originally by Muth (1960). I show that the perceived optimal value of the gain parameter assigned to the last observed inflation rate is given by the fixed point of a nonlinear map that relates the gain parameter to the autocorrelation of inflation changes. The model allows for either a constant gain or variable gain, depending on the length of the sample period used by the agent to compute the autocorrelation of inflation changes. In the variable-gain setup, the equilibrium law of motion for inflation is nonlinear and can generate time-varying inflation dynamics similar to those observed in long-run U.S. data. The model's inflation dynamics are driven solely by white-noise fundamental shocks propagated via the expectations feedback mechanism; all monetary policy-dependent parameters are held constant
    Keywords: Inflation Expectations, Phillips Curve, Time-Varying Persistence & Volatility
    JEL: E31 E37
    Date: 2006–12–03
  36. By: Craig Burnside (Department of Economics Duke University); Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo
    Abstract: Currencies that are at a forward premium tend to depreciate. This `forward premium-depreciation anomaly' represents an egregious deviation from uncovered interest parity. We document the returns to currency speculation strategies that exploit this anomaly. The first strategy, known as the carry trade, is widely used by practitioners. This strategy involves selling currencies forward that are at a forward premium and buying those that are at a forward discount. The second strategy relies on a particular regression to forecast the payoff to selling currencies forward. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. However, these Sharpe ratios do not represent unexploited profit opportunities. In the presence of microstructure frictions, spot and forward exchange rates move against traders as they increase their positions. The resulting `price pressure' drives a wedge between average and marginal Sharpe ratios. We argue that marginal Sharpe ratios are zero even though average Sharpe ratios are positive. We display a simple microstructure model that simultaneously rationalizes `price pressure' and the forward premium-depreciation puzzle. The central feature of this model is that market makers face an adverse selection problem that is less severe when, based on public information, the currency is expected to appreciate
    Keywords: uncovered interest parity, BGT regressions, price pressure
    JEL: G12 G13 G15
    Date: 2006–12–03
  37. By: Iris Biefang-Frisancho Mariscal; Peter Howells (School of Economics, University of the West of England)
    Abstract: It is widely believed that institutional arrangements influence the quality of monetary policy outcomes. Judged on its ‘transparency’ characteristics, therefore the Bank of England should do better than both the Bundesbank and ECB. However, studies based on market evidence show that on average, agents anticipate policy moves by both banks equally well. Since benefits from transparency should also show in a narrowing of the diversity in cross sectional forecasts, this paper extends the existing literature in an attempt to reconcile the contradictory evidence on ‘transparency’ of both banks. We show that the diversity in interest rate forecasts is greater under the Bundesbank/ECB than the Bank of England. Other factors than ‘transparency’ do not seem to affect interest rate uncertainty in Germany. Increasing difficulty in forecasting inflation appears to explain in part UK interest rate forecast dispersion.
    Keywords: transparency, yield curve, forecasting uncertainty, Bank of England, Bundesbank, ECB
    JEL: E58
    Date: 2006–11
  38. By: Arnab Bhattacharjee; Sean Holly
    Abstract: The transparency of the monetary policymaking process at the Bank of England has provided very detailed data on both the votes of individual members of the Monetary Policy Committee and the information on which they are based. In this paper we consider interval censored responses of individual committee members in the context of a model in which inflation forecast targeting is used but there is both heterogeneity and interaction among the members of the committee. We find substantial heterogeneity in the policy reaction function across members. Further, we identify significant interactions between individual decisions of the committee members. The nature of these interdependencies inform about information sharing and strategic interactions within the Bank of England’s Monetary Policy Committee.
    Keywords: Monetary policy; Interest rates; Committee decision making; Expectation-Maximisation Algorithm; Spatial Weights Matrix; Spatial Error Model.
