nep-cba New Economics Papers
on Central Banking
Issue of 2007‒04‒28
forty papers chosen by
Alexander Mihailov
University of Reading

  1. Simple versus optimal rules as guides to policy By William A. Brock; Steven N. Durlauf; James M. Nason; Giacomo Rondina
  2. Time consistent monetary policy with endogenous price rigidity By Henry E. Siu
  3. Term Structure Transmission of Monetary Policy By Sharon Kozicki and P.A. Tinsley
  4. Mortgage Markets, Collateral Constraints, and Monetary Policy: Do Institutional Factors Matter? By Calza, Alessandro; Monacelli, Tommaso; Stracca, Livio
  5. Distribution-Free Learning By Karl H. Schlag
  6. Assessing China’s Exchange Rate Regime By Frankel, Jeffrey A; Wei, Shang-Jin
  7. On the Interplay between Keynesian and Supply Side Economics By Karanassou, Marika; Snower, Dennis J.
  8. Purchasing power parity exchange rates for the poor: using household surveys to construct PPPs By Angus Deaton
  9. Optimising indexation arrangements under Calvo contracts and their implications for monetary policy By Le, Vo Phuong Mai; Minford, Patrick
  10. Calvo Contracts - Optimal Indexation in General Equilibrium By Le, Vo Phuong Mai; Minford, Patrick
  11. The Price-Level Computation Method By Sydney Afriat; Carlo Milana
  12. Asset Pricing with Adaptive Learning By Carceles-Poveda, Eva; Giannitsarou, Chryssi
  13. Are real wages rigid downwards? By Steinar Holden; Fredrik Wulfsberg
  14. Assessing the Gap between Observed and Perceived Inflation in the Euro Area : Is the Credibility of the HICP at Stake ? By Luc Aucremanne; Marianne Collin; Thomas Stragier
  15. The Endogeneity of the Natural Rate of Growth – an Empirical Study for Latin-American Countries By Lena Vogel
  16. Customer Trading in the Foreign Exchange Market: Empirical Evidence from an Internet Trading Platform By Ingmar Nolte; Sandra Lechner
  17. Optimal inflation for the U.S. By Roberto M. Billi
  18. Lessons from the ECB experience: Frankfurt still matters! By Zeno Rotondi; Giacomo Vaciago
  19. Remittances and the real exchange rate By Bussolo, Maurizio; Molina, Luis; Lopez, Humberto
  20. Equilibrium exchange rates in oil-dependent countries By Korhonen, Iikka; Juurikkala, Tuuli
  21. Understanding the puzzling effects of technology shocks By Pengfei Wang; Yi Wen
  22. The sustainability of euro area debt: a re-assessment By Peter Wierts
  23. Optimal Sticky Prices under Rational Inattention By Mackowiak, Bartosz Adam; Wiederholt, Mirko
  24. Inflation Differentials and Business Cycle Fluctuations in the European Monetary Union By Christian Proaño Acosta
  25. Modelling the reporting discrepancies in bilateral data By Arie ten Cate
  26. Enhancing the Quality of Data on the Measurement of Income and Wealth By F. Thomas Juster; Honggao Cao; Mick Couper; Daniel H. Hill; Michael Hurd; Joseph P Lupton; Michael Perry; James P. Smith
  27. Monetary policy and economic growth: combining short and long run macro analysis By Gomes, Orlando
  28. Nonlinear inflation expectations and endogenous fluctuations By Gomes, Orlando
  29. Stability analysis in a monetary model with a varying intertemporal elasticity of substitution By Gomes, Orlando
  30. Effet peso : présentation théorique et application à la politique monétaire. By Nicolas Million
  31. Testing the Purchasing Power Parity: Evidence from the New EU Countries By Minoas Koukouritakis
  32. Nonmonetary Determinants of Inflation in Romania: A Decomposition By Felix Hammermann
  33. Exchange Rate Regimes, Globalisation, and the Cost of Capital in Emerging Markets By Antonio Diez de los Rios
  34. A forewarning indicator system for financial crises: the case of six Central and Eastern European countries By Irène Andreou; Gilles Dufrénot; Alain Sand-Zantman; Aleksandra Zdzienicka-Durand
  35. Determinants of growth in the central and eastern European EU member states - a production function approach. By Olga Arratibel; Frigyes Ferdinand Heinz; Reiner Martin; Marcin Przybyla; Lucasz Rawdanowicz; Roberta Serafini; Tina Zumer
  36. The Continental Dollar: How Much was Issued and What Happened to It? By Farley Grubb
  37. On the Rand: Determinants of the South African Exchange Rate By Jeffrey Frankel
  38. Commodity price fluctuations and their impact on monetary and fiscal policies in Western and Central Africa By Uwe Böwer; André Geis; Adalbert Winkler
  39. Modeling the impact of real and financial shocks on Mercosur: the role of the exchange rate regime By Jean-Pierre Allegret; Alain Sand-Zantman
  40. Fiscal Policy Throughout the Cycle: The Colombian Experience By Ignacio Lozano; Jorge Toro

  1. By: William A. Brock; Steven N. Durlauf; James M. Nason; Giacomo Rondina
    Abstract: This paper contributes to the policy evaluation literature by developing new strategies to study alternative policy rules. We compare optimal rules to simple rules within canonical monetary policy models. In our context, an optimal rule represents the solution to an intertemporal optimization problem in which a loss function for the policymaker and an explicit model of the macroeconomy are specified. We define a simple rule to be a summary of the intuition policymakers and economists have about how a central bank should react to aggregate disturbances. The policy rules are evaluated under minimax and minimax regret criteria. These criteria force the policymaker to guard against a worst-case scenario, but in different ways. Minimax makes the worst possible model the benchmark for the policymaker, while minimax regret confronts the policymaker with uncertainty about the true model. Our results indicate that the case for a model-specific optimal rule can break down when uncertainty exists about which of several models is true. Further, we show that the assumption that the policymaker’s loss function is known can obscure policy trade-offs that exist in the short, medium, and long run. Thus, policy evaluation is more difficult once it is recognized that model and preference uncertainty can interact.
