nep-cba New Economics Papers
on Central Banking
Issue of 2007‒09‒02
thirty-two papers chosen by
Alexander Mihailov
University of Reading

  1. The Renminbifs Dollar Peg at the Crossroads By Maurice Obstfeld
  2. How Important is Money in the Conduct of Monetary Policy? By Michael Woodford
  3. Monetary Policy in East Asia: the Case of Singapore By Bennett T. McCallum
  4. Price-Level Targeting By Agathe Côté
  5. Exchange rate dynamics in a target zone: a heterogeneous expectations approach By Bauer, Christian; De Grauwe, Paul; Reitz, Stefan
  6. Financial Globalization and Emerging Market Portfolios By Michael B Devereux
  7. The Influence of Actual and Unrequited Interventions By Kathryn M. E. Dominguez; Freyan Panthaki
  8. Oil Shocks and External Balances By Lutz Kilian; Alessandro Rebucci; Nikola Spatafora
  9. Independence and Accountability of Monetary and Fiscal Policy Committees By Mihailov, Alexander; Ullrich, Katrin
  10. Optimal Monetary Policy Committee Size: Theory and Cross Country Evidence By Szilárd Erhart; Jose Luis Vasquez-Paz
  11. Information Acquisition in Committees By Dino Gerardi; Leeat Yariv
  12. A Microfounded Sectoral Model for Open Economies By Plasmans, J.E.J.; Fornero, J.; Michalak, T.
  13. Inflation-linked bonds from a central bank perspective By Juan Angel Garcia; Adrian van Rixtel
  14. Currency Invoicing in International