nep-cba New Economics Papers
on Central Banking
Issue of 2007‒06‒11
forty papers chosen by
Alexander Mihailov
University of Reading

  1. Inflation Dynamics By Frederic S. Mishkin
  2. Monetary Policy with Model Uncertainty: Distribution Forecast Targeting By Svensson, Lars E O; Williams, Noah
  3. Inflation persistence: alternative interpretations and policy implications By Argia M. Sbordone
  4. Euro area inflation persistence in an estimated nonlinear DSGE model. By Gianni Amisano; Oreste Tristani
  5. Exchange Rate Fundamentals and Order Flow By Martin D. D. Evans; Richard K. Lyons
  6. In Search of the Transmission Mechanism of Fiscal Policy By Roberto Perotti
  7. Oil Price Movements and the Global Economy: A Model-Based Assessment By Selim Elekdag; René Lalonde; Douglas Laxton; Dirk Muir; Paolo Pesenti
  8. Estimating the Inflation-Output Variability Frontier with Inflation Targeting: A VAR Approach By W. Douglas McMillin; James S. Fackler
  9. Openness and inflation By Mark A. Wynne; Erasmus K. Kersting
  10. Are EU budget deficits sustainable? By Mark J. Holmes; Jesus Otero; Theodore Panagiotidis
  11. Fiscal deficits in the U.S. and Europe: Revisiting the link with interest rates By Andrea Terzi
  12. What Promotes Fiscal Consolidation: OECD Country Experiences By Stéphanie Guichard; Mike Kennedy; Eckhard Wurzel; Christophe André
  13. Segmented Asset Markets and Optimal Exchange Rate Regimes By Amartya Lahiri; Rajesh Singh; Carlos A. Vegh
  14. The Relative Importance of Symmetric and Asymmetric Shocks: the Case of United Kingdom and Euro Area By Gert Peersman
  16. Inflation-linked bonds from a Central Bank perspective By Juan Angel Garcia; Adrian van Rixtel
  17. Globalization, aggregate productivity, and inflation By W. Michael Cox
  18. The U.S. Dynamic Taylor Rule With Multiple Breaks, 1984-2001. By Travaglini, Guido
  19. A General Schema for Optimal Monetary Policymaking: Objectives and Rules By Huiping Yuan; Stephen M. Miller
  20. La transparence de la politique monétaire et la dynamique des marchés financiers. By Meixing DAI; Moïse SIDIROPOULOS; Eleftherios SPYROMITROS
  21. Monetary Policy with Liquidity Frictions By Oscar Mauricio VALENCIA A.
  22. Demand Shocks and Trade Balance Dynamics By José García-Solanes; Jesús Rodríguez López; José Luis Torres Chacón
  23. Interventions in the Foreign Exchange Market: Effectiveness of Derivatives and Other Instruments By Walter Novaes; Fernando N. de Oliveira
  24. Methodische Fragen mittelfristiger gesamtwirtschaftlicher Projektionen am Beispiel des Produktionspotenzials By Gustav Horn; Camille Logeay; Silke Tober
  25. Macroeconomic Policy in a Heterogeneous Monetary Union By Oliver Grimm; Stefan Ried
  26. Business Cycle and Bank Capital: Monetary Policy Transmission under the Basel Accords By Alvaro Aguiar; Ines Drumond
  27. Fiscal Shocks, the Trade Balance, and the Exchange Rate By Faik Koray; W. Douglas McMillin
  28. Why Investors Prefer Nominal Bonds: a Hypothesis By William Coleman
  29. ‘This Arbitrary Rearrangement of Riches’: an Alternative Theory of the Costliness of Inflation By William Coleman
  30. On Keynesian effects of (apparent) non-Keynesian fiscal policies By Canale, Rosaria Rita; Foresti, Pasquale; Marani, Ugo; Napolitano, Oreste
  31. A Solution Method for Linear Rational Expectation Models under Imperfect Information By Katsuyuki Shibayama
  32. Transmission of business cycle shocks between unequal neighbours: Germany and Austria By Gerhard Fenz; Martin Schneider
  33. Memory for prices and the euro cash changeover: An analysis for cinema prices in Italy By Vincenzo Cestari; Paolo Del Giovane; Clelia Rossi-Arnaud
  34. Estimation of the Equilibrium Real Exchange Rate in Russia: Trade-Balance Approach By Nadezhda Ivanova
  35. Exchange Rate Pass-Through and Domestic Inflation: A Comparison between East Asia and Latin American Countries By ITO Takatoshi; SATO Kiyotaka
  36. Foreign Exchange, Interest and the Dynamics of Public Debt in Latin America By Carlos E. Schonerwald da Silva; Matías Vernengo
  37. A (Lack of) Progress Report on China's Exchange Rate Policies By Morris Goldstein
  38. Bank Restructuring in Asia: Crisis management in the aftermath of the Asian financial crisis and prospects for crisis prevention -Malaysia- By ITO Takatoshi; HASHIMOTO Yuko
  39. Effects of Monetary Policy on Corporations in Brazil. An Empirical Analysis of the Balance Sheet Channel By Fernando N. de Oliveira; Marco Antônio Costa
  40. Monetary policy, structural break, and the monetary transmission mechanism in Thailand By Hesse, Heiko

  1. By: Frederic S. Mishkin
    Abstract: This paper first outlines the key stylized facts about changes in inflation dynamics in recent years: 1) inflation persistence has declined, 2) the Phillips curve has flattened, and 3) inflation has become less responsive to other shocks. These changes in inflation dynamics are interpreted as resulting from an anchoring of inflation expectations as a result of better monetary policy. The paper then goes on to draw implications for monetary policy from this interpretation, as well as implications for inflation forecasts.