    Date: 2007
  2. By: Henry E. Siu
    Abstract: I characterize time consistent equilibrium in an economy with price rigidity and an optimizing monetary authority operating under discretion. Firms have the option to increase their frequency of price change, at a cost, in response to higher inflation. Previous studies, which assume a constant degree of price rigidity across inflation regimes, find two time consistent equilibria—one with low inflation, the other with high inflation. In contrast, when price rigidity is endogenous, the high inflation equilibrium ceases to exist. Hence, time consistent equilibrium is unique. This result depends on two features of the analysis: (1) a plausible quantitative specification of the fixed cost of price change, and (2) the presence of an arbitrarily small cost of inflation that is independent of price rigidity.
    Keywords: Monetary policy
    Date: 2007
  3. By: Sharon Kozicki and P.A. Tinsley
    Abstract: Under bond-rate transmission of monetary policy, the authors show that a generalized Taylor Principle applies, in which the average anticipated path of policy responses to inflation is subject to a lower bound of unity. This result helps explain how bond rates may exhibit stable responses to inflation, even in periods of passive policy. Another possible explanation is time-varying term premiums with risk pricing that depends on inflation. The authors present a no-arbitrage model of the term structure with horizon-dependent policy perceptions and time-varying term premiums to illustrate the mechanics and provide empirical results that support these transmission channels.
    Keywords: Interest rates; Transmission of monetary policy
    JEL: E3 E5 N1
    Date: 2007
  4. By: Calza, Alessandro; Monacelli, Tommaso; Stracca, Livio
    Abstract: We study the role of institutional characteristics of mortgage markets in affecting the strength and timing of the effects of monetary policy shocks on house prices and consumption in a sample of OECD countries. With frictionless credit markets, those characteristics should in principle be immaterial for the transmission of monetary impulses. We document three facts: (1) there is significant divergence in the structure of mortgage markets across the main industrialized countries; (2) at the business cycle frequency, the correlation between consumption and house prices increases with the degree of flexibility/development of mortgage markets; (3) the transmission of monetary policy shocks on consumption and house prices is stronger in countries with more flexible/developed mortgage markets. We then build a two-sector dynamic general equilibrium model with price stickiness and collateral constraints, where the ability of borrowing is endogenously linked to the nominal value of a durable asset (housing). We study how the response of consumption to monetary policy shocks is affected by alternative values of three key institutional parameters: (i) down-payment rate; (ii) mortgage repayment rate; (iii) interest rate mortgage structure (variable vs. fixed interest rate). In line with our empirical evidence, the sensitivity of consumption to monetary policy shocks increases with lower values of (i) and (ii), and is larger under a variable-rate mortgage structure.
    Keywords: collateral constraint; house prices; monetary policy; mortgage markets
    JEL: E21 E44 E52
    Date: 2007–04
  5. By: Karl H. Schlag
    Abstract: We select among rules for learning which of two actions in a stationary decision problem achieves a higher expected payo¤when payoffs realized by both actions are known in previous instances. Only a bounded set containing all possible payoffs is known. Rules are evaluated using maximum risk with maximin utility, minimax regret, competitive ratio and selection procedures being special cases. A randomized variant of fictitious play attains minimax risk for all risk functions with ex-ante expected payoffs increasing in the number of observations. Fictitious play itself has neither of these two properties. Tight bounds on maximal regret and probability of selecting the best action are included.
    Keywords: fictitious play, nonparametric, finite sample, matched pairs, foregone payoffs, minimax risk, ex-ante improving, selection procedure
    JEL: D83 D81 C44
    Date: 2006
  6. By: Frankel, Jeffrey A; Wei, Shang-Jin
    Abstract: This paper examines two related issues: (a) the implicit methodology used by the U.S. Treasury in determining whether China and its other trading partners manipulate their exchange rates, and (b) the nature of the Chinese exchange rate regime since July 2005. On the first issue, we investigate the roles of both economic variables consistent with the IMF definition of manipulation - the partners' overall current account/GDP, its reserve changes, and the real overvaluation of its currency - and variables suggestive of American domestic political considerations -- the bilateral trade balance, US unemployment, and an election year dummy. The econometric results suggest that the Treasury verdicts are driven heavily by the US bilateral deficit, though other variables also turn out to be quite important. On the issue of China's de facto exchange rate regime, we apply the technique introduced by Frankel and Wei (1994) to estimate implicit basket weights and add several refinements. Within 2005, the de facto regime remained a peg to the dollar. However, there was a modest but steady increase in flexibility subsequently. We test whether US pressure has promoted RMB flexibility. We also test whether the recent appreciation against the dollar is due to a trend appreciation against the reference basket or a declining weight on the dollar in the reference basket, and argue that they have different policy implications.