    JEL: E42 E43 E50 E58 C31 C34
    Date: 2006–12
  39. By: Miquel Faig (Department of Economics University of Toronto); Belen Jerez
    Abstract: The low velocity of circulation of money implies that households hold more money than they normally spend. This behavior is explained if households face uncertain expenditure needs, so that they have a precautionary motive for holding money. We investigate this motive in a search model where households are subject to preference shocks. The model predicts that the velocity is not only low but also interest elastic. The model closely fits United States data on velocity and interest rates (1892-2003). The empirical analysis reveals a dramatic reduction in precautionary balances towards the end of our sample, which is important for policy issues
    Keywords: Precautionary Balances, Velocity of Circulation of Money, Demand for Money
    JEL: E41 E52
    Date: 2006–12–03
  40. By: Ricardo Cavalcanti; Andres Erosa
    Abstract: We show that price stickiness is predicted by the theory of second best, applied to a random- matching model of money. The economy is hit with iid, aggregate, preference shocks, and allocations are allowed to be history dependent. Due to individual anonymity and lack of commitment, implementable allocations must satisfy participation constraints. Price stickiness becomes necessary for optimality, in terms of average, ex-ante welfare, when aggregate uncen- tainty is present but not too severe, and the degree of patience is neither too low or too high. By applying mechanism design to an alternative economy with centralized markets, we also Þnd important that macroeconomic policies, such as the taxation of money holdings, are unable to implement the Þrst best for price stckiness to have a social role
    Keywords: Mechanism Design, monetary theory, history dependence
    JEL: E10 E50
    Date: 2006–12–03
  41. By: Alejandro Justiniano; Bruce Preston (Economics Department Columbia University)
    Abstract: This paper evaluates whether an estimated, structural, small open economy model of the Canadian economy can account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The analysis shows that the benchmark model --- and a number of variants which include a range of market imperfections --- imply cross-equation restrictions that are too stringent when confronted with the data, yielding implausible parameter estimates. While appropriate choice of ad hoc disturbances can relax these cross-equation restrictions and therefore capture certain properties of the data --- for instance, the volatility and persistence of the real exchange rate --- and yield plausible parameter estimates, this success is qualified by the model's inability to account for the transmission of foreign disturbances to the domestic economy: less than one percent of the variance of output is explained by foreign shocks
    Keywords: Open Economy, Transmission, Business Cycles
    JEL: F41
    Date: 2006–12–03
  42. By: Torsten Persson; Gerard Roland; Guido Tabellini
    Date: 2006–12–30
  43. By: Tomoyuki Nakajima (Kyoto University)
    Abstract: We consider an efficiency-wage model with the Calvo-type sticky prices and analyze optimal monetary policy when unemployment insurance is not perfect. With imperfect risk sharing, strict zero-inflation policy is no longer optimal even if the zero-inflation steady-state equilibrium is assumed to be (conditionally) efficient. Quantitative result depends on how idiosyncratic earning losses, measured by the (inverse of the) relative income of the unemployed to the employed, vary over business cycles. If idiosyncratic income losses are acyclical, optimal policy differs very little from the zero-inflation policy. However, if they vary countercyclically, as evidence suggests, the deviation of optimal policy from complete price stabilization becomes quantitatively significant. Furthermore, optimal policy in such a case involves stabilization of output to a much larger extent
    Keywords: optimal monetary policy, efficiency wage, unemployment, nominal rigidities
    JEL: E3 E5
    Date: 2006–12–03
  44. By: Fabio Ghironi; Jaewoo Lee; Alessandro Rebucci (Research Department International Monetary Fund)
    Abstract: This paper explores the valuation channel of external adjustment in a two-country dynamic stochastic general equilibrium model (DSGE) with international equity trading. The theoretical model we set up matches key moments of the data for the United States at business cycle frequency at least as well as standard models of international real business cycles (RBCs). In our theoretical analysis, we find that two-asset trading is necessary for a valuation channel of external adjustment to emerge. However, other features of the economy, such as on the nature of the shock that generates the external imbalance and other features of the economy – the extent of nominal rigidity and the size of finacial frictions – determine the magnitude and significance of this channel of adjustment. The relative importance of the valuation channel is larger the higher the degree of nominal rigidity and the higher finacial intermediation costs. Monetary policy shocks have no valuation effects with flexible prices and trade only in equity. Specifying the theoretical model with net foreign assets different from zero in necessary to start matching satisfactorily empirical moments of changes in the US net foreign asset position.
