nep-cba New Economics Papers
on Central Banking
Issue of 2007‒04‒09
eighty-six papers chosen by
Alexander Mihailov
University of Reading

  1. Coordination of Monetary and Fiscal Policy in a Monetary Union: Policy Issues & Analytical Models* By Matthew Canzoneri
  2. Signaling in a Global Game: Coordination and Policy Traps By George-Marios Angeletos; Christian Hellwig; Alessandro Pavan
  3. Central Bank Transparency: Where, Why, and with What Effects? By N. Nergiz Dincer; Barry Eichengreen
  4. Nowcasting GDP and Inflation: The Real-Time Informational Content of Macroeconomic Data Releases By Domenico Giannone; Lucrezia Reichlin; David H Small
  5. What is global excess liquidity, and does it matter? By Rasmus Ruffer; Livio Stracca
  6. Real-Time Effects of Central Bank Interventions in the Euro Market By Rasmus Fatum; Jesper Pedersen
  7. A State Space Approach To The Policymaker's Data Uncertainty Problem By Alastair Cunningham; Chris Jeffery; George Kapetanios; Vincent Labhard
  8. Caution or Activism? Monetary Policy Strategies in an Open Economy By Martin Ellison; Lucio Sarno; Jouko Vilmunen
  10. The New Keynesian Phillips Curve revisited By Pål Boug, Ådne Cappelen and Anders Rygh Swensen
  11. Price setting in the euro area : some stylised facts from individual producer price data By Philip Vermeulen; Daniel Dias; Maarten Dossche; Erwan Gautier; Ignacio Hernando; Roberto Sabbatini; Harald Stahl
  12. Price setting in the euro area: some stylised facts from individual producer price data By Dias, Daniel; Sabbatini, Roberto; Dossche, Maarten; Stahl, Harald; Gautier, Erwan; Vermeulen, Philip; Hernando, Ignacio
  14. Commodity prices, money and inflation By Frank Browne; David Cronin
  15. Monetary policy implementation: A European Perspective By Bindseil, Ulrich; Nyborg, Kjell G.
  16. Is Bad News About Inflation Good News for the Exchange Rate? By Richard Clarida; Daniel Waldman
  18. The Future of the Euro : A Public Choice Perspective By Vaubel, Roland
  19. Endogenous Cycles in Optimal Monetary Policy with a Nonlinear Phillips Curve By Gomes, O.; Mendes, D. A.; Mendes, V. P.; Sousa Ramos, J.
  20. The Eurosystem, the US Federal Reserve and the Bank of Japan - similarities and differences By Dieter Gerdesmeier; Francesco Paolo Mongelli; Barbara Roffia
  21. Is a word to the wise indeed enough? ECB statements and the predictability of interest rate decisions By David-Jan Jansen; Jakob de Haan
  22. ``Taylored'' Rules. Does One Fit All? By Cinzia Alcidi; Alessandro Flamini; Andrea Fracasso
  23. Bank Behaviour and the Cost Channel of Monetary Transmission By Eric Mayer; Oliver Hülsewig; Timo Wollmershäuser
  24. Bayesian versus robust control approach towards parameter uncertainty in monetary policymaking: how close are the outcomes? Some illustrating evidence from the EMU economies By Juha Kilponen; Marc-Alexandre Sénégas; Jouko Vilmunen
  25. Credit Cycles in a OLG Economy with Money and Bequest By Agliari Anna; Assenza Tiziana; Delli Gatti Domenico; Santoro Emiliano
  26. Heterogeneity, Asymmetries and Learning in InfIation Expectation Formation: An Empirical Assessment By Damjan Pfajfar; Emiliano Santoro
  27. Learning, Forecasting and Structural Breaks By John M Maheu; Stephen Gordon
  28. Risk and Uncertainty in Central Bank Signals: An Analysis of MPC Minutes By Sheila Dow; Matthias Klaes; Alberto Montagnoli
  30. Constructing Historical Euro Area Data By Heather Anderson; Mardi Dungey; Denise Osborn; Farshid Vahid
  31. Exchange Rate Monitoring Bands: Theory and Policy By Luisa Corrado; Marcus Miller; Lei Zhang
  32. The distribution of contract durations across firms: a unified framework for understanding and comparing dynamic wage and price setting models By Huw Dixon
  33. The Law of One Price: Nonlinearities in Sectoral Real Exchange Rate Dynamics By Luciana Juvenal; Mark P. Taylor
  34. Learning in a Misspecified Multivariate Self-Referential Linear Stochastic Model By Eran Guse
  36. Long-run real exchange rate changes and the properties of the variance of k-differences By Masao Ogaki; Sungwook Park
  37. A New Cost Channel of Monetary Policy By M. Alper Cenesiz
  38. Optimal Monetary Policy Rules for the Euro Area in a DSGE Framework By Pelin Ilbas
  39. Does Instrument Independence Matter under the Constrained Discretionof an Inflation Targeting Goal? Lessons from UK Taylor Rule Empirics By Alexander Mihailov
  40. Is European Monetary Policy Appropriate for the EMU Member Countries? A Counterfactual Analysis By Bernd Hayo
  41. Transition economy convergence in a two-country model - implications for monetary integration By Jan Bruha; Jirí Podpiera
  42. Assessing Inflation Targeting Through Intervention Analysis By Alvaro Angeriz; Philip Arestis
  43. Money and Monetary Policy in DSGE Models By Arnab Bhattacharjee; Christoph Thoenissen
  44. The predictive content of the real interest rate gap for macroeconomic variables in the euro area By Jean-Stéphane MESONNIER
  45. Simple Pricing Rules, the Phillips Curve and the Microfoundations of Inflation Persistence By Richard Mash
  46. Real exchange rates and current account imbalances in the Euro-area By Michael G Arghyrou; Georgios Chortareas
  47. Are Euro Interest Rates led by FED Announcements? By Andrea Monticini; Giacomo Vaciago
  48. Interest Rate Pass-Through, Monetary Policy Rules and Macroeconomic Stability By Claudia Kwapil; Johann Scharler
  49. The Costs of EMU for Transition Countries By Alexandra Ferreira Lopes
  50. The narrative approach for the identification of monetary policy shocks in small open economies By Eleni Angelopoulou
  51. Evaluating the Taylor Principle Over the Distribution of the Interest Rate: Evidence from the US, UK and Japan By Paul Mizen; Tae-Hwan Kim; Alan Thanaset
  52. Inflation Targeting and Fear of Floating By Reginaldo Pinto Nogueira Junior
  53. Monetary Stabilisation Policy and Long-run Growth By Galindev Ragchaasuren
  55. Monetary Policy Amplification Effects through a Bank Capital Channel By Alvaro Aguiar; Inês Drumond
  56. Financial Systems and the Cost Channel Transmission of Monetary Policy Shocks By Johann Scharler; Sylvia Kaufmann
  57. Monetary Policy under Rule-of-Thumb Consumers and External Habits By Giovanni Di Bartolomeo; Lorenza Rossi; Massimiliano Tancioni
  58. The Complex Response of Monetary Policy to Asset Prices By Ram Kharel; Chris Martin; Costas Milas
  59. Inflation, inflation uncertainty, and Markov regime switching heteroskedasticity: Evidence from European countries By Donal Bredin; Stilianos Fountas
  60. Exchange rate regimes and trade By Christopher Adam; David Cobham
  61. Learning Hyperinflations By Atanas Christev
  62. Effects of Exchange Rate Volatility on the Volume and Volatility of Bilateral Exports By Christopher F Baum; Mustafa Caglayan
  63. Uncovering Yield Parity: A New Insight into the UIP Puzzle through the Stationarity of Long Maturity Forward Rates By Zsolt Darvas; Gábor Rappai; Zoltán Schepp
  64. Asset pricing implications for a New Keynesian model By Bianca De Paoli, Alasdair Scott, Olaf Weeken
  65. Sectoral money demand models for the euro area based on a common set of determinants By Julian von Landesberger
  66. Monetary Policy and the Political Support for a Labor Market Reform By ÿlvaro Aguiar; Ana Paula Ribeiro
  67. Unemployment, Job Flows and Hours in a New Keynesian Model By Richard Holt
  68. Forecasting Exchange Rate Volatility with High Frequency Data: Is the Euro Different? By Georgios Chortareas; John Nankervis; Ying Jiang
  69. From Currency Unions to a World Currency: A Possibility? By Davide Furceri
  70. Bank Lending and Asset Prices in the Euro Area By Michael Frömmel; Torsten Schmidt
  71. Liquidity Risk Aversion, Debt Maturity, and Current Account Surpluses: A Theory and Evidence from East Asia By Shin-ichi Fukuda; Yoshifumi Kon
  72. Fiscal Discipline and Stability under Currency Board Systems By Oliver Grimm
  73. The behaviour of the real exchange rate: Evidence from regression quantiles By Kleopatra Nikolaou
  74. On the role of debt constraints in monetary equilibrium By Mario R. Páscoa; Myrian Petrassi; Juan Pablo Torres-Martinez
  75. The defense of multilateral XR target zones against contagious crises By Jean-Sébastien Pentecôte
  76. The foundations of money, payments and central banking: A review essay By Stephen Millard
  78. Words, deeds, and outcomes: A survey on the growth effects of exchange rate regimes By Philipp Harms; Marco Kretschmann
  79. Does the IMF cause moral hazard and political business cycles? Evidence from panel data By Dreher, Axel; Vaubel, Roland
  80. Explaining Exchange Rate Movements in New Member States of the European Union: Nominal and Real Convergence By Monika Blaszkiewicz-Schwartzman
  81. Exchange rate pass-through in emerging markets By Michele Ca’ Zorzi; Elke Hahn; Marcelo Sánchez
  82. Hot Money Inflows and Monetary Stability in China: How the People's Bank of China Took up the Challenge By Vincent Bouvatier
  85. Argentina: The Central Bank in the Foreign Exchange Market By Roberto Frenkel

  1. By: Matthew Canzoneri (Department of Economics Georgetown University)
    Abstract: Non
    Date: 2007–02–02
  2. By: George-Marios Angeletos; Christian Hellwig; Alessandro Pavan
    Abstract: This paper examines the ability of a policy maker to control equilibrium outcomes in a global coordination game; applications include currency attacks, bank runs, and debt crises. A unique equilibrium is known to survive when the policy is exogenously fixed. We show that, by conveying information, endogenous policy re-introduces multiple equilibria. Multiplicity obtains even in environments where the policy is observed with idiosyncratic noise. It is sustained by the agents coordinating on different interpretations of, and different reactions to, the same policy choices. The policy maker is thus trapped into a position where both the optimal policy and the coordination outcome are dictated by self-fulfilling market expectations.
    Keywords: global games, complementarities, signaling, self-fulfilling expectations, multiple equilibria, currency crises, regime change.
    JEL: C7 D8 E5 E6 F3
  3. By: N. Nergiz Dincer; Barry Eichengreen
    Abstract: Greater transparency in central bank operations is the most dramatic change in the conduct of monetary policy in recent years. In this paper we present new information on its extent and effects. We show that the trend is general: a large number of central banks have moved in the direction of greater transparency since the late 1990s. We then analyze the determinants and effects of central bank transparency in an integrated empirical framework. Transparency is greater in countries with more stable and developed political systems and deeper and more developed financial markets. Our preliminary analysis suggests broadly favorable if relatively weak impacts on inflation and output variability.