    Keywords: Chinese economy; implicit currency weights; renminbi
    JEL: F3 F5 O1
    Date: 2007–04
  7. By: Karanassou, Marika (Department of Economics, Queen Mary and Westfield College, London, United Kingdom); Snower, Dennis J. (The Kiel Institute for the World Economy, Kiel, Germany)
    Abstract: Conventional wisdom suggests that nominal, demand-side shocks have only temporary effects on real macroeconomic magnitudes and that the duration of their effects depends on the degree of nominal inertia. It is also argued that, in the absence of unit roots, temporary supply-side shocks also have only temporary real affects and that the duration of these effects depends on the various sources of real inertia. Our analysis indicates that there is a potentially important interplay between real and nominal inertia in generating the persistent effects of real and nominal shocks. In this sense, then, Keynesian and supply-side economics are mutually interdependent. Our analysis has identified circumstances when real and nominal inertia are complementary in generating real and nominal persistence. Here, we argue, lies a potentially crucial, but as yet largely unexplored, set of determinants of the effectiveness of Keynesian and supply-side economic policies.
    Keywords: Unemployment, employment, wage setting, labour force participation, labour market dynamics, unemployment persistence, imperfect unemployment responsiveness
    JEL: J21 J23 J31 J64 J68
    Date: 2007–04
  8. By: Angus Deaton (Princeton University)
    Abstract: This paper builds a bridge between two literatures, that on purchasing power parity (PPP) exchange rates, which is an extension of national income accounting, and that on poverty measurement, which is based on household survey data on consumption expenditures. It also aims to serve as a manual for those who wish to calculate PPP price indexes using household surveys, particularly, although not exclusively, the PPP price indexes for the poor to be used to construct internationally comparable poverty lines. Because poverty analysts are often unfamiliar with PPP construction, PPP indexes are dealt with from something like first principles. The paper begins with the idea that PPP price indexes, like the usual domestic consumer price indexes, can be computed using weights from household surveys. Section 1 deals with the case of two countries, each with a set of consumer prices, and each with a household survey detailing expenditures on each good for a national sample of households. This first section is concerned with national aggregates, as in standard PPP comparisons, so that the household survey is used only to provide the national average consumption pattern. In this simplified two-country case, where the object of interest is a standard national PPP consumption comparison, it is possible to set up a framework that can be easily extended to deal with many countries and with poverty-weighting. In particular, standard errors are defined and formulas given. Prices are treated as known, so that the source of estimation variance is the sampling variability of the expenditure weights from the household survey, a sampling variability that depends on the sample size and on the survey design. A second type of standard error is distinguished which is new to the literature. In a world of perfect arbitrage and costless trade, relative prices would be the same in all countries, and all methods of computing PPP indexes would give the same answer. Deviations of prices from this ideal give rise to uncertainty about the index. Treating these deviations as random, as in the stochastic approach to price indexes, but with expenditure weights as non-stochastic, gives a second set of standard errors that reflect the uncertainty associated with the failure of arbitrage that is the fundamental reason why we need PPP index numbers. Formulas are given for these standard errors for the usual PPP price index numbers, including the Fisher and Törnqvist versions of the EKS index, as well as weighted CPD indexes. Section 2 provides illustrative calculations for a national consumer PPP index for food, fuel, alcohol, and tobacco for Indonesia in terms of India in 1999–2000. Section 3 extends the two-country analysis to the case of “poverty” PPPs, which are international price indexes calculated for people at or near the poverty line, under the requirement that the ratio of the two poverty lines is equal to the PPP index. It shows that, when the Engel curves take a specific but realistic functional form, there is a closed form solution for the poverty PPP index, and proposes using this case as a starting value for a non-parametric, but iterative, calculation. Section 4 applies this case to the Indonesian to Indian comparison. Section 5 extends the analysis in Sections 1 and 3 to the multiple country case, and Section 6 provides illustrative calculations of food and tobacco PPPs for India, Indonesia, Bangladesh, and Pakistan.
    Date: 2006–08
  9. By: Le, Vo Phuong Mai (Cardiff Business School); Minford, Patrick (Cardiff Business School)
    Abstract: This paper investigates optimal indexation in the New Keynesian model, when the indexation choice includes the possibility of partial indexation and of varying weights on rational and lagged indexation. It finds that the Calvo contract adjusted for rationally expected indexation under both inflation and price level targeting regimes delivers the highest expected welfare under both restricted and full current information. Rational indexation eliminates the effectiveness of monetary policy on welfare when there is only price-level targeting under the current micro information. If including both wage setting and full current information, monetary policy is effective; and a price-level targeting rule delivers the highest benefits because it minimises the size of shocks to prices and thus dispersion. However, even less than full rational indexation ensures that there is very little nominal rigidity in the adapted world of Calvo contracts.