    Keywords: External adjustment, Portfolio Models, Valuation Channel, SDGE Models
    JEL: F32 F41
    Date: 2006–12–03
  45. By: Barbara Annicchiarico (Department of Economics, University of Rome "Tor Vergata"); Alessandro Piegallini (Department of Economics, University of Rome "Tor Vergata")
    Abstract: Recent empirical evidence by Fair (2002, 2005) and Giordani (2003) shows that a positive inflation shock with the nominal interest rate held constant has contractionary effects. These results cannot be reconciled with the standard "New Synthesis" literature. This paper reconsiders the effects of inflation shocks in a simple New Keynesian framework extended to include wealth effects. It is demonstrated that, following an inflation shock, the decline of output coupled with passive interest rate rules is not puzzling.
    Keywords: Interest Rate Rules; Nominal Rigidities; Overlapping Generations; Inflation Shocks.
    JEL: E52 E58
    Date: 2006–06–01
  46. By: Alessandro Riboni; Francisco Ruge-Murcia (Economics University of Montreal)
    Abstract: This paper develops a model where the value of the monetary policy instrument is selected by a heterogenous committee engaged in a dynamic voting game. Committee members differ in their institutional power and, in certain states of nature, they also differ in their preferred instrument value. Preference heterogeneity and concern for the future interact to generate decisions that are dynamically inefficient and inertial around the previously-agreed instrument value. This model endogenously generates autocorrelation in the policy variable and provides an explanation for the empirical observation that the nominal interest rate under the central bank's control is infrequently adjusted
    Keywords: Committees, status-quo bias, interest-rate smoothing, dynamic voting
    JEL: E58 D02
    Date: 2006–12–03
  47. By: Dror Goldberg (Department of Economics Texas A&M University)
    Abstract: Monetary search models are difficult to analyze unless the distribution of money holdings is made degenerate. Popular techniques include using an infinitely large household (Shi 1997) and adding a centralized market with quasi-linear utility (Lagos and Wright 2005). Wallace (2002) suggests as an alternative to have two-member households who can somehow direct their search, thus creating a degenerate distribution in a different way. This idea is modelled here for the first time by modifying the partially directed search model of Goldberg (forthcoming). The Friedman rule is optimal, but the costs of deviating from it are different from the above mentioned models
    Keywords: directed search, Friedman rule
    JEL: E31 E40 E50
    Date: 2006–12–03
  48. By: ROSS STARR
    Abstract: General equilibrium is investigated with N commodities traded at N(N − 1)/2 commodity-pairwise trading posts. Bid and ask prices are quoted as commodity rates of exchange. Trade is a resource-using activity undertaken by firms recovering transaction costs through the spread between bid (wholesale) and ask (retail)prices. Budget constraints are enforced at each trading post separately;there is demand for a carrier of value between trading posts,commodity money. Existence of general equilibrium follows from convexity and continuity conditions and technical assumptions assuring boundedness of price ratios. Trade in media of exchange(commodity money) is the difference between gross and net trades.
    Keywords: trading post, bid price, ask price, medium of exchange, money,
    Date: 2005–08–01
  49. By: Sen Dong (Finance and Ecnomomics Department Columbia University)
    Abstract: Expected exchange rate changes are determined by interest rate differentials across countries and risk premia, while unexpected changes are driven by innovations to macroeconomic variables, which are amplified by time-varying market prices of risk. In a model where short rates respond to the output gap and inflation in each country, I identify macro and monetary policy risk premia by specifying no-arbitrage dynamics of each country's term structure of interest rates and the exchange rate. Estimating the model with US/German data, I find that the correlation between the model-implied exchange rate changes and the data is over 60%. The model implies a countercyclical foreign exchange risk premium with macro risk premia playing an important role in matching the deviations from Uncovered Interest Rate Parity. I find that the output gap and inflation drive about 70% of the variance of forecasting the conditional mean of exchange rate changes
    Keywords: exchange rate, monetary policy,term structure, no arbitrage
    JEL: C13 E43 E52
    Date: 2006–12–03
  50. By: Bernhard Herz; Werner Roeger; Lukas Vogel
    Abstract: The paper discusses the stabilizing potential of fiscal policy in a dynamic general-equilibrium model of monetary union. We consider a small open economy inside the currency area. We analyze the demand and supply effects of direct taxation, indirect taxation and government spending and derive optimal simple rules for fiscal stabilization of a technology shock. Fiscal policy achieves substantial macroeconomic stabilization. Simple public-expenditure rules show the highest degree of both output and inflation stabilization. The implementation lag substantially weakens output stabilization, but hardly affects the stabilization of prices. Output-oriented rules imply less instrument inertia than inflation-dominated rules. The implementation lag leads to higher coefficients for inflation relative to output in the optimal rule. Compared to the single-instrument approach the simultaneous optimization of two instrument rules implies only little additional stabilization gains.