    JEL: E0 E4 F0
    Date: 2007–03
  4. By: Domenico Giannone (ECARES Université Libre de Bruxelles); Lucrezia Reichlin (European Central Bank); David H Small (Federal Reserve Board)
    Abstract: This paper formalizes the process of updating the nowcast and forecast on out-put and inflation as new releases of data become available. The marginal contribution of a particular release for the value of the signal and its precision is evaluated by computing "news" on the basis of an evolving conditioning information set. The marginal contribution is then split into what is due to timeliness of information and what is due to economic content. We find that the Federal Reserve Bank of Philadelphia surveys have a large marginal impact on the nowcast of both inflation variables and real variables and this effect is larger than that of the Employment Report. When we control for timeliness of the releases, the effect of hard data becomes sizeable. Prices and quantities affect the precision of the estimates of inflation while GDP is only affected by real variables and interest rates
    JEL: E52 C33 C53
    Date: 2007–02–02
  5. By: Rasmus Ruffer (European Central Bank); Livio Stracca (European Central Bank)
    Abstract: This paper endeavours to provide a comprehensive analysis of the nature and the possible importance of “global excess liquidityâ€, a concept which has attracted considerable attention in recent years. The contribution of this paper is threefold. First, we present some conceptual discussion on the meaning of excess liquidity in countries with developed financial markets, where the monetary base plays only a relatively minor quantitative role. Moreover, we analyse the theoretical channels through which shocks to excess liquidity may be transmitted across borders. The co-movement between several measures of excess liquidity across a relatively large number of countries is significant, but the evidence of cross-country spill-over of excess liquidity on excess liquidity and nominal spending abroad is not very strong. Last, we estimate an SVAR model for an aggregate of the major industrialised countries and analyse the transmission of shocks to global excess liquidity to a number of domestic variables in the world’s two largest economies (the US and the euro area). Our overall conclusion is that global excess liquidity appears to be a useful measure of the monetary policy stance at the level of the world economy. Moreover, there is some evidence that global excess liquidity shocks have some spill-over on output, the price level and asset prices in the euro area, while the US appears to be more insulated from global shocks
    Keywords: Global excess liquidity, monetary aggregates, international transmission of shocks, international economics.
    JEL: E41 E51
    Date: 2007–02–02
  6. By: Rasmus Fatum (University of Alberta); Jesper Pedersen (Department of Economics, University of Copenhagen)
    Abstract: This paper investigates the real-time effects of foreign exchange intervention using official intraday intervention data provided by the Danish central bank. Denmark is currently pursuing an active intervention policy under the provisions of the Exchange Rate Mechanism (ERM II) and intervenes on a discretionary basis when considered necessary. Prior participation in ERM II is a requirement for adoption of the Euro. Therefore, our study is of particular relevance for the new European Union member states that are either currently participating in ERM II or expected to do so at a later date as well as for Denmark. Our analysis employs the two-step weighted least squares estimation procedure of Andersen, Bollerslev, Diebold and Vega (2003) and an array of robustness tests. We find that intervention exerts a statistically and economically significant influence on exchange rate returns when the direction of intervention is consistent with fundamentals and intervention is carried out during a period of high exchange rate volatility. We also show that the exchange rate does not adjust instantaneously to the unannounced and discretionary interventions under study. We conclude that intervention can be an important short-term policy instrument for exchange rate management.
    Keywords: foreign exchange intervention; intraday data; ERM II
    JEL: D53 E58 F31 G15
    Date: 2007–03
  7. By: Alastair Cunningham (Bank of England); Chris Jeffery (Bank of England); George Kapetanios (Queen Mary and WestÂ…eld College and Bank of England); Vincent Labhard (European Central Bank)
    Abstract: The paper describes the challenges that uncertainty over the true value of key macroeconomic variables poses for policymakers and the way in which they may form and update their priors in light of a range of indicators. Speci…cally, it casts the data uncertainty challenge in state space form and illustrates - in this setting - how the policymaker’s data uncertainty problem is related to any constraints that an optimising statistical agency might face in resolving its own data uncertainty challenge. The paper uses this intuition to motivate a set of identifying assumptions that might be used in the practical application of the Kalman Filter to form and update priors on the basis of a variety of indicators. In doing so, it moves beyond the simple methodology for deriving "best guesses" of the true value of economic variables outlined in Ashley, Driver, Hayes, and Je¤ery (2005)
    Date: 2007–02–02
  8. By: Martin Ellison (University of Warwick); Lucio Sarno (Warwick Business School); Jouko Vilmunen (Bank of Finland)
    Abstract: We examine optimal policy in an open-economy model with uncertainty and learning, where monetary policy actions affect the economy through the real exchange rate channel. Our results show that the degree of caution or activism in optimal policy depends on whether central banks are in coordinated or uncoordinated equilibrium. If central banks coordinate their policy actions then activism is optimal. In contrast, if there is no coordination, caution prevails. In the latter case caution is optimal because it helps central banks to avoid exposing themselves to manipulative actions by other central banks
    Keywords: learning; monetary policy, open economy
    JEL: D83 E52 F41
    Date: 2007–02–02
  9. By: Timo Henckel
    Abstract: Some authors have argued that multiplicative uncertainty may be beneficial to society as the cautionary move reduces the inflation bias. Contrary to this claim, I show that, when there are non-atomistic wage setters, an increase in multiplicative uncertainty rises the real wage premium and unemployment and hence may reduce welfare. Furthermore, since central bank preferences also affect real variables, delegating policy to an independent central banker with an optimal degree of conservatism cannot, in general, deliver a second-best outcome.
    JEL: E52
    Date: 2006–07
  10. By: Pål Boug, Ådne Cappelen and Anders Rygh Swensen (Statistics Norway)
    Abstract: Recently, several authors have questioned the evidence claimed by Galí and Gertler (1999) and Galí, Gertler and López-Salido (2001) that a hybrid version of the New Keynesian Phillips Curve approximates European and US inflation dynamics quite well. We re-examine the evidence using likelihood-based methods. Although including lagged inflation enhances the empirical fit, the improvement is not large enough to yield a model that passes a likelihood ratio test. We also show that the likelihood surface is rather flat, especially in the European case, indicating that the model may be weakly identified as criticised by others using alternative methods.
    Keywords: European and US inflation; the New Keynesian Phillips Curve; vector autoregressive models and likelihood ratio tests.
    JEL: C51 C52 E31
    Date: 2007–03
  11. By: Philip Vermeulen (European Central Bank); Daniel Dias (Banco de Portugal); Maarten Dossche (National Bank of Belgium); Erwan Gautier (Banque de France); Ignacio Hernando (Banco de España); Roberto Sabbatini (Banca d’Italia); Harald Stahl (Deutsche Bundesbank)
    Abstract: This paper documents producer price setting in 6 countries of the euro area: Germany, France, Italy, Spain, Belgium and Portugal. It collects evidence from available studies on each of those countries and also provides new evidence. These studies use monthly producer price data. The following five stylised facts emerge consistently across countries. First, producer prices change infrequently: each month around 21% of prices change. Second, there is substantial cross-sector heterogeneity in the frequency of price changes: prices change very often in the energy sector, less often in food and intermediate goods and least often in non-durable non- food and durable goods. Third, countries have a similar ranking of industries in terms of frequency of price changes. Fourth, there is no evidence of downward nominal rigidity: price changes are for about 45% decreases and 55% increases. Fifth, price changes are sizeable compared to the inflation rate. The paper also examines the factors driving producer price changes. It finds that costs structure, competition, seasonality, inflation and attractive pricing all play a role in driving producer price changes. In addition producer prices tend to be more flexible than consumer prices.
    Keywords: Price-setting, producer prices
    JEL: E31 D40 C25
    Date: 2007–03
  12. By: Dias, Daniel; Sabbatini, Roberto; Dossche, Maarten; Stahl, Harald; Gautier, Erwan; Vermeulen, Philip; Hernando, Ignacio
    Abstract: This paper documents producer price setting in 6 countries of the euro area: Germany, France, Italy, Spain, Belgium and Portugal. It collects evidence from available studies on each of those countries and also provides new evidence. These studies use monthly producer price data. The following five stylised facts emerge consistently across countries. First, producer prices change infrequently : each month around 21% of prices change. Second, there is substantial cross-sector heterogeneity in the frequency of price changes: prices change very often in the energy sector, less often in food and intermediate goods and least often in nondurable non- food and durable goods. Third, countries have a similar ranking of industries in terms of frequency of price changes. Fourth, there is no evidence of downward nominal rigidity: price changes are for about 45% decreases and 55% increases. Fifth, price changes are sizeable compared to the inflation rate. The paper also examines the factors driving producer price changes. It finds that costs structure, competition, seasonality, inflation and attractive pricing all play a role in driving producer price changes. In addition producer prices tend to be more flexible than consumer prices.
    Keywords: Price-setting, producer prices
    JEL: C25 D40 E31
    Date: 2007
  13. By: Jan Libich
    Abstract: This paper shows an avenue through which a numerical inflation target ensures low inflation and high credibility: one that is independent of the usual Walsh incentive contract. Our novel game theoretic framework - a generalization of alternating move games - formalizes the fact that since the target is explicit/legislated, it cannot be frequently reconsidered. The "explicitness" therefore serves as a commitment device. There are two key results. First, it is shown that if the inflation target is sufficiently rigid (explicit) relative to the public's wages, low inflation is time consistent and hence credible even if the policymaker's output target is above potential. Second, it is found that the central banker's optimal explicitness level is decreasing in the degree of her patience/independence (due to their substitutability in achieving credibility). Our analysis therefore offers an explanation for the "inflation and credibility convergence" over the past two decades as well as the fact that inflation targets were legislated primarily by countries that had lacked central bank independence like New Zealand, Canada and the UK rather than the US, Germany, or Switzerland. We show that there exists fair empirical support for all the predictions of our analysis.
    JEL: E42 E61 C70 C72
    Date: 2006–09
  14. By: Frank Browne (Monetary Policy and Financial Stability Department, Central Bank and Financial Services Authority of Ireland, P.O. Box 559, Dame Street, Dublin 2, Ireland.); David Cronin (Corresponding author: Monetary Policy and Financial Stability Department, Central Bank and Financial Services Authority of Ireland, P.O. Box 559, Dame Street, Dublin 2, Ireland.)
    Abstract: The influence of commodity prices on consumer prices is usually seen as originating in commodity markets. We argue, however, that long run and short run relationships should exist between commodity prices, consumer prices and money and that the influence of commodity prices on consumer prices occurs through a money-driven overshooting of commodity prices being corrected over time. Using a cointegrating VAR framework and US data, our empirical findings are supportive of these relationships, with both commodity and consumer prices proportional to the money supply in the long run, commodity prices initially overshooting their new equilibrium values in response to a money supply shock, and the deviation of commodity prices from their equilibrium values having explanatory power for subsequent consumer price inflation. JEL Classification: E31, E51, E52.
    Keywords: Overshooting, VECM, impulse response analysis.
