nep-cba New Economics Papers
on Central Banking
Issue of 2007‒07‒27
sixteen papers chosen by
Alexander Mihailov
University of Reading

  1. Flattened Inflation-Output Tradeoff and Enhanced Anti-Inflation Policy: Outcome of Globalization? By Assaf Razin; Alon Binyamini
  2. Are the facts of UK inflation persistence to be explained by nominal rigidity or changes in monetary regime? By Meenagh, David; Minford, Patrick; Nowell, Eric; Sofat, Prakriti; Srinivasan, Naveen
  3. Optimal Monetary Policy in a 'Sudden Stop' By Fabio Braggion; Lawrence J. Christiano; Jorge Roldos
  4. Understanding the Forward Premium Puzzle: A Microstructure Approach By Burnside, A Craig; Eichenbaum, Martin; Rebelo, Sérgio
  5. Understanding the Forward Premium Puzzle: A Microstructure Approach By Craig Burnside; Martin S. Eichenbaum; Sergio Rebelo
  6. Large Hoarding of International Reserves and the Emerging Global Economic Architecture By Joshua Aizenman
  7. Inflation-output gap trade-off with a dominant oil supplier By Anton Nakov; Andrea Pescatori
  8. Is the Bank of Canada any more or less independent than the Fed? By J. Stephen Ferris
  9. Determinants and Costs of Current Account Reversals under Heterogeneity and Serial Correlation By Aßmann, Christian
  10. Asian Currency Crises: Do Fundamentals still Matter? A Markov-Switching Approach to Causes and Timing By J L Ford; Bagus Santoso; N J Horsewood
  11. The Economics of Uncovered Interest Parity Condition for Emerging Markets: A Survey By Alper, C. Emre; Ardic, Oya Pinar; Fendoglu, Salih
  12. Currency Preferences in a Tri-Polar Model of Foreign Exchange By Melecky, M
  13. The Causes of Excessive Deficits in The European Union By Castro, Vítor
  14. An estimated New Keynesian policy model for Australia By Buncic, Daniel; Melecky, Martin
  15. Forecasting Exchange Rate Density using Parametric Models: The Case of Brazil By Marcos M. Abe; Eui J. Chang; Benjamin M. Tabak
  16. An Evaluation of Foreign Exchange Intervention and Monetary Aggregates in Nigeria (1986- 2003) By Adebiyi, Michael Adebayo

  1. By: Assaf Razin; Alon Binyamini
    Abstract: The paper provides a unified analysis of globalization effects on the Phillips curve and monetary policy, in a New-Keynesian framework. The main proposition of the paper is twofold. Labor, goods, and capital mobility flatten the tradeoff between inflation and activity. If policy makers are guided by the welfare criterion of the representative household, globalization forces also lead monetary policy to be more aggressive with regard to inflation fluctuations but, at the same time, more benign with respect to the output-gap fluctuations.
    JEL: E31 F3 F4
    Date: 2007–07
  2. By: Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Nowell, Eric; Sofat, Prakriti; Srinivasan, Naveen
    Abstract: It has been widely argued that inflation persistence since WWII has been widespread and durable and that it can only be accounted for by models with a high degree of nominal rigidity. We examine UK post-war data and find that the varying persistence it reveals is largely due to changing monetary regimes and that models with moderate or even no nominal rigidity are best equipped to explain it.
    Keywords: Inflation Persistence; New Keynesian; New Classical; Nominal Rigidity; Monetary Regime Shifts
    JEL: E31 E37
    Date: 2007–07
  3. By: Fabio Braggion; Lawrence J. Christiano; Jorge Roldos
    Abstract: In the wake of the 1997-98 financial crises, interest rates in Asia were raised immediately, and then reduced sharply. We describe an environment in which this is the optimal monetary policy. The optimality of the immediate rise in the interest rate is an example of the theory of the second best: although high interest rates introduce an inefficiency wedge into the labor market, they are nevertheless welfare improving because they mitigate distortions due to binding collateral constraints. Over time, as various real frictions wear off and the collateral constraint is less binding, the familiar Friedman forces dominate, and interest rates are optimally set as low as possible.
    JEL: E4 E44 E5
    Date: 2007–07
  4. By: Burnside, A Craig; Eichenbaum, Martin; Rebelo, Sérgio
    Abstract: High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this `forward premium puzzle.' The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.
    Keywords: Exchange rates; microstructure; Uncovered interest parity
    JEL: F31
    Date: 2007–07
  5. By: Craig Burnside; Martin S. Eichenbaum; Sergio Rebelo
    Abstract: High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this 'forward premium puzzle.' The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.