    Keywords: Fiscal policy, monetary union, simple policy rules
    JEL: E E F
  51. By: Skander Van den Heuvel (Finance Department University of Pennsylvania)
    Abstract: This paper examines the role of bank lending in the transmission of monetary policy in the presence of capital adequacy regulations. I develop a dynamic model of bank asset and liability management that incorporates risk-based capital requirements and an imperfect market for bank equity. These conditions imply a failure of the Modigliani-Miller theorem for the bank: its lending will depend on the bank’s financial structure, as well as on lending opportunities and market interest rates. Combined with a maturity mismatch on the bank’s balance sheet, this gives rise to a ‘bank capital channel’ by which monetary policy affects bank lending through its impact on bank equity capital. This mechanism does not rely on any particular role of bank reserves and thus falls outside the conventional ‘bank lending channel’. I analyze the dynamics of the new channel. An important result is that monetary policy effects on bank lending depend on the capital adequacy of the banking sector; lending by banks with low capital has a delayed and then amplified reaction to interest rate shocks, relative to well-capitalized banks. Other implications are that bank capital affects lending even when the regulatory constraint is not momentarily binding, and that shocks to bank profits, such as loan defaults, can have a persistent impact on lending
    Keywords: Monetary Policy, Bank Capital, Capital Requirements, Bank Lending Channel
    JEL: E44 E52 G28
    Date: 2006–12–03
  52. By: Bernhard Herz; Christian Bauer; Volker Karb
    Abstract: Empirically, currency crises are more frequently accompanied by simultaneous sovereign debt crises than by banking crises. Nevertheless the phenomenon of twin currency and debt crises has so far been treated in economic literature only sparsely. We analyse the optimal policy of a government that may choose and combine two policy alternatives. She may choose at the same time whether to keep or alternatively exit an existing exchange rate peg and whether or not to default on her debt. Both parameters have a large impact not only on the public welfare but on the government’s budget as well. The resulting incentive system can generate situations with self-fulfilling expectations. In some situations an internal contagion effect arises. A crisis in the sovereign debt market spreads to the sector of exchange rate policy and causes a devaluation as well. Private investors’ default expectations thus can not only cause a sovereign debt crisis but may lead to a currency crisis as well.
    Keywords: Currency crises, internal contagion, self-fulfilling expectations and sovereign debt
    JEL: E61 F34 F41
  53. By: Joao Miguel Sousa (Banco de Portugal); Andrea Zaghini (Banca d'Italia and CFS)
    Abstract: The paper constructs a global monetary aggregate, namely the sum of the key monetary aggregates of the G5 economies (US, Euro area, Japan, UK, and Canada), and analyses its indicator properties for global output and inflation. Using a structural VAR approach we find that after a monetary policy shock output declines temporarily, with the downward effect reaching a peak within the second year, and the global monetary aggregate drops significantly. In addition, the price level rises permanently in response to a positive shock to the global liquidity aggregate. The similarity of our results with those found in country studies might supports the use of a global monetary aggregate as a summary measure of worldwide monetary trends.