    JEL: E31 E50
    Date: 2007–06
  2. By: Svensson, Lars E O; Williams, Noah
    Abstract: We examine optimal and other monetary policies in a linear-quadratic setup with a relatively general form of model uncertainty, so-called Markov jump-linear-quadratic systems extended to include forward-looking variables and unobservable "modes." The form of model uncertainty our framework encompasses includes: simple i.i.d. model deviations; serially correlated model deviations; estimable regime-switching models; more complex structural uncertainty about very different models, for instance, backward- and forward-looking models; time-varying central-bank judgment about the state of model uncertainty; and so forth. We provide an algorithm for finding the optimal policy as well as solutions for arbitrary policy functions. This allows us to compute and plot consistent distribution forecasts - fan charts - of target variables and instruments. Our methods hence extend certainty equivalence and "mean forecast targeting" to more general certainty non-equivalence and "distribution forecast targeting."
    Keywords: multiplicative uncertainty; Optimal policy
    JEL: E42 E52 E58
    Date: 2007–06
  3. By: Argia M. Sbordone
    Abstract: In this paper, I consider the policy implications of two alternative structural interpretations of observed inflation persistence, which correspond to two alternative specifications of the new Keynesian Phillips curve (NKPC). The first specification allows for some degree of intrinsic persistence by way of a lagged inflation term in the NKPC. The second is a purely forward-looking model, in which expectations farther into the future matter and coefficients are time-varying. In this specification, most of the observed inflation persistence is attributed to fluctuations in the underlying inflation trend, which are a consequence of monetary policy rather than a structural feature of the economy. With a simple quantitative exercise, I illustrate the consequences of implementing monetary policy, assuming a degree of intrinsic persistence that differs from the true one. The results suggest that the costs of implementing a stabilization policy when the policymaker overestimates the degree of intrinsic persistence are potentially higher than the costs of ignoring actual structural persistence; the result is more clear-cut when the policymaker minimizes a welfare-based loss function.>
    Keywords: Phillips curve ; Inflation (Finance) ; Monetary policy
    Date: 2007
  4. By: Gianni Amisano (Directorate General Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Oreste Tristani (Directorate General Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We estimate the approximate nonlinear solution of a small DSGE model on euro area data, using the conditional particle filter to compute the model likelihood. Our results are consistent with previous findings, based on simulated data, suggesting that this approach delivers sharper inference compared to the estimation of the linearised model. We also show that the nonlinear model can account for richer economic dynamics - the impulse responses to structural shocks vary depending on initial conditions selected within our estimation sample. JEL Classification: C11, C15, E31, E32, E52.
    Keywords: DSGE models, inflation persistence, second order approximations, sequential Monte Carlo, Bayesian estimation.
    Date: 2007–05
  5. By: Martin D. D. Evans; Richard K. Lyons
    Abstract: We address whether transaction flows in foreign exchange markets convey fundamental information. Our GE model includes fundamental information that first manifests at the micro level and is not symmetrically observed by all agents. This produces foreign exchange transactions that play a central role in information aggregation, providing testable links between transaction flows, exchange rates, and future fundamentals. We test these links using data on all end-user currency trades received at Citibank over 6.5 years, a sample sufficiently long to analyze real-time forecasts at the quarterly horizon. The predictions are borne out in four empirical findings that define this paper's main contribution: (1) transaction flows forecast future macro variables such as output growth, money growth, and inflation, (2) transaction flows forecast these macro variables significantly better than the exchange rate does, (3) transaction flows (proprietary) forecast future exchange rates, and (4) the forecasted part of fundamentals is better at explaining exchange rates than standard measured fundamentals.
    JEL: F31 G12 G14
    Date: 2007–06
  6. By: Roberto Perotti
    Abstract: Most economists would agree that a hike in the federal funds rate will cause some slowdown in growth and inflation, and that the bulk of the empirical evidence is consistent with this statement. But perfectly reasonable economists can and do disagree even on the basic effects of a shock to government spending on goods and services: neoclassical models predict that private consumption and the real wage will fall, while some neo-keyenesian models predict the opposite. This paper discusses alternative time series methodologies to identify government spending shocks and to estimate their effects. Applying these methodologies to data from the US and three other OECD countries provides little evidence in favor of the neoclassical predictions. Using the US input-output tables, the paper then turns to industry-level evidence around two major military buildups to shed light on the effects of government spending shocks.
    JEL: E2 E6 E62
    Date: 2007–06
  7. By: Selim Elekdag; René Lalonde; Douglas Laxton; Dirk Muir; Paolo Pesenti
    Abstract: We develop a five-region version (Canada, an oil exporter, the United States, emerging Asia and Japan plus the euro area) of the Global Economy Model (GEM) encompassing production and trade of crude oil, and use it to study the international transmission mechanism of shocks that drive oil prices. In the presence of real adjustment costs that reduce the short- and medium-term responses of oil supply and demand, our simulations can account for large endogenous variations of oil prices with large effects on the terms of trade of oil-exporting versus oil-importing countries (in particular, emerging Asia), and result in significant wealth transfers between regions. This is especially true when we consider a sustained increase in productivity growth or a shift in production technology towards more capital- (and hence oil-) intensive goods in regions such as emerging Asia. In addition, we study the implications of higher taxes on gasoline that are used to reduce taxes on labor income, showing that such a policy could increase world productive capacity while being consistent with a reduction in oil consumption.
