|
on Central Banking |
| By: | Jordi Galí; Mark Gertler |
| Abstract: | We describe some of the main features of the recent vintage macroeconomic models used for monetary policy evaluation. We point to some of the key differences with respect to the earlier generation of macro models, and highlight the insights for policy that these new frameworks have to offer. Our discussion emphasizes two key aspects of the new models: the significant role of expectations of future policy actions in the monetary transmission mechanism, and the importance for the central bank of tracking of the flexible price equilibrium values of the natural levels of output and the real interest rate. We argue that both features have important implications for the conduct of monetary policy. |
| Keywords: | Monetary policy, new Keynesian model, expectations management, inflation targeting |
| JEL: | E32 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1039&r=cba |
| By: | Olivier Blanchard; Jordi Gali |
| Abstract: | We develop a utility based model of fluctuations, with nominal rigidities, and unemployment. In doing so, we combine two strands of research: the New Key- nesian model with its focus on nominal rigidities, and the Diamond-Mortensen-Pissarides model, with its focus on labor market frictions and unemployment. In developing this model, we proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained effcient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and we draw the implications for optimal monetary policy. |
| Keywords: | new Keynesian model, labor market frictions, search model, unemployment, sticky prices, real wage rigidities |
| JEL: | E32 E50 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1335&r=cba |
| By: | John M. Roberts |
| Abstract: | Over the past forty years, U.S. inflation has exhibited highly persistent movements. Moreover, these shifts in inflation have typically had real consequences, implying a "sacrifice ratio," whereby disinflations are typically associated with recessions and persistent increases in inflation often associated with booms. One hypothesis about the source of the sacrifice ratio is that inflation - and not just the price level - is sticky. Another is that private-sector agents typically must infer changes in inflation objectives indirectly from central bank interest- rate policy. The resulting learning process can lead to a sacrifice ratio trade-off. In this paper, I allow for both sticky inflation and learning in interpreting U.S. macroeconomic developments since 1955. Two key empirical findings are, first, that allowing for learning reduces the evidence for sticky inflation. Second, there is less evidence for sticky inflation in the post-1983 period than earlier. Indeed, in some estimates, there is little evidence of sticky inflation in the period since 1983, although this result is sensitive to the details of the specification. Nonetheless, simulation results suggest that for realistic models, the sacrifice ratio can be accounted for entirely by learning. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1365&r=cba |
| By: | Athanasios Orphanides (Central Bank of Cyprus, 80, Kennedy Avenue, 1076 Nicosia, Cyprus.); John C. Williams (Federal Reserve Bank of San Francisco, 101 Market Street, San Francisco, CA 94105, USA.) |
| Abstract: | We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess imperfect knowledge about the true structure of the economy. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize fluctuations of unemployment around its natural rate but are uncertain about the economy’s natural rates of interest and unemployment and how private agents form expectations. In particular, we consider two models of expectations formation - rational expectations and learning. We show that in this environment the ability to stabilize the real side of the economy is significantly reduced relative to an economy under rational expectations with perfect knowledge. Furthermore, policies that would be optimal under perfect knowledge can perform very poorly if knowledge is imperfect. Efficient policies that take account of private learning and misperceptions of natural rates call for greater policy inertia, a more aggressive response to inflation, and a smaller response to the perceived unemployment gap than would be optimal if everyone had perfect knowledge of the economy. We show that such policies are quite robust to potential misspecification of private sector learning and the magnitude of variation in natural rates. JEL Classification: E52. |
| Keywords: | Monetary policy, natural rate misperceptions, rational expectations, learning. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070764&r=cba |
| By: | George Evans; Eran Guse; Seppo Honkapohja |
| Abstract: | We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals. |
| Keywords: | Adaptive Learning, Monetary Policy, Fiscal Policy, Zero Interest Rate Lower Bound, Indeterminacy |
| JEL: | E63 E52 E58 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1341&r=cba |
| By: | Paul Levine (Department of Economics, University of Surrey, Guildford, Surrey, GU2 7XH, United Kingdom.); Joseph Pearlman (London Metropolitan University, 31 Jewry Street, London, EC3N 2EY, United Kingdom.); Richard Pierse (Department of Economics, University of Surrey, Guildford, Surrey, GU2 7XH, United Kingdom.) |
| Abstract: | We examine the linear-quadratic (LQ) approximation of non-linear stochastic dynamic optimization problems in macroeconomics, in particular for monetary policy. We make four main contributions: first, we draw attention to a general Hamiltonian framework for LQ approximation due toMagill (1977). We show that the procedure for the ‘large distortions’ case of Benigno and Woodford (2003, 2005) is equivalent to the Hamiltonian approach, but the latter is far easier to implement. Second, we apply the Hamiltonian approach to a Dynamic Stochastic General Equilibrium model with external habit in consumption. Third, we introduce the concept of target-implementability which fits in with the general notion of targeting rules proposed by Svensson (2003, 2005). We derive sufficient conditions for the LQ approximation to have this property in the vicinity of a zero-inflation steady state. Finally, we extend the Hamiltonian approach to a non-cooperative equilibrium in a two-country model. JEL Classification: E52, E37, E58. |
| Keywords: | Linear-quadratic approximation, dynamic stochastic general equilibrium models, utility-based loss function. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070759&r=cba |
| By: | Zheng Liu; Daniel F. Waggoner; Tao Zha |
| Abstract: | We assess the quantitative importance of expectation effects of regime shifts in monetary policy in a DSGE model that allows the monetary policy rule to switch between a “bad” regime and a ”good” regime. When agents take into account such regime shifts in forming expectations, the expectation effect is asymmetric. In the good regime, the expectation effect is small despite agents’ disbelief that the regime will last forever. In the bad regime, however, the expectation effect on equilibrium dynamics of inflation and output is quantitatively important, even if agents put a small probability that monetary policy will switch to the good regime. Although the expectation effect dampens aggregate fluctuations in the bad regime, a switch from the bad regime to the good regime can still substantially reduce the volatility of both inflation and output, provided that we allow some “reduced-form” parameters in the private sector to change with monetary policy regime. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1357&r=cba |
| By: | Ron Smith; M. Hashem Pesaran |
| Abstract: | The standard derivation of a Phillips curve from a DSGE model requires that all variables are measured as deviations from their steady states. But in practice this is not done. The steady state for output is estimated by some statistical procedure, such as the HP filter, and the steady state for other variables, including inflation, is treated as a constant. This is inconsistent with the theory and raises econometric problems since inflation, for instance, is a very persistent series. We argue that the natural definition of the steady state is the long-horizon forecast and estimate these permanent components from a cointegrating VAR that takes account of global interactions. This estimate of the steady state will reflect any long-run theoretical relationships embodied in the cointegrating vectors. We then estimate Phillips Curves and other standard monetary transmission equations using deviations from the steady states on US data. This is both consistent with the theory and uses the relevant economic information about steady states. |
| Keywords: | Global VAR (GVAR), Phillips Curve, Monetary Transmisssion |
| JEL: | C32 E17 F37 F42 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1366&r=cba |
| By: | Florin O. Bilbiie; Fabio Ghironi; Marc J. Melitz |
| Abstract: | This paper studies the role of endogenous producer entry and product creation for monetary policy analysis and business cycle dynamics in a general equilibrium model with imperfect price adjustment. Optimal monetary policy stabilizes product prices, but lets the consumer price index vary to accommodate changes in the number of available products. The free entry condition links the price of equity (the value of products) with marginal cost and markups, and hence with inflation dynamics. No-arbitrage between bonds and equity links the expected return on shares, and thus the financing of product creation, with the return on bonds, affected by monetary policy via interest rate setting. This new channel of monetary policy transmission through asset prices restores the Taylor Principle in the presence of capital accumulation (in the form of new production lines) and forward-looking interest rate setting, unlike in models with traditional physical capital. We also study the implications of endogenous variety for the New Keynesian Phillips curve and business cycle dynamics more generally, and we document the effects of technology, deregulation, and monetary policy shocks, as well as the second moment properties of our model, by means of numerical examples. |
| JEL: | E31 E32 E52 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13199&r=cba |
| By: | Marvin Goodfriend |