    Keywords: Monetary Policy, Structural VAR, Global Eco
    JEL: E52 F01
    Date: 2006–12–20
  54. By: Benjamin Lester (Department of Economics University of Pennsylvania)
    Abstract: A settlement system is a set of rules and procedures that govern when and how funds are transferred between banks. Perhaps the most crucial feature of a settlement system is the frequency with which settlement occurs. On the one hand, a higher frequency of settlement limits the risk of default should a bank be rendered insolvent. On the other hand, a lower frequency of settlement is less costly for banks to operate. We construct a model of the banking sector in which this trade-off between cost and risk arises endogenously. We then complete the economy with a trading sector that has a micro-founded role for credit as a media of exchange. The result is a general equilibrium model that allows for welfare and policy analysis. We parameterize the economy and study the optimal intra-day borrowing policy that the operator of a settlement system should impose on member banks. We also determine conditions under which one settlement system is more appropriate than another
    Keywords: Payment Systems, Banking, Liquidity
    JEL: E40 E50
    Date: 2006–12–03
  55. By: Jasmina Arifovic; Olena Kostyshyna
    Abstract: We study individual evolutionary learning in the setup developed by Deissenberg and Gonzalez (2002). They study a version of the Kydland-Prescott model in which in each time period monetary authority optimizes weighted payoff function (with selfishness parameter as a weight on its own and agent's payoffs) with respect to inflation announcement, actual inflation and the selfishness parameter. And also each period agent makes probabilistic decision on whether to believe in monetary authority's announcement. The probability of how trustful the agent should be is updated using reinforcement learning. The inflation announcement is always different from the actual inflation, and the private agent chooses to believe in the announcement if the monetary authority is selfish at levels tolerable to the agent. As a result, both the agent and the monetary authority are better off in this model of optimal cheating. In our simulations, both the agent and the monetary authority adapt using a model of individual evolutionary learning (Arifovic and Ledyard, 2003): the agent learns about her probabilistic decision, and the monetary authority learns about what level of announcement to use and how selfish to be. We performed simulations with two different ways of payoffs computation - simple (selfishness weighted payoff from Deissenberg/Gonzales model) and "expected" (selfishness weighted payoffs in believe and not believe outcomes weighted by the probability of agent to believe). The results for the first type of simulations include those with very altruistic monetary authority and the agent that believes the monetary authority when it sets announcement of inflation at low levels (lower than critical value). In the simulations with "expected" payoffs, monetary authority learned to set announcement at zero that brought zero actual inflation. This Ramsey outcome gives the highest possible payoff to both the agent and the monetary authority. Both types of simulations can also explain changes in average inflation over longer time horizons. When monetary authority starts experimenting with its announcement or selfishness, it can happen that agent is better off by changing her believe (not believe) action into the opposite one that entails changes in actual inflation
    JEL: C63 E5
    Date: 2005–11–11
  56. By: Andre Kurmann (Economics UQAM); Nicolas Petrosky-Nadeau
    Abstract: Empirical evidence suggests that capital separation is an important phenomenon over and beyond depreciation and that reallocation is a costly and time-consuming process. In addition, both separation and reallocation rates display substantial variation over the business cycle. We build a dynamic general equilibrium model where capital separation occurs endogenously because of credit constraints and capital (re)allocation is costly due to search frictions and capital specificity. Compared to the frictionless counterpart but also compared to models of financial frictions without costly capital reallocation, our model matches surprisingly well the persistence in U.S. output growth. Furthermore, our model implies that productive capital stocks vary more than reported in the data, which has the potential to substantially reduce the volatility of technology shocks inferred from the Solow residual
    Keywords: Credit Market Frictions, Capital Reallocation, Investment, Business Cycles, Output Growth Persistence
    JEL: E22 E32
    Date: 2006–12–03
  57. By: Siem Jan Koopman (Vrije Universiteit Amsterdam and Tinbergen Institute Amsterdam); Roman Kräussl (Vrije Universiteit Amsterdam and CFS); André Lucas (Vrije Universiteit Amsterdam and Tinbergen Institute Amsterdam); André Monteiro (Vrije Universiteit Amsterdam and Tinbergen Institute Amsterdam)
    Abstract: We study the relation between the credit cycle and macro economic fundamentals in an intensity based framework. Using rating transition and default data of U.S. corporates from Standard and Poor’s over the period 1980–2005 we directly estimate the credit cycle from the micro rating data. We relate this cycle to the business cycle, bank lending conditions, and financial market variables. In line with earlier studies, these variables appear to explain part of the credit cycle. As our main contribution, we test for the correct dynamic specification of these models. In all cases, the hypothesis of correct dynamic specification is strongly rejected. Moreover, accounting for dynamic mis-specification, many of the variables thought to explain the credit cycle, turn out to be insignificant. The main exceptions are GDP growth, and to some extent stock returns and stock return volatilities. Their economic significance appears low, however. This raises the puzzle of what macro-economic fundamentals explain default and rating dynamics.