    Keywords: Economic models; Inflation and prices; International topics
    JEL: E66 F32 F47
    Date: 2007
  8. By: W. Douglas McMillin; James S. Fackler
    Abstract: This paper (i) illustrates how a VAR model can be used to evaluate inflation targeting, (ii) derives the policy frontier available to the central bank using counterfactual experiments with real time data, and (iii) estimates how this frontier has changed over time in terms of the position and slope of the available tradeoff between output gap variability and inflation variability under inflation targeting. Various inflation targets are considered as are tolerance bands of varying width around these targets. The results indicate that over time (i) a given reduction in inflation variability is associated with a smaller rise in output variability and that (ii) a given inflation variability is achieved with smaller interest rate volatility. Consistent with the data, our results require federal funds rate persistence, though no instrument instability was observed.
  9. By: Mark A. Wynne; Erasmus K. Kersting
    Abstract: This paper reviews the evidence on the relationship between openness and inflation. There is a robust negative relationship across countries, first documented by Romer (1993), between a country's openness to trade and its long-run inflation rate. However, a key part of the standard explanation for this relationship—that central banks have a smaller incentive to engineer surprise inflations in more-open economies because the Phillips curve is steeper—seems at odds with the facts. While the United States is still not a very open economy by conventional measures, there are channels through which global developments may influence the nation's inflation. We document evidence that global resource utilization may play a role in U.S. inflation and suggest avenues for future research.
    Keywords: Inflation (Finance) ; Trade ; Phillips curve
    Date: 2007
  10. By: Mark J. Holmes (Dept of Economics, Waikato University); Jesus Otero (Facultad de Economia, Universidad del Rosario); Theodore Panagiotidis (Department of Economics, Loughborough University)
    Abstract: In this paper, we test for the stationarity and sustainability of European Union budget deficits over the period 1971 to 2006, using a panel of thirteen member countries. Our testing strategy addresses two key concerns with regard to unit root panel data testing, namely (i) the identication of which members-states are stationary, and (ii) the presence of cross-sectional dependence. We employ a moving block bootstrap approach to the Hadri (2000) procedure that tests the null of joint stationarity. In contrast to the existing literature, we find that the EU countries considered are characterised by fiscal sustainability over the full sample period. This conclusion also holds when analysing sub-periods based on before and after the Maastricht treaty.
    Keywords: Heterogeneous dynamic panels, fiscal sustainability, mean reversion, panel stationarity test.
    JEL: C33 F32 F41
    Date: 2007–05
  11. By: Andrea Terzi (Universita Cattolica, Milan, Italy)
    Keywords: deficits; fiscal deficit; interest rates; inflation
    Date: 2007–05–14
  12. By: Stéphanie Guichard; Mike Kennedy; Eckhard Wurzel; Christophe André
    Abstract: Fiscal consolidation is required in most OECD countries. This is especially so in view of mediumand long-term spending pressures on public finances, related, inter alia, to ageing. Based on a dataset covering a large number of OECD fiscal consolidation episodes starting in the late 1970s, the paper presents evidence, both descriptive and econometric, on macroeconomic conditions and policy set-ups that have been effective in triggering and sustaining fiscal consolidation. Main findings include: Large initial deficits and high interest rates have been important in prompting fiscal adjustment and also in boosting the overall size and duration of consolidation. Concerning the quality of fiscal policies, an emphasis on cutting current expenditures has been associated with overall larger consolidation. Fiscal rules with embedded expenditure targets tended to be associated with larger and longer adjustments, pointing to institutional features playing a potentially important role in generating successful consolation efforts. Experience across countries also shows that certain design features such as transparency, flexibility to face shocks and effective enforcement mechanisms seem important for the effectiveness of fiscal rules. <P>Qu’est-ce qui favorise la consolidation budgétaire : L’expérience des pays de l’OCDE <BR>La plupart des pays de l’OCDE doivent consolider leurs finances publiques. C’est particulièrement le cas en raison des pressions de dépenses à moyen et long terme sur les finances publiques, liées entre autres au vieillissement des populations. Sur la base de données couvrant un grand nombre d’épisodes de consolidation budgétaire dans les pays de l’OCDE depuis la fin des années 70, le papier met en évidence, á la fois de manière descriptive et économétrique, les conditions macroéconomiques et les politiques qui ont été efficaces pour initier et supporter la consolidation budgétaire. Il montre en particulier que lorsque le déficit budgétaire et les taux de grand intérêt sont élevés la consolidation est non seulement plus probable mais aussi plus importante et plus longue. Concernant la qualité de l'ajustement budgétaire, des efforts concentrés sur la réduction des dépenses courantes sont associés à des consolidations plus importantes. La présence de règles budgétaires incluant des cibles de dépenses a été généralement associée à des ajustements plus important et plus longs, soulignant ainsi que les dispositifs institutionnels jouent un rôle potentiellement important pour le succès des consolidations budgétaires. L’expérience des différents pays montre aussi que certaines caractéristiques telles que la transparence, la flexibilité face à des chocs et les mécanismes d’application efficaces semblent importantes pour l?efficacité des règles budgétaires.
