nep-cba New Economics Papers
on Central Banking
Issue of 2007‒06‒02
twenty-two papers chosen by
Alexander Mihailov
University of Reading

  1. Why is the Dollar So High? By Martin Feldstein
  2. Long run macroeconomic relations in the global economy By Stephane Dees; Sean Holly; M. Hashem Pesaran; L. Vanessa Smith
  3. Computing Optimal Policy in a Timeless-Perspective: An Application to a Small-Open Economy By Michel Juillard; Florian Pelgrin
  4. Fiscal Policy and the Exchange Rate-Current Account Nexus By Jun Il Kim
  5. An assessment of the trends in international price competitiveness among EMU countries By Fischer, Christoph
  6. Reconsidering the role of monetary indicators for euro area inflation from a Bayesian perspective using group inclusion probabilities By Scharnagl, Michael; Schumacher, Christian
  7. Productivity shocks and Optimal Monetary Policy in a Unionized Labor Market Economy By Fabrizio Mattesini; Lorenza Rossi
  8. Bulls, Bears and Excess Volatility: can currency intervention help? By Corrado, L.; Miller, M.; Zhang, L.
  9. Monetary Policy Implementation: Results from a Survey By Rodolfo Maino; Inese Buzeneca
  10. Monetary Policy Design under Competing Models of Inflation Persistence By Solange Gouvea; Abhijit Sen Gupta
  11. Money Velocity in an Endogenous Growth Business Cycle with Credit Shocks By Benk, Szilárd; Gillman, Max; Kejak, Michal
  12. Durable goods and their effect on household saving rations in the euro area. By Samuel Reynard
  13. Excess money growth and inflation dynamics By Barbara Roffia; Andrea Zaghini
  14. The Inequality Channel of Monetary Transmission By Marta Areosa; Waldyr Areosa
  15. Home Bias and Purchasing Power Parity: Evidence from the G-7 Countries By Nikolaos Mylonidis; Dimitrios Sideris
  16. New Keynesian Phillips curve for Estonia, Latvia and Lithuania By Aurelijus Dabušinskas; Dmitry Kulikov
  17. China: Strengthening Monetary Policy Implementation By Rodolfo Maino; Bernard Laurens
  18. Nonlinear Mechanisms of the Exchange Rate Pass-Through: a Phillips curve model with threshold for Brazil By Arnildo da Silva Correa; André Minella
  19. Brazil: taming inflation expectations By Afonso S. Bevilaqua; Mário Mesquita; André Minella
  20. The Recent Brazilian Disinflation Process and Costs By Alexandre A. Tombini; Sergio A. Lago Alves
  21. Yemen: Exchange Rate Policy in the Face of Dwindling Oil Exports By Faisal Ahmed; Nabil Ben Ltaifa; Todd Schneider; Saade Chami
  22. Can a Rule-Based Monetary Policy Framework Work in a Developing Country? The Case of Yemen By Selim Elekdag; Nabil Ben Ltaifa; Todd Schneider; Saade Chami

  1. By: Martin Feldstein
    Abstract: The level of the dollar is part of a complex general equilibrium system. Nevertheless, it is helpful to recognize that the high level of the dollar is necessary to generate the current account deficit equal to the difference between national saving and investment. Understanding the high level of the dollar therefore requires understanding the reasons for the low level of national saving in the United States. Reducing the large current account deficit will require both a higher rate of national saving and a more competitive dollar. Although the necessary decline in the real value of the dollar can in theory occur without a decline in the dollar's nominal value, the implied magnitude of the fall in the domestic price level is implausible. A decline of the real value of the dollar that is large enough to reduce the current account deficit significantly requires a significant decline in the nominal value of the dollar.
    JEL: F3 F32
    Date: 2007–05
  2. By: Stephane Dees (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Sean Holly (Faculty of Economics and CIMF, University of Cambridge, Austin Robinson Building, Sidgwick Avenue, Cambridge CB3 9DD, United Kingdom.); M. Hashem Pesaran (Faculty of Economics and CIMF, University of Cambridge, Austin Robinson Building, Sidgwick Avenue, Cambridge CB3 9DD, United Kingdom.); L. Vanessa Smith (CEFAP, Judge Business School, University of Cambridge, Trumpington Street, Cambridge CB2 1AG, United Kingdom.)