    Keywords: optimal indexation; price-level target; inflation target; Calvo contracts; rational expectation; New Keynesian model
    JEL: E50 E52
    Date: 2007–03
  10. By: Le, Vo Phuong Mai (Cardiff Business School); Minford, Patrick (Cardiff Business School)
    Abstract: Calvo contracts, which are the basis of the current generation of New Keynesian models, widely include indexation to general inflation. We argue that the indexing formula should be expected inflation rather than lagged inflation. This is likely to optimise the welfare of the representative agent in a general equilibrium model of the New Keynesian type. This is shown analytically for a simplified model and by numerical simulation for a full model with price and wage contracts as well as capital. The consequence of such indexation is that monetary policy no longer has any effect on welfare.
    Date: 2007–03
  11. By: Sydney Afriat; Carlo Milana
    Abstract: It has been submitted that, for the very large number of different traditional type formulae to determine price indices associated with a pair of periods, which are joined with the longstanding question of which one to choose, they should all be abandoned. For the method proposed instead, price levels associated with periods are first all computed together, subject to a consistency of the data, and then price indices that are as taken together true are determined from their ratios. An approximation method can apply in the case of inconsistency. Here is an account of the mathematics of the method
    Keywords: inflation, index-number problem, non-parametric, price index, price level, revealed preference
    JEL: C43 E31
    Date: 2007–04
  12. By: Carceles-Poveda, Eva; Giannitsarou, Chryssi
    Abstract: We study the extent to which self-referential adaptive learning can explain stylized asset pricing facts in a general equilibrium framework. In particular, we analyze the effects of recursive least squares and constant gain algorithms in a production economy and a Lucas type endowment economy. We find that recursive least squares learning has almost no effects on asset price behaviour, since the algorithm converges relatively fast to rational expectations. On the other hand, constant gain learning may contribute towards explaining the stock price and return volatility as well as the predictability of excess returns in the endowment economy. In the production economy, however, the effects of constant gain learning are mitigated by the persistence induced by capital accumulation. We conclude that, contrary to popular belief, standard self-referential learning cannot fully resolve the asset pricing puzzles observed in the data.
    Keywords: Adaptive learning; Asset pricing; Excess returns; Predictability
    JEL: D83 D84 G12
    Date: 2007–04
  13. By: Steinar Holden (Norges Bank (Central Bank of Norway) University of Oslo and CESifo Department of Economics, University of Oslo); Fredrik Wulfsberg (Norges Bank (Central Bank of Norway) and Federal Reserve Bank of Boston)
    Abstract: This paper explores the existence of downward real wage rigidity (drwr) in 19 OECD countries, over the period 1973–1999, using data for hourly nominal earnings at industry level. Based on a nonparametric statistical method, which allows for country and year specific variation in both the median and the dispersion of industry wage changes, we find evidence of some downward rigidity of real wages in oecd countries overall, as well as for regions and time periods. There is some evidence that real wage cuts are less prevalent under strict employment protection legislation and high union density. Generally, we find stronger evidence for downward nominal than for downward real wage rigidity.
    Keywords: Downward real wage rigidity, OECD, Employment protection legislation, Wage setting
    JEL: J3 J5 C14 C15 E31
    Date: 2007–04–11
  14. By: Luc Aucremanne (National Bank of Belgium, Research Department); Marianne Collin (National Bank of Belgium, Research Department); Thomas Stragier (National Bank of Belgium, Research Department)
    Abstract: We find strong econometric support for a break in the relationship between perceived and HICP inflation in the euro area, triggered by the introduction of euro notes and coins in January 2002. The break is fairly homogeneous across individuals with different socio-economic characteristics. We found no support for the thesis according to which perceptions are systematically formed by frequently purchased products. A similar break is found when national CPIs instead of HICPs are used as benchmarks. The role of the non-inclusion of owner-occupied housing in the HICP was negligible. Therefore the credibility of the HICP per se is not at stake.
    Keywords: inflation, perceived inflation, panel unit roots tests
    JEL: C22 C23 D12 E31
    Date: 2007–04
  15. By: Lena Vogel (Department for Economics and Politics, University of Hamburg)
    Abstract: The aim of this paper is to analyse the sensitivity of the natural rate of growth to the actual rate of growth for a sample of eleven Latin-American countries, assuming the natural rate to be determined endogenously by changes in the actual rate of growth. The natural rates of growth are estimated in a system of SUR estimations over the period 1986-2003. In order to determine whether they react endogenously to changes in the actual rate of growth, a dummy variable for boom periods is added to the system of regressions. In the second part of the empirical analysis, the direction of causality between input growth and output growth is then tested for four of the countries in the first sample. The results confirm not only the hypothesis about the endogeneity of the natural rate of growth, but also show causality from output growth to input growth to be much stronger than the reverse. Length: 28 pages
    Keywords: Natural rate of growth, actual rate of growth, endogeneity, Granger causality, Latin America
    JEL: O40 E10 C23
    Date: 2007–04
  16. By: Ingmar Nolte (University of Konstanz); Sandra Lechner (University of Konstanz)
    Abstract: This paper analyzes the relationship between currency price changes and their expectations. Currency price change expectations are derived with the help of different order flow measures, from the trading behavior of investors on OANDA FXTrade, which is an internet trading platform in the foreign exchange market. We investigate whether forecasts of intra-day price changes on different sampling frequencies can be improved with the information contained in the flow of our investors’ orders. Moreover, we verify several hypotheses on the trading behavior and the preference structure of our investors by investigating how past price changes affect future order flow.