    Date: 2007–03
  15. By: Bindseil, Ulrich (European Central Bank, Germany); Nyborg, Kjell G. (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
    Abstract: Monetary policy implementation is one of the most significant areas of interaction between central banking and financial markets. Historically, how this interaction takes place has been viewed as having an important impact on the ultimate objective of monetary policy, for example price stability or stimulating economic growth. In this article, we survey different approaches to monetary policy implementation. We cover briefly some of the historical trends, but give particular attention to the practice that is now (again) very common world-wide; namely, targeting short term interest rates. We discuss various ways this can be done and the implications for financial markets. We emphasize different European approaches, while also providing comparisons with the Fed.
    Keywords: Monetary policy; short term interest rates; financial markets
    JEL: E52 G10
    Date: 2007–03–27
  16. By: Richard Clarida; Daniel Waldman
    Abstract: We show in a simple -- but robust -- theoretical monetary exchange rate model that the sign of the covariance between an inflation surprise and the nominal exchange rate can tell us something about how monetary policy is conducted. Specifically, we show that 'bad news' about inflation -- that it is higher than expected -- can be 'good news' for the nominal exchange rate -- that it appreciates on this news -- if the central bank has an inflation target that it implements with a Taylor Rule. The empirical work in this paper examines point sampled data on inflation announcements and the reaction of nominal exchange rates in 10 minute windows around these announcements for 10 countries and several different inflation measures for the period July 2001 through March 2005. When we pool the data, we do in fact find that bad news about inflation is indeed good news for the nominal exchange rate, that the results are statistically significant, and that the r-square is substantial, in excess of 0.25 for core measures of inflation. We also find significant differences comparing the inflation targeting countries and the two non-inflation targeting countries.
    JEL: E31 F3 F31
    Date: 2007–04
  17. By: Timothy Kam; Kirdan Lees; Philip Liu
    Abstract: We estimate the underlying macroeconomic policy objectives of three of the earliest explicit inflation targeters - Australia, Canada and New Zealand - within the context of a small open economy DSGE model. We assume central banks set policy optimally, such that we can reverse engineer policy objectives from observed time series data. We find that none of the central banks show a concern for stablizing the real exchange rate. All three central banks share a cocnern for minimizing the volatility in the change in the nominal interest rate. The Reserve Bank of Australia places the most weight on minimizing the deviation of output from trend. Joint tests of the posterior distributions of these policy preference parameters suggest that the central banks are very similar in their overall objective.
    JEL: C51 E52 F41
    Date: 2006–11
  18. By: Vaubel, Roland (Institut für Volkswirtschaft und Statistik (IVS))
    Abstract: Judging from past inflation and opinion poll data, France occupies the inflation median in the ECB Council if real exchange rate changes are ignored. Central bank independence does not have a significant effect on inflation if the population's sensitivity to inflation is controlled for. Owing to a clustering of election dates, the economy of the euro-zone is likely to be booming from May 2002 to June 2004. Between the euro-zone and the U.S. dollar, nominal exchange-rate trends are increasingly in line with the required real exchange rate trends. In this respect, exchange-rate flexibility has outperformed the Bretton Woods system. Of all 15 EU members, Britain is the least suitable candidate for joining the euro-zone as far as the need for real exchange rate adjustment is concerned. Most of the Eastern European countries require even considerably larger real exchange rate adjustments vis-à-vis the euro-zone. The European System of Central Banks is highly overstaffed by international standards. Its personnel has to be cut by at least 12 per cent (6,520 persons), notably in France, Belgium and Italy.
  19. By: Gomes, O. (IPL, Lisbon); Mendes, D. A. (ISCTE, Lisbon); Mendes, V. P. (ISCTE, Lisbon); Sousa Ramos, J. (IST, Lisbon)
    Abstract: There is by now a large consensus in modern monetary policy. This consensus has been built upon a dynamic general equilibrium model of optimal monetary policy with sticky prices a la Calvo and forward looking behavior. In this paper we extend this standard model by introducing nonlinearity into the Phillips curve. As the linear Phillips curve may be questioned on theoretical grounds and seems not to be favoured by empirical evidence, a similar procedure has already been undertaken in a series papers over the last few years, e.g., Schaling (1999), Semmler and Zhang (2004), Nobay and Peel (2000), Tambakis (1999), and Dolado et al. (2004). However, these papers were mainly concerned with the analysis of the problem of inflation bias, by deriving an interest rate rule which is nonlinear, leaving the issues of stability and the possible existence of endogenous cycles in such a framework mostly overlooked. Under the specific form of nonlinearity proposed in our paper (which allows for both convexity and concavity and secures closed form solutions), we show that the introduction of a nonlinear Phillips curve into a fully deterministic structure of the standard model produces significant changes to the major conclusions regarding stability and the efficiency of monetary policy in the standard model. We should emphasize the following main results: (i) instead of a unique fixed point we end up with multiple equilibria; (ii) instead of saddle--path stability, for different sets of parameter values we may have saddle stability, totally unstable and chaotic fixed points (endogenous cycles); (iii) for certain degrees of convexity and/or concavity of the Phillips curve, where endogenous fluctuations arise, one is able to encounter various results that seem interesting. Firstly, when the Central Bank pays attention essentially to inflation targeting, the inflation rate may have a lower mean and is certainly less volatile; secondly, for changes in the degree of price stickiness the results are not are clear cut as in the previous case, however, we can also observe that when such stickiness is high the inflation rate tends to display a somewhat larger mean and also higher volatility; and thirdly, it shows that the target values for inflation and the output gap (π^,x^), both crucially affect the dynamics of the economy in terms of average values and volatility of the endogenous variables --- e.g., the higher the target value of the output gap chosen by the Central Bank, the higher is the inflation rate and its volatility --- while in the linear case only the π^ does so (obviously, only affecting in this case the level of the endogenous variables). Moreover, the existence of endogenous cycles due to chaotic motion may raise serious questions about whether the old dictum of monetary policy (that the Central Bank should conduct policy with discretion instead of commitment) is not still very much in the business of monetary policy.
    Keywords: Optimal monetary policy, Interest Rate Rules, Nonlinear Phillips Curve, Endogenous Fluctuations and Stabilization
    JEL: E52 E58
    Date: 2007–02–02
  20. By: Dieter Gerdesmeier (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Francesco Paolo Mongelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Barbara Roffia (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The paper provides a systematic comparison of the Eurosystem, the US Federal Reserve and the Bank of Japan. These monetary authorities exhibit somewhat different status and tasks, which reflect different historical conditions and national characteristics. However, widespread changes in central banking practices in the direction of greater independence and increased transparency, as well as changes in the economic and financial environment over the past 15-20 years, have contributed to reduce the differences among these three world’s principal monetary authorities. A comparison based on simple “over-the-counter” policy reaction functions shows no striking differences in terms of monetary policy implementation. JEL Classification: E40, E52, E58.
    Keywords: Monetary policy, central banks and their policies, monetary policy committees.
    Date: 2007–03
  21. By: David-Jan Jansen (De Nederlandsche Bank); Jakob de Haan (Rijksuniversiteit Groningen)
    Abstract: We show that comments by euro area central bankers contain information on future ECB interest rate decisions, but that the comments mainly reflect recent developments in macroeconomic variables. Furthermore, models using only communication variables are outperformed by straightforward Taylor rule models. During the first years of the European Economic and Monetary Union, comments by ECB Executive Board members and high-level Bundesbank policy-makers were more informative than comments by national central bank presidents. We also find that differences of opinion were informative when they concerned the outlook for economic growth. Finally, our results suggest that the ECB used communication especially to signal interest rate increases
    Keywords: central bank communication, ECB, interest rate decisions
    JEL: E43 E52 E58
    Date: 2007–02–02
  22. By: Cinzia Alcidi (Graduate Institute of International Studies, Geneva); Alessandro Flamini (Keele University, Centre for Economic Research); Andrea Fracasso (Graduate Institute of International Studies, Geneva)
    Abstract: Modern monetary policymakers consider a huge amount of information in their evaluation of events and contingencies. However, most research on monetary policy relies on simple rules, and one relevant underpinning for this choice is the good empirical fit of the Taylor rule. This paper challenges the solidness of this foundation. We model the Federal Reserve reaction function during the Greenspan tenure as a Logistic Smoothing Transition Regime model in which a series of economically meaningful transition variables drive the transition across monetary regimes and allow the coefficients of the rule to change over time. We argue that estimated linear rules are weighted averages of the actual rules working in the diverse monetary regimes, where the weights merely reflect the length and not necessarily the relevance of the regimes. Thus, the actual presence of finer monetary policy regimes corrupts the general predictive and descriptive power of linear Taylor-type rules.
    Keywords: Judgement, LSTR, Monetary Policy Regime, Risk Management, Taylor Rule.
    JEL: E4 E5
    Date: 2005–04
  23. By: Eric Mayer (University of Wuerzburg); Oliver Hülsewig (Ifo Institute, Munich); Timo Wollmershäuser (Ifo Institute, Munich)
    Abstract: This paper provides a micro-foundation of the behavior of the banking industry in a Stochastic Dynamic General Equilibrium model of the New Keynesian style. The role of banks is reduced to the supply of loans to ¯rms that must pay the wage bill before they receive revenues from sell- ing their products. This leads to the so-called cost channel of monetary policy transmission. Our model is based on the existence of a bank{client relationship which provides a rationale for monopolistic competition in the loan market. Using a Calvo-type staggered price setting approach, banks decide on their loan supply in the light of expectations about the future course of monetary policy, implying that the adjustment of loan rates to a monetary policy shock is sticky. This is in contrast to Ravenna and Walsh (2006) who focus primarily on banks operating under perfect competition, which means that the loan rate always equals the money market rate. The structural parameters of our model are determined using a minimum distance estimation, which matches the theoretical impulse responses to the empirical responses of an estimated VAR for the euro zone to a monetary policy shock
    Keywords: New Keynesian Model, monetary policy transmission, bank behavior, cost channel, minimum distance estimation
    JEL: E44 E52 E58
    Date: 2007–02–02
  24. By: Juha Kilponen (Economics Department, Bank of Finland); Marc-Alexandre Sénégas (GRAPE, University Montesquieu-Bordeaux IV); Jouko Vilmunen (Research Department, Bank of Finland)
    Abstract: This paper tries to assess the proximity of the macroeconomic outcomes which could arise from a monetary policymaking process based upon either a robust control or a Bayesian (à la Brainard) approach towards parameter uncertainty. We use a small, structural, backward-looking, aggregate model of the EMU economies as the basis for this empirical exercise. After deriving the optimal feedback rules which correspond to the two approaches that we consider in this study, we assess their relative performances with respect to the behavior of the output gap and the in.ation rate volatilities and compare with the no-uncertainty benchmark case. We are particularly interested in the output-in.ation variability trade-o¤ which is usually associated with the implementation of the optimal monetary policy rule in the literature and in the distortions that the presence of parameter uncertainty and its taking into account via the robust control approach or the Bayesian method may induce to this trade-o¤. The results show that the performances of the rules are not too divergent but they appear to be highly contingent upon the preference parameters in the model, ie the relative weight that the monetary authorities attach to output variability (w.r.t. in.ation variability) in the loss function and the robustness aversion of the policymaker which is associated to the robust control approach. In particular, non-standard shapes of the output-in.ation variability trade-o¤ obtain in the robust control case what may be due to the way the misspeci-.cations associated with the worst case scenario feedback into the structural equations of the model. When the rules are considered within the nominal model, the volatility outcomes appear to be closer to each other.