| Abstract: | This paper applies principles of the New Neoclassical Synthesis (NNS) to questions of international trade and financial adjustment. The analytical framework is a 2-country, 2-good, 2- period model designed to explore the behavior of the balance of payments, the terms of trade, and aggregate fluctuations in terms of interest rate and exchange rate policies practiced by the world's most important central banks. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1345&r=cba |
| By: | Veloso, Thiago; Meurer, Roberto; Da Silva, Sergio |
| Abstract: | We make a case for the usefulness of an optimal control approach for the central banks’ choice of interest rates in inflation target regimes. We illustrate with data from selected developed and emerging countries with longest experience of inflation targeting. |
| Keywords: | inflation targeting; optimal control theory; Taylor rule; monetary policy |
| JEL: | E52 C61 |
| Date: | 2007–07–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:3834&r=cba |
| By: | Richard Mash |
| Abstract: | Models in which firms use rules of thumb or partial indexing in their price setting have become prominent in the recent monetary policy literature. The extent to which these firms adjust their prices to lagged inflation has been taken as fixed. We consider the implications of firms choosing the optimal degree of indexation so these simple pricing rules deliver prices as close as possible to those which would be chosen optimally. We find that the degree of indexation depends on the extent of persistence in the economy such that models with constant indexation are vulnerable to the Lucas critique. We also study the interactions between firms price setting and the macroeconomic environment finding that, for the models which appear most plausible on microeconomic grounds, the Nash equilibrium between firms and the policy maker is characterised by zero indexation and zero macroeconomic persistence. |
| Keywords: | Indexing, Monetary Policy, Phillips curve, Inflation persistence, Microfoundations |
| JEL: | E52 E58 E22 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1358&r=cba |
| By: | Aleksander Berentsen; Guido Menzio; Randall Wright |
| Abstract: | Inflation and unemployment are central issues in macroeconomics. While progress has been made on these issues recently using models that explicitly incorporate search-type frictions, existing models analyze either unemployment or inflation in isolation. We develop a framework to analyze unemployment and inflation together. This makes contributions to disparate literatures, and provides a unified model for theory, policy, and quantitative analysis. We discuss optimal fiscal and monetary policy. We calibrate the model, and discuss the extent to which it can account for salient aspects of a half century’s experience with inflation, unemployment, interest rates, and velocity. Depending on some details concerning how one calibrations certain parameters, the model can do a good job matching the data. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1334&r=cba |
| By: | Andrew T. Levin; J. David Lopez-Salido; Tack Yun |
| Abstract: | In this paper, we show that strategic complementarities–such as firm-specific factors or quasikinked demand–have crucial implications for the design of monetary policy and for the welfare costs of output and inflation variability. Recent research has mainly used log-linear approximations to analyze the role of these mechanisms in amplifying the real effects of monetary shocks. In contrast, our analysis explicitly considers the nonlinear properties of these mechanisms that are relevant for characterizing the deterministic steady state as well as the second-order approximation of social welfare in the stochastic economy. We demonstrate that firm-specific factors and quasi-kinked demand curves yield markedly different implications for the welfare costs of steady-state inflation and inflation volatility, and we show that these considerations have dramatic consequences in assessing the relative price distortions associated with the Great Inflation of 1965-1979. |
| Keywords: | firm-specific factors, quasi-kinked demand, welfare analysis |
| JEL: | E31 E32 E52 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1355&r=cba |
| By: | Torben M. Andersen; Martin Seneca |
| Abstract: | This paper takes a first step in analysing how a monetary union performs in the presence of labour market asymmetries. Differences in wage flexibility, market power and country sizes are allowed for in a setting with both country-specific and aggregate shocks. The implications of asymmetries for both the overall performance of the monetary union and the country-specific situation are analysed. It is shown that asymmetries can have important effects, and that there are substantial spill-over effects. Among other things, it is found that aggregate output volatility is not strictly increasing in nominal rigidity but hump-shaped. A disproportionate share of the consequences of wage inflexibility may fall on small countries. In the case of country-specific shocks a country unambiguously benefits in terms of macroeconomic stability by becoming more flexible, but in general an inflexible country does not necessarily achieve more output stability by becoming more flexible. As this may be desirable for the monetary union as a whole, there is a risk of a ’reform deficit’ in an asymmetric monetary union. |
| Keywords: | wage formation, nominal wage rigidity, staggered contracts, monetary policy, monetary union, business cycles, shocks |
| JEL: | E30 E52 F41 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1331&r=cba |
| By: | Alex Cukierman; Alberto Dalmazzo |
| Abstract: | OBJECTIVES AND MOTIVATION: This paper considers the impact of interactions between competitiveness, fiscal policy and monetary institutions in the presence of unionized labor markets on economic outcomes and welfare in the long run. Two main classes of questions are investigated. First, what is the impact of exogenously given labor taxes and unemployment benefits on the choice of monetary policy by the central bank, on the choice of nominal wages by unions, on the choice of prices by monopolistically competitive firms and through them on unemployment, inflation and welfare? A related question is, how does the level of competitiveness on goods’ market affect the economy and welfare? Second, how are labor taxes and redistribution chosen by a (Stackelberg leader) fiscal authority whose objectives are a weighted average of social welfare and of catering to the interests of political supporters, and how does the general equilibrium induced by this choice affect welfare? The framework of the paper is motivated by the European scene in which the fraction of the labor force covered by collective agreements dominates wage setting in the labor market. “PLAYERS” AND PAYOFFS: The model economy features labor unions that maximize the expected real income of union members over states of employment and of unemployment, a central bank that strives to minimize the combined costs of inflation and of unemployment, and a continuum of monopolistically competitive firms, each of which maximizes its profits. The last part of the paper also features a fiscal authority that sets taxes and redistribution so as to maximize a combination of social welfare and of benefits to particular constituencies. Utility from consumption is characterized by means of a CES, Dixit-Stiglitz, utility function and (as in Sidrauski type models) money appears in the utility function. METHODOLOGY AND “PLAYERS” STRATEGIES: The first question is investigated within a three stage game in which labor unions move first and commit to nominal wages and the central bank moves second and chooses the money supply. In the third and last stage each of a large number of monopolistically competitive firms picks its price. To deal with the second class of questions the game is expanded to feature a preliminary stage in which government chooses labor taxes and redistribution anticipating the subsequent responses of the other players. General equilibrium is characterized and used to find the impact of various economic and institutional parameters. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1338&r=cba |
| By: | Andrew McCallum; Frank Smets |
| Abstract: | We use the Factor-Augmented Vector Autoregression (FAVAR) approach of Bernanke, Boivin and Eliasz (2005) to estimate the effects of monetary policy shocks on wages and employment in the euro area. The use of a large data set comprising country, sectoral and euro area-wide data allows us to better identify common monetary policy shocks in the euro area and their effects on labour market outcomes. At the same time the FAVAR approach gives us estimates of how relative wages and employment in the various countries and sectors respond to these common shocks. The ultimate objective of our work is to relate the estimated cross-country differences in wage and employment responses to differences in labour market institutions and sectoral composition. |
| Keywords: | VAR, factor models, rigidity, labour market |
| JEL: | E3 E4 J3 J6 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1360&r=cba |
| By: | Tatiana Kirsanova; David Vines; Simon Wren-Lewis |
| Abstract: | In this paper we present two examples where the presence of inflation persistence could influence the qualitative nature of monetary policy. In the first case the desirability of a monetary policy regime comes under question when extensive inflation persistence exists. In the second case the direction in which interest rates move following a cost push shock changes when inflation persistence becomes important. In both cases, inflation persistence is central to the process influencing policy. |
| Keywords: | Inflation Persistence, Macroeconomic Stabilisation |
| JEL: | E52 E61 E63 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1351&r=cba |
| By: | Federico Ravenna; Carl E. Walsh |