    Keywords: Customer Dataset, Order Flow, Price Changes, Foreign Exchange Market
    JEL: G10 F31 C32
    Date: 2007–03–15
  17. By: Roberto M. Billi
    Abstract: What is the correctly measured inflation rate that monetary policy should aim for in the long-run? This paper characterizes the optimal inflation rate for the U.S. economy in a New Keynesian sticky-price model with an occasionally binding zero lower bound on the nominal interest rate. Real-rate and mark-up shocks jointly determine the optimal inflation rate to be positive but not large. Even allowing for the possibility of extreme model misspecification, the optimal inflation rate is robustly below 1 percent. The welfare costs of optimal inflation and the lower bound are limited.>
    Date: 2007
  18. By: Zeno Rotondi; Giacomo Vaciago (DISCE, Università Cattolica; DISCE, Università Cattolica)
    Abstract: This paper compares the European Central Bank’s conduct of monetary policy (1999-2005) with that of the Bundesbank (after the German Unification: 1990-1998) in order to test the hypothesis of an ECB with “Bundesbank’s preferences” put forward in the theoretical literature (Alesina and Grilli 1993, Fatum 2006). Econometric tests and simulations based on monetary policy reaction functions show that the continuation of the former Bundesbank regime is supported by the data. Given this empirical evidence we discuss the lessons for future Monetary Unions stemming from the ECB experience.
    Keywords: EMU, Monetary Policy, Reaction Function, Taylor rule, ECB, Bundesbank
    JEL: E52 E58
    Date: 2007–03
  19. By: Bussolo, Maurizio; Molina, Luis; Lopez, Humberto
    Abstract: Existing empirical eviden ce indicates that remittances have a positive impact on a good number of development indicators of recipient countries. Yet when flows are too large relative to the size of the recipient economies, as those observed in a number of Latin American countries, they may also bring a number of undesired problems. Among those probably the most feared in this context is the Dutch Disease. This paper explores the empirical evidence regarding the impact of remittances on the real exchange rate. The findings suggest that remittances indeed appear to lead to a significant real exchange rate appreciation. The paper also explores policy options that may somewhat offset the observed effect.
    Keywords: Economic Stabilization,Macroeconomic Management,Economic Theory & Research,Remittances,Pro-Poor Growth and Inequality
    Date: 2007–04–01
  20. By: Korhonen, Iikka (BOFIT); Juurikkala, Tuuli (BOFIT)
    Abstract: We assess the determinants of equilibrium real exchange rates in a sample of oil-dependent countries. Our basic data cover OPEC countries from 1975 to 2005. We also include three oil-producing Commonwealth of Independent States (CIS) countries in our robustness analysis. Utilising several estimation techniques, including pooled mean group and mean group estimators, we find that the price of oil has a clear, statistically significant effect on real exchange rates in our group of oil-producing countries. Higher oil price lead to appreciation of the real exchange rate. Elasticity of the real exchange rate with respect to the oil price is typically between 0.4 and 0.5, but may be larger depending on the specification. Real per capita GDP, on the other hand, does not appear to have a clear effect on real exchange rate. This latter result contrasts starkly with the consensus view of real exchange rates determinants, emphasising the unique position of oil-dependent countries.
    Keywords: equilibrium exchange rate; pooled mean group estimator; resource dependency
    JEL: F31 F41 P24 Q43
    Date: 2007–04–20
  21. By: Pengfei Wang; Yi Wen
    Abstract: Under aggregate technology shocks, both aggregate inputs and sectorial inputs decline initially and then rise permanently. However, under sector-specific technology shocks, sectorial inputs decline permanently. In addition, sectorial output is very responsive to aggregate technology shocks but not so to sector-specific technology shocks. We show that a flexible-price RBC model with firm entry and exit is consistent with these stylized facts.
    Date: 2007
  22. By: Peter Wierts
    Abstract: This paper re-assesses findings of the literature that the systematic debt stabilising response in fiscal policy has been sufficiently strong for keeping debt ratios on a sustainable path in Euro area countries. In doing so, it adjusts the standard approach to the specific context of Economic and Monetary Union. Results show that before 1993 policy responses towards net and gross debt are comparable. After 1993, the reaction to net debt weakens while policies react more strongly to the build-up of gross debt according to the definition of the EU fiscal rules. This suggests that financial assets have increasingly been used for managing gross debt ratios while improving net worth has received less priority.
    Keywords: debt; sustainability; EMU; stock flow adjustment
    JEL: E62 H62 H63
    Date: 2007–04
  23. By: Mackowiak, Bartosz Adam; Wiederholt, Mirko
    Abstract: This paper presents a model in which price setting firms optimally decide what to pay attention to, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in micro data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks. Nominal shocks have strong and persistent real effects. We use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms' environment.
    Keywords: rational inattention; real effects of nominal shocks; sticky prices
    JEL: D8 E3 E5
    Date: 2007–04
  24. By: Christian Proaño Acosta (IMK at the Hans Boeckler Foundation, University of Bielefeld)
    Abstract: The high degree of persistence in the national inflation differentials of the majority of EMU Member States observed since the introduction of the euro has raised serious concerns among researchers and policy-makers alike. In this paper the main theoretical arguments which explain the existence of such inflation differentials within a monetary union are reviewed and, by means of econometric methods, their dynamic behaviour prior and after the introduction of the euro is analyzed. Furthermore, the empirical evidence for different degrees of correlation between the country-specific business cycles fluctuations and the arise of national inflation differentials with respect to the euro area average are investigated through single-equation GMM and panel TSLS estimations.