    Keywords: monetary policy, uncertainty, robust control, Brainard
    JEL: E52 E47
    Date: 2007–02–02
  25. By: Agliari Anna (Catholic University of Piacenza); Assenza Tiziana (Catholic University of Piacenza); Delli Gatti Domenico (Catholic University of Piacenza); Santoro Emiliano (University of Cambridge and University of Trento)
    Abstract: In this paper we develop an extended version of the original Kiyotaki and Moore's model ("Credit Cycles" Journal of Political Economy, vol. 105, no 2, April 1997)(hereafter KM) using an overlapping generation structure instead of the assumption of infinitely lived agents adopted by the authors. In each period the population consists of two classes of heterogeneous interacting agents, in particular: a financially constrained young agent (young farmer), a financially constrained old agent (old farmer), an unconstrained young agent (young gatherer), an unconstrained old agent (old gatherer). By assumption each young agent is endowed with one unit of labour. Heterogeneity is introduced in the model by assuming that each class of agents use different technologies to pro- duce the same non durable good. If we study the effect of a technological shock it is possible to demonstrate that its effects are persistent over time in fact the mechanism that it induces is the reallocation the durable asset ("land")among agents. As in KM we develop a dynamic model in which the durable asset is not only an input for production processes but also collateralizable wealth to secure lenders from the risk of borrowers'default. In a context of intergenerational altruism, old agents leave a bequest to their offspring. Money is a means of payment and a reserve of value because it enables to access consumption in old age. For simplicity we assume that preferences are defined over consumption and bequest of the agent when old. Money plays two different and contrasting roles with respect to landholding. On the one hand, given the bequest, the higher the amount of money the young wants to hold, the lower landholding. On the other hand the higher the money of the old, the higher the resources available to him and the higher bequest and landholding. We study the complex dynamics of the allocation of land to farmers and gatherers - which determines aggregate output - and of the price of the durable asset. If a policy move does not change the ratio of money of the farmer and of the gatherer, i.e. if the central bank changes the rates of growth of the two monetary aggregates by the same amount, monetary policy is superneutral, i.e. the allocation of land to the farmer and to the gatherer does not change, real variables are unaffected and the only e¤ect of the policy move is an increase in the rate of inflation, which is pinned down to the (uniform) rate of change of money, and of the nominal interest rate. If, on the other hand, the move is differentiated, i.e. the central bank changes the rates of growth of the two monetary aggregates by different amounts so that the rates of growth are heterogeneous, money is not superneutral, i.e. the allocation of land changes and real variables are permanently affected, even if the rates of growth of the two aggregates go back to the original value afterwards
    Keywords: Credit Cycles, monetary policy
    JEL: E3 E4
    Date: 2007–02–02
  26. By: Damjan Pfajfar (University of Cambridge); Emiliano Santoro (University of Cambridge)
    Abstract: Relying on Michigan Survey' monthly micro data on inflation expectations we try to determine the main features -- in terms of sources and degree of heterogeneity - of inflation expectation formation over different phases of the business cycle and for different demographic subgroups. We identify three regions of the overall distribution corresponding to different expectation formation processes, which display a heterogeneous response to main macroeconomic indicators: a static or highly autoregressive (LHS) group, a "nearly" rational group (middle), and a group of "pessimistic" agents (RHS), who overreact to macroeconomic fluctuations. Different learning rules have been applied to the data, in order to test whether agents' are learning and whether their expectations are converging towards rational expectations (perfect foresight). The results obtained by applying conventional and recursive methods confirm our initial conjecture that behaviour of agents in the RHS of distribution is more associated with learning dynamics. We also regard the overall distribution as a mixture of normal distributions. This strategy allows us to get a deeper understanding of the existence and the main features of convergence and learning in the data, as well as to identify the demographic participation in each subcomponent
    Keywords: Heterogeneous Expectations, Adaptive Learning, Survey Expectations
    JEL: E31 C53 D80
    Date: 2007–02–02
  27. By: John M Maheu; Stephen Gordon
    Abstract: We provide a general methodology for forecasting in the presence of structural breaks induced by unpredictable changes to model parameters. Bayesian methods of learning and model comparison are used to derive a predictive density that takes into account the possibility that a break will occur before the next observation. Estimates for the posterior distribution of the most recent break are generated as a by-product of our procedure. We discuss the importance of using priors that accurately reflect the econometrician's opinions as to what constitutes a plausible forecast. Several applications to macroeconomic time-series data demonstrate the usefulness of our procedure.
    Keywords: Bayesian Model Averaging, Markov Chain Monte Carlo, Real GDP Growth, Phillip's Curve
    JEL: C53 C22 C11
    Date: 2007–03–30
  28. By: Sheila Dow (Department of Economics, University of Stirling); Matthias Klaes (Keele University, Centre for Economic Research); Alberto Montagnoli (Department of Economics, University of Stirling)
    Abstract: This paper analyses the signal uncertainty implicit in the communications of the Bank of England's Monetary Policy Committee (MPC). Unlike previous studies, which seek to construct a qualitative uncertainty index that heavily relies on subjective interpretations of key expressions, we limit ourselves to lexical frequencies of those expressions. We establish seasonality in the term 'risk' that coincides with Inflation Report publication dates, and matches what we identify as a surprising degree of prima facie seasonality in interest rate changes. Our findings suggest that frequencies of key terms expressing signal uncertainty in MPC minutes may either yield proxy measures to the amount of information at the disposal of the MPC, or offer evidence for the presence of an irreducible kind of signal uncertainty that shows up as white noise, casting doubt on the soundness of the various qualitative uncertainty indices found in the literature.
    Keywords: MPC, signal uncertainty, central bank uncertainty, word frequencies, uncertainty index, seasonality
    JEL: E52 E58 E12 D81
    Date: 2007–02
  29. By: Gordon Menzies; Daniel Zizzo
    Abstract: We present a macroeconomic market experiment on the financial determination of exchange rates, and consider whether the assumption that belief formation be treated as a classical hypothesis test, which we label inferential expectations, can explain the effect of uncertainty on exchange rates. In a non-stochastic environment, exchange rates closely follow standard predictions. In our stochastic environment, inferential expectations with a low test size alpha (conservative inferential expectations) predict exchange rates better than rational expectations in ten sessions out of twelve. Belief conservatism appears magnified rather than diminished at the market level, and the degree of belief conservatism seems connected to the failure of uncovered interest rate parity regressions.
    JEL: C91 D84 E50 F31
    Date: 2006–12
  30. By: Heather Anderson (Australian National University); Mardi Dungey (University of Cambridge); Denise Osborn (University of Manchester); Farshid Vahid (Australian National University)
    Abstract: The conduct of time series analysis on the Euro Area currently presents problems in terms of availability of sufficiently long data sets. The ECB has provided a dataset of quarterly data from 1970 covering many data series in its Area Wide Model (AWM), but not for a number of important financial market series. This paper discusses methods for producing such backdata and in the resulting difficulties in selecting aggregation methods. Simple applicaiton of the AWM weights results in orders of magnitude difference in financial series. The use of different aggregation methods across series induces relationships. The effects of different possible methods of constructing data are shown through estimation of simple Taylor rules, which result in different weights on output gaps and inflation deviation for what are purportedly the same data
    Keywords: Euro area, data aggregation, Taylor rule
    JEL: C82 C43 E58
    Date: 2007–02–02
  31. By: Luisa Corrado (University of Cambridge); Marcus Miller (University of Warwick); Lei Zhang (University of Warwick)
    Abstract: Recent empirical research by Mark Taylor and coauthors has found evidence of hybrid dynamics for the real exchange rate. While there is a random walk near equilibrium, for real exchange rates some distance from equilibrium there is mean-reversion which increases with the degree of misalignment. An interesting question is whether this nonlinear mean-reversion is policy-induced. John Williamson (1998) for example, has proposed a "monitoring band" in which there is no intervention near equilibrium but there is substantial intervention triggered by exchange rate deviations outside a preset band. In this paper we develop a theoretical model for a stylised monitoring band to see whether it can generate patterns of nonlinear mean-reversion akin to those reported in empirical research
    Keywords: Monitoring Band, Non-linear Mean-Reversion, Near Random Walk Dynamics
    JEL: D52 F31 G12
    Date: 2007–02–02
  32. By: Huw Dixon (University of York)
    Abstract: This paper shows how any steady state distribution of ages and related hazard rates can be represented as a distribution across firms of completed contract lengths. The distribution is consistnet with a Generalised Taylor Economy or a Generalised Calvo model with duration dependent reset probabilities. Equivalent distributions have different degrees of forward lookingness and imply different behaviour in response to monetary shocks. We also interpret data on the proportions of firms changing price in a period, and the resultant range of average contract lengths
    Keywords: Contract length, steady state, hazard rate, Calvo, Taylor
    JEL: E50
    Date: 2007–02–02
  33. By: Luciana Juvenal (University of Warwick); Mark P. Taylor (University of Warwick, Centre for Economic Policy Research)
    Abstract: Using Self-Exciting Threshold Autoregressive Models (SETAR), this paper explores the validity of the Law of One Price (LOOP) for nineteen sectors in ten European countries. We find strong evidence of nonlinear mean reversion in deviations from the LOOP. We highlight the importance of modelling the real exchange rate in a nonlinear fashion in an attempt to solve the PPP Puzzle. Using the US dollar as a reference currency, half-life estimates range from nine to sixteen months (country averages), which are significantly lower than the `consensus estimates' of three to five years. The results also show that transaction costs differ enormously across sectors and countries
    Keywords: Law of One Price, mean reversion, nonlinearities, thresholds
    JEL: F31 F41 C22
    Date: 2007–02–02
  34. By: Eran Guse (University of Cambridge)
    Abstract: This paper introduces a general method to study stability (under learning) of equilibria resulting from agents with misspecified perceptions of the law of motion of the economy. This is done by transforming the actual and perceived laws of motion into the form of seemingly unrelated regressions and then linearly projecting the actual law of motion into the same class as the perceived law of motion. I study the New Keynesian IS-LM model with inertia under all possible classes of restricted perceptions. It turns out that the results found in Bullard and Mitra (2002, 2003) are robust under misspecified expectations
    Keywords: Adaptive Learning, Expectational Stability, Monetary Policy Rules, Restricted Perceptions Equilibria, Seemingly Unrelated Regression
    JEL: E4 E5
    Date: 2007–02–02
  35. By: Kenneth W. Clements; Renee Fry
    Abstract: There is a large literature on the influence of commodity prices on the currencies of countries with a large commodity-based export sector such as Australia, New Zealand and Canada ("commodity currencies"). There is also the idea that because of pricing power, the value of currencies of certain commodity-producing countries affects commodity prices, such as metals, energy, and agricultural-based products ("currency commodities"). This paper merges these two strands of the literature to analyse the simultaneous workings of commodity and currency markets. We implement the approach by using the Kalman filter to jointly estimate the determinants of the prices of these currencies and commodities. Included in the specification is an allowance for spillovers between the two asset types. The methodology is able to determine the extent that currencies are indeed driven by commodities, or that commodities are driven by currencies, over the period 1975 to 2005.
