nep-cba New Economics Papers
on Central Banking
Issue of 2007‒03‒17
fifteen papers chosen by
Alexander Mihailov
University of Reading

  1. Understanding the New-Keynesian Model when Monetary Policy Switches Regimes By Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
  2. The Influence of Actual and Unrequited Interventions By Kathryn M.E. Dominguez; Freyan Panthaki
  3. The Taylor rule and interest rate uncertainty in the U.S. 1955-2006 By Mandler, Martin
  4. Two-Pillar Monetary Policy and Bootstrap Expectations By Heinz-Peter Spahn
  5. World Real Interest Rates: A Global Savings and Investment Perspective By Brigitte Desroches; Michael Francis
  6. Monitoring the Economy of the Euro Area: A Comparison of Composite Coincident Indexes By Andrea Carriero and Massimiliano Marcellino
  7. Current Account Deficits: The Australian Debate By Rochelle Belkar; Lynne Cockerell; Christopher Kent
  8. A Structural Model of Australia as a Small Open Economy By Kristoffer Nimark
  9. Inflation Illusion, Credit, and Asset Pricing By Monika Piazzesi; Martin Schneider
  10. Global Monetary Policy Shocks in the G5: A SVAR Approach By Joao Miguel Sousa; Andrea Zaghini
  11. Dollarization and exchange rate fluctuations By Honohan, Patrick
  12. Do Exchange Rates Move in Line With Uncovered Interest Parity? By Huisman, R.; Mahieu, R.J.; Mulder, A.
  13. Does the Dispersion of Unit Labor Cost Dynamics in the EMU Imply Long-run Divergence? : Results from a Comparison with the United States of America and Germany By Sebastian Dullien; Ulrich Fritsche
  14. Efficiency of stability-oriented institutions: the European case By Fabrice Capoen; Jerome Creel
  15. La politique de diffusion de l'information By Jean-Pierre Allegret; Camille Cornand

  1. By: Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
    Abstract: This paper studies a New-Keynesian model in which monetary policy may switch between regimes. We derive sufficient conditions for indeterminacy that are easy to implement and we show that the necessary and sufficient condition for determinacy, provided by Davig and Leeper, is necessary but not sufficient. More importantly, we use a two-regime model to show that indeterminacy in a passive regime may spill over to an active regime, no matter how active the latter regime is. As a result, a passive monetary policy is more damaging than has been previously thought. Our results imply that the propagation of shocks in an active regime, such as that of the Federal Reserve in the post-1982 period, may be substantially affected by the possibility of a return to a passive regime of the kind that was followed in the 1960s and 1970s.
    JEL: E3 E5 E52
    Date: 2007–03
  2. By: Kathryn M.E. Dominguez; Freyan Panthaki
    Abstract: Intervention operations are used by governments to manage their exchange rates but officials rarely confirm their presence in the market, leading inevitably to erroneous reports in the financial press. There are also reports of what we term, unrequited interventions, interventions that the market expects but do not materialize. In this paper we examine the effects of various types of intervention news on intra-day exchange rate behavior. We find that unrequited interventions have a statistically significant influence on returns, volatility and order flow, suggesting that the expectation of intervention, even when governments do not intervene, can affect currency values.
    JEL: F3 F31 G14 G15
    Date: 2007–03
  3. By: Mandler, Martin
    Abstract: We use a Taylor rule with time-varying policy coefficients in combination with an unobserved components model for the output gap to estimate the uncertainty about future values of the Federal Funds Rate. The model makes it possible to separate ex-ante interest rate uncertainty into three components: 1) uncertainty about the Fed's future policy coefficients, 2) uncertainty about future economic fundamentals, and 3) residual uncertainty. The results show important changes in uncertainty about future short-term interest rates over time with peaks in the late 1960s/early 1970s, mid 1970s and late 1970s/early 1980s. While for one-quarter forecasts uncertainty about the Fed's policy reaction is more important than uncertainty about economic fundamentals this result is reversed for the two-quarter forecast horizon. Results from a modified model with regime shifts in the variance of the policy shocks confirm the previous findings but show changes in residual uncertainty to be important as well.