    Keywords: public debt, dette publique, dépenses publiques, fiscal rules, règles budgétaires, fiscal consolidation, government revenue, consolidation budgétaire, deficit, déficit, government spending, recettes budgétaires
    JEL: H11 H62 H63
    Date: 2007–05–28
  13. By: Amartya Lahiri; Rajesh Singh; Carlos A. Vegh
    Abstract: This paper revisits the issue of the optimal exchange rate regime in a flexible price environment. The key innovation is that we analyze this question in the context of environments where only a fraction of agents participate in asset market transactions (i.e., asset markets are segmented). Under this friction, alternative exchange rate regimes have different implications for real allocations in the economy. In particular -- and contrary to standard results under sticky prices -- we show that flexible exchange rates are optimal under monetary shocks and fixed exchange rates are optimal under real shocks.
    JEL: F3 F40 F41
    Date: 2007–06
  14. By: Gert Peersman (Ghent University)
    Abstract: In this paper, we show how a simple model with sign restrictions can be used to identify symmetric and asymmetric supply, demand and monetary policy shocks in a two-country structural VAR. The results can be used to deal with several issues that are important in the OCA-literature. Whilst the method can be applied to many countries, we provide evidence for the UK versus the Euro Area which are compared versus the US as a benchmark. An important role for symmetric shocks with the Euro Area in explaining UK output fluctuations is found. However, the relative importance of asymmetric shocks, being around 20 percent in the long-run, cannot be ignored. In contrast, the degree of business cycle synchronization seems to have been higher with the US. Moreover, the historical average reaction of the policy rate to symmetric aggregate demand shocks was stronger in the UK than the Euro Area. We also confirm existing evidence of the exchange rate being an important independent source of shocks in the economy.
    Keywords: optimal currency areas, symmetric and asymmetric shocks, vector autoregressions
    JEL: C32 E42 F31 F33
    Date: 2007–10–05
  15. By: Yuzo Honda (School of Economics, Osaka University); Yoshihiro Kuroki (Chuo University); Minoru Tachibana (Osaka Prefecture University)
    Abstract: Many macroeconomists and policymakers have debated the effectiveness of the quantitative monetary-easing policy (QMEP) that was introduced in Japan in 2001. This paper measures the effect of the QMEP on aggregate output and prices, and examines its transmission mechanism, based on the vector autoregressive (VAR) methodology. To ascertain the transmission mechanism, we include several financial market variables in the VAR system. The results show that the QMEP increased aggregate output through the stock price channel. This evidence suggests that further injection of base money is effective even when short-term nominal interest rates are at zero.
    Keywords: Quantitative easing; Money injection; Portfolio rebalancing; Stock price channel; Vector autoregression
    JEL: E44 E52
    Date: 2007–03
  16. By: Juan Angel Garcia (Capital markets and Financial Structure Division, Directorate Monetary Policy, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Adrian van Rixtel (Capital markets and Financial Structure Division, Directorate Monetary Policy, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Inflation-linked bond markets have experienced significant growth in recent years. This growth is somewhat surprising, for inflation-linked bonds cannot be considered a financial innovation and their development has taken place in a period of historically low global inflation and inflation expectations. In this context, the purpose of this paper is twofold. First, it provides a selective survey of the key arguments for and against the issuance of inflation-linked debt, and some of the factors that help to understand their recent growth. Second, it illustrates the use of these instruments to better monitor investors’ inflation expectations and growth prospects from a central bank perspective.
    Date: 2007–06
  17. By: W. Michael Cox
    Abstract: This paper investigates the effects of globalization on aggregate productivity, output growth, and inflation. I present a simple two-country, two-good, flexible exchange rate model using Fisher Ideal aggregators to examine changes in the mapping from microeconomic to macroeconomic productivity growth as nations globalize. Advances in industry-specific labor productivity are shown to have potentially a much greater passthrough to aggregate productivity, output, and prices the more open nations are to trade. Globalization raises both the level and growth rate of aggregate productivity by allowing more economywide reorganization in response to ongoing technological advances than would be optimal otherwise. ; I develop a globalized version of the quantity equation of money, where inflation in the home country depends on domestic money growth and a weighted average of home and foreign GDP growth. Relative country size, consumer preferences, production technologies, and the openness of trade are the chief determinants of these weights. Calibrating the model to match certain stylized facts about the U.S. and global economies, U.S. consumer price inflation falls from roughly 3.8 percent when economies are closed to under 2 percent in the transition period, eventually settling at around 2.3 percent in free trade. Producer and consumer prices trek a common path under autarky but diverge as the world globalizes. Both home and foreign aggregate productivity growth rates increase—by 0.4 and 0.7 percentage points, respectively. Roughly 30 percent of the output weight in the determination of home inflation shifts from the home to the foreign economy—greater than might be expected from strong home bias.
    Date: 2007
  18. By: Travaglini, Guido
    Abstract: This paper combines two major strands of literature: structural breaks and Taylor rules. At first, I propose a nonstandard t-test statistic for detecting multiple level and trend breaks of I(0) series by supplying theoretical and limit-distribution critical values obtained from Montecarlo experimentation. Thereafter, I introduce a forward-looking Taylor rule expressed as a dynamic model which allows for multiple breaks and reaction-function coefficients of the leads of inflation, of the output gap and of an equity market index. Sequential GMM estimation of the model, applied to the Effective Federal Funds Rate for the period 1984:01-2001:06, produces three main interesting results: the existence of significant structural breaks, the substantial role played by inflation in the FOMC decisions and a marked equity targeting policy approach. Such results reveal departures from rationality, determined by structured and unstructured uncertainty, which the Fed systematically attempts at reducing by administering inflation scares and misinformation about the actual Phillips curve, in order to keep the output and equity markets under control.