    Date: 2006–07
  36. By: Masao Ogaki (Department of Economics, Ohio State University); Sungwook Park (Department of Economics, Ohio State University)
    Abstract: Engel (1999) computes the variance of k-differences for each time horizon us- ing the method of Cochrane (1988) in order to measure the importance of the traded goods component in U.S. real exchange rate movements. The importance of traded goods should decrease as the horizon increases if the law of one price holds for traded goods in the long run. However, Engel ?nds that the variance of k-di¤erences decreases only initially and then increases as k approaches the sample size. He interpets the increasing variance as evidence of an increase in the long-run importance of the traded goods component. By contrast, we show that the variance of k-di¤erences tends to return to the initial value as k approaches the sample size whether the variable is stationary or unit root nonstationary. Our results imply that the increasing variances for k-values close to the sample size cannot be inter- preted as evidence of an increase in the importance of the traded goods component in the long run. We ?nd that our test results regarding the variance of k-di¤erences are consistent with smaller importance of the traded goods component in the longer run.
    Keywords: Real exchange rate, Variance ratio, Traded and nontraded goods
    JEL: F31
    Date: 2007–02
  37. By: M. Alper Cenesiz (Saarland University, University of Kiel)
    Abstract: In this paper, I developed a new cost channel of monetary policy transmission in a small scale, dynamic, general equilibrium model. The new cost channel of monetary policy transmission implies that the frequency of price adjustment increases in the nominal interest rate. I found that allowing for the new cost channel can account both for the muted and delayed inflation response and for the persistence of the output response to monetary policy shocks. Without any additional assumption, my model can also generate the delayed output response, though for a slightly more competitive goods market calibration
    Keywords: Price stickiness, Monetary policy, Price adjustment, Persistence
    JEL: E31 E32 E52
    Date: 2007–02–02
  38. By: Pelin Ilbas (Catholic University of Leuven)
    Abstract: This paper evaluates optimal monetary policy rules within the context of a dynamic stochastic general equilibrium model estimated for the Euro Area. Under assumption of an ad hoc loss function for the central bank, we compute the unconditional losses both under discretion and commitment. We compare the performance of unrestricted optimal rules to the performance of optimal simple rules. The results indicate that there are considerable gains from commitment over discretion, probably due to the stabilization bias present under discretion. The lagged variant of the Taylor type of rule that allows for interest rate inertia does relatively well in approaching the performance of the unrestricted optimal rule derived under commitment. On the other hand, simple rules expressed in terms of forecasts to next period's inflation rate seem to perform relatively worse.
    Keywords: monetary policy, discretion, commitment
    JEL: E52 E58
    Date: 2007–02–02
  39. By: Alexander Mihailov (University of Essex)
    Abstract: We investigate whether increased independence affects central bank behavior when monetary policy is already in an inflation targeting regime. Taking advantage of the recent UK experience to identify such an exogenous change, we estimate Taylor rules via alternative methods, specifications and proxies. Our contribution is to detect two novel results: the Bank of England has responded to the output gap, not growth; and in a stronger way after receiving operational independence. Both findings are consistent with the Bank's mandate and New Keynesian monetary theory. Economic expansion and anchored inflation have thus complemented greater autonomy in influencing the Bank's policy feedback
    Keywords: asymmetry of monetary policy reaction function across the business cycle, response to output gap vs output growth, Taylor rules, operational independence, inflation targeting, United Kingdom
    JEL: E52 E58 F41
    Date: 2007–02–02
  40. By: Bernd Hayo (University of Marburg)
    Abstract: This paper analyses whether interest rate paths in the EMU member countries would have been different if the previous national central banks had not handed over monetary policy to the ECB. Using estimates of monetary policy reaction functions over the last 20 years before the formation of EMU, we derive long-run rules the relate interest rate setting to the expected one-year ahead inflation rate and the current output gap. These Taylor rules allow to derive long-run target rates which are employed in the simulation of counterfactual interest rate paths over the time period January 1999 to December 2004 and then compared to actual short-term interest rates in the euro area. It is found that for almost all EMU member countries euro area interest rates tend to be below the national target interest rates, even after explicitly accounting for a lower real interest rate in the EMU period, with Germany being the only exception.
    Keywords: Taylor rule, monetary policy, ECB, European Monetary Union
    JEL: E5
    Date: 2007–02–02
  41. By: Jan Bruha (External Economic Relations Division, Czech National Bank, Na P??kop? 28, 115 03 Praha 1, Czech Republic.); Jirí Podpiera (External Economic Relations Division, Czech National Bank, Na P??kop? 28, 115 03 Praha 1, Czech Republic.)
    Abstract: In this paper we present a two-country dynamic general equilibrium model of ex ante unequally developed countries. The model explains a key feature recently observed in transition economies – the long-run trend real exchange rate appreciation – through investments into quality. Our exchange-rate projections bear important policy implications, which we illustrate on the collision between the price and nominal exchange rate criterion for the European Monetary Union in a set of selected transition economies in Central and Eastern Europe. JEL Classification: E58, F15, F43.
    Keywords: Two-country modeling, Convergence, Monetary Policy, Currency area.
    Date: 2007–03
  42. By: Alvaro Angeriz (CCEPP and Wolfson College, University of Cambridge); Philip Arestis (CCEPP and Wolfson College, University of Cambridge)
    Abstract: The aim of this paper is to deal with the empirical aspects of the ‘new’ monetary policy framework, known as Inflation Targeting. Applying Intervention Analysis to multivariate Structural Time Series models, new empirical evidence is produced in the case of a number of OECD countries,. These results demonstrate that although Inflation Targeting has gone hand-in hand with low inflation, the strategy was introduced well after inflation had begun its downward trend. But, then, Inflation Targeting ‘locks in’ low inflation rates. The evidence produced in this paper suggests that non-IT central banks have also been successful on this score.
    Keywords: Inflation targeting, Intervention Analysis, Multivariate Structural Time Series
    JEL: E31 E52
    Date: 2007–02–02
  43. By: Arnab Bhattacharjee (University of St Andrews); Christoph Thoenissen (University of St Andrews)
    Abstract: We compare three methods of motivating money in New Keynesian DSGE Models: Money-in-the-utility function, shopping time and cash-in-advance constraint, as well as two ways of modelling monetary policy, interest rate feedback rule and money growth rules. We use impulse response analysis, and a set of econometric distance measures based on comparing model and data variance-covariance matrices to compare the different models. We find all models closed by an estimated interest rate feedback rule imply counter-cyclical policy and inflation rates, which is at odds with the data. This problem is robust to the introduction of demand side shocks, but is not a feature of models closed by an estimated money growth rule. Drawing on our econometric analysis, we argue that the cash-in-advance model, closed by a money growth rule, comes closest to the data
    Keywords: Intertemporal Macroeconomics, monetary policy, role of money, model selection, model selection
    JEL: C13 E32 E52
    Date: 2007–02–02
  44. By: Jean-Stéphane MESONNIER (Banque de France)
    Abstract: The real interest rate gap -IRG-, i.e. the gap between the short term real interest rate and its “natural†level, is a theoretical concept of potential policy relevance for central banks, at least to evaluate the monetary policy stance, at best as a guideline for policy moves. This paper aims at clarifying the practical relevance of IRG indicators for monetary policy. To this end, it provides an empirical assessment of the usefulness of various univariate and multivariate estimates of the real IRG for predicting inflation, real activity and real credit growth in the euro area. On the basis of out-of-sample evidence using real-time data, I find that IRG measures are globally of little help to improve our knowledge of future inflation in the euro area. By contrast, some of the estimated IRG measures exhibit a significant predictive power for future real activity, in line with the intuition from a traditional IS curve, as well as for credit growth. Nevertheless, in most cases, the forecasting models that include estimated IRG do not outperform a simpler AR model augmented with the first difference of the nominal interest rate
    Keywords: natural rate of interest, monetary policy, forecasting
    JEL: C53 E37 E52
    Date: 2007–02–02
  45. By: Richard Mash (Oxford University)
    Abstract: Models in which pricing decisions depend on indexing or rule of thumb behaviour have become prominent in the monetary policy literature and tend to match macroeconomic data well given their prediction of inflation persistence. The extent to which firms index their prices to past inflation has been assumed constant. We explore the consequences of endogenising the degree of indexing such that firms move closer to constrained optimal prices and find that the degree of indexing depends sensitively on firms’ perceptions of the degree of persistence in the economy. This has striking implications. Firstly models in which the degree of indexing is fixed are vulnerable to the Lucas critique since that parameter will change in different regimes. Secondly we study the interactions between perceived persistence, which governs indexing and thus the quantitative significance of lagged inflation in the Phillips curve, and actual persistence which depends on the latter. We find that if firms adjust their indexing behaviour to actual persistence, lagged inflation disappears from the Phillips curve and the models no longer predict persistence
    Keywords: Monetary policy, Phillips curve, Inflation Persistence, Microfoundations, Indexing
    JEL: E52 E58 E22
    Date: 2007–02–02
  46. By: Michael G Arghyrou (Cardiff Business School); Georgios Chortareas (University of Essex)
    Abstract: Global current account imbalances have been one of the focal points of interest for policymakers during the last few years. Less attention has been paid, however, to the growing imbalances within the Euro-area. In the short period since the commencement of the EMU two distinct groups of member state have emerged: those with consistently improving current accounts and those with consistently worsening current accounts. In this paper we consider the dynamics of current account adjustment and the role of real exchange rates in current account determination in the EMU member countries. Monetary union participation, which entails giving up the nominal exchange rate, can make the correction of current account imbalances more cumbersome. While most theoretical models of open economies rely on a causal relationship between real exchange rates and the current account limited, if any, contemporary evidence exist on the empirical validity of this relationship. We find that the above relationship is substantial in size and subject to pronounced non-linear effects. We identify two groups of countries since the abandonment of European national currencies: those with persistent real exchange rate depreciation leading to current account improvement; and those with systematic real appreciation and deteriorating current accounts. These groups largely correspond to those previous research has identified as respectively belonging and not belonging to a European Optimum Currency Area. Our findings validate the theoretical arguments concerning the potential costs of EMU participation and suggest that meeting the nominal convergence criteria has come, in some countries, at the cost of growing current account imbalances. The latter pose policy-response questions for national authorities and the ECB, suggesting that it may be optimal to add to the EMU-accession criteria one referring to the balance of the current account; and highlighting the importance of increasing the flexibility of relative prices to facilitate real exchange rate and current account adjustment
    Keywords: current account, real exchange rate, EMU, nonlinearities
    JEL: C51 F32 F41
    Date: 2007–02–02
  47. By: Andrea Monticini (University of Exeter); Giacomo Vaciago (Universita' Cattolica Milano)
    Abstract: This paper investigates, for the first time, the reactions of markets to the monetary policy decisions of their own Central Bank and to the decisions of the Central Banks of other countries. In particular, using daily interest rates to estimate the impact of the monetary policy announcements of a Central Bank, we analyse the effect of the FED, ECB, and BoE monetary policy announcements on their own markets, and on the others. Surprisingly, we find that while the US rates respond only to FED announcements, and the British rates respond mainly to BoE announcements and marginally to FED announcements, the response of Euro bond rates to the FED announcements is stronger than their response to ECB announcements
    Keywords: Monetary Policy, Term structure of interest rates, Interdependence
    JEL: E4 E43 E52 F42
    Date: 2007–02–02
  48. By: Claudia Kwapil (Oesterreichische Nationalbank); Johann Scharler (Oesterreichische Nationalbank)
    Abstract: In this paper we analyze equilibrium determinacy in a sticky price model in which the pass-through from policy rates to retail interest rates is sluggish and potentially incomplete. In addition, we empirically characterize and compare the interest rate pass-through process in the euro area and the U.S. We find that if the pass-through is incomplete in the long run, the standard Taylor principle is insufficient to guarantee equilibrium determinacy. Our empirical analysis indicates that this result might be particularly relevant for bank-based financial systems as for instance that in the euro area.