    Keywords: Credit Cycles, Business Cycles, Bank Lending Conditions, Unobserved Component Models, Intensity Models, Monte Carlo Likelihood
    JEL: G11 G21
    Date: 2007–01–02
  58. By: Helge Braun (Department of Economics Northwestern University)
    Abstract: This paper estimates an identified VAR on US data to gauge the dynamic response of the job finding rate, the worker separation rate, and vacancies to monetary policy shocks. I develop a general equilibrium model that can account for the large and persistent responses of vacancies, the job finding rate, the smaller but distinct response of the separation rate, and the inertial response of inflation. The model incorporates labor market frictions, capital accumulation, and nominal price rigidities. Special attention is paid to the role of different propagation mechanisms and the impact of search frictions on marginal costs. Estimates of selected parameters of the model show that wage rigidity, moderate search costs, and a high value of non-market activities are important in explaining the dynamic response of the economy. The analysis extends to a broader set of aggregate shocks and can be used to understand and design monetary, labor market, and other policies in the presence of labor market frictions
    Keywords: Unemployment, Inflation, Labor Market Frictions
    JEL: E30 J63 J64
    Date: 2006–12–03
  59. By: Filippo Occhino
    Abstract: How should taxes, government expenditures, the primary and fiscal surpluses and government liabilities be set over the business cycle? We assume that the government chooses expenditures and taxes to maximize the utility of a representative household, utility is increasing in government expenditures, only distortionary labor income taxes are available, and the cycle is driven by exogenous technology shocks. We first consider the commitment case, and characterize the Ramsey equilibrium. In the case that the utility function is constant elasticity of substitution between private and public consumption and separable between the composite consumption good and leisure, taxes, government expenditures and the primary surplus should all be constant positive fractions of production, and both government liabilities and the fiscal surplus should be positively correlated with production. Then, we relax the commitment assumption, and we show how to determine numerically whether the Ramsey equilibrium can be sustained by the threat to revert to a Markov perfect equilibrium. We find that, for realistic values of the preferences discount factor, the Ramsey equilibrium is sustainable.
    Keywords: Fiscal policy, Commitment, Time-consistency, Ramsey equilibrium, Markov perfect equilibria, Sustainable equilibria.
    JEL: E62
    Date: 2006–12–03
  60. By: Benjamin Eden (Department of Economics, Vanderbilt University)
    Abstract: What are the "liquidity services" provided by ìover-pricedî assets? How do international seigniorage payments affect the choice of monetary policies? Does a country gain when other hold its ìover-pricedî assets? These questions are analyzed here in a model in which demand uncertainty (taste shocks) and sequential trade are key. It is shown that a country with a relatively stable demand may issue "over priced" debt and get seigniorage payments from countries with unstable demand. But this does not necessarily improve welfare in the stable demand country.
    Keywords: Seigniorage, liquidity, rate of return dominance, optimal monetary policy
    JEL: E42 F00 G00 H62
    Date: 2006–11
  61. By: Agnes Benassy-Quere; Jacopo Cimadomo
    Abstract: This paper documents time variation in domestic fiscal policy multipliers in Germany, the UK and the US, and in cross-border fiscal spillovers from Germany to the seven largest European Union economies. We propose two VAR models which incorporate three “global factors” representing developments in the world economy, and we combine them with identification of fiscal shocks à la Blanchard and Perotti (2002) and Perotti (2005), to study the effects of net tax and government spending shocks on GDP, inflation and interest rates. By recursively estimating these models on different samples of data, we find that the domestic impact of tax shocks has been positive but vanishing for Germany and the US, stably not significant for the UK. Financial markets deregulations may play an important role in that since they allow households to be less dependent on disposable income and to smooth more easily consumption. Domestic government spending multipliers are found to be positive but feeble in the short-run and close to zero or slightly negative in the medium-run, implying that private consumption and investments might be crowded out. These results suggest that, in the European Monetary Union, discretionary fiscal policy “surprises” (i.e. unexpected tax cuts and government spending expansions) cannot be used by governments as substitutes for lost national monetary instruments, since they have shown to be progressively ineffective over time. Finally, we find that fiscal expansions in Germany have had beneficial (though declining) effects for neighboring countries, especially the smaller ones. This may indicate that the trade channel of transmission of fiscal policy dominates the interest rate one.