| Abstract: | The canonical new Keynesian Phillips Curve has become a standard component of models designed for monetary policy analysis. However, in the basic new Keynesian model, there is no unemployment, all variation in labor input occurs along the intensive hours margin, and the driving variable for inflation depends on workers’ marginal rates of substitution between leisure and consumption. In this paper, we incorporate a theory of unemployment into the new Keynesian theory of inflation and empirically test its implications for inflation dynamics. We show how a traditional Phillips curve linking inflation and unemployment can be derived and how the elasticity of inflation with respect to unemployment depends on structural characteristics of the labor market such as the matching technology that pairs vacancies with unemployed workers. We estimate on US data the Phillips curve generated by the model, and derive the implied marginal cost measure driving inflation dynamics. |
| JEL: | E52 E58 J64 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1362&r=cba |
| By: | Marvin Goodfriend; Bennett T. McCallum |
| Abstract: | The paper reconsiders the role of money and banking in monetary policy analysis by including a banking sector and money in an optimizing model otherwise of a standard type. The model is implemented quantitatively, with a calibration based on U.S. data. It is reasonably successful in providing an endogenous explanation for substantial steady-state differentials between the interbank policy rate and (i) the collateralized loan rate, (ii) the uncollateralized loan rate, (iii) the T-bill rate, (iv) the net marginal product of capital, and (v) a pure intertemporal rate. We find a differential of over 3 % pa between (iii) and (iv), thereby contributing to resolution of the equity premium puzzle. Dynamic impulse response functions imply pro-or-counter-cyclical movements in an external finance premium that can be of quantitative significance. In addition, they suggest that a central bank that fails to recognize the distinction between interbank and other short rates could miss its appropriate settings by as much as 4% pa. Also, shocks to banking productivity or collateral effectiveness call for large responses in the policy rate. |
| JEL: | E44 E52 G21 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13207&r=cba |
| By: | Marika Karanassou; Hector Sala; Dennis J. Snower |
| Abstract: | This paper argues that there is a nonzero inflation-unemployment tradeoff in the long-run due to frictional growth, a phenomenon that encapsulates the interplay of nominal staggering and money growth. The existence of a downward-sloping long-run Phillips curve suggests the development of a holistic framework that can jointly explain the evolution of inflation and unemployment. Hence, we estimate an interactive dynamics model for the US that includes wage-price setting and labour market equations. We then evaluate the inflation-unemployment tradeoff and assess the impact of productivity, money growth, budget deficit, and trade deficit on the unemployment and inflation trajectories during the nineties. |
| Keywords: | Inflation dynamics, unemployment dynamics, Phillips curve, roaring nineties |
| JEL: | E24 E31 E51 E62 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1350&r=cba |
| By: | Assaf Razin; Alon Binyamini |
| Abstract: | This paper reviews the analytics of the effects of globalization on the Phillips curve and the utility-based objective function of the central bank. It demonstrates that in an endogenous-policy set up, when trade in goods is liberalized, financial openness increases, and in- and out-labor migration are allowed, policymakers become more aggressive on inflation and less responsive to the output gap. In other words, globalization induces the monetary authority, when guided in its policy by the welfare criterion of a representative household, to put more emphasis on the reduction of inflation variability, at the expense of an increase in the output gap variability. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1363&r=cba |
| By: | Ricardo Reis; Mark W. Watson |
| Abstract: | This paper estimates a common component in many price series that has an equiproportional effect on all prices. Changes in this component can be interpreted as changes in the value of the numeraire since, by definition, they leave all relative prices unchanged. The first aim of the paper is to measure these changes. The paper provides a framework for identifying this component, suggests an estimator for the component based on a dynamic factor model, and assesses its performance relative to alternative estimators. Using 187 U.S. time-series on prices, we estimate changes in the value of the numeraire from 1960 to 2006, and further decompose these changes into a part that is related to relative price movements and a residual ‘exogenous’ part. The second aim of the paper is to use these estimates to investigate two economic questions. First, we show that the size of exogenous changes in the value of the numeraire helps distinguish between different theories of pricing, and that the U.S. evidence argues against several strict theories of nominal rigidities. Second, we find that changes in the value of the numeraire are significantly related to changes in real quantities, and discuss interpretations of this apparent non-neutrality. |
| Keywords: | Inflation, Money illusion, Monetary neutrality, Price index |
| JEL: | E31 C43 C32 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1364&r=cba |
| By: | Luca Benati (Monetary Policy Strategy Division, European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.) |
| Abstract: | We use a Bayesian time-varying parameters structural VAR with stochastic volatility for GDP deflator inflation, real GDP growth, a 3-month nominal rate, and the rate of growth of M4 to investigate the underlying causes of the Great Moderation in the United Kingdom. Our evidence points towards a dominant role played by shocks in fostering the more stable macroeconomic environment of the last two decades. Results from counterfactual simulations, in particular, show that (1) the Great Inflation was due, to a dominant extent, to large demand non-policy shocks, and to a lesser extent–especially in 1973 and 1979–to supply shocks; (2) imposing the 1970s’ monetary rule over the entire sample period would have made almost no difference in terms of inflation and output growth outcomes; and (3) mechanically ‘bringing the Monetary Policy Committee back in time’ would only have had a limited impact on the Great Inflation episode, at the cost of lower output growth. These results are quite striking in the light of the more traditional, narrative approach, which suggests that the monetary policy regime is an important factor in explaining the Great Moderation in the United Kingdom. We discuss one interpretation which could explain both sets of results, based on the ‘indeterminacy hypothesis’ advocated, for the United States, by Clarida, Gali, and Gertler (2000) and Lubik and Schorfheide (2004). JEL Classification: E32, E47, E52, E58. |
| Keywords: | VARs; stochastic volatility; identified VARs; timevarying parameters; frequency domain; Great Inflation; policy counterfactuals; Lucas critique; European Monetary System. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070769&r=cba |
| By: | Axel Dreher (Department of Management, Technology, and Economics, ETH Zurich); Jan-Egbert Sturm (Department of Management, Technology, and Economics, ETH Zurich); JAkob de Haan (University of Groningen, The Netherlands and CESifo, Munich, Germany,) |
| Abstract: | This paper introduces new data on the term in office of central bank governors in 137 countries for 1970-2004. Our panel models show that the probability that a central bank governor is replaced in a particular year is positively related to the share of the term in office elapsed, political and regime instability, the occurrence of elections, and inflation. The latter result suggests that the turnover rate of central bank governors (TOR) is a poor indicator of central bank independence. This is confirmed in models for cross-section inflation in which TOR becomes insignificant once its endogeneity is taken into account. |
| Keywords: | central bank governors, central bank independence, inflation |
| JEL: | E5 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kof:wpskof:07-167&r=cba |
| By: | Francis Cripps (Alphametrics Co.); Alex Izurieta (University of Cambridge); Terry McKinley (International Poverty Centre) |
| Abstract: | . |
| Keywords: | Poverty, Exchange Rate |
| JEL: | C19 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ipc:opager:38&r=cba |
| By: | Laura Alfaro; Fabio Kanczuk |
| Abstract: | Most models currently used to determine optimal foreign reserve holdings take the level of international debt as given. However, given the sovereign's willingness-to-pay incentive problems, reserve accumulation may reduce sustainable debt levels. In addition, assuming constant debt levels does not allow addressing one of the puzzles behind using reserves as a means to avoid the negative effects of crisis: why do not sovereign countries reduce their sovereign debt instead? To study the joint decision of holding sovereign debt and reserves, we construct a stochastic dynamic equilibrium model calibrated to a sample of emerging markets. We obtain that the reserve accumulation does not play a quantitative important role in this model. In fact, we find the optimal policy is not to hold reserves at all. This finding is robust to considering interest rate shocks, sudden stops, contingent reserves and reserve dependent output costs. |
| JEL: | F32 F33 F34 F4 |
| Date: | 2007–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13216&r=cba |
| By: | Kiminori Matsuyama |
| Abstract: | Credit market imperfections provide the key to understanding many important issues in business cycles, growth and development, and international economics. Recent progress in these areas, however, has left in its wake a bewildering array of individual models with seemingly conflicting results. This paper offers a road map. Using the same single model of credit market imperfections throughout, it brings together a diverse set of results within a unified framework. In so doing, it aims to draw a coherent picture so that one is able to see some close connections between these results, thereby showing how a wide range of aggregate phenomena may be attributed to the common cause. They include, among other things, endogenous investment-specific technical changes, development traps, leapfrogging, persistent recessions, recurring boom-and-bust cycles, reverse international capital flows, the rise and fall of inequality across nations, and the patterns of international trade. The framework is also used to investigate some equilibrium and distributional impacts of improving the efficiency of credit markets. One recurring finding is that the properties of equilibrium often respond non-monotonically to parameter changes, which suggests some cautions for studying aggregate implications of credit market imperfections within a narrow class or a particular family of models. |