    Keywords: monetary policy rules; interest rate uncertainty; Kalman filter
    JEL: C53 C32 E52
    Date: 2007–03
  4. By: Heinz-Peter Spahn
    Abstract: The paper integrates the two-pillar Phillips curve, which explains expected inflation by the money growth trend, within a simple macro model. A Taylor-like interest rule contains also a money growth target. The model takes into account serially correlated supply and money demand shocks; the latter induce goods demand shocks, thereby establishing a feedback mechanism from money to markets which is missing in the modern New Keynesian approach. Two groups of market agents are distinguished from which one derives inflation expectations from money growth trend figures whereas the other builds rational expectations by way of learning. The inspection of output and inflation variances show that a policy of reacting to excess money growth requires precise information on shock characteristics whereas inflationgap and output-gap oriented interest policies provide more robust stabilization services.
    Date: 2007
  5. By: Brigitte Desroches; Michael Francis
    Abstract: Over the past 15 years, long-term interest rates have declined to levels not seen since the 1970s. This paper explores possible shifts in global savings and investment that have led to this fall in the world real interest rate. There are several key findings. First, the authors identify the relative weakness in investment demand as more important than the relative increase in desired global savings to explain the decline in global interest rates. Second, the results indicate that the key factors explaining movements in savings and investment are variables that evolve relatively slowly over time, such as labour force growth and age structure. The conclusions suggest that over the coming years, world real interest rates are likely to continue to adjust slowly, reflecting longterm trends.
    Keywords: Interest rates; International topics
    JEL: E2 E4 F3
    Date: 2007
  6. By: Andrea Carriero and Massimiliano Marcellino
    Abstract: Monitoring the current status of the economy is quite relevant for policy making but also for the decisions of private agents, consumers and firms. Since it is difficult to identify a single variable that provides a good measure of current economic conditions, it can be preferable to consider a combination of several coincident indicators, i.e., a composite coincident index (CCI). In this paper, we review the main statistical techniques for the construction of CCIs, propose a new pooling-based method, and apply the alternative techniques for constructing CCIs for the largest European countries in the euro area and for the euro area as a whole. We find that different statistical techniques yield comparable CCIs, so that it is possible to reach a consensus on the status of the economy.
  7. By: Rochelle Belkar (Reserve Bank of Australia); Lynne Cockerell (Reserve Bank of Australia); Christopher Kent (Reserve Bank of Australia)
    Abstract: This paper documents the clear change of view, which has taken place in Australia over the past three decades or so, concerning the relevance of the current account deficit for policy. Historical experience under a fixed exchange rate regime suggested that large persistent deficits were unsustainable and could leave the economy vulnerable to sudden reversals in sentiment. These concerns persisted after the floating of the Australian dollar and financial deregulation, and it was thought that all arms of policy should help to rein in the then much larger current account deficits. However, these policies were shown to be ineffective and, by the early 1990s, the argument that current account deficits represent the optimal outcomes of decisions made by ‘consenting adults’ gained wide support. This paper presents some empirical evidence consistent with optimal smoothing in the face of temporary shocks; the persistence of the deficit is attributed to a modest degree of impatience relative to the rest of the world. Although it is now widely accepted that policy should not seek to influence the current account balance, the issue of external vulnerability remains of interest. Here, country-specific considerations are important, and it is argued that the factors that have made Australia relatively resilient to external shocks are also those that helped to attract foreign capital in the first place.
    Keywords: current account; external vulnerability; exchange rate regimes
    JEL: E60 F32 N10
    Date: 2007–03
  8. By: Kristoffer Nimark (Reserve Bank of Australia)
    Abstract: This paper sets up and estimates a structural model of Australia as a small open economy using Bayesian techniques. Unlike other recent studies, the paper shows that a small micro-founded model can capture the open economy dimensions quite well. Specifically, the model attributes a substantial fraction of the volatility of domestic output and inflation to foreign disturbances and matches the evidence from reduced-form studies. In addition, the model relies much less than other estimated models on a persistent shock to the risk premium to explain changes in the nominal exchange rate. The paper also investigates the effects of various exogenous shocks on the Australian economy.
    Keywords: small open economy; Australia; Bayesian methods
    JEL: E30 F41
    Date: 2007–02
  9. By: Monika Piazzesi; Martin Schneider
    Abstract: This paper considers asset pricing in a general equilibrium model in which some, but not all, agents suffer from inflation illusion. Illusionary investors mistake changes in nominal interest rates for changes in real rates, while smart investors understand the Fisher equation. The presence of smart investors ensures that the equilibrium nominal interest rate moves with expected inflation. The model also predicts a nonmonotonic relationship between the price-to-rent ratio on housing and nominal interest rates -- housing booms occur both when the nominal rate is especially low and when it is especially high. In either situation, disagreement about real interest rates between smart and illusionary investors stimulates borrowing and lending and drives up the price of collateral. The resulting housing boom is stronger if credit markets are more developed. We document that many countries experienced a housing boom in the high-inflation 1970s and a second, stronger, boom in the low-inflation 2000s.