    JEL: E30 F31
    Date: 2007–07
  6. By: Joshua Aizenman
    Abstract: This paper analyzes competing interpretations for the large increases in the hoarding of international reserves by developing countries. While the first phase of the rapid hoarding of reserves in the aftermath of the East Asian crisis has been dominated by self insurance against exposure to foreign shocks, the self insurance motive falls short of explaining the hoarding in Asia in the 2000s. These developments may be a symptom of an emerging new global financial architecture, which is manifested in the proliferation of decentralized and less cooperative arrangements. The emerging financial configuration of developing countries in the aftermath of the 1990s crises has been growing managed exchange rate flexibility, greater monetary independence, and deeper financial integration. Hoarding international reserves is a key ingredient enhancing the stability of this emerging configuration. While not a panacea, international reserves help by providing self insurance against sudden stops; mitigating REER effects of TOT shocks; smoothing overtime the adjustment to shocks by allowing more persistent current account patterns; and possibly even export promotion, though this mercantilist use of reserves remains debatable due to possible coordination issues. Countries following an export oriented growth strategy may end up with competitive hoarding, akin to competitive devaluations. The sheer size of China, and its lower sterilization costs suggests that China may be the winner of a hoarding game. Hoarding international reserves may also be motivated by a desire to deal with vulnerability to internal and external instability, which is magnified by exposure of the banking system to non performing loans. Testing the self insurance and precautionary motives in the context of China may be challenged by a version of the "peso problem." Hoarding international reserves and sterilization have been complementing each other during the last ten years, as developing countries have increased the intensity of both margins.
    JEL: F02 F1 F15 F31 F32 F33 F36 F4
    Date: 2007–07
  7. By: Anton Nakov (Banco de España; Universitat Pompeu Fabra); Andrea Pescatori (Universitat Pompeu Fabra)
    Abstract: An exogenous oil price shock raises inflation and contracts output, similar to a negative productivity shock. In the standard New Keynesian model, however, this does not generate a tradeoff between inflation and output gap volatility: under a strict inflation targeting policy, the output decline is exactly equal to the efficient output contraction in response to the shock. We propose an extension of the standard model in wich the presence of a dominant oil supplier (OPEC) leads to inefficient fluctuations in the oil price markup, reflecting a dynamic distortion of the economy´s production process. As a result, in the face of oil sector shocks, stabilizing inflation does not automatically stabilize the distance of output from first-best, and monetary policymarkers face a tradeoff between the two goals.
    Keywords: oil shocks, inflation-output gap tradeoff, dominant firm
    JEL: E31 E32 E52 Q43
    Date: 2007–07
  8. By: J. Stephen Ferris (Department of Economics, Carleton University)
    Abstract: In this paper I apply the work of Abrams and Iossifov (2006) to monetary policy in canada to see if same political party affiliation is needed to produce evidence of political opportunism. After modifying their anaylsis to maintain consistency in the time series dimensions of their variables for Canada, I find both an error correction model and a Taylor rule of reformulation of their test generate evidence consistent with same party political opportunism, but only weakly so. On the other hand, I find also that more traditional indicators of political influence present even more convincing evidence of political dependence. In particular, the data suggest that the election of a Liberal party government, a decrease in the degree of political competition, and to a lesser extent, the election of a minority government all positively influence the expansiveness of Canadian monetary policy. In combination, these findings are consistent with the hypothesis that the Bank of Canada is less rather than more independent that is the Fed.
    JEL: E52 E58
    Date: 2007–04–29
  9. By: Aßmann, Christian
    Abstract: Recent empirical evidence suggests that reversing current account balances imply costly adjustment processes leading to reduced economic growth. Using large panel data sets to analyze determinants and costs of reversals asks for controls of heterogeneity among countries. This paper contributes a Bayesian analysis, which allows a parsimonious yet flexible handling of country specific heterogeneity via random coeffcients. Furthermore, the analysis allows for serially correlated errors in order to capture persistence within the employed macroeconomic data. Bayesian specification tests provide evidence in favor of models incorporating heterogeneity and serial correlation. The results suggest that consideration of serial correlation and heterogeneity is necessary to assess correctly the determinants and costs of reversals. Results are checked for robustness against the underlying reversal definition.
    Keywords: Current account reversals, Bayesian Analysis, Panel Probit Model, Panel Treatment Model, Random Parameters, Serial Correlation
    JEL: C30 C33 C35 F32 F43
    Date: 2007
  10. By: J L Ford; Bagus Santoso; N J Horsewood
    Abstract: This paper examines the extent to which the Asian currency crises can be accounted for by the macroeconomic fundamentals suggested by first and second generation models, exclusive of the ideas of the third generation models. In doing so we extend the literature on the earlier models by using GARCH and Path Independent Markov-Switching GARCH models to explain the market pressure on the exchange rate, and the probability of the timing of a crisis. In addition, we account for appreciations of the exchange rate. Our empirical estimates for Indonesia, South Korea, Malaysia and Thailand confirm that macroeconomic variables can explain the crises and the probability of occurrence at any time, dominating the conventionally used logit model.
    Keywords: Currency crisis, macroeconomic fundamentals, Markov-switching, volatile sate, stable state, probability of a crisis, logit model
    JEL: F31 F40
    Date: 2007–07
  11. By: Alper, C. Emre; Ardic, Oya Pinar; Fendoglu, Salih
    Abstract: Financial account liberalizations since the second half of the 1980s paved way for the burgeoning literature that investigates foreign exchange market efficiency in emerging markets via testing for the uncovered interest parity (UIP) condition. This paper provides a broad and critical survey on this recent literature as well as a general understanding on the topic through reviewing the related literature on developed economies where recent methodological advances in time series econometrics have provided favorable results, questioning the previously documented UIP puzzle. The literature on emerging markets suggests that these countries deserve a special treatment by taking into account the existence of additional types of risk premia, high inflation episodes, financial contagion, peso problem, simultaneity problem, asymmetricity, and the determination of de facto structural breaks.