| JEL: | E32 E44 F15 F36 O11 O16 |
| Date: | 2007–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13209&r=cba |
| By: | Michael Ehrmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | The question how best to communicate monetary policy decisions remains a highly topical issue among central banks. Focusing on the experience of the European Central Bank, this paper studies how explanations of monetary policy decisions at press conferences are perceived by financial markets. The empirical findings show that ECB press conferences provide substantial additional information to financial markets beyond that contained in the monetary policy decisions, and that the information content is closely linked to the characteristics of the decisions. Press conferences indeed have on average had larger effects on financial markets than even the corresponding policy decisions, and with lower effects on volatility. Moreover, the Q&A part of the press conference fulfils a clarification role about the economic outlook, in particular during periods of large macroeconomic uncertainty. JEL Classification: E52, E58, G14. |
| Keywords: | Monetary policy; financial markets; real-time analysis; press conference; communication; European Central Bank. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070767&r=cba |
| By: | Amisano, Giovanni; Tristani, Oreste |
| 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. |
| Keywords: | Bayesian estimation; DSGE models; inflation persistence; second order approximations; sequential Monte Carlo |
| JEL: | C11 C15 E31 E32 E52 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6373&r=cba |
| By: | Willem Buiter |
| Abstract: | In this paper I analyse four different but related concepts, each of which highlights someaspect of the way in which the state acquires command over real resources through its ability to issue fiat money. They are (1) seigniorage (the change in the monetary base), (2) Central Bank revenue (the interest bill saved by the authorities on the outstanding stock of base money liabilities), (3) theinflation tax (the reduction in the real value of the stock of base money due to inflation and (4) the operating profits of the central bank, or the taxes paid by the Central Bank to the Treasury.To understand the relationship between these four concepts, an explicitly intertemporalapproach is required, which focuses on the present discounted value of the current and future resource transfers between the private sector and the state. Furthermore, when the Central Bank is operationally independent, it is essential to decompose the familiar consolidated 'government budget constraint' and consolidated 'government intertemporal budget constraint' into the separate accountsand budget constraints of the Central Bank and the Treasury. Only by doing this can we appreciate the financial constraints on the Central Bank's ability to pursue and achieve an inflation target, and theimportance of cooperation and coordination between the Treasury and the Central Bank when facedwith financial sector crises involving the need for long-term recapitalisation or when confronted with the need to mimic Milton Friedman's helicopter drop of money in an economy faced with a liquidity trap. |
| Keywords: | inflation tax, central bank budget constraint, coordination of monetary and fiscal policy |
| JEL: | E4 E5 E6 H6 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp0786&r=cba |
| By: | Fabien Curto Millet |
| Abstract: | Conjectures about inflation expectations are inextricably linked to our understanding of the relationship between the real and monetary sides of the economy; yet, direct empirical research on the matter has been scarce at best. This paper therefore examines the empirical properties of inflation expectations data constructed on the basis of both qualitative and quantitative surveys of consumers for a set of eight European countries. The rational perceptions hypothesis is tested and rejected by the data, a finding which in turn leads us to reject the rational expectations hypothesis and casts doubt on the New Keynesian Phillips Curve model. The popular alternative of using “rule-of-thumb” expectations in such models empirically is also found to be unrobust. Similarly, the conjecture by Akerlof et al. (2000) of a non-vertical long-run Phillips curve arising from the presence of “near-rational” expectations cannot be supported. The Mankiw and Reis (2002) Phillips curve based on the idea of “sticky information” succeeds in its intuition of a gradual adjustment of expectations, but its assumption of rational updating is challenged by the data in the context of the natural experiment provided by the UK's ERM disinflation. Instead, the adjustment mechanism for expectations appears to display largely adaptive characteristics. Finally, the paper provides some insights into the nature of the interaction between monetary policy and inflation expectations. |
| Keywords: | Inflation expectations, inflation perceptions, survey data, rationality, Phillips curve, consumers, expectations distribution, inflation targeting |
| JEL: | D84 E31 E52 E58 E61 E65 C22 C42 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1339&r=cba |
| By: | Javier Andrés (Universidad de Valencia); Fernando Restoy (Banco de España) |
| Abstract: | We analyse the likely effects of changes in the monetary and financial regimes of EMU countries on the dynamics of output and inflation. In particular, we evaluate the impact of the regime shift on the forecasting performance of reduced-form models. Data for both the pre-EMU and the EMU regimes are generated by a relatively standard open-economy-DSGE model with sticky prices and wages and restricted access to financial markets for some individuals. We find that the effects of the shift in the monetary regime on the processes followed by macroeconomic variables depend on the nature of the shocks hitting the economy. For plausible shocks distributions the reduction in the accuracy of VAR-based inflation forecasts is relatively large and significant. The effect of the regime shift on output forecasts seem rather more modest and statistically insignificant. The impact on ouput forecasting accuracy would be comparatively much larger if the new monetary union regime is accompanied by a moderate relaxation of constraints affecting financial market access. |
| Keywords: | forecasting, general equilibrium models, monetary union, inflation and output dynamics |
| JEL: | E17 E32 E37 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:0718&r=cba |
| By: | Philippe Bacchetta; Eric van Wincoop |
| Abstract: | Two well-known, but seemingly contradictory, features of exchange rates are that they are close to a random walk while at the same time exchange rate changes are predictable by interest rate differentials. In this paper we investigate whether these two features of the data may in fact be related. In particular, we ask whether the predictability of exchange rates by interest differentials naturally results when participants in the FX market adopt random walk expectations. We find that random walk expectations can explain the forward discount puzzle, but only if FX portfolio positions are revised infrequently. In contrast, with frequent portfolio adjustment and random walk expectations, we find that high interest rate currencies depreciate much more than what UIP would predict. |
| JEL: | F3 F31 F41 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13205&r=cba |
| By: | Philipp Engler (Freie Universität Berlin, D-10785 Berlin, Germany.); Michael Fidora (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Christian Thimann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | The influential work of Obstfeld and Rogoff argues that a closing-up of the US current account deficit involves a large exchange rate adjustment. However, the Obstfeld-Rogoff model works exclusively via demand-side channels and abstracts from possible supply-side changes. We extend the framework to allow for endogenous supply-side changes and show that this fundamentally alters the mechanism of the adjustment process. Allowing for such an extension attenuates quite significantly the implied exchange rate adjustment. The paper also provides some empirical evidence of variations in the supply-side structure and correlations with the exchange rate and the current account. The policy implications are that measures to foster a supply-side reaction would facilitate the external adjustment by alleviating an exclusive reliance on demand and exchange rate changes, with the latter being potentially destabilising for the global financial system. JEL Classification: E2, F32, F41. |
| Keywords: | Global imbalances, US current account deficit, dollar adjustment, sectoral adjustment. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070761&r=cba |
| By: | Michael P. Dooley; Peter M. Garber; David Folkerts-Landau |
| Abstract: | In this essay, we argue that key assumptions in international macroeconomic theory, though useful for understanding the economic relationships among developed countries, have been pushed beyond their competence to include relationships between developed economies and emerging markets. The Achilles heel of this extended development model is the assumption that threats to deprive the debtor countries of gains from trade provide incentives for poor countries to repay more than trivial amounts of international debt. Replacing this assumption with the idea that collateral is required to support gross international capital flows suggests that the pattern of current account balances seen in recent years is a sustainable equilibrium. |
| JEL: | F02 F21 F32 F33 F4 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13197&r=cba |
| By: | Matteo Ciccarelli; Benoît Mojon |