    Keywords: Inflation differentials, convergence and stationary tests, GMM es- timation, Phillips Curve
    JEL: C23 C33 E31 E32
    Date: 2007–03
  25. By: Arie ten Cate
    Abstract: The discrepancies in reported bilateral statistical data ("mirror data") are used to estimate the accuracy of the reporters. The estimated accuracies are to be used to compute optimal combinations of mirror data. <P> Two models of the discrepancies are presented: (a) unbiased reporting with inaccurate reporters having a large variance, and (b) biased reporting with inaccurate reporters having a large bias (either positive or negative). Estimation methods are least squares regression and maximum likelihood. <P> A numerical illustration is given, using data of the international trade in services. It is shown how to judge the two models empirically. <P> Research has been continued after the publication. In particular about the maximum likelihood estimation of the variance model.
    Keywords: discrepancies; mirror; mirror data; bilateral; international trade; services; GTAP; GAMS
    JEL: C82
    Date: 2007–04
  26. By: F. Thomas Juster (University of Michigan); Honggao Cao (Wells Fargo); Mick Couper (University of Michigan); Daniel H. Hill (University of Michigan); Michael Hurd (RAND); Joseph P Lupton (Federal Reserve); Michael Perry (University of Michigan); James P. Smith (RAND)
    Abstract: Over the last decade or so, a substantial effort has gone into the design of a series of methodological investigations aimed at enhancing the quality of survey data on income and wealth. These investigations have largely been conducted at the Survey Research Center at the University of Michigan, and have mainly involved two longitudinal surveys: the Health and Retirement Study (HRS), with a first wave beginning in 1992 and continued thereafter every other year through 2004; and the Assets and Health Dynamics Among the Oldest Old (AHEAD) Study, begun in 1993 and continued in 1995 and 1998, then in every other year through 2006. This paper provides an overview of the main studies and summarizes what has been learned so far. The studies include; a paper by Juster and Smith (Improving the Quality of Economic Data: Lessons from the HRS and AHEAD, JASA, 1997); a paper by Juster, Cao, Perry and Couper (The Effect of Unfolding Brackets on the Quality of Wealth Data in HRS, MRRC Working Paper, WP 2006-113, January 2006); a paper by Hurd, Juster and Smith (Enhancing the Quality of Data on Income: Recent Innovations from the HRS, Journal of Human Resources, Summer 2003); a paper by Juster, Lupton and Cao (Ensuring Time-Series Consistency in Estimates of Income and Wealth, MRRC Working Paper, WP 2002-030, July 2002); a paper by Cao and Juster (Correcting Second-Home Equity in HRS/AHEAD: MRRC Working Paper WP 2004-081, June 2004); and a paper by Rohwedder, Haider and Hurd (RAND Working Paper, 2004).
    Date: 2007–01
  27. By: Gomes, Orlando
    Abstract: The new Keynesian monetary policy model studies the response of the inflation – output gap trade-off to policy decisions taken by the Central Bank, concerning the nominal interest rate time trajectory. Under an optimal setup, this model displays a saddle-path stable equilibrium and, if the stable trajectory is followed, the steady state is characterized by an inflation rate that coincides with the selected inflation target. A high inflation target has positive effects over the rise of effective output relatively to its potential level (the monetary policy problem captures this effect), but it has a perverse impact over investment decisions (the referred problem does not capture this effect, taking it as granted). This second relation can be understood by associating to the first macro model a second setup, which takes consumption and investment decisions, i.e., by considering a long term growth setup. The link between the two is present on the impact of inflation over investment decisions. With this integrated framework one is able to simultaneously study short and long-run macroeconomic phenomena and to jointly analyze the behaviour of nominal and real aggregates. The most important results consist on the determination of an optimal inflation target and on the consideration of short term supply shocks as having a long-run impact producing business cycles.
    Keywords: Monetary policy; Economic growth; Inflation targeting; Output gap.
    JEL: C61 O41 E52
    Date: 2006–10
  28. By: Gomes, Orlando
    Abstract: The standard new Keynesian monetary policy problem is, in its original presentation, a linear model. As a result, only three possibilities are admissible in terms of long term dynamics: the equilibrium may be a stable node, an unstable node or a saddle point. Fixed point stability (a stable node) is generally guaranteed only under an active monetary policy rule. The benchmark model also considers extremely simple assumptions about expectations (perfect foresight is frequently assumed). In this paper, one inquires how a change in the way inflation expectations are modelled implies a change in monetary policy results when an active Taylor rule is taken. By assuming that inflation expectations are constrained by the evolution of the output gap, we radically modify the implications of policy intervention: endogenous cycles, of various periodicities, and chaotic motion will be observable for reasonable parameter values.
    Keywords: Monetary policy; Taylor rule; Inflation expectations; Endogenous business cycles; Nonlinear dynamics and chaos
    JEL: C61 E52 E32
    Date: 2006–08
  29. By: Gomes, Orlando
    Abstract: Models dealing with monetary policy are generally based on microfoundations that characterize the behaviour of representative agents (households and firms). To explain the representative consumer behaviour, it is generally assumed a utility function in which the intertemporal elasticity of substitution is constant. Recent literature casts some doubts about the relevance of considering such a constant elasticity value. In this note, we explore the new Keynesian monetary policy model under the assumption that the elasticity of substitution changes with expectations regarding real economic performance. As a result, one observes that some combinations of parameter values allow for a stable fixed point outcome, while other combinations of parameters are compatible with cycles of various periodicities and even a-periodic fluctuations.