    Keywords: Generalized Method of Moments; Monetary Policy Rules; Multiple Breaks.
    JEL: C61 C12 E58
    Date: 2007–06–06
  19. By: Huiping Yuan (Xiamen University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper examines four equivalent methods of optimal monetary policymaking, committing to the social loss function, using discretion with the central bank long-run and short-run loss functions, and following monetary policy rules. All lead to optimal economic performance. The same performance emerges from these different policymaking methods because the central bank actually follows the same (similar) policy rules. These objectives (the social loss function, the central bank long-run and short-run loss functions) and monetary policy rules imply a complete regime for optimal policy making. The central bank long-run and short-run loss functions that produce the optimal policy with discretion differ from the social loss function. Moreover, the optimal policy rule emerges from the optimization of these different central bank loss functions.
    Keywords: Optimal Policy, Central Bank Loss Functions, Policy Rules
    JEL: E42 E52 E58
    Date: 2007–03
  20. By: Meixing DAI; Moïse SIDIROPOULOS; Eleftherios SPYROMITROS
    Abstract: Cet article étudie les implications, en termes de stabilité économique, de la relation entre le degré d’indépendance de la Banque centrale et le degré de transparence (ou d’opacité) de la politique monétaire dans un modèle qui tient explicitement compte des marchés financiers et ainsi de la dynamique jointe de l’inflation et des cours boursiers. Nous montrerons que l’opacité sur les préférences de la Banque centrale exerce une influence négative sur la stabilité. Cette influence négative pourrait être modérée ou compensée par les effets d’un écart positif entre le poids relatif perçu par le public et le vrai poids que la Banque centrale attribue à l’objectif d’output. Par ailleurs, un marché du travail peu flexible, une demande de biens peu sensible au taux d’intérêt réel, ou encore une vitesse de circulation de la monnaie et une élasticité - intérêt de la demande de monnaie élevées exigent une plus grande transparence pour assurer la stabilité de l’économie.
    Keywords: Transparence, règle de taux d’intérêt, prix des actifs, stabilité macroéconomique.
    JEL: E5
    Date: 2007
  21. By: Oscar Mauricio VALENCIA A.
    Abstract: This paper explores the welfare efects of a reduction in the inflation rates in an environment of incomplete markets. We built a dynamic heterogeneous agent model that features idiosyncratic risks in the labor supply and liquidity frictions. The model shows that a disinflation policy results in an income reallocation among debtors and lenders. The changes in the capital returns conveys variations in the precautionary savings and hence, an intertemporal redistribution of wealth and income. The welfare implications are develop according to the incomplete market features and the money plays a role of smoothing consumption when the agents faces income variability without state contingent insurance. The model is calibrated for the Colombian economy in such a way that disinflation episodes are replicated. Early results show that the disinflation monetary policy leads to improvements of liquidity in the economy because the money holdings are used by the agents for wealth transfer over time. This paper shows quantitative evidence in which disin°ation facts are associated with increments in the average real money holdings and average consumption. In addition, the volatility of consumption is reduced as the inflation rate falls, while the volatility of money holdings increases (i.e precautionary demand for money balance).
    Date: 2007–02–15
  22. By: José García-Solanes (Departamento de Fundamentos del Análisis Económico, Universidad de Murcia); Jesús Rodríguez López (Department of Economics, Universidad Pablo de Olavide); José Luis Torres Chacón (Departamento de Teoría e Historia Económica, Universidad de Málaga)
    Abstract: This paper studies the current account dynamics in the G-7 countries plus Spain. We estimate a SVAR model which allows us to identify three different shocks: supply shocks, real demand shocks and nominal shocks. We use a different identification procedure from previous work based on a microfounded stochastic open-economy model in which the real exchange rate is a determinant of the Phillips curve. Estimates from a structural VAR show that real demand shocks explain most of the variability of current account imbalances, whereas, contrary to previous findings, nominal shocks play no role. The results we obtain are consistent with the predictions of a widely set of open-economy models and illustrate that demand policies are the main responsible of trade imbalances.
    Keywords: Current account, SVAR.
    JEL: F3
    Date: 2007–05
  23. By: Walter Novaes (PUC/RJ); Fernando N. de Oliveira (IBMEC Business School - Rio de Janeiro and Central Bank of Brazil)
    Abstract: This paper discusses the effectiveness in Brazil of the traditional instruments of exchange rate interventions (spot interventions and interest rates) as well as instruments based on exchange rate derivatives (swaps and dollar indexed public bonds). We show that in periods of high volatility of the nominal exchange rate the instruments are not capable of significantly modifying the dynamics of the nominal exchange rate. In periods of low volatility of the nominal exchange rate, in contrast, both the traditional instruments and the derivative instruments are effective. These results are robust to the two techniques of estimation employed: GMM in continuous time and in discrete time.
    Keywords: Central Bank, intervention in the foreign exchange market, foreign exchange derivatives
    JEL: E58 F31 E52
    Date: 2007–06–05
  24. By: Gustav Horn (IMK at the Hans Boeckler Foundation); Camille Logeay (IMK at the Hans Boeckler Foundation); Silke Tober (IMK at the Hans Boeckler Foundation)
    Abstract: Potential output measures a country's attainable aggregate living standard and is thus one of the most important categories of economics. It is also a key indicator for monetary and fiscal policy. Despite its prominence, however, potential output is a difficult concept to pinpoint theoretically and even more so empirically. The study discusses these difficulties and also the marked revision of potential output estimates by major international organizations. The authors furthermore present the results of their attempts to quantify Germany's potential output based on a production function approach coupled with the Kalman-filter technique to estimate the NAIRU. The authors find that potential output and potential output growth greatly depend on how the NAIRU and potential total factor productivity are modelled. Given the difficulties involved in robustly estimating potential output, especially in real time, economic policy makers need to learn to pursue their policy objectives without reference to this variable.