    Keywords: Fiscal policy effectiveness, fiscal shocks, spillovers, factor-augmented VAR, Great Moderation
    JEL: E30 E61 E62
    Date: 2006–12
  62. By: Gilbert Koenig; Irem Zeyneloglu
    Abstract: L’article propose une revue des travaux récents de politique budgétaire effectués dans le cadre analytique et méthodologique de la nouvelle macroéconomie internationale développée à partir des contributions de Obstfeld et Rogoff (1995, 1998, 2002). La substitution de l’approche préconisée par la nouvelle macroéconomie internationale à celle des modèles agrégés du type Mundell-Fleming permet d’analyser d’une façon plus rigoureuse les thèmes traditionnels de l’efficacité d’une politique budgétaire discrétionnaire en fonction du régime de changes, du mode de financement des dépenses publiques et du degré de mobilité des capitaux. Elle permet aussi de prendre en compte des phénomènes observés, mais souvent négligés, comme la répercussion partielle des variations du taux de change sur les prix (pass-through) et le degré de substitution entre les produits. De plus, dans le cadre de modèles stochastiques, des développements récents analysent les réactions budgétaires optimales à des chocs aléatoires et les stratégies des autorités face à ces chocs. Cette nouvelle approche de la politique budgétaire ne propose pas seulement un renouvellement et un approfondissement de l’analyse des mécanismes de transmission internationale des effets de cette politique, mais aussi une modification du critère de son efficacité. Celle-ci n’est plus appréciée par ses effets sur le revenu global, mais par ses incidences sur le bien-être dont le revenu n’est que l’un des déterminants.
    Keywords: politique budgétaire, interdépendance, macroéconomie internationale.
    JEL: E62 F41 F42
    Date: 2006
  63. By: Christine Dwane; Philip R. Lane; Tara McIndoe
    Abstract: Ireland has participated in two currency unions - a bilateral union with the United Kingdom that lasted until 1979 and as a founder member of European Monetary Union that began in 1999. This paper investigates whether currency unions have influenced Irish trade patterns.
    Date: 2007–01–05
  64. By: Philipp Paulus
    Abstract: The continued debate on even the softened Stability and Growth Pact (SGP) highlights that the question of public debt in the European Monetary Union (EMU) needs further scrutiny. Both political economy models for emerging market sovereign debt and exchange rate regimes, as well as models on common pool and debt spillover problems in a monetary union point to an upward drift of public debt for countries joining EMU. In turn, this could lead to the expectation that, the more countries join EMU, the more pressure on an already battered SGP will develop. However, such models and first empirical research tend to focus only on the behaviour of governments – that is, the demand side on the market for government debt. Factors determining the supply side of government debt – i.e. capital markets – are most of the time left out of the analysis. This paper tries to fill this gap by analysing empirically the effects of both public debt demand and supply factors on the budget balances in the EMU candidate countries of Central and Eastern Europe (CEE) as well as in EMU and other OECD countries from 1994 to 2005. The results suggest that, although demand factors seem to have played a more important role than supply factors, some evidence for market conditions limiting new debt is found. More interestingly, despite the SGP disappointment, membership of EMU, as well as the time of the convergence to EMU, so far appears to coincide with more positive budget balances. Since most of the SGP literature assumes that EMU will cause a bias for higher debt due to spillover effects between EMU member countries, this could warrant a different theoretical approach to the impact of monetary unions on government debt.
    Keywords: monetary union, fiscal stability, government debt, EMU enlargement
    JEL: F33 G15 H62 H63
    Date: 2006–12
  65. By: Uluc Aysun (University of Connecticut)
    Abstract: This paper shows that countries characterized by a financial accelerator mechanism may reverse the usual finding of the literature -- flexible exchange rate regimes do a worse job of insulating open economies from external shocks. I obtain this result with a calibrated small open economy model that endogenizes foreign interest rates by linking them to the banking sector.s foreign currency leverage. This relationship renders exchange rate policy more important compared to the usual exogeneity assumption. I find empirical support for this prediction using the Local Projections method. Finally, 2nd order approximation to the model finds larger welfare losses under flexible regimes.