    Abstract: This paper focuses on testing long run macroeconomic relations for interest rates, equity, prices and exchange rates suggested by arbitrage in financial and goods markets. It uses the global vector autoregressive (GVAR) model to test for long run restrictions in each country/region conditioning on the rest of the world. Bootstrapping is used to compute both the empirical distribution of the impulse responses and the log-likelihood ratio statistic for over-identifying restrictions. The paper also examines the speed with which adjustments to the long run relations take place via the persistence profiles. We find strong evidence in favour of the UIP and to a lesser extent the Fisher equation across a number of countries, but our results for the PPP are much weaker. Also the transmission of shocks and subsequent adjustments in financial markets are much faster than those in goods markets. JEL Classification: C32, E17, F47, R11.
    Keywords: Global VAR, Fisher relationship, Uncovered Interest Rate Parity, Purchasing Power Parity, persistence profile.
    Date: 2007–05
  3. By: Michel Juillard; Florian Pelgrin
    Abstract: Since the contribution of Kydland and Prescott (1977), it is well known that the optimal Ramsey policy is time inconsistent. In a series of recent contributions, Woodford (2003) proposes a new methodology to circumvent this problem, namely the timeless perspective solution. However, one main limitation is that it is not yet empirically implementable. In this paper, we develop a new methodology to compute initial values of the Lagrange multipliers in order to implement the timeless-perspective solution. In so doing, we also provide a generalization of the Ramsey and timeless-perspective problems. We apply our results to a small-open economy model in Canada.
    Keywords: Monetary policy framework
    JEL: C6 E5 E6
    Date: 2007
  4. By: Jun Il Kim
    Abstract: By using a simple intertemporal model of the current account, I show that the exchange rate elasticity of the trade balance would ceteris paribus be smaller for countries with higher government spending ratios (relative to GDP) and with more limited scope for private consumption smoothing. This finding may have important implications for the design of adjustment programs and for resolving current global imbalances. It could also help explain and reconcile mixed empirical findings on trade elasticities.
    Keywords: Exchange rates , Current account , Balance of trade , Fiscal policy , Consumption , Economic models ,
    Date: 2007–02–06
  5. By: Fischer, Christoph
    Abstract: Inflation differentials within European Monetary Union (EMU) are increasingly seen as exerting adverse effects on the price competitiveness of member countries’ firms and – given the common monetary policy within EMU – as being detrimental to euro-area economies, in particular to those with relatively high inflation rates. Using three simple measures of international price competitiveness for EMU countries, the paper analyses whether these indicators have displayed distinctive trends since the start of EMU and whether they converge with or diverge from their respective fundamental value. It is found that all three indicators suggest a gain in competitiveness for the German economy and a corresponding loss for Italy, Portugal and Spain. Two of the indicators, however, suggest that these trends reduce former disparities and, thus, contribute to a convergence of competitiveness within EMU while the third would imply the opposite.
    Keywords: Price competitiveness, EMU, purchasing power parity, productivity approach, panel unit root tests, panel cointegration
    JEL: E31 F31 F36
    Date: 2007
  6. By: Scharnagl, Michael; Schumacher, Christian
    Abstract: This paper addresses the relative importance of monetary indicators for forecasting inflation in the euro area in a Bayesian framework. Bayesian Model Averaging (BMA)based on predictive likelihoods provides a framework that allows for the estimation of inclusion probabilities of a particular variable, that is the probability of that variable being in the forecast model. A novel aspect of the paper is the discussion of group-wise inclusion probabilities, which helps to address the empirical question whether the group of monetary variables is relevant for forecasting euro area inflation. In our application, we consider about thirty monetary and non-monetary indicators for inflation. Using this data, BMA provides inclusion probabilities and weights for Bayesian forecast combination. The empirical results for euro area data show that monetary aggregates and non-monetary indicators together play an important role for forecasting inflation, whereas the isolated information content of both groups is limited. Forecast combination can only partly outperform single-indicator benchmark models.