    Keywords: Interest Rate Pass-Through, Equilibrium Determinacy, Stability
    JEL: E32 E52 E58
    Date: 2007–02–02
  49. By: Alexandra Ferreira Lopes (ISEG, ISCTE and DINÂ MIA)
    Abstract: Czech Republic, Hungary and Poland will have to join the European and Monetary Union. Surprisingly, there is very little work on the welfare consequences of the loss of monetary policy flexibility for these countries. This paper fills this void by providing a framework to evaluate quantitatively the economic costs of joining the EMU. Using a two country dynamic general equilibrium model with sticky prices we investigate the economic implications of the loss of monetary policy flexibility associated with EMU for each country. The main contribution of our general equilibrium approach is that we can evaluate the effects of monetary policy in terms of welfare. Our findings suggest that these economies may experience sizable welfare losses as a result of joining the EMU. Results show that the cost associated with the loss of the monetary policy flexibility is bigger in the presence of persistence technological shocks, weak correlation of monetary shocks, strong risk aversion and a small trade share with the EMU
    Keywords: Monetary Policy, Eastern and Central Europe Countries, Euro, Open Economy Macroeconomics, General Equilibrium
    JEL: C68 E52 F41
    Date: 2007–02–02
  50. By: Eleni Angelopoulou (Bank of Greece and Athens University of Economics and Business)
    Abstract: This paper reviews 22 years of UK monetary policy (1971-1992) using official record from the Quarterly Bulletin of the Bank of England. A definition of policy shocks, which allows for the exclusion of cases of interest rate increases, which were unrelated to the monetary policy objectives, is used. The empirical analysis shows that output displays the usual hump-shaped response after a shock to the policy indicator but adjustment to pre-shock levels is slow. Other variables also display theory-consistent behaviour. Based on this policy indicator monetary policy is found to cause very limited output fluctuation in a four year horizon. The policy indicator is found to outperform the intervention rate as a measure of policy
    Keywords: monetary policy shocks, narrative approach, UK
    JEL: E52 E58
    Date: 2007–02–02
  51. By: Paul Mizen (University of Nottingham); Tae-Hwan Kim (University of Nottingham); Alan Thanaset (University of Nottingham)
    Abstract: Support for the Taylor principle is considerable but the focus of empirical investigation has been on estimated coefficients at the mean of the interest rate distribution. We offer a new approach that estimates the response of interest rates to inflation and the output gap at various points (quantiles) on the conditional distribution corresponding to different levels of interest rates. We find support for the Taylor principle at all but low rates in normal times for the US and the UK, but an increasingly aggressive (nonlinear) response to inflation as rates increase. This is robust to the inflation horizon, instrument choice and use of a real time output gap data. In abnormal times, described by events in Japan, we find strong support for the Taylor principle, and increasing aggression to inflation when rates increase. We confirm that increasing aggression towards inflation can be observed as interest rates approach zero. The results have implications for the modeling of economies when inflation is very low, and provides some insights into Japanese monetary policy in particular
    Keywords: Taylor Principle, policy rules, quantile regression, low inflation, Japan
    JEL: E42 E52
    Date: 2007–02–02
  52. By: Reginaldo Pinto Nogueira Junior (University of Kent at Canterbury)
    Abstract: The paper presents evidence on the “Fear of Floating†hypothesis in an Inflation Targeting regime. We use the methodologies of Calvo and Reinhart (2002) and Ball and Reyes (2004) for a set of developed and emerging market economies to examine the existence of a possible trend of greater exchange rate flexibility after the adoption of the new regime. This exercise shows a strong movement of the economies towards a more flexible exchange rate regime after the adoption of Inflation Targeting. We also analyse interventions in the foreign exchange market using a structural VAR, and conclude that although “Fear of Floating†cannot be totally discarded it is not the only explanation for interventions, as the exchange rate pass-through still is an important issue for the attainment of the inflation targets for many economies
    Keywords: Inflation Targeting, Exchange Rate Pass-through, Fear of Floating
    JEL: E42 E52 E58
    Date: 2007–02–02
  53. By: Galindev Ragchaasuren (Department of Economics University of Essex)
    Abstract: This paper presents a stochastic monetary growth model with nominal rigidities and active monetary policy in which technological change contains both deliberate (internal) and serendipitous (external) learning mechanisms. The model is used to describe how the implications of monetary stabilization policy for the long-run economic performance could change due to the ambiguity on the relationship between secular growth and cyclical volatility
    Keywords: growth, cyclies, money, stabilisation policy
    JEL: E32 E52 O42
    Date: 2007–02–02
  54. By: Edda Claus; Mardi Dungey; Renee Fry
    Abstract: Two impediments to effective monetary policy operation include illiquidity in bond markets and the move towards the zero bound of interest rates. Either or both of these scenarios have been evident in many countries in the last decade, raising the suggestion that alternative means of enacting monetary policy may be required. This paper empirically explores policy options implemented through equity and currency markets that will generate similar inflation responses at a short (2 year) and a long (10 year) time frame as those obtained under current arrangements. The results show that current monetary policy arrangements are least costly in terms of the output loss from achieving lower inflation outcomes. However, if this option ceases to be available the next best alternative is to use the equity market option provided a longer run focus is maintained. Focus on short horizons increases the longer term output costs of the policy in all cases.
    JEL: E52 C51
    Date: 2006–07
  55. By: Alvaro Aguiar (Faculdade de Economia, Universidade do Porto); Inês Drumond (Faculdade de Economia, Universidade do Porto)
    Abstract: This paper improves the analysis of the role of financial frictions in the transmission of monetary policy, by bringing together the borrowers' balance sheet channel with an additional channel working through bank capital, considering capital adequacy regulations and households' preferences for liquidity. Detailing a dynamic new Keynesian general equilibrium model, in which households require a (countercyclical) liquidity premium to hold bank capital, we find that the introduction of bank capital amplifies monetary shocks to the macroeconomy through a liquidity premium effect on the external finance premium. This effect, together with the financial accelerator, generates quantitatively large amplification effects
    Keywords: Bank capital channel; Bank capital requirements; Financial accelerator; Liquidity premium; Monetary transmission mechanism
    JEL: E44 E32 E52 G28
    Date: 2007–02–02
  56. By: Johann Scharler (Oesterreichische Nationalbank); Sylvia Kaufmann (Oesterreichische Nationalbank)
    Abstract: In this paper we study the role of financial systems for the cost channel transmission of monetary policy in a calibrated business cycle model. We analyze the different effects that monetary policy has on the economy, in particular on output and inflation, which are due to differences in country-specific financial systems. For a plausible calibration of the model, differences in financial systems have a rather limited effect on the transmission mechanism and do not appear to give rise to cross country differences in the strength of the cost channel
    Keywords: Financial Systems, Cost Channel, Transmission Mechanism
    JEL: E40 E50
    Date: 2007–02–02
  57. By: Giovanni Di Bartolomeo (University of Rome I and University of Teramo); Lorenza Rossi (University of Rome II and ISTAT); Massimiliano Tancioni (University of Rome I)
    Abstract: This paper develops and estimates a simple New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model with rule-of-thumb consumers and external habits. Our theoretical model has a closed-form solution which allows the analytical derivation of its dynamical and stability properties. These properties are analyzed and discussed in the light of their implications for the efficacy and the calibration of the conduct of the monetary policy. The model is then evaluated empirically, employing numerical simulations based on Monte Carlo Bayesian estimates of the structural parameters and impulse response analyses based on weakly identified SVECMs. The estimates are repeated for each of the G7 national economies. Providing single country estimates and simulations, we derive some indications on the relative efficacy of monetary policy and of its potential asymmetric effects resulting from the heterogeneity of the estimated models.
    Keywords: Rule-of-thumb, habits, monetary policy transmission, price puzzle, DSGE New Keynesian model, monetary policy, SVECM and Monte Carlo Bayesian estimators.
    Date: 2007–02–02
  58. By: Ram Kharel (Economics and Finance Brunel University); Chris Martin (Economics and Finance Brunel University); Costas Milas (Keele)
    Abstract: There is a large literature on monetary policy and asset prices. There are 2 aspects to this literature: do monetary policymakers respond to asset prices? should monetary policymakers respond to asset prices? This paper addresses the first of thes
    Date: 2007–02–02
  59. By: Donal Bredin (University College Dublin); Stilianos Fountas (University of Macedonia and National University of Ireland)
    Abstract: We use a Markov regime-switching heteroskedasticity model in order to examine the association between inflation and inflation uncertainty in four European countries over the last forty years. This approach allows for regime shifts in both the mean and variance of inflation in order to assess the association between inflation and its uncertainty in short and long horizons. We find that this association differs (i) between transitory and permanent shocks to inflation and (ii) across countries. In particular, the association is positive or zero for transitory shocks and negative or zero for permanent shocks. Hence, Friedman's belief that inflation is positively associated with inflation uncertainty is only partially supported in this study, i.e., by short-run inflation uncertainty
    Keywords: Inflation, Inflation uncertainty, Markov process, regime-switching heteroskedasticity
    JEL: E31 C22
    Date: 2007–02–02
  60. By: Christopher Adam (Oxford University); David Cobham (Heriot-Watt University)
    Abstract: A ‘new version’ gravity model, is used to estimate the effect of a full range of de facto exchange rate regimes, as classified by Reinhart and Rogoff (2004), on bilateral trade. The results indicate that, while participation in a common currency union is typically strongly ‘pro-trade’– as first suggested by Rose (2000) – other exchange rate regimes which lower the exchange rate uncertainty and transactions costs associated with international trade between countries are significantly more pro-trade than the default regime of a ‘double float’. They suggest that the direct and indirect effects of exchange rate regimes on uncertainty and transactions costs tend to outweigh the trade-diverting substitution effects. In addition, there is evidence that membership of different currency unions by two countries has pro-trade effects, which can be understood in terms of a large indirect effect on transactions costs. Tariff-equivalent monetary barriers associated with each of the exchange rate regimes are also calculated
    Keywords: gravity, geography, exchange rate regime, currency union, transactions costs, tariff-equivalent barriers
    JEL: F10 F33 F49
    Date: 2007–02–02
  61. By: Atanas Christev (Heriot-Watt University, Edinburgh)
    Abstract: Emprical studies of hyperinflations reveal that the rational expectations hypothesis fails to hold. To address this issue, we study a model of hyperinflation and learning in an attempt to better understand the volatility in movements of expectations, money, and prices. The findings surprisingly imply that the dynamics under neural network learning appear to support the outcome achieved under least squares learning reported in the earlier literature. Relaxing the assumption that inflationary expectations are rational, however, is essential since it improves the fit of the model to actual data from episodes of severe hyperinflation. Simulations provide ample evidence that if equilibrium in the model exists, then the inflation rate converges to the low inflation rational expectations equilibrium. This suggests a classical result: a permanent increase in the government deficit raises the stationary inflation rate (Marcet and Sargent, 1989)
    Keywords: Hyperinflation, Learning, Rational Expectations Equlibria, Neural Networks
    JEL: C62 E63 E65
    Date: 2007–02–02
  62. By: Christopher F Baum (Boston College); Mustafa Caglayan (University of Glasgow)
    Abstract: We present an empirical investigation of a recently suggested but untested proposition that exchange rate volatility can have an impact on both the volume and variability of trade flows, considering a broad set of countries' bilateral real trade flows over the period 1980-1998. We generate proxies for the volatility of real trade flows and real exchange rates after carefully scrutinizing these variables' time series properties. Similar to the findings of earlier theoretical and empirical research, our first set of results show that the impact of exchange rate uncertainty on trade flows is indeterminate. Our second set of results provide new and novel findings that exchange rate volatility has a consistent positive and significant effect on the volatility of bilateral trade flows.