    Keywords: Uncovered Interest Parity; Forward Premium Bias; Emerging Markets.
    JEL: F31
    Date: 2007–05–30
  12. By: Melecky, M
    Abstract: This paper reopens the subject of currency preferences while modeling the exchange rates among three major currencies - the US dollar, the euro and the Japanese yen. The exchange rate model presented in this paper includes not only traditional determinants of bilateral exchange rates but incorporates third-currency effects in addition. The obtained estimation results are interpreted from the perspective of possible currency substitution and complementarity relationships. We find evidence of currency complementarity between the yen and the euro, and currency substitution of the dollar for both the euro and the yen. The estimated third-currency effects are consistent with our findings on currency substitution and complementarity among the three major currencies.
    Keywords: Exchange Rate Modeling; Currency Substitution; Currency Complementarity; Third-Currency Effects
    JEL: F36 F42 F31
    Date: 2007–04
  13. By: Castro, Vítor (University of Warwick, University of Coimbra and NIPE)
    Abstract: Several studies have identified the factors that cause public deficits in industrial democracies. They consider that economic, political and institutional factors play an important role in the understanding of those deficits. However, the study of the determinants of excessive deficits remains practically unexplored. Since excessive deficits can have large negative spillover effects when countries are forming a monetary union without a centralised budget – as it is the case for a group of European countries – this paper tries to explore that gap in the literature by identifying the main causes of excessive deficits and the ways of avoiding them. Binary choice models are estimated over a panel of 15 European Union countries for the period 1970-2006, where an excessive deficit is defined as a deficit higher than 3% of GDP. Results show that a weak fiscal stance, low economic growth, the timing of parliamentary elections and majority left-wing governments are the main causes of excessive deficits in the EU countries. Moreover, the institutional constraints imposed after Maastricht over the EU countries’ fiscal policy have succeeded in reducing the probability of excessive deficits in Europe, especially in small countries. Therefore, this study concludes that supranational fiscal constraints, national efforts to reduce public debts, growth promoting policies and mechanisms to avoid political opportunism and partisan effects are essential factors for an EU country to avoid excessive deficits. Finally, the results presented in this paper raise the idea that a good strategy for the EU countries to avoid excessive deficits caused by the opportunistic behaviour of their policymakers would be to schedule elections for the beginning or the end of the year.
    Keywords: Excessive public deficits ; European Union ; Political opportunism ; Binary choice models
    JEL: E62 H6 O52
    Date: 2007
  14. By: Buncic, Daniel; Melecky, Martin
    Abstract: An open economy New Keynesian policy model for Australia is estimated in this study. We investigate how important external shocks are as a source of macroeconomic fluctuations when compared to domestic ones. The results of our analysis suggest that the Australian business cycle and domestic inflation are most affected by domestic demand and supply shocks, respectively. However, domestic output also appears to be strongly affected by foreign demand shocks, and domestic inflation by exchange rate shocks. Domestic variables do not seem to be significantly affected by foreign supply and monetary policy shocks.
    Keywords: New Keynesian Policy Modelling; Small Open Economy Model; Australia; US; Bayesian Estimation.
    JEL: E40 E37 F41
    Date: 2007–07–18
  15. By: Marcos M. Abe; Eui J. Chang; Benjamin M. Tabak
    Abstract: This paper employs a recently developed parametric technique to obtain density forecasts for the Brazilian exchange rate, using the exchange rate options market. Empirical results suggest that the option market contains useful information about future exchange rate density. These results suggests that density forecasts using options markets may add value for portfolio and risk management, and may be useful for financial regulators to assess financial stability.
    Date: 2007–05
  16. By: Adebiyi, Michael Adebayo
    Abstract: The paper investigates the impact of foreign exchange intervention in the Nigerian foreign exchange market using an Autoregressive Distributed Lag (ARDL) modeling approach. Quarterly time series data spanning 1986:1 to 2003:4 are used and a number of statistical tools are employed to verify this hypothesis. The study examines stochastic characteristics of each time series by testing their stationarity using Phillip Perron (PP) test. This is followed by performing cointegration test using Johansen technique. The existence of co-integration motivates us to estimate the error correction model for broad money, M2. The overall finding from all the techniques employed is that foreign exchange intervention in Nigeria is sterilized because the cumulative aid, which constitute part of foreign exchange inflows, and net foreign assets variables, which are proxies for intervention, are not significant. Thus, paper concludes by recommending, among others, that the use of stock of external reserves to support the exchange rate through increased funding of the foreign exchange market should be encouraged.
    Keywords: Nigeria; Foreign Exchange Intervention; Co-integration and Auto-regressive Distributed Lag
    JEL: E52 E5
    Date: 2007–07–04

This nep-cba issue is ©2007 by Alexander Mihailov. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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