    Keywords: inflation forecasting, monetary indicators, Bayesian Model Averaging, inclusion probability
    JEL: C11 C52 E31 E37
    Date: 2007
  7. By: Fabrizio Mattesini (Università di Roma 2); Lorenza Rossi (DISCE, Università Cattolica)
    Abstract: In this paper we analyze a general equilibrium dynamic stochastic New Keynesian model characterized by labor indivisibilities, unemployment and a unionized labor market. The presence of monopoly unions introduces real wage rigidities in the model. We show that as in Blanchard Galì (2005) the so called "divine coincidence" does not hold and a trade-off between inflation stabilization and the output stabilization arises. In particular, a productivity shock has a negative effect on inflation, while a reservation-wage shock has an effect of the same size but with the opposite sign. We derive a welfare-based objective function for the Central Bank as a second order Taylor approximation of the expected utility of the economy's representative household, and we analyze optimal monetary policy under discretion and under commitment. Under discretion a negative productivity shock and a positive exogenous wage shock will require an increase in the nominal interest rate. An operational instrument rule, in this case, will satisfy the Taylor principle, but will also require that the nominal interest rate does not necessarily respond one to one to an increase in the interest rate that supports the efficient equilibrium. The results of the model are consistent with a well known empirical regularity in macroeconomics, i.e. that employment volatility is relatively larger than real wage volatility.
    Keywords: Optimal Monetary Policy, Monopolist Union, Labor Indivisibility
    JEL: E24 E32 E50 J23 J51
    Date: 2007–03
  8. By: Corrado, L.; Miller, M.; Zhang, L.
    Abstract: Asset mis-pricing may reflect investor psychology, with excess volatility arising from switches of sentiment. For a floating exchange rate where fundamentals follow a random walk, we show that excess volatility can be generated by the repeated entry and exit of currency `bulls' and `bears' with switches driven by `draw-down' trading rules. We argue that non-sterilised intervention - in support of `monitoring band' - can reduce excess volatility by coordinating beliefs in line with policy. Strategic complementarity in the foreign exchange market suggests that sterilised intervention may also play a coordinating role.
    Keywords: Monitoring Rules, Monitoring Band, Bear and Bull Traders, Excess Volatility, Central Bank Intervention.
    JEL: D52 F31 G12
    Date: 2007–01
  9. By: Rodolfo Maino; Inese Buzeneca
    Abstract: Since the early 1990s, the IMF has been advising countries to shift to the use of indirect instruments for executing monetary policy. This paper provides information about a monetary policy instruments database, maintained by the Monetary and Capital Markets Department of the IMF. We offer an overview of the information contained in the database in the form of comparative summary tables and graphs to illustrate the use of monetary policy instruments by groups of countries (developing, emerging market and developed countries). The main trend that can be identified from the database information is the increasing reliance on money market operations for monetary policy implementation. We emphasize the relevance and usefulness of the data collected through periodic surveys of central banks, for general descriptive and analytical purposes.
    Keywords: Monetary policy , Databases , Central banks ,
    Date: 2007–01–17
  10. By: Solange Gouvea; Abhijit Sen Gupta
    Abstract: Most of the recent research in monetary policy has focused on the use of a single exogenously specified standard ad hoc loss function to evaluate policy performance. This literature has come to the conclusion that backward looking models are more difficult to control i.e. monetary policy performance deteriorates with an increase in inflation persistence. In this paper we test the validity of this conclusion using both a standard ad hoc loss function and a model consistent loss function across competing models of inflation persistence. We find that conclusions vary markedly with different types of loss functions. We also look into the case where the policymaker is uncertain about the pricing behavior of firms and investigate the presence of robust policy rules. We find that the existence of robust rules depend crucially on the type of loss function used to evaluate outcomes.
    Date: 2007–05
  11. By: Benk, Szilárd; Gillman, Max (Cardiff Business School); Kejak, Michal
    Abstract: The explanation of velocity in neoclassical monetary business cycle models relies on a goods productivity shocks to mimic the data's procyclic velocity feature; money shocks are not important; and the financial sector plays no role. This paper sets the model within endogenous growth, adds exchange credit shocks, and finds that money and credit shocks explain much of the velocity variation. The role of the shocks varies across sub-periods in an intuitive fashion. Endogenous growth is key to the construction of the money and credit shocks since these have similar effects on velocity, but opposite effects upon growth. The model matches the data's average velocity and simulates most of the velocity volatility that is found in the data. Its underlying money demand is Cagan-like in its interest elasticity, so that money and credit shocks cause greater velocity variation the higher is the nominal interest rate.