    Keywords: exchange rates, volatility, fractional integration, trade flows
    JEL: F17 F31 C22
    Date: 2007–02–02
  63. By: Zsolt Darvas (Corvinus University Budapest); Gábor Rappai (University of Pécs); Zoltán Schepp (University of Pécs)
    Abstract: Results and models of this paper are based on a strikingly new empirical observation: long maturity forward rates between bilateral currency pairs of the US, Germany, UK, and Switzerland are stationary. Based on this result, we suggest a new explanation for the UIP-puzzle maintaining rational expectations and risk neutrality. The model builds on the interaction of foreign exchange and fixed income markets. Ex ante short run and long run UIP and the EHTS is assumed. We show that ex post shocks to the term structure could explain the behavior of the nominal exchange rate including its volatility and the failure of ex post short UIP regressions. We present evidence on ex post validity of long run UIP and strikingly new evidence on the stationarity of the long forward exchange rates of major currencies. We set up, calibrate and simulate a stylized model that well captures the observed properties of spot exchange rates and UIP regressions of major currencies. We define the notion of yield parity and test its empirical performance for monthly series of major currencies with favorable results
    Keywords: EHTS, forward discount bias, stationarity of long maturity forward rates, UIP, yield parity
    JEL: E43 F31
    Date: 2007–02–02
  64. By: Bianca De Paoli, Alasdair Scott, Olaf Weeken (Bank of England)
    Abstract: To match the stylised facts of goods and labour markets, the canonical New Keynesian model augments the optimising neoclassical growth model with nominal and real rigidities. We ask what the implications of this type of model are for asset prices. Using a second-order numerical solution to the model, we examine bond and equity returns, the equity risk premium, and the behaviour of the real and nominal term structure. We catalogue the factors that are most important for determining the size of risk premia and the slope and level of the yeild curve. In a world of technology shocks only, increasing the degree of real rigidities raises risk premia and increasing nominal rigidities reduces risk premia. In a world of monetary policy shocks only, both real and nominal rigidities raise risk premia. The results indicate that the iimplications of the New Keynesian nodel for average asset returns depend critically on the characterisation of shocks hitting the model economy
    Keywords: Asset prices, New Keynesian, Rigidities
    JEL: E43 E44 E52 G12
    Date: 2007–02–02
  65. By: Julian von Landesberger (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Empirical money demand analysis undertaken at the aggregate level may obscure behavioural differences between the financial, non-financial corporation and household sectors. Looking at the individual and more homogenous sectors may allow more clearly interpretable empirical relationships between money holding, scale variables and opportunity costs to be estimated. Two possible approaches can be taken to address this issue: aggregate and sectoral money holdings are explained either by a common set of determinant variables or by specific determinants, which may differ across sectors. In this analysis, the first approach has been chosen in order to highlight the different elasticities of the long-run money demand with respect to a common set of macroeconomic determinants and thereby to allow comparison of the model for the aggregate M3 with corresponding models for households, non-financial corporations and non-monetary financial intermediaries. This paper presents results for cointegrated VAR systems estimated over a sample of quarterly data from 1991 to 2005. A SUR system is estimated to cross-check the robustness of the findings and to analyse the importance of common shocks across sectors. JEL Classification: E41, C32, E59.
    Keywords: Sectoral money holdings, money demand, cointegrated VAR systems.
    Date: 2007–03
  66. By: ÿlvaro Aguiar (CEMPRE-Faculdade de Economia do Porto); Ana Paula Ribeiro (CEMPRE-Faculdade de Economia do Porto)
    Abstract: Lagged benefits relative to costs can politically block an efficiency-enhancing labor market reform, lending support to the "two-handed approach". An accommodating monetary policy, conducted alongside the reform, could help bringing the positive effects of the reform to the fore. In order to identify the mechanisms through which monetary policy may affect the political sustainability of a reform, we add stylized features of the labor market to a standard New-Keynesian model for monetary policy analysis. A labor market reform is modeled as a structural change inducing a permanent shift in the flexible-price unemployment and output levels. In addition to the permanent gains, the impact of the timing and magnitude of the reform-induced adjustments on the welfare of workers - employed and unemployed - is crucial to the political feasibility of the reform. Since the adjustments depend, on one hand, on the macroeconomic structure and, on the other hand, can be influenced by monetary policy, we simulate various degrees of output persistence across different policy rules. We find that, if inertia is present, monetary policy affects the political support for the reform. Choosing a particular policy rule, as well as the business cycle timing of the reform, are means to enhance political sustainability
    JEL: E24 E37 E52 E61
    Date: 2007–02–02
  67. By: Richard Holt (Edinburgh University)
    Abstract: New Keynesian models attempt to account for economic fluctuations under nominal rigidities without modelling unemployment. They struggle to generate observed output and inflation persistence. To address these issues, recent research embeds labour search with matching frictions in a New Keynesian framework. Models with labour market search, matching and endogenous job destruction, feature unemployment, but generate an upward sloping Beveridge curve and overly volatile gross job flows. By introducing a second margin, hours, in the adjustment of labour input I obtain a negative unemployment-vacancy correlation and plausible gross job flow volatilities without affecting the desirable persistence properties of the model. I show that these results are affected by real wage rigidity, endogenous job destruction and capital adjustment costs
    Keywords: Beveridge Curve, Hours, Gross Job Flows, Inflation
    JEL: E24 E31 J64
    Date: 2007–02–02
  68. By: Georgios Chortareas (University of Essex); John Nankervis (University of Essex); Ying Jiang (University of Essex)
    Abstract: This paper focuses on forecasting volatility of high frequency Euro exchange rates. Four 15 minute frequency Euro exchange rate series, including Euro/CHF, Euro/GBP, Euro/JPY and Euro/USD, are used to test the forecast performance of six models, including both traditional time series volatility models and the realized volatility model. Besides the normally used regression test and accuracy test, an equal accuracy test, the HLN-DM test, and a superior predictive ability test are also employed in the out-of-sample forecast evaluation. The FIGARCH model is found to be superior in almost all exchange rate series. Although the widely preferred ARFIMA model shows better performance than the traditional daily volatility models, generally speaking, it cannot surpass the FIGARCH model and the intraday GARCH model. Furthermore, the SVX model does not significantly outperform the SV model in the accuracy test, which contradicts the results of some earlier research. The paper confirms the advantage of using high frequency data and modelling the long memory factor. It also analyses the characteristics of Euro exchange rates and compares the test results with the conclusions drawn by previous studies
    Keywords: exchange rates, volatility, euro, high frequency
    JEL: F31 C22
    Date: 2007–02–02
  69. By: Davide Furceri (University of Illinois at Chicago)
    Abstract: The purpose of this paper is to analyze the main macroeconomic determinants of benefits and costs by undertaking processes of monetary integration, and investigate the possibility that currency unions could be lead to the creation of a global currency in the future. In particular, we will consider two main costs and benefits predicted by the theory of Optimum Currency Areas: (i) the business-cycle correlation between the candidate’s economy and that of the currency zone as a whole, and (ii) the candidate economy’s inflationary bias. Using this methodology, the results of the paper provide empirical evidence of the existence of several optimal currency areas in the world. Moreover, the creation of a world common currency area is not as unrealistic as it might seem at first sight.
    Keywords: Currency Unions, World Currency
    JEL: E32 F33 F41
    Date: 2007–02–02
  70. By: Michael Frömmel; Torsten Schmidt
    Abstract: We examine the dynamics of bank lending to the private sector for countries of the Euro area by applying a Markov switching error correction model.We identify for Belgium, Germany, Ireland and Portugal stable, mean reverting regimes and unstable regimes with no tendency to return to the long term credit demand equation, whereas for some other countries there is only weak evidence. Furthermore, for these as well as for other countries we detect in the less stable regimes a strong co-movement with the development of the stock market. We interpret this as evidence for constraints in bank lending. In contrast, the banks’ capital seems to have only marginal impact on the lending behaviour.
    Keywords: Credit demand, credit rationing, asset prices, credit channel
    JEL: C32 G21
    Date: 2006–05
  71. By: Shin-ichi Fukuda; Yoshifumi Kon
    Abstract: The purpose of this paper is to show that macroeconomic impacts might be very different depending on what strategy developing countries will take. In the first part, we investigate what macroeconomic impacts an increased aversion to liquidity risk can have in a simple open economy model. When the government keeps foreign reserves constant, an increased aversion to liquidity risk reduces liquid debt and increases illiquid debt. However, its macroeconomic impacts are not large, causing only small current account surpluses. In contrast, when the government responds to the shock, the changed aversion increases foreign reserves and may lead to a rise of liquidity debt. In particular, under some reasonable parameter set, it causes large macroeconomic impacts, including significant current account surpluses. In the second part, we provide several empirical supports to the implications. In particular, we explore how foreign debt maturity structures changed in East Asia. We find that many East Asian economies reduced short-term borrowings temporarily after the crisis but increased short-term borrowings in the early 2000s. We discuss that our results have important implications for the recent deterioration in the U.S. current account.
    JEL: F21 F32 F34
    Date: 2007–04
  72. By: Oliver Grimm (Center of Economic Research (CER-ETH) at ETH Zurich)
    Abstract: In economic discussions, currency board systems are frequently described as arrangements with self-binding character to the monetary authorities by their strict rules and establishments by law. Hard pegs and especially currency boards are often seen as remedies to overcome economic and financial turmoils and to return to low inflation. A sustainable debt level closely linked to a disciplined fiscal policy is, however, a premise for medium-term success. We show in a two-period model that the choice of a currency board can increase fiscal discipline compared to a standard peg regime. We derive, furthermore, the conditions for a currency boards to gain a stability advantage compared to a common peg system.