    Keywords: Monetary policy; Intertemporal elasticity of substitution; Stability; Nonlinear dynamics.
    JEL: C62 E52 E32
    Date: 2007–04
  30. By: Nicolas Million (Banque de France et Centre d'Economie de la Sorbonne)
    Abstract: This article deals with the theoretical implications implied by the presence of Peso effects in expectations. After presenting the Peso effect as the probability of occurence of an unusual event though important enough to be taken into account in the forecasts, we present a model able to isolate the systematic expectation error. The appearance of this error comes especially from imperfect information concerning the future states as well as the current regime. This uncertainty about the current regime leads the agents to implement a learning process for the model. In the last part of this article, we show how a credible central bank can limit the occurrence of Peso effects.
    Keywords: Peso effect, efficient markets, rational expectations.
    JEL: E4 C12 C22
    Date: 2007–03
  31. By: Minoas Koukouritakis (Department of Economics, University of Crete, Greece)
    Abstract: This paper examines the validity of the purchasing power parity between each of the twelve new EU countries vis-à-vis the Eurozone. Using the Johansen cointegration methodology for a period that begins from the mid-1990s and allowing for a structural break for the countries that joined the EU on May 2004, it is found that there is a long-run equilibrium relationship among the nominal exchange rate, the domestic prices and the foreign prices, for all the new EU countries. The evidence also suggests that the PPP vector enters the cointegration space for Bulgaria, Cyprus, Romania and Slovenia, which means that only for these countries the long-run PPP vis-à-vis the Eurozone is verified. For the rest of the new EU countries the long-run PPP is violated, may due to the fact that the currencies of these countries have been pegged to the euro and cannot reflect the inflation differences vis-à-vis the Eurozone.
    Keywords: Purchasing Power Parity, EU Enlargement, Cointegration, Structural Break, Symmetry and Proportionality.
    JEL: F15 F42
    Date: 2007–04–17
  32. By: Felix Hammermann
    Abstract: Why is inflation, 15 years after transition started, still considerably higher in Romania than in the eight EU member states (EU-8) that joined in May 2004? Panel estimation based on ten central and eastern European countries allows us to decompose the inflation differential between Romania and the EU-8. The decomposition suggests that neither the revenue, nor the balance of payments, nor the financial stability motive are driving inflation; rather structural differences are at play. The employment motive, together with indicators reflecting the prolonged structural change, explain most of the inflation gap vis-à-vis the EU-8.
    Keywords: inflation, panel data, transition economics
    JEL: E58
    Date: 2007–03
  33. By: Antonio Diez de los Rios
    Abstract: This paper presents a multifactor asset pricing model for currency, bond, and stock returns for ten emerging markets to investigate the effect of the exchange rate regime on the cost of capital and the integration of emerging financial markets. Since there is evidence that a fixed exchange rate regime reduces the currency risk premia demanded by foreign investors, the tentative conclusion is that a fixed exchange rate regime system can help reduce the cost of capital in emerging markets.
    Keywords: Exchange rate regimes; Development economics
    JEL: F30 F33 G15
    Date: 2007
  34. By: Irène Andreou (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Gilles Dufrénot (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - [Université de la Méditerranée - Aix-Marseille II][Université de droit, d'économie et des sciences - Aix-Marseille III] - [Ecole des Hautes Etudes en Sciences Sociales]); Alain Sand-Zantman (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Aleksandra Zdzienicka-Durand (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines])
    Abstract: We propose a measure of the probability of crises associated with an aggregate indicator, where the percentage of false alarms and the proportion of missed signals can be combined to give an appreciation of the vulnerability of an economy. In this perspective, the important issue is not only to determine whether a system produces true predictions of a crisis, but also whether there are forewarning signs of a forthcoming crisis prior to its actual occurrence. To this end, we adopt the approach initiated by Kaminsky, Lizondo and Reinhart (1998), analyzing each indicator and calculating each threshold separately. We depart from this approach in that each country is also analyzed separately, permitting the creation of a more “custom-made” early warning system for each one.
    Keywords: composite indicator ; currency crisis ; early warning system
    Date: 2007–04–19
  35. By: Olga Arratibel (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Frigyes Ferdinand Heinz (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Reiner Martin (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcin Przybyla (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Lucasz Rawdanowicz (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Roberta Serafini (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Tina Zumer (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Overall, the prospects for a continued and reasonably fast real convergence process between the EU8 countries and the euro area are good. However, the continuation of the rapid progress made by many EU8 countries in the past cannot be taken for granted. In fact, in order to ensure that fast economic growth in the EU8 countries remains sustainable, it is crucial for these economies to take appropriate policy action. First it is important to recall that sound macroeconomic policies including credible monetary policy and appropriate fiscal policy are essential to ensure the appropriate framework conditions for further growth and convergence. Second, they need to address structural labour market problems, in particular by reducing regional and skill mismatches. Third, they must make further efforts to improve the business environment, in order to ensure that the capital accumulation process continues and R&D investments increase. Many of the above-mentioned facets of growth-enhancing policy will also help to ensure a continued inflow of foreign direct investment (FDI), which in turn is expected to help accelerate the convergence process.