    Date: 2007
  25. By: Oliver Grimm (Center of Economic Research (CER-ETH) at ETH Zurich); Stefan Ried (at ETH Zurich, Institute of Economic Policy I, Humboldt-Universität zu Berlin)
    Abstract: We use a two-country model with a central bank maximizing union-wide welfare and two fiscal authorities minimizing comparable, but slightly different country-wide losses. We analyze the rivalry between the three authorities in seven static games. Comparing a homogeneous with a heterogeneous monetary union, we find welfare losses to be significantly larger in the heterogeneous union. The best-performing scenarios are cooperation between all authorities and monetary leadership. Cooperation between the fiscal authorities is harmful to both the whole union’s and the country-specific welfare.
    Keywords: monetary union, heterogeneities, policy game, simultaneous policy, sequential policy, coordination, discretionary policies
    JEL: E52 E61 F42
    Date: 2007–05
  26. By: Alvaro Aguiar (CEMPRE, Faculdade de Economia, Universidade do Porto, Portugal); Ines Drumond (CEMPRE, Faculdade de Economia, Universidade do Porto, Portugal)
    Abstract: This paper improves the analysis of the role of financial frictions in the transmission of monetary policy and in business cycle fluctuations, by focusing on an additional channel working through bank capital. Detailing a dynamic general equilibrium model, in which households require a (countercyclical) liquidity premium to hold bank capital, we find that, together with the financial accelerator, the introduction of regulatory bank capital significantly amplifies monetary shocks through a liquidity premium effect on the external finance premium faced by firms. This amplification effect is larger under Basel II than under Basel I regulatory rules. Indeed, introducing bank capital enhances the role of financial frictions in the propagation of shocks, in line with arguments in related literature.
    Keywords: Bank capital channel; Bank capital requirements; Financial accelerator; Liquidity premium; Monetary transmission mechanism; Basel Accords
    JEL: E44 E32 E52 G28
    Date: 2007–06
  27. By: Faik Koray; W. Douglas McMillin
    Abstract: This paper investigates empirically, using a VAR model, the response of the exchange rate and the trade balance to fiscal policy shocks for the U.S. economy during the period 1981:3-2006:3. The results indicate that positive shocks to real government purchases generate a persistent increase in the budget deficit, a transitory expansionary effect on output, and a long-lived positive effect on the price level, but reduce the real interest rate. Simultaneously, and consistent with interest parity, the real exchange rate depreciates, and the trade balance improves. Negative shocks to net taxes also generate a persistent increase in the budget deficit, and the effects on the model variables are generally in the same direction, but are almost never significant. Our results indicate it is inappropriate to attribute rising trade balance deficits to expansionary fiscal policy shocks, even though these shocks generate long-lived increases in the budget deficit.
  28. By: William Coleman
    Abstract: The paper advances an answer to a puzzle: Why is any lending or borrowing done in terms of money, when such money debt exposes the lenders’ wealth to inflation risk? The ‘received’ answer to this question is that money bonds are just proxies for real bonds, proxies born of insufficient appreciation, or a benign neglect, of inflation risk. As mere ‘proxies’, this answer implies that money bonds are redundant: anything a money bond could do, a real bond could do. The thesis of the paper is that money bonds are not redundant. Money bonds have a social benefit. That benefit lies in the reduction that money bonds secure in the unpredictability of consumption that arises from the operation of real balance effects in an environment of unpredictable money shocks. It is the very vulnerability of money bonds to inflation makes them useful in immunising the economy against unpredictable redistributions of purchasing power caused by real balance effects.
    Keywords: Real balance effect, inflation risk, indexed bonds
    JEL: E44 E52
    Date: 2007–05
  29. By: William Coleman
    Abstract: This paper develops a model of the costliness of inflation that places the locus of costs in the bond market, rather than the money market. It argues that inflation is costly on account on the contraction of the bond market caused by the riskiness of inflation. The theory is premised upon the social function of bond markets as consisting of the transference of technological risk from those economic interests where risk is most concentrated (and so most painful) to interests where it is less concentrated (and so less painful). Using a Ramsey-Solow model with decision-makers maximising expected utility from consumption and real balances, the paper argues that unpredictable inflation impedes this useful transfer in risks secured by the bond market. Unpredictable inflation makes debt most costly when income is the most needed by debtors (since when the ex post real interest is highest, the debtor is in consequence the poorest), and credit the most remunerative when income is the least needed by creditors (since when the ex post real interest is the highest, the creditor is as a consequence richest). The upshot of these disincentives to borrow and lend is that less risk is transferred. Thus unpredictable inflation reduces the socially beneficial transfer of risks that a bond market secures.
    Keywords: inflation cost, inflation risk, debt
    JEL: E31 E43 E61
    Date: 2007–05
  30. By: Canale, Rosaria Rita; Foresti, Pasquale; Marani, Ugo; Napolitano, Oreste
    Abstract: The aim of the paper is to evaluate the robustness of the theory that claims for restrictive effects of expansionary fiscal policy. It shows that such so-called “non-Keynesian effects” may arise as a consequence of a synchronous and opposite monetary policy intervention. The paper demonstrate this conclusion through a stylized model – supported by an empirical investigation on ECB and FED reaction functions - in which Central Banks take into account deficit spending as an element that generate inflation expectations. The econometric analysis shows also that the ECB reacts asymmetrically to deficit spending variations while the FED has a linear reaction to this indicator.