| Abstract: | This paper shows that ination in industrialized countries is largely a global phenom- enon. First, inations of (22) OECD countries have a common factor that alone accounts for nearly 70% of their variance. This large variance share that is associated to Global Ination is not only due to the trend components of ination (up from 1960 to 1980 and down thereafter) but also to uctuations at business cycle frequencies. Second, Global In- ation is, consistently with standard models of ination, a function of real developments at short horizons and monetary developments at longer horizons. Third, there is a very robust "error correction mechanism" that brings national ination rates back to Global Ination. This model consistently beats the previous benchmarks used to forecast ination 1 to 8 quarters ahead across samples and countries. |
| Keywords: | Inflation, common factor, international business cycle, OECD countries |
| JEL: | E31 E37 F42 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1337&r=cba |
| By: | Eran Yashiv |
| Abstract: | The Beveridge curve depicts a negative relationship between unemployed workers and jobvacancies, a robust finding across countries. The position of the economy on the curve givesan idea as to the state of the labour market. The modern underlying theory is the search andmatching model, with workers and firms engaging in costly search leading to randommatching. The Beveridge curve depicts the steady state of the model, whereby inflows intounemployment are equal to the outflows from it, generated by matching. |
| Keywords: | business cycle, job search, matching function, Phillips curve, unemployment,vacancies, wage inflation |
| JEL: | E24 E32 J63 J64 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp0807&r=cba |
| By: | Giovanni Lombardo (Corresponding author: European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.); David Vestin (European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.) |
| Abstract: | This paper compares the welfare implications of two widely used pricing assumptions in the New-Keynesian literature: Calvo-pricing vs. Rotemberg- pricing. We show that despite the strong similarities between the two assumptions to a first order of approximation, in general they might entail different welfare costs at higher order of approximation. In the special case of non-distorted steady state, the two pricing assumptions imply identical welfare losses to a second order of approximation. JEL Classification: E3, E5. |
| Keywords: | Calvo price adjustment; Rotemberg price adjustment; welfare; inflation; second-order approximation. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070770&r=cba |
| By: | Bennett T. McCallum |
| Abstract: | It is clear that at present various versions of the Calvo (1983) model of price adjustment are dominant in monetary policy analysis—see, e.g., Woodford (2003). This is true despite well-known criticisms including Mankiw (2001) or Mankiw and Reis (2002) and the well-documented need for the addition of ad-hoc features if actual inflation and output data are to be matched. Accordingly, there is ample reason, to give consideration to alternative models. In this paper, a new look is given to the P-bar model utilized by McCallum and Nelson (1999a, 1999b), based on previous work by Mussa (1981) and others. Relative to the Calvo model, the P-bar specification has three significant advantages: it satisfies the strict version of the natural rate hypothesis; it relies on costs of adjusting output, which are more tangible than menu costs of changing prices; and its basic version produces more realistic autocorrelation patterns than does the basic Calvo specification. The present paper develops these comparisons more completely and systematically than in previous work. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1361&r=cba |
| By: | Alistair Dieppe (Directorate General Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Thomas Warmedinger (Directorate General Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | The paper proposes a modelling approach for euro area goods and services trade volumes and prices on the basis of a break-down of trade data into their intra- and extra-area components. Using the evidence from the newly estimated trade equations, the paper gives new insights into two important issues. The first issue concerns the exchange-rate pass-through (ERPT) to euro area import prices. The second issue relates to substitution effects between intra- and extra-area trade. These issues are further elaborated through simulation analyses using the ECB’s area-wide model (AWM). The simulations illustrate the impact of external and domestic shocks to trade in the euro area, in particular on intra- and extra-area trade. The richer dynamics from this disaggregated perspective provide additional insights and elucidate transmission channels of shocks that are not detectable from an aggregate (i.e. total trade) perspective. For instance, one interesting finding is that an appreciation of the euro has a significant downward impact on intra euro area trade. JEL Classification: E31, F17, C5. |
| Keywords: | Intra-/ extra-area trade, euro area, competitiveness and trade substitution, exchange-rate passthrough, pricing-to-market. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070760&r=cba |
| By: | Jerzy Konieczny; Fabio Rumler |
| Abstract: | We ask why, in many circumstances and many environments, decision-makers choose to act on a time-regular basis (e.g. adjust every six weeks) or on a stateregular basis (e.g. set prices ending in a 9), even though such an approach appears suboptimal. The paper attributes regular behaviour to adjustment cost heterogeneity. We show that, given the cost heterogeneity, the likelihood of adopting regular policies depends on the shape of the benefit function: the flatter it is, the more likely, ceteris paribus, is regular adjustment. We provide sufficient conditions under which, when policymakers differ with respect to the shape of the benefit function (as in Konieczny and Skrzypacz, 2006), the frequency of adjustments across markets is negatively correlated with the incidence of regular adjustments. On the other hand, if policymakers differences are due to the level of adjustment costs (as in Dotsey, King and Wolman, 1999), then the correlation is positive. To test the model we apply it to optimal pricing policies. We use a large Austrian data set, which consists of the direct price information collected by the statistical office and covers 80% of the CPI over eight years. We run cross-sectional tests, regressing the proportion of attractive prices and, separately, the excess proportion of price changes at the beginning of a year and at the beginning of a quarter, on various conditional frequencies of adjustment, inflation and its variability, dummies for good types, and other relevant variables. We find that the lower is, in a given market, the conditional frequency of price changes, the higher is the incidence of time- and state-regular adjustment. |
| Keywords: | Optimal pricing, attractive prices, menu costs |
| JEL: | E31 L11 E52 D01 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1352&r=cba |
| By: | Emmanuel Dhyne (National Bank of Belgium, Research Department; Centre de Recherche Warocqué, Université de Mons-Hainaut); Jerzy Konieczny (Department of Economics, Wilfrid Laurier University, Waterloo, Ont., Canada) |
| Abstract: | Temporal distribution of individual price changes is of crucial importance for business cycle theory and for the micro-foundations of price adjustment. While it is routinely assumed that price changes are staggered over time, both theory and evidence are ambiguous. We use a large Belgian data set to analyze whether price changes are staggered or synchronized. We find that the more aggregate the data, the closer the distribution to perfect staggering. This result holds for both aggregation across goods and across locations. Our results provide support for Bhaskar’s (2002) model of synchronized adjustment within, and staggered adjustment across, industries. |
| Keywords: | staggering, synchronization, aggregation, price setting |
| JEL: | E31 L16 D21 L11 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbb:reswpp:200706-02&r=cba |
| By: | Daniel Levy; Haipeng (Allan) Chen; Sourav Ray; Mark Bergen |
| Abstract: | Analyzing a large weekly retail transaction price dataset, we uncover a surprising regularity— small price increases occur more frequently than small price decreases for price changes of up to about 10 cents, while there is no such asymmetry for larger price changes. The asymmetry holds for the entire sample and for individual categories. We find that while inflation can explain some of the asymmetry, inflation is not the whole story as the asymmetry holds even after excluding inflationary periods from the data, and even for products whose price had not increased over the eight-year period. The findings hold for different measures of inflation and also after allowing for lagged price adjustments. We offer a consumer-based explanation for these findings. |
| Keywords: | Asymmetric Price Adjustment, Price Rigidity |
| JEL: | E31 D11 D21 D80 L11 M31 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1356&r=cba |
| By: | Luis J. Alvarez |
| Abstract: | The New Keynesian Phillips curve (NKPC) has become the dominant model on inflation dynamics. Moreover, a large body of empirical research has documented in recent years price-setting behaviour at the individual level, which allows the assessment of the microfoundations of pricing models. It is found that a generalised version of the hybrid NKPC of Gali and Gertler (1999) accounts for a number of stylised facts, including rule of thumb price setters, and inflation persistence. Other frequently used versions of the NKPC, such as those that consider full or partial indexation or costs of adjustment, are clearly at odds with micro price evidence. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1330&r=cba |
| By: | Leif Danziger |
| Abstract: | This paper analyzes the optimal adjustment strategy of an inventory-holding firm facing price- and quantity-adjustment costs in an inflationary environment. The model nests both the original menu-cost model that allows production to be costlessly adjusted, and the later model that includes price- and quantity-adjustment costs, but rules out inventory holdings. The firm’s optimal adjustment strategy may involve stockouts. At low inflation rates, output is inversely related to the inflation rate, and the length of time demand is satisfied decreases with the absolute value of the demand elasticity, the storage cost, and the real interest rate. |