    Keywords: currency board, fixed exchange rate, commitment, inflation bias, fiscal discipline, public debt, time-inconsistency problem
    JEL: E52 E58 E62 F33
    Date: 2007–03
  73. By: Kleopatra Nikolaou (Warwick Business School)
    Abstract: We test for mean reversion in real exchange rates using a recently developed unit root test for non- normal processes based on quantile autoregression inference in semi-parametric and non-parametric settings. The quantile regression approach allows us to directly capture the impact of di¤erent magnitudes of shocks that hit the real exchange rate, conditional on its past history, and can detect asymmetric, dynamic adjustment of the real exchange rate towards its long run equilibrium. Our results suggest that large shocks tend to induce strong mean reverting tendencies in the exchange rate, with half lives less than one year in the extreme quantiles. Mean reversion is faster when large shocks originate at points of large real exchange rate deviations from the long run equilibrium. However, in the absence of shocks no mean reversion is observed. Finally, we report asymmetries in the dynamic adjustment of the RER
    Keywords: real exchange rate, purchasing power parity, quantile regression
    JEL: F31
    Date: 2007–02–02
  74. By: Mario R. Páscoa; Myrian Petrassi (Department of Economics, PUC-Rio); Juan Pablo Torres-Martinez (Department of Economics, PUC-Rio)
    Abstract: We show that in economies without liquidity frictions, but with incomplete financial markets, when agents are infinitely lived and uniformly impatient, money can still be essential (that is, have a positive price in equilibrium) if and only if each agent has binding debt constraints at some node of her life span. That is, contrary to what might be expected, in the absence of a very productive financial market, frictions induced by debt constraints create some room for improving efficiency, by allowing money to have a role in transferring wealth across dates and states of nature.
    Keywords: Cashless economies, Binding debt constraints, Fundamental value of money.
    JEL: D50 D52
    Date: 2007–03
  75. By: Jean-Sébastien Pentecôte (CREM, Universty of Rennes 1)
    Abstract: A growing literature has emerged to assess the importance and the channels of contagion during the recent currency crises which occured in the 1990s. However, little attention has been paid to the policy implications of the way to coordinate interventions in order to defend not only a single, but rather a given set of currencies altogether. To this end, a state-space model is built to describe the dynamics of many bilateral exchange rates. Using the Kalman filter, we check in particular the stability and the controllability of the system. The ERM evidence show that a successfull strategy heavily depends on both the time-horizon and the cost attached by the monetary authority to her interventions
    Keywords: contagion, currency crises, state-space model, mulitvariate control
    Date: 2007–02–02
  76. By: Stephen Millard (Bank of England)
    Abstract: The purpose of this paper is to understand the economics behind the evolution of payments where by payments I mean the ‘transfer of monetary value’ (in return for goods, services, or real or financial assets). It is clear from this definition of payments that, in order for there to be payments, there first needs to be money. So, the paper first discusses why money might evolve as a result of some frictions inherent in real-world economies. It then discusses the evolution of banks, arguing that banks developed in order to provide payment services (making ‘money’ work more efficiently). The paper then discusses how banks can save on the use of collateral to make payments – collateral that they can convert into loans to earn a return – by the development of ‘payment systems’. Such systems will involve some form of netting of payments (clearing) and final settlement in some asset. ‘Central banks’ fit into this picture by providing, in their liabilities, a settlement asset that the other banks are happy to use. In so doing, they are incentivised to worry about monetary and financial stability
    Keywords: Money, banks, payment systems, central banks
    JEL: E42 E58
    Date: 2007–02–02
  77. By: Warwick J. McKibbin; Kang Yong Tan
    Abstract: This paper studies the implications of adaptive learning in the modelling of international linkages in a two-region MSG-Cubed (MSG3) model built on micro-founded behaviours of firms and households. The nature of the transmission process under rational expectations versus the adaptive learning methodology (evans and Honkapohja, 2001) is explored. We investigate the propagation mechanism within and across borders for various shocks and policy changes within the United States: change in inflation target, fiscal policy, productivity shock, and rise in equity risk. Adaptive learning is found to change the short run sign of transmission in all cases except for the inflation target shock. Learning could also resolve the quantity anomaly puzzle in the international RBC literature. The findings suggest the choice of expectations formation scheme is crucial in large-scale macroeconomic models.
    JEL: D83 E60 F42
    Date: 2006–12
  78. By: Philipp Harms (RWTH Aachen University, Study Center Gerzensee); Marco Kretschmann (RWTH Aachen)
    Abstract: Recent studies on the growth effects of exchange rate regimes offer a wide range of different, sometimes contradictory results. In this paper, we systematically compare three prominent contributions in this field. Using a common data set, a common specification, and common estimation methods, we argue that the contradictory findings can be explained by the fact that these studies use regime classifications which reflect fundamentally different aspects of exchange rate policy.
    Date: 2007–03
  79. By: Dreher, Axel; Vaubel, Roland (Institut für Volkswirtschaft und Statistik (IVS))
    Abstract: Using panel data for 106 countries in 1971 - 1997, we estimate generalized least squares regressions to explain IMF lending as well as monetary and fiscal policies in the recipient countries. With respect to moral hazard, we find that a country`s rate of monetary expansion and its government budget deficit is higher the less it has exhausted its borrowing potential in the Fund and the more credit it has recieved from the Fund. As for political business cycles, our evidence indicates that, even with a considerable number of control variables, IMF credits in the more democratic recipient countries are larger in pre-election and post-election years. Thus, IMF lending seems to faciliate the generation of political business cycles, while IMF conditionality may serve as a scapegoat for unpopular corrective measures after the election. The paper concludes with implications for IMF reform.
    JEL: D72 F33 F34
  80. By: Monika Blaszkiewicz-Schwartzman (NUIM, Ireland)
    Abstract: This paper uses the univariate and bivariate structural VAR variance framework to quantify real and nominal exchange rate volatility in the selective New Member States of the European Union, and identify factors responsible for movements of those rates. The scale and the nature of nominal and real exchange rate volatility are tightly linked to fulfilment of Maastricht criteria, real convergence, and the effectiveness of the nominal exchange rate in absorbing asymmetric real shocks. Given that there is no consensus on the appropriate definition of real convergence, and since the degree of real exchange rate volatility reflects the scale of idiosyncratic shocks, as well as overall flexibility of the economy to adjust to these shocks, this paper measures the degree of real convergence by the degree of real exchange rate variability. The results indicate that (i) real asymmetric shocks are not insignificant when compared with the poorer Old Member States of the European Union (ii) the nominal exchange rates, in general, do play a stabilising role, and that (iii) nominal shocks, on average, do not move real exchange rates. Therefore, based on the analysis conducted in this paper, it appears that among the New Member States, only Estonia and Slovenia are ready to give up monetary and exchange rate independence
    Keywords: Exchange Rate Volatility, Convergence, European Monetary Integration, Structural Vector Autoregression, Heteroskedasticity, Small-sample Confidence Intervals
    Date: 2007–02–02
  81. By: Michele Ca’ Zorzi (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Elke Hahn (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper examines the degree of Exchange Rate Pass-Through (ERPT) to prices in 12 emerging markets in Asia, Latin America, and Central and Eastern Europe. Our results, based on three alternative vector autoregressive models, partly overturn the conventional wisdom that ERPT into both import and consumer prices is always higher in “emerging” than in “developed” countries. For emerging markets with only one digit inflation (most notably the Asian countries), passthrough to import and consumer prices is found to be low and not very dissimilar from the levels of developed economies. The paper also finds robust evidence for a positive relationship between the degree of the ERPT and inflation, in line with Taylor’s hypothesis once two outlier countries (Argentina and Turkey) are excluded from the analysis. Finally, the presence of a positive link between import openness and ERPT, while plausible theoretically, finds only weak empirical support. JEL Classification: C32, E31.
    Keywords: Exchange Rate Pass-Through, Emerging Markets.
    Date: 2007–03
  82. By: Vincent Bouvatier (Universite Paris 1)
    Abstract: Non-foreign direct investment capital inflows in China were particularly strong in 2003 and 2004. They were even stronger than current account surpluses or net foreign direct investment inflows. As a result, the pace of international reserves accumulation in China increased significantly. This paper investigates if the rapid build up of international reserves in 2003 and 2004 was a source of monetary instability in China. The relationship between international reserves and domestic credit is examined with a Vector Error Correction Model (VECM), estimated on monthly data from March 1995 to December 2005. Empirical results show that this relationship was stable and consistent with monetary stability. Direct and indirect Granger causality tests are implemented to show how the People's Bank of China (PBC) achieved this monetary stability
    Keywords: hot money inflows, international reserves, VECM, Granger causality
    JEL: C32 E5
    Date: 2007–02–02
  83. By: Riccardo Bonci (Bank of Italy); Francesco Columba (Bank of Italy)
    Abstract: We study in a VAR model the effects of monetary policy shocks with new Italian flow of funds data for 1980-2002. First, our results are consistent with the literature, without being affected by commonly found puzzles. Second, new features of the transmission of monetary policy shocks to the Italian economy are provided. We do not find evidence of financial frictions which prevent firms from reduction of nominal expenditures. Households quickly adjust portfolios leading to a careful evaluation of limited participation hypothesis. Finally, the public sector increases net borrowing after the shock, improving on puzzling opposite results in the literature.
    Keywords: flow of funds, monetary policy, VAR.
    JEL: E32 E52
    Date: 2007–02–02
  84. By: Philip Liu
    Abstract: The importance of the time-consistency poblem depends critically on the model one is working with and its parameterizations. This paper attempts to quantify the magnitude of stabilization bias for a small open economy using an empirically estimated micro-founded dynamic stochastic general equilibrium model. The resultant model is used to investigate the degree to which precommitment policy can improve welfare. Rather than presenting a point estimate of the welfare gain measures, the paper maps out the entire distribution of the welfare gain using the Bayesian posterior distribution of the model's parameters. The welfare improvement is an increasing function of the weight the central bank places on exchange rate variability. However, there is no simple relationship between the gains from precommitment and the degree of openness of the economy.
    JEL: C15 C51 E17 E61
    Date: 2006–12
  85. By: Roberto Frenkel
    Abstract: This article, originally published in Spanish in La Nación, December 31, 2006, explains the mechanics of the Argentine Central Bank's intervention in exchange rates markets to target a stable and competitive exchange rate, a macroeconomic policy that has played a significant role in Argentina's economic growth since 2002.
    JEL: E58 E52 E42
    Date: 2007–02
  86. By: Hsiao Chink Tang
    Abstract: This paper investigates the relative strength of four monetary policy transmission channels (exchange rate, asset price, interest rate and credit) in Malaysia using a 12-variable open economy VAR model. By comparing the baseline impulse response with the constrained impulse response where a particular channel is being switched off, the interest rate channel is found to be the most important in influencing output and inflation in the horizon of about two years, and the credit channel beyond that. The asset price channel is also relevant in the shorter-horizon, more so than the exchange rate channel, particularly in influencing output. For inflation, the exchange rate channel is more relevant than the asset price channel.
    Date: 2006–08

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