    Keywords: Fiscal policy; Monetary policy; Central Banks Policy strategies
    JEL: E63 E52 E62 E58
    Date: 2007–05–30
  31. By: Katsuyuki Shibayama
    Abstract: This paper has developed a solution algorithm for linear rational expectation models under imperfect information. Imperfect information in this paper means that some decision makings are based on smaller information sets than others. The algorithm generates the solution in the form of k_t+1 = Hk_t + Jx^t,S f_t = Fk_t + Gx^t,S where k_t and f_t are column vectors of crawling and jump variables, respectively, while x^t,S is the vertical concatenation of the column vectors of past and present innovations. The technical breakthrough in this article is made by expanding the innovation vector, rather than expanding the set of crawling variables. Perhaps surprisingly, the H and F matrices are the same as those under the corresponding perfect information models. This implies that if the corresponding perfect information model is saddle path stable (sunspot, explosive), the imperfect model is also saddle-path stable (sunspot, explosive, respectively). Moreover, if the minimum information set in the model has all the information up to time t-S-1, then the direct effects on the impulse response functions last for only the first S periods after the impulse. In the subsequent dates, impulse response functions follow essentially the same process as in the perfect information counterpart. However, imperfect information can significantly alter the quantitative properties of a model, though it does not drastically change its qualitative nature. This article demonstrates, as an example, that adding imperfect information to the standard RBC models remarkably improves the correlation between labour productivity and output. Hence, a robustness check for information structure is recommended.
    Keywords: Linear rational expectations models, imperfect information
    JEL: C63 C65 C68
    Date: 2007–01
  32. By: Gerhard Fenz (Oesterreichische Nationalbank, Economic Analysis Division); Martin Schneider (Oesterreichische Nationalbank, Economic Analysis Division)
    Abstract: This paper analyses the comovement of the German and Austrian economies and the transmission of German shocks to Austria. Static and dynamic correlation measures show a strong comovement and a change of the relative position in time of these two economies. The transmission of German shocks to Austria is analysed with a two-country VAR model. Using sign restrictions on impulse response functions, we identify German supply, demand and monetary policy shocks. We find that the average reaction of the Austrian economy to German shocks amounts to 44% of the German reaction and remains broadly stable over time.
    Keywords: business cycle, synchronization, vector autoregression, shock transmission, Austria, Germany.
    JEL: C32 E32 F41
    Date: 2007–05–14
  33. By: Vincenzo Cestari (Università Lumsa and CNR); Paolo Del Giovane (Bank of Italy); Clelia Rossi-Arnaud (Università di Roma - La Sapienza)
    Abstract: The question addressed by this study is whether consumers remember past prices correctly. We test Italian citizens’ memory for cinema prices with questionnaires distributed to moviegoers. The analysis concentrates on the memory of pre-euro prices, but the recall for a more recent period is also investigated. The results show that only a small percentage of respondents recalled the correct price, and that the average prices recalled were much lower than the actual pre-euro prices and dated back to years before the changeover. Price recall is less accurate for the respondents who perceive higher and more persistent inflation; it is also worse for the older respondents and for the less frequent movie-goers.
    Keywords: prices, memory, perceptions, euro
    JEL: D12 D8 E31
    Date: 2007–02
  34. By: Nadezhda Ivanova (CEFIR)
    Abstract: The paper estimates the equilibrium real exchange rate (ERER) in Russia for 1995-20065 using the partial-equilibrium version of the trade-balance approach. The three-good framework is applied, allowing distinction between the RER for imports and RER for exports. The terms of trade are viewed as exogenous. Russia’s export demand is regarded as infinitely price elastic, implying the estimation of export supply function. Russian imports are assumed to be demand determined. The estimation of the trade-volume equations is based on the search of cointegrating relationships. The import elasticities are in line with estimates obtained in other studies. The estimations for the export supply equation confirm “supply elasticity pessimism”. The ERER simulations reveal the degree of rouble overvaluation of 25%-40%, depending on the measure of the RER used, before the August 1998 crisis. In recent years, given the surge in oil prices and pro-active exchange rate policy of the Bank of Russia, the rouble appears to be substantially undervalued. In 2004-2006, given the surge in oil prices and pro-active exchange rate policy of the Bank of Russia, the rouble appears to be substantially undervalued: by 40-70% on average, depending on the measure of the RER used.