    Keywords: Velocity; business cycle; credit shocks; endogenous growth
    JEL: E13 E32 E44
    Date: 2007–05
  12. By: Samuel Reynard (Swiss National Bank, Research Unit, Boersenstrasse 15, 8022 Zurich, Switzerland.)
    Abstract: This paper presents a systematic empirical relationship between money and subsequent prices and output, using US, euro area and Swiss data since the 1960-70s. Monetary developments, unlike interest rate stance measures, are shown to provide qualitative and quantitative information on subsequent inflation. The usefulness of monetary analysis is contrasted to weaknesses in modeling monetary policy and inflation with respectively short-term interest rates and real activity measures. The analysis sheds light on the recent change in inflation volatility and persistence as well as on the Phillips curve flattening, and reveals drawbacks in pursuing a low inflation target without considering monetary aggregates. JEL Classification: E52, E58, E41, E3.
    Keywords: Monetary policy, monetary aggregates, inflation, output, Taylor rule, equilibrium interest rate.
    Date: 2007–05
  13. By: Barbara Roffia (European Central Bank, Directorate General Economics, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Andrea Zaghini (Banca d’Italia, Economic Research Department, Via Nazionale 91, 00184 Rome, Italy.)
    Abstract: The paper analyses the short-run impact of periods of strong monetary growth on inflation dynamics for 15 industrialised economies. We find that, over a 3-year horizon, the positive link between monetary aggregates and prices holds in approximately fifty percent of the cases. An econometric investigation suggests that a contemporaneous increase in the gap measures of the real stock price and real housing price and strong dynamics of loans to the private sector significantly increase the probability of turning an episode of excessive money growth into an inflationary outburst. JEL Classification: E31, E40.
    Keywords: Inflation, money growth, quantity theory of money.
    Date: 2007–05
  14. By: Marta Areosa; Waldyr Areosa
    Abstract: We study optimal monetary policy when inequality is present by introducing agents with different productivities, wages, and financial market accesses into a general equilibrium model with sticky prices. Our main results are: (i) There is a channel from interest rate to inflation throughout inequality; (ii) The welfare-based objective of monetary policy includes inequality stabilization; (iii) Higher levels of financial exclusion are associated to bigger welfare losses and to smaller interest rate variability, providing an alternative explanation to why observed interest rate paths are much less volatile than optimal policies implied by most theoretical models of the monetary transmission mechanism.
    Date: 2006–08
  15. By: Nikolaos Mylonidis (University of Ioannina); Dimitrios Sideris (Bank of Greece and University of Ioannina)
    Abstract: Recent studies in the international economics literature emphasize the role of home bias in explaining a number of empirical puzzles. In the present study, we test for the following hypotheses: (i) that a home bias effect, which is nevertheless falling over time as traded goods markets become more integrated and consumption preferences become more similar across developed countries, influences the relationship among nominal exchange rates, domestic prices and foreign prices, and (ii) that incorporation of the home bias effect in the empirical specification of PPP enhances the robustness of the theory. We perform a panel data analysis using quarterly observations for the G-7 economies in the post-Bretton Woods era. The results confirm our hypotheses.
    Keywords: PPP; Home bias; Panel data
    JEL: F31 C33
    Date: 2007–04
  16. By: Aurelijus Dabušinskas; Dmitry Kulikov
    Abstract: This paper presents an empirical analysis of the inflation process in Estonia, Latvia and Lithuania within the framework of the New Keynesian Phillips Curve (NKPC) model of Galí and Gertler (1999) and Galí et al. (2001). An open economy extension by Leith and Malley (2003) and a NKPC model that explicitly incorporates energy into the average real marginal cost measure are also considered. The primary focus of the paper is to identify and compare the underlying structural parameters of the NKPC model across the three Baltic economies. Empirical NKPC model estimates point to a limited role of the cost measure in determining inflation dynamics in the three Baltic countries. It has been found that the inflation process in these countries primarily depends on inflation expectations and past inflation rates. Price setting flexibility, as measured by the price stickiness parameter, tends to be lower than in the euro area but higher than in the US, while the share of backward-looking price setters is found to be higher on average.
    Keywords: New Keynesian Phillips Curve, inflation dynamics, open economy,
    JEL: E31 C22
  17. By: Rodolfo Maino; Bernard Laurens
    Abstract: The People's Bank of China (PBC) has made great strides in modernizing its monetary policy frameworks but their effectiveness will diminish as the sophistication of the economy increases. Empirical evidence supports maintaining a reference to money in China's monetary strategy and enhancing the role of interest rates in its conduct. We advocate adoption of an eclectic strategy involving the monitoring of several indicators, and of a short-term interest rate as the operational target. The PBC should be granted discretion to change its policy rate, and there are no technical obstacles for such a move to occur in the near future.