| Keywords: | Menu costs; Quantity-adjustment costs; Inventories; Output; Inflation |
| JEL: | D21 D24 L23 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1340&r=cba |
| By: | Cuciniello, Vincenzo |
| Abstract: | In a micro-founded framework in line with the new open economy macroeconomics, the paper shows that more centralized wage setting (CWS) and central bank conservatism (CBC) curb unemployment only if labor market distortions are sizeable. When labor market distortions are sufficiently low, employment may be maximized by atomistic wage setters or a populist CB. The comparison between a national monetary policy (NMP) regime and the monetary union (MU) reveals that a move to a MU boosts inflation in the absence of strategic effects. However, when strategic interactions between CB(s) and trade unions are taken into account, the shift to a MU when monopoly distortions are sizeable unambiguously increases welfare and employment either in presence of a sufficiently conservative CB or with a fully CWS. Finally, when labor market distortions are less relevant, an ultra-populist CB or atomistic wage setters are optimal for the society and a shift to a MU regime is unambiguously welfare improving. |
| Keywords: | Central bank conservatism; centralization of wage setting; inflationary bias; monetary union. |
| JEL: | F41 F31 E42 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:3789&r=cba |
| By: | Guido Ascari; Tiziano Ropele |
| Abstract: | We show that low trend inflation strongly affects the dynamics of a standard Neo-Keynesian model where monetary policy is described by a standard Taylor rule. Moreover, trend inflation enlarges the indeterminacy region in the parameter space, substantially altering the so-called Taylor principle. The main results hold for di¤erent types of Taylor rules, inertial policy rules and indexation schemes. The key message is that, whatever the set up, the literature on Taylor rules cannot disregard average inflation in both theoretical and empirical analysis. |
| Keywords: | Sticky Prices, Taylor Rules and Trend Inflation |
| JEL: | E31 E52 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1332&r=cba |
| By: | Jürgen Kromphardt; Camille Logeay |
| Abstract: | In this paper we introduce and test the hypothesis that the relation between inflation and unemployment has been in many countries subject to a significant change in the early 1990's after the disinflation period. That period began between 1975 and 1980 after the first (or the second) oil price shock in autumn 1973. During the disin°ation period, inflation and unemployment were the result of the struggle between the wage and price setters trying to influence the distribution of income to their favour and the Central Bank fighting against inflation. Since the wage and price setters did not fully believe in an \unconditional" pursuit of the anti-inflationary policy, the result was a gradual decline of the inflation rate rendered possible by a rising rate of unemployment. Our hypothesis was inspired by the observation that the statistical Phillips curves are now rather flat in many countries. If such horizontal Phillips curves will also result when they are estimated taking into account the most important other factors influencing the inflation rate (mainly supply shocks) they may be explained by the hypothesis that during the 1990's, wage and price setters finally accepted the new rigour of the monetary policy and tried no more (nor had the market power { due to increasing globalisation and international competition) to pursue a policy which raises the inflation rate significantly above the target inflation rate of the Central Bank. In that case a "break" in the parameters of the Phillips-Curve should be observed. We use econometric methods to test whether the presumed \break" in the re- lation between inflation and unemployment can be shown to exist. We restrict our study to the four largest countries of the Euro area (Germany, France, Italy and Spain), the UK and the USA. The result are very di®erent for the countries; therefore we intend in a further step to detect the reasons for there divergences. |
| Keywords: | Phillips curve, unemployment, inflation, wage and price setting, Central Bank, structural break |
| JEL: | E10 E50 C22 C32 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1354&r=cba |
| By: | Bernardina Algieri (Department of Economics and Statistics, University of Calabria, I-87036 Arcavacata di Rende, Italy.); Thierry Bracke (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | The paper examines over seventy episodes of current account adjustment in industrial and major emerging market economies. It argues that these episodes were characterised by strongly divergent economic developments. To reduce this divergence, the paper classifies episodes with similar characteristics in three groups, using cluster analysis. A majority of cases was characterised by internal adjustment through a slowdown of domestic demand and did not involve significant exchange rate movements. In some cases, the adjustment was mainly external, facilitated by a relatively modest exchange rate depreciation and without economic slowdown. Finally, some cases involved a crisis-like combination of a severe slowdown and a significant currency depreciation. Using a multinomial logit, we find that this classification of episodes helps improve the predictability of current account adjustment. JEL Classification: F32, C14, C25. |
| Keywords: | External imbalances, current account adjustment, cluster analysis, multinomial logit. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070762&r=cba |
| By: | Jiri Podpiera (Corresponding address: External Economic Relations Division, Czech National Bank, Na P?íkop? 28, 115 03, Prague 1, Czech Republic.) |
| Abstract: | Policymakers do not always follow a simple rule for setting policy rates for various reasons and thus their choices are co-driven by a decision to follow a rule or not. Consequently, some observations are censored and cause bias in conventional estimators of typical Taylor rules. To account for the censored and discrete process of policy rate setting, I devise a new method for monetary policy rule estimation and demonstrate its ability to outperform the existing conventional estimators using two examples. JEL Classification: E4, E5. |
| Keywords: | Monetary policy; Policy rule; Bias in parameters. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070771&r=cba |
| By: | Mathias Trabandt |
| Abstract: | How can we explain the observed behavior of aggregate inflation in response to e.g. monetary policy changes? Mankiw and Reis (2002) have proposed sticky information as an alternative to Calvo sticky prices in order to model the conventional view that i) inflation reacts with delay and gradually to a monetary policy shock, ii) announced and credible disinflations are contractionary and iii) inflation accelerates with vigorous economic activity. I use a fully-fledged DSGE model with sticky information and compare it to Calvo sticky prices, allowing also for dynamic inflation indexation as in Christiano, Eichenbaum, and Evans (2005). I find that sticky information and sticky prices with dynamic inflation indexation do equally well in my DSGE model in delivering the conventional view. |
| Keywords: | sticky information, sticky prices, inflation indexation, DSGE |
| JEL: | E0 E3 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1369&r=cba |
| By: | Paul Turner (Dept of Economics, Loughborough University) |
| Abstract: | This paper seeks to demonstrate that a backward looking specification of the IS curve using UK data can encompass the forward looking model recently discussed by Kara and Nelson (2004). By relaxing the restriction that the interest rate and the inflation rate enter the IS curve with coefficients of equal magnitude but opposite sign, we obtain IS curve estimates which are empirically plausible and which encompass the rival specification. |
| Keywords: | IS curve, forward looking, real interest rate. |
| JEL: | E17 E31 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:lbo:lbowps:2007_16&r=cba |
| By: | Samuel Bentolila; Juan J. Dolado; Juan F. Jimeno |
| Abstract: | This paper examines the evolution of the Phillips Curve (PC) for the Spanish economy since 1980. In particular, we focus on what has happened since the late 1990s. Since 1999 the unemployment rate has fallen by almost 7 percentage points, while inflation has remained relatively subdued around a plateau of 2%- 4%. Thus, the slope of the PC has become much flatter. We argue that this favorable evolution is largely due to the huge rise in the immigration rate, from 1% of the population in 1994 to 9.3% in 2006. We derive a New Keynesian Phillips curve accounting for the e¤ects of immigration, a variable which is found to shift the curve if preferences and bargaining power of immigrants and natives di¤er. We then estimate this curve for Spain since 1980 and find that while the fall in unemployment over the last 8 years comes along with an increase in inflation of 2.2 percentage points per year, the increase of the relative unemployment rate of immigrants vis-à-vis natives accounts for an ofsetting 0.9 percentage points drop in the inflation rate per year. |
| Keywords: | Phillips curve, immigration |
| JEL: | E31 J64 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1333&r=cba |
| By: | Michael U. Krause; David J. Lopez-Salido; Thomas Lubik |
| Abstract: | We assess the empirical relevance for inflation dynamics of accounting for the presence of search frictions in the labor market. The New Keynesian Phillips curve explains inflation dynamics as being mainly driven by current and expected future marginal costs. Recent empirical research has emphasized different measures of real marginal costs to be consistent with observed inflation persistence. We argue that, allowing for search frictions in the labor market, real marginal cost should also incorporate the cost of generating and maintaining long-term employment relationships, along with conventional measures, such as real unit labor costs. In order to construct a synthetic measure of real marginal costs, we use newly available labor market data on worker finding and separation rates that reflect firing and hiring costs to the firm. We then estimate a New Keynesian Phillips curve using structural econometric techniques. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1353&r=cba |