    Keywords: Equilibrium Real Exchange Rate, Trade Elasticities, Russia
    JEL: C22 E52 F4
    Date: 2007–05
  35. By: ITO Takatoshi; SATO Kiyotaka
    Abstract: Currency crises, accompanied by large devaluation, tend to have significant impacts on the domestic economy. If the exchange rate also depreciates in real terms, the economy can take advantage of the export price competitiveness to promote its exports. In contrast, if the currency devaluation induces an increase in domestic inflation, the currency value in real terms will return toward the pre-crisis level, which results in a loss of the export price competitiveness and, hence, a slow recovery from the severe economic downturn. This paper analyzes the degree of domestic price responses to the exchange rate changes in crisis-hit countries in East Asian and Latina American countries and Turkey in order to reveal why the post-crisis inflation performance was very different across countries. The structural vector autoregression (VAR) technique is applied to examining exchange rate pass-through. The degree of exchange rate pass-through is found to be higher in Latin American countries and Turkey than in East Asian countries with a notable exception of Indonesia. In particular, Indonesia, Mexico, Turkey and, to a lesser extent, Argentina show a strong response of CPI to the exchange rate shock. More noteworthy is that excessive supply of base money played an important role in increasing the domestic inflation rate in Indonesia, while such effect is not observed in other countries, which indicates the importance of credible monetary policy committed to price stability in order to prevent the post-crisis inflation. Shock transmission from import prices or PPI to CPI is quite large in Indonesia, Mexico and Turkey. This finding implies that the channel of shocks at different stage of pricing chain may be an additional factor in high domestic inflation.
    Date: 2007–06
  36. By: Carlos E. Schonerwald da Silva; Matías Vernengo
    Abstract: The relationship between the exchange rate and public debt is intermediated by two mechanisms. On the one hand, exchange rate devaluation implies higher payment on local currency over the debt denominated in foreign currency. On the other hand, the rise of public debt leads a perception of higher default risk, forcing capital outflows and a devaluation of the exchange rate. The present paper develops a simple model where the exchange is crucial to analyze public debt dynamics. The paper also discusses the recent trajectory of the public debt in Latin America. The dynamics of the exchange rate is important for developing countries that do not have strong currencies and have a significant portion of public debt denominated in US dollars (original sin). Also, primary budget surpluses were crucial for the consistent and significant reduction of the public debt-to-GDP ratio. Hence, the economic expansion has created a larger fiscal space for Latin American economies to expand infrastructure and social spending, and reduce unemployment levels.
    Keywords: Exchange Rate, Public Debt, Latin America
    JEL: F31 H60 O54
    Date: 2007–02
  37. By: Morris Goldstein (Peterson Institute for International Economics)
    Abstract: This working paper assesses the progress made in improving China’s exchange rate policies over the past five years (that is, since 2002). I first discuss four indicators of progress on China’s external imbalance and its exchange rate policies—namely, the change in (and level of) China’s global current account position, movements in the real effective exchange rate of the renminbi (RMB), the role of market forces in the determination of the RMB, and China’s compliance with its obligations on exchange rate policy as a member of the International Monetary Fund (IMF). I then discuss why the lack of progress in improving China’s exchange rate policies matters for the economies of the China and the United States and for the international monetary and trading system. I also argue that several popular arguments and excuses for why more cannot be accomplished on removing the large undervaluation of the RMB are unpersuasive. Finally, I consider what can and should be done by China, the United States, and the IMF to accelerate progress over the next year or two.
    Keywords: exchange rate, current account adjustment, China, IMF
    JEL: F31 F32 F41
    Date: 2007–06
  38. By: ITO Takatoshi; HASHIMOTO Yuko
    Abstract: This paper analyzes the bank restructuring process in Malaysia from the currency crisis of 1997 to present. Even though the banking sector in Malaysia had relatively lower NPLs compared to other Asian countries, financial sector suffered financial crisis and various problems emerged. This paper covers topics such as setting up financial restructuring agencies, a scheme of capital injection to weak banks, and a corporate restructuring process conducted by the Malaysian government. Plans of Mergers/ closures of banks, setting up an asset management company, a recapitalization agency, and a corporate debt restructuring committee, such as Pengurusan Danaharta Nasional Berhad (Danaharta), Danamodal Nasional Berhad (Danamodal), and the Corporate Debt Restructuring Committee (CDRC), were accompanied by several policy measures such as an exchange rate system pegged to the U.S. dollar, capital controls, and a fiscal stimulus package. Through these measures, the authorities, to some extent, succeeded in bringing down NPLs and in merging several banks to some extent. The reform was considered basically completed by 2002. The banking sector was reorganized with 10 banking groups, and two of the restructuring agencies were closed by 2003.
    Date: 2007–06
  39. By: Fernando N. de Oliveira (IBMEC Business School - Rio de Janeiro and Central Bank of Brazil); Marco Antônio Costa (IBMEC Business School - Rio de Janeiro)
    Abstract: This paper investigates the transmission mechanism of monetary policy in Brazil. It is an empirical analysis of the effects of monetary policy on the behavior of corporations in Brazil. We use the balance sheet theory to investigate how corporations respond to monetary contractions. Our results show that small corporations are more sensitive to monetary contractions than large corporations.
    Keywords: Monetary Transmission Mechanism, Balance Sheet Channel, Central Bank, Monetary Contractions
    JEL: E22 E52 E44
    Date: 2007–06–05
  40. By: Hesse, Heiko
    Abstract: The paper studies monetary policy and the monetary transmission mechanism in Thailand in light of the Asian crisis in 1997. Existing studies that adopt structural vector auto-regression (VAR) approaches do not give a clear and agreed-upon view how monetary shocks are transmitted to the Thai economy that is subject to structural breaks. This study explicitly models a pre-crisis and post-crisis cointegrated VAR model. This analysis supports arguments that the trinity of open capital markets, pegged exchange rate regime, and monetary policy autonomy is inconsistent in the pre-crisis period. In contrast, the model points to an effective monetary policy in the post-crisis period. Further, the author analyzes the common driving trends of the model.
    Keywords: Economic Stabilization,Economic Theory & Research,Macroeconomic Management,Fiscal & Monetary Policy,Financial Economics
    Date: 2007–06–01

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