    Keywords: accelerator, balance sheets, welfare, EMBI
    JEL: E44 F31 F41
    Date: 2006–08
  66. By: Uluc Aysun (University of Connecticut)
    Abstract: This paper tests the presence of balance sheets effects and analyzes the implications for exchange rate policies in emerging markets. The results reveal that the emerging market bond index (EMBI) is negatively related to the banks. foreign currency leverage, and that these banks. foreign currency exposures are relatively unhedged. Panel SVAR methods using EMBI instead of advanced country lending rates find, contrary to the literature, that the amplitude of output responses to foreign interest rate shocks are smaller under relatively fixed regimes. The findings are robust to the local projections method of obtaining impulse responses, using country specific and GARCH-SVAR models.
    Keywords: EMBI, bank balance sheets, leverage, country risk premium, exchange rates.
    JEL: E44 F31 F41
    Date: 2006–08
  67. By: John Quigley (University of California, Berkeley)
    Abstract: This paper tests the "lock−in" effect of mortgage contract terms and establishes the link between changes in market interest rates and homeowner mobility. The analysis is based on the Panel Study of Income Dynamics during 1990−1993, when mortgage interest rates declined by almost 30 percent.
    Keywords: Households, Mortgage,
    Date: 2006–06–27
  68. By: Mehl, Arnaud (BOFIT)
    Abstract: This paper investigates the extent to which the slope of the yield curve in emerging economies predicts domestic inflation and growth. It also examines international financial linkages and how the US and euro area yield curves help to predict. It finds that the domes-tic yield curve in emerging economies contains in-sample information even after control-ling for inflation and growth persistence, at both short and long forecast horizons, and that it often improves out-of-sample forecasting performance. Differences across countries are seemingly linked to market liquidity. The paper further finds that the US and euro area yield curves also contain in- and out-of-sample information for future inflation and growth in emerging economies. In particular, for emerging economies with exchange rates pegged to the US dollar, the US yield curve is often found to be a better predictor than the domes-tic curves and to causally explain their movements. This suggests that monetary policy changes and short-term interest rate pass-through are key drivers of international financial linkages through movements at the low end of the yield curve.
    Keywords: emerging economies; yield curve; forecasting; international linkages
    JEL: C50 E44 F30
    Date: 2006–12–20
  69. By: Christian Bauer; Bernhard Herz
    Abstract: Regaining exchange rate stability has been a major monetary policy goal of East Asian countries in the aftermath of the 1997/98 currency crisis. While most countries have abstained from re-establishing a formal US Dollar peg, they have typically managed the US Dollar exchange rate de facto. We show that most of these countries were able to regain their monetary credibility within a relatively short time period. The Argentine crisis in 2001 caused a minor setback in this process for some countries. We measure the credibility of monetary policy by separating the fundamental and excess volatility of the exchange rate on the basis of a chartist fundamentalist model. The degree of excess volatility is interpreted as the ability of the central bank to manage the exchange rate via the coordination channel.
    Keywords: monetary policy, exchange rate policy, credibility, technical trading, East Asia
    JEL: D84 E42 F31
  70. By: Shin-ichi Fukuda (Faculty of Economics, University of Tokyo); Sanae Ohno (Faculty of Economics, Musashi University)
    Abstract: The purpose of this paper is to investigate what affected the post-crisis exchange rates of three ASEAN countries: Singapore, Thailand, and Malaysia. Our critical departure from previous studies is the use of intra-daily exchange rates. The use of the intra-daily data is useful in removing possible estimation biases which the choice of numeraire may cause. It can also contrast exchange rate movements during the time zone when the government intervention is active with those when the intervention is not active. We examine how and when the ASEAN currencies changed their correlations with the U.S. dollar and the Japanese yen. We find significant structural breaks in the correlations during the time zone when East Asian market is open. In the post-crisis period, the first structural break happened when Malaysia adopted the fixed exchange rate and the second break happened when some East Asian countries introduced inflation targeting. The structural breaks suggest strong monetary and real linkages among the ASEAN countries.
    Date: 2006–10

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