| By: | Ray C. Fair |
| Abstract: | How inflation and unemployment are related in both the short run and long run is perhaps the key question in macroeconomics. This paper tests various price equations using quarterly U.S. data from 1952 to the present. Issues treated are the following. 1) Estimating price and wage equations in which wages affect prices and vice versa versus estimating "reduced form" price equations with no wage explanatory variables. 2) Estimating price equations in (log) level terms, rst difference (i.e., inflation) terms, and second difference (i.e., change in inflation) terms. 3) The treatment of expectations. 4) The choice and functional form of the demand variable. 5) The choice of the cost-shock variable. The results reject the use of rational expectations and suggest that the best speci cation is a price equation in level terms imbedded in a price-wage model, where the wage equation is also in level terms. The best cost-shock variable is the import price deflator, and the best demand variable is the unemployment rate. There is some evidence of a nonlinear effect of the unemployment rate on the price level at low values of the unemployment rate. Many of the results in this paper are contrary to common views in the literature, but the empirical support for them is strong. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1342&r=cba |
| By: | Marika Karanassou; Dennis Snower |
| Abstract: | A major criticism against staggered nominal contracts is that they give rise to the so called "persistency puzzle" - although they generate price inertia, they cannot account for the stylised fact of inflation persistence. It is thus commonly asserted that, in the context of the new Phillips curve (NPC), inflation is a jump variable. We argue that this "persistency puzzle" is highly misleading, relying on the exogeneity of the forcing variable (e.g. output gap, marginal costs, unemployment rate) and the assumption of a zero discount rate. We show that when the discount rate is positive in a general equilibrium setting (in which real variables not only affect inflation, but are also influenced by it), standard wage-price staggering models can generate both substantial inflation persistence and a nonzero inflation-unemployment tradeoff in the long-run. This is due to frictional growth, a phenomenon that captures the interplay of nominal staggering and permanent monetary changes. We also show that the cumulative amount of inflation undershooting is associated with a downward-sloping NPC in the long-run. |
| Keywords: | Inflation dynamics, persistence, wage-price staggering, new Phillips curve, monetary policy, frictional growth |
| JEL: | E31 E32 E42 E63 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1349&r=cba |
| By: | Liam Graham; Dennis J. Snower |
| Abstract: | Using a standard dynamic general equilibrium model, we show that the interaction of staggered nominal contracts with hyperbolic discounting leads to inflation having significant long-run effects on real variables. |
| Keywords: | inflation, unemployment, Phillips curve, nominal inertia, monetary policy, dynamic general equilibrium |
| JEL: | E20 E40 E50 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1346&r=cba |
| By: | Jarkko Jääskelä (Reserve Bank of Australia); Mariano Kulish (Reserve Bank of Australia) |
| Abstract: | The rational expectations equilibrium of a small open economy can be subject to indeterminacy if foreign monetary policy does not satisfy the Taylor principle. We study the implications of foreign-induced indeterminacy for the conduct of monetary policy in a small open economy. In the canonical sticky-price small open economy model, we find that indeterminacy arising in the large economy can increase the volatility of the small economy. Our main finding, however, is that ‘smallness’ is a property of the unique rational expectations equilibrium of the large economy, and not a general property of the small open economy model. If the <em>large</em> economy fails to anchor expectations, shocks to the small economy can affect the large one. This form of indeterminacy gives rise to a ‘butterfly effect’. Additional assumptions are required to preserve the ‘smallness’ of the small economy. |
| Keywords: | indeterminacy; small open economy; rational expectations |
| JEL: | E30 E32 E52 E58 F41 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:rba:rbardp:rdp2007-06&r=cba |
| By: | Inci Ötker; Inci Ötker |
| Abstract: | Many countries have moved towards more flexible exchange rate regimes over the last decade to take advantage of greater monetary policy autonomy and flexibility in responding to external shocks. Some reluctance to let go of pegged exchange rates persists, however, despite the benefits of flexibility. The institutional and operational requirements needed to support a floating exchange rate, as well as difficulties in assessing the right time and manner to exit, tend to be additional factors in this reluctance. This volume presents the concrete steps taken by a number of countries in transition to greater exchange rate flexibility and elaborates on the operational ingredients that proved helpful in promoting successful and durable transitions. It attempts to provide a better understanding (and hence a "road map") of how these various operational ingredients were established and coordinated, how their implementation interacted with macro and other conditions, and how they contributed to the smoothness of each transition. |
| Keywords: | Floating exchange rates , Monetary policy , Foreign exchange , |
| Date: | 2007–04–30 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfocp:256&r=cba |
| By: | Harashima, Taiji |
| Abstract: | In this paper, I present a unified and micro-founded explanation for various types of inflation without assuming ad hoc frictions or irrationality. The explanation is similar to the conventional inflation theory in the sense that an independent central bank can control inflation and also similar to the fiscal theory of the price level in the sense that a source of inflation lies in the behavior of government. Inflation accelerates or decelerates through the simultaneous optimization of a government and the representative household if their time preference rates are heterogeneous. This inflation acceleration mechanism will be prevented from working if a central bank is truly independent. |
| Keywords: | Hyperinflation; chronic inflation; disinflation; deflation; central bank independence; the fiscal theory of the price level |
| JEL: | E58 E31 E63 |
| Date: | 2007–07–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:3836&r=cba |
| By: | Alpo Willman (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | In an overlapping generations maximization framework with consumers, whose information on uncertain future income realizations is front-loaded, a closed form aggregate consumption function with CRRA preferences is derived. To have a closed form solution we assume that consumers solve their intertemporal optimization problem sequentially. First they assess riskadjusted life-time wealth and then the optimal consumption path. The derived model captures precautionary saving, which is dependent on the human to non-human wealth ratio. On aggregate level, after accounting for habit formation, the model is able to explain both the short-run (e.g. the excess sensitivity and the excess smoothness puzzle) and long-run stylized facts of the U.S. consumption data. JEL Classification: D11, D12, D82, E21. |
| Keywords: | Consumption, Information, Habit Persistence, Precautionary Saving. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070765&r=cba |
| By: | Hian Teck Hoon; Kong Weng Ho |
| Abstract: | This paper builds upon Hoon and Phelps (1992, 1997) to ask how much of the evolution of the unemployment rate over several decades in country can be explained by real factors in an equilibrium model of the natural rate where country's productivity growth depends upon its distance from the world's technological leader. One motivating contemporary example includes the evolution of unemployment rates in Europe as it recovered from the second world war and caught up technologically to the US. Another example that may be less familiar to many people is Singapore (the second fastest growing economy from 1960 to 2000 in Barro's data set of 112 countries) that is best thought of as catching up to the world's technological leaders (the G5 countries with whom it trades extensively and from where it receives substantial foreign direct investments) and that saw its unemployment rate go down from double-digit levels in the early 1960's to the low 2 to 3 percent in the late 1990's. How much of the big movements in the unemployment rate can be explained by non-monetary factors in a model of an endogenous natural rate exhibiting both monetary neutrality and super-neutrality? What room is left for monetary policy in explaining the movements of the unemployment rate? The paper develops the theory and seeks to ask how much non-monetary factors can quantitatively account for the evolution of the unemployment rate. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1347&r=cba |
| By: | Imed Drine (IHEC Sousse and EUREQua, Sorbonne University); Christophe Rault (LEO, University of Orleans and IZA) |
| Abstract: | The aim of this paper is to apply recently developed panel cointegration techniques proposed by Pedroni (1999, 2004) and generalized by Banerjee and Carrion-i-Silvestre (2006) to examine the robustness of the PPP concept for a sample of 80 developed and developing countries. We find that strong PPP is verified for OECD countries and weak PPP for MENA countries. However in African, Asian, Latin American and Central and Eastern European countries, PPP does not seem relevant to characterize the long-run behavior of the real exchange rate. Further investigations indicate that the nature of the exchange rate regime doesn’t condition the validity of PPP which is more easily accepted in countries with high than low inflation. |
| Keywords: | purchasing power parity, real exchange rate, developed country, developing country, panel unit-root and cointegration tests |