    Keywords: Monetary policy , China , Monetary policy instruments , Demand for money , Economic indicators , Interest rates ,
    Date: 2007–01–25
  18. By: Arnildo da Silva Correa; André Minella
    Abstract: This paper investigates the presence of nonlinear mechanisms of pass-through from the exchange rate to inflation in Brazil. In particular, it estimates a Phillips curve with a threshold for the pass-through. The paper examines whether the short-run magnitude of the pass-through is affected by the business cycle, direction and magnitude of exchange rate changes, and exchange rate volatility. The results indicate that the short-run pass-through is higher when the economy is growing faster, when the exchange rate depreciates above some threshold and when exchange rate volatility is lower. These results have important implications for monetary policy and are possibly related to pricing-to-market behavior, menu costs of price adjustment and uncertainty about the degree of persistence in exchange rate movements.
    Date: 2006–11
  19. By: Afonso S. Bevilaqua; Mário Mesquita; André Minella
    Abstract: This paper analyzes monetary policy implementation and convergence of inflation and inflation expectations to the targets in Brazil after the crisis in 2002. It covers the initial disinflation and subsequent economic recovery, followed by the inflation rebound and corresponding policy response, and finally the consolidation of disinflation in 2005-06. Monetary policy implementation and the overall improvement in macroeconomic fundamentals have contributed substantially to create a more stable and predictable environment, evidenced by signs of reduction in inflation uncertainty. Furthermore, econometric exercises indicate the critical role played by the targets as attractors for inflation expectations.
    Date: 2007–01
  20. By: Alexandre A. Tombini; Sergio A. Lago Alves
    Abstract: This work revisits the recent disinflation process in Brazil and finds that solely the agents' perception that a policy rupture could occur is capable of triggering a change in the way firms and households used to behave in their pricing and consuming decisions. This change was captured by structural breaks in the parameters of a generalized hybrid Phillips curve, following the 2002 inflation shock. The paper also shows that such parameter changes led to an increase in the disinflation cost evidenced by a free market inflation gain that would have been observed should the coefficients on the Phillips curve have not changed. The paper finds that, maintaining the occurred paths for interest rates, output gap, nominal exchange rates, administered price inflation and exogenous shocks, the free market inflation would have been significantly lower in the absence of such structural break in the underlying inflation process, since mid 2002.
    Date: 2006–06
  21. By: Faisal Ahmed; Nabil Ben Ltaifa; Todd Schneider; Saade Chami
    Abstract: This paper investigates the likely implications of declining oil production on Yemen's equilibrium exchange rate, and discusses policy options to ensure a smooth transition to a nonoil economy. The empirical results suggest that, as oil production and foreign exchange earnings fall, the Yemeni rial will have to adjust downward in real effective terms to keep pace with the equilibrium exchange rate. In light of strong pass-through from exchange rate depreciation to domestic inflation, this could entail a substantial depreciation in nominal terms. Given the nature of the adjustment, a floating exchange rate regime appears to be the best option, if supported by appropriate macroeconomic policies. However, given public fixation on a exchange rate stability, a softly managed float would be a better option for Yemen whereby the central bank may have to lead the market toward the equilibrium exchange rate.
    Keywords: Exchange rate policy , Yemen, Republic of , Oil exports ,
    Date: 2007–01–17
  22. By: Selim Elekdag; Nabil Ben Ltaifa; Todd Schneider; Saade Chami
    Abstract: Monetary policy in Yemen is largely rudimentary and ad hoc in nature. The Central Bank of Yemen's (CBY) approach has been based on discretionary targeting of broad money without any clear target to anchor inflation expectations. This paper argues in favor of a new formal monetary policy framework for Yemen emphasizing a proactive and rule-based approach with a greater direct focus on price stability in the context of a flexible management of the exchange rate. Although, as in many developing countries, institutional capacity is a concern, adopting a more formal framework could impel the kind of changes that are required to strengthen the ability of the CBY in achieving low and stable rates of inflation over the medium term.
    Keywords: Monetary policy , Yemen, Republic of , Inflation targeting , Developing countries , Exchange rates , Prices ,
    Date: 2007–01–17

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