    Date: 2007–04
  36. By: Farley Grubb
    Abstract: The U.S. Congress issued paper money called Continental Dollars to finance the American Revolution. The story of the Continental Dollar is familiar to all -- excessive amounts were issued causing hyper-inflation. It became worthless and was forgotten. However, the details of this story, including its veracity, are less well known. Scholars even disagree over how much was issued. Evidence is gathered to establish the exact amount and time path of Continental Dollars emitted and then remitted to the U.S. Treasury and burned. Why some Dollars were hoarded rather than trashed between 1779 and 1790 is also documented.
    JEL: N1 N11 N2 N21
    Date: 2007–04
  37. By: Jeffrey Frankel
    Abstract: This paper is an econometric investigation of the determinants of the real value of the South African rand over the period 1984-2006. The results show a relatively good fit. As so often with exchange rate equations, there is substantial weight on the lagged exchange rate, which can be attributed to a momentum component. Nevertheless, economic fundamentals are significant and important. This is especially true of an index of the real prices of South African mineral commodities, which even drives out real income as a significant determinant of the rand's value. An implication is that the 2003-2006 real appreciation can be attributed to the Dutch Disease. In other respects, the rand behaves like currencies of industrialized countries with well-developed financial markets. In particular, high South African interest rates raise international demand for the rand and lead to real appreciation, controlling for a forward-looking measure of expected inflation and a measure of default risk or country risk. It is in the latter respects, in particular, that the paper hopes to have improved on earlier studies of the rand.
    JEL: F31
    Date: 2007–04
  38. By: Uwe Böwer (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); André Geis (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Adalbert Winkler (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Commodity prices play an important role in economic developments in most of the 24 Western and Central African (WCA) countries covered in this paper. It is confirmed that in the light of rising commodity prices between 1999 and 2005, net oil exporters recorded strong growth rates while net oil-importing countries – albeit benefiting from increases in their major non-oil commodity export prices – displayed somewhat lower growth. For most WCA economies, inflation rates appear less affected by commodity price changes and more determined by exchange rate regimes as well as monetary and fiscal policies. While passthrough effects from international to domestic energy prices were significant, notably in oilimporting countries, second-round effects on overall prices seem limited. Governments of oil-rich countries reacted prudently to windfall revenues, partly running sizable fiscal surpluses. A favourable supply response to rising spending as well as sterilisation efforts and increasing money demand also helped to dampen inflationary pressures. However, substantial excess reserves of commercial banks reflect challenges in financial sector developments and the effectiveness of monetary policy in many WCA countries. Given currently widelyused fixed exchange rate regimes, fiscal policy will continue to carry the main burden of macroeconomic adjustment and of sustaining non-inflationary growth, which remains the key policy challenge facing WCA authorities.
    Date: 2007–04
  39. By: Jean-Pierre Allegret (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Alain Sand-Zantman (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines])
    Abstract: This paper studies to what extent the diversity of exchange rate regimes within Mercosur exerts an influence on the feasibility of a monetary union in this area. A semi-structural VAR model is built for each country, including a set of international and domestic variables. Based on impulse response functions and forecast error decomposition, we conclude that differences of exchange rate regime explain significantly the divergences of economic dynamics triggered by foreign or domestic shocks. Second, we decompose the structural innovations generated by each country model into unobservable common and idiosyncratic components, using a state-space model. This last exercise, intended to assess the degree of policy coordination between the Mercosur members, did not disclose any common component for the structural innovations generated by the three national models.
    Keywords: co-movement ; Cycles ; Mercosur ; optimum currency area ; unobserved components model
    Date: 2007–04–19
  40. By: Ignacio Lozano; Jorge Toro
    Abstract: This paper reviews the relationship between the business cycle and public finances in Colombia. The evidence shows that cyclical movements in output systematically affect the situation of public finances. Hence, the distinction between the cyclical and permanent (i.e. structural) components of the fiscal balance may allow fiscal authorities to determine the extent to which the fiscal stance in a particular year reflects their discretionary actions. Our findings indicate that the cyclical component of the central government balance in Colombia has in general been fairly small. For instance, during the recession and recovery period 1999-2003, the cyclical component attained, on average, -0,5% of the GDP which explained only 8% of the actual overall deficit. More recently in 2006, the cyclical component amounted to +0,8% of the GDP, equivalent to 17% of the actual fiscal imbalance. Governments are not usually neutral during the business cycle. Ideally, they ought to practice a counter-cyclical fiscal policy to moderate the magnitude of output fluctuations. However, in emerging economies, counter-cyclical fiscal policies are inhibited by domestic and external factors, such as credit restrictions, quality of institutions, fiscal rules, corruption, voracity effect, etc. Using a standard approach we find that fiscal policy in Colombia has been pro-cyclical over the last 45 years or so, with the primary surplus falling (and the deficit rising) as a share of GDP by approximately 1/5th of a percentage point when the output gap improves by one percentage point.
    Keywords: Fiscal Policy, Business Cycle, Stabilization, Deficit, Budget. Classification JEL: E62; E32; E63; H62; H61.

This nep-cba issue is ©2007 by Alexander Mihailov. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.