| JEL: | E31 F0 F31 C15 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp2887&r=cba |
| By: | Enrique Alberola (Banco de España); Daniel Navia (Banco de España) |
| Abstract: | New EU members share two very marked features which have conflicting implications for the evolution of their real exchange rates in the long run: accelerated growth and systematic current account imbalances, which would anticipate, respectively an appreciation and a depreciation of their currencies, according to different theories of exchange rate determination. Furthermore, both elements are intertwined, for current account imbalances are the other side of capital inflows which have been central in boosting potential output and productivity convergence in these economies. In this paper, we aim at achieving some insight on the role of persistent and substantial capital inflows and the consequent accumulation of net foreign liabilities in improving competitiveness and in the determination of the exchange rate for the three largest new EU members: Poland, Hungary and the Czech Republic. We adopt a sequential approach that sheds light on the role of capital flows and their interaction with the Balassa-Samuelson hypothesis. We start by noting in a bivariate cointegration analysis that the accumulation of net foreign liabilities, far from depressing the exchange rate in the long-run, has gone hand-in-hand with exchange rate appreciation. We claim that this may be due to the induced effect that capital inflows are expected to have on productivity and competitiveness. After testing that foreign direct investment is cointegrated with productivity trends, we show that a extended empirical model comprising relative productivity and net foreign assets is well-suited in general to capture this indirect, opposite effect of liabilities accumulation on the real exchange rate. Finally, the model makes it possible to estimate for the considered countries equilibrium exchange rates and misalignments and perform some simulations on their expected future path. |
| Keywords: | new EU members, Balassa-Samuelson, FDI, REER, current account, convergence |
| JEL: | F21 F31 F32 F36 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:0708&r=cba |
| By: | Bernd Fitzenberger; Wolfgang Franz; Oliver Bode |
| Abstract: | Starting in 2006 the German economy currently experiences a cyclical revival which spreads to the labor market. Unemployment decreases markedly and regular employ- ment rises. At present, virtually all professional forecasts expect this upswing to con- tinue in the foreseeable future. |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1344&r=cba |
| By: | Annika Alexius; Bertil Holmlund |
| Abstract: | A widely spread belief among economists is that monetary policy has relatively short-lived effects on real variables such as unemployment. Previous studies indicate that monetary policy affects the output gap only at business cycle frequencies, but the effects on unemployment may well be more persistent in countries with highly regulated labor markets. We study the Swedish experience of unemployment and monetary policy. Using a structural VAR we find that around 30 percent of the fluctuations in unemployment are caused by shocks to monetary policy. The effects are also quite persistent. In the preferred model, almost 30 percent of the maximum effect of a shock still remains after ten years. |
| Keywords: | Unemployment, Monetary policy, structural VARs |
| JEL: | J60 E24 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1329&r=cba |
| By: | Robert Lavigne, Philipp Maier, and Eric Santor |
| Abstract: | The ongoing review of the IMF, initiated in 2005 by Managing Director De Rato, presents an excellent opportunity to re-examine the role, functions and governance of the Fund. In particular, the objective, scope and conduct of IMF surveillance have been identified as a key area for renewal. In this paper, we offer a new vision for IMF surveillance. There are two main parts to our proposal. First, we develop "Guidelines for Economic Policy Frameworks" that outline the objective and scope of surveillance. They delineate the benchmarks against which members economic policy frameworks can be assessed. The Guidelines also serve to clarify the principles under which surveillance is conducted, and reaffirm members' commitments to the surveillance process under their Article IV obligations. The second element of our proposal is a "Surveillance Remit". The Remit defines the aim of surveillance and the obligations of the Fund to pursue this goal. As such the Remit creates a mechanism to hold the Fund accountable. An important implication of the Remit is that it requires the Fund to become more independent in its day-to-day operations. In addition, we propose procedures for communicating surveillance and for assessing the Fund's conduct of surveillance. Taken together, the various elements reinforce each other, providing a clear role for the IMF, as well as its member countries, in the surveillance process. This principles-based approach can bolster the credibility and legitimacy of surveillance, and ultimately its effectiveness, to the benefit of all members. |
| Keywords: | International topics; Financial stability |
| JEL: | F33 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:07-37&r=cba |
| By: | Etienne Gagnon |
| Abstract: | This paper provides new insight into the relationship between inflation and consumer price setting by examining a large data set of Mexican consumer prices covering episodes of both low and high inflation, as well as the transition between the two. Overall, the economy shares several characteristics with time-dependent models when the annual inflation rate is low (below 10-15%), while displaying strong state dependence when inflation is high (above 10-15%). At low inflation levels, the aggregate frequency of price changes responds little to movements in inflation because movements in the frequency of price decreases partly offset movements in the frequency of price increases. When the annual inflation rate rises beyond 10-15 percent, however, there are no longer enough price decreases to counterbalance the rising occurrence of price increases, making the frequency of price changes more responsive to inflation. It is shown that a simple menu-cost model with idiosyncratic technology shocks predicts remarkably well the level of the average frequency and magnitude of price changes over a wide range of inflation. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:896&r=cba |
| By: | Ansgar Belke; Albina Zenkic |
| Abstract: | In the academic literature some criteria have been identified which could have an impact on the success of the transition process, such as macroeconomic stability, microeconomic restructuring and implementation of legal and institutional reforms. The role of the exchange rate system in general is to foster the stability of the monetary environment characterized by low inflation rates and a stable domestic currency. Although the importance of a sustainable price-level oriented monetary policy for the transition-success has been stressed in the academic literature, there are still further questions to be answered related to the choice of the exchange rate system throughout the different phases of the transition process. This paper intends to contribute to close this gap in the literature. The guiding research question is how the choice of an exchange rate system influences the economic success of a country in transition and its gradual integration within the European Union (EU) and the European Monetary Union (EMU). For this purpose, the study focuses on the transition process of South-eastern Europe (SEE). In particular and for the first time in a joint study, we will take a look at the following South-eastern European Countries (SEECs), often referred to as the “West Balkans”: Bosnia and Herzegovina (BiH), Croatia, Former Yugoslav Republic of Macedonia (FYRM), Serbia and Montenegro, as these five countries share certain common characteristics: they were part of the Former Yugoslav Republic (FYR); they are countries in transition; they are members of the Stability Pact for South-eastern Europe and they are all potential EU-accession candidates. |
| Keywords: | Balkans, exchange rate mechanism, optimum currency areas, economic transition, trade integration |
| JEL: | E44 F33 P21 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:hoh:hohdip:288&r=cba |
| By: | Korhonen, Iikka (BOFIT); Mehrotra, Aaron (BOFIT) |
| Abstract: | Estimating money demand functions for Russia following the 1998 crisis, we find a stable money demand relationship when augmented by a deterministic trend signifying falling velocity. As predicted by theory, higher income boosts demand for real rouble balances and the income elasticity of money is close to unity. Inflation affects the adjustment towards equilibrium, while broad money shocks lead to higher inflation. We also show that exchange rate fluctuations have a considerable influence on Russian money demand. The results indicate that Russian monetary authorities have been correct in using the money stock as an information variable and that the strong influence of exchange rate on money demand is likely to continue despite de-dollarisation of the Russian economy. |
| Keywords: | money demand; vector error correction models; dollarisation; Russia |
| JEL: | E31 E41 E51 P22 |
| Date: | 2007–06–29 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofitp:2007_014&r=cba |
| By: | Robert Pollin (Univ. of Massachusetts); James Heintz (Univ. of Massachusetts) |
| Abstract: | This IPC Country Study by Robert Pollin and James Heintz examines three policy areas related to monetary policies in Kenya: inflation dynamics and the relationship between inflation and long-run growth; monetary policy targets and instruments; and exchange rate dynamics and the country?s external balance. It concludes with five main policy recommendations |
| Keywords: | Poverty, Inflation Control, Exchange Rate |
| JEL: | H21 O23 O17 F23 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:ipc:cstudy:6&r=cba |
| By: | Gerald Epstein (Univ. of Massachusetts); James Heintz (Univ. of Massachusetts) |
| Abstract: | . |
| Keywords: | Monetary Policy Financial Sector; Reform; Ghana |
| Date: | 2006–06 |
| URL: | http://d.repec.org/n?u=RePEc:ipc:cstudy:2&r=cba |