    JEL: E2 E4 G1
    Date: 2007–03
  10. 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
  11. By: Honohan, Patrick
    Abstract: Although the worldwide growth in dollarization of bank deposits has recently slowed, it has already reached very high levels in dozens of countries. Building on earlier findings that allowed the main cross-country variations in the share of dollars to be explained in terms of national policies and institutions, this paper turns to analysis of short-run variations, particularly the response of dollarization to exchange rate changes, which is shown to be too small to warrant " fear of floating " by dollari zed economies. But high dollarization is shown to increase the risk of depreciation and even suspension, as indicated by interest rate spreads. While specific policy is needed to deal with the risks associated with dollarization, the underlying causes of unwanted dollarization should also be tackled.
    Keywords: Economic Theory & Research,Banks & Banking Reform,Macroeconomic Management,Fiscal & Monetary Policy,Financial Economics
    Date: 2007–03–01
  12. By: Huisman, R.; Mahieu, R.J.; Mulder, A. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: According to uncovered interest rate Parity (UIP), the expected relative change in an exchange rate is equal to the difference between interest rates between the two currencies. Empirically, UIP is frequently rejected. In this paper, we examine whether exchange rates have at least any tendency to move in the direction predicted by UIP and whether exchange rates tend to move more in line with UIP in periods with large interest rate differentials.
    Keywords: Exchange rates;Uncovered interest rate parity;Logit models;
    Date: 2007–02–19
  13. By: Sebastian Dullien; Ulrich Fritsche
    Abstract: Using unit labor cost (ULC) data from Euro area countries as well as US States and German Länder we investigate inflation convergence using different approaches, namely panel unit root tests, co-integration tests and error-correction models. All in all we cannot reject convergence of ULC growth in EMU, however, country-specific deviations from the rest of the currency union are more pronounced in Europe and more persistent. This holds before and after the introduction of the common currency.
    Keywords: Unit labor costs, inflation, EMU, convergence, panel unit root tests, convergence clubs
    JEL: E31 O47 C32
    Date: 2007
  14. By: Fabrice Capoen (Université de Caen); Jerome Creel (Observatoire Français des Conjonctures Économiques)
    Abstract: Stability-oriented European institutions correspond to the general prescriptions of the ‘new macroeconomics consensus’. This contribution provides an assessment of the pros and cons of these institutions in terms of macro stabilisation and exchange-rate swings drawing on different scenarios. We argue that the institutions which have been associated with the Euro – limits on public deficits and a conservative central bank – have somewhat jeopardized the efficiency of this new exchange-rate regime. Adaptation of institutions is thus needed: either cooperation or coordination may enhance European welfare.
    Keywords: monetary policy, fiscal policy, central bank; stability pact; time-consistency; exchange rate, cooperation, coordination
    JEL: E63 F41 H60
    Date: 2007
  15. By: Jean-Pierre Allegret (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Camille Cornand (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines])
    Abstract: La transparence est devenue l'un des piliers des banques centrales et des institutions internationales afin d'accroître leur efficacité. Dans cet article, nous nous interrogeons sur le bien fondé de cette stratégie en proposant une synthèse de la littérature existante. A partir de l'approche en termes de jeux de coordination, nous montrons qu'un accroissement de la transparence en matière d'information peut conduire à des résultats non optimaux. Cette caractérisation repose sur le fait que l'information publique facilite la coordination entre les agents et favorise par là même les comportements de sur-réaction. Cependant, nous ne déduisons pas d'un tel résultat le fait que la transparence n'est pas utile. Nous montrons alors que celle-ci doit tenir compte des complémentarités stratégiques entre les agents. Les banques centrales et les institutions internationales ont à leur disposition plusieurs outils de diffusion d'information qui sont analysés dans cet article.
    Keywords: Transparence ; jeux de coordination ; banques centrales ; Fonds Monétaire International ; Informations publique et privée
    Date: 2007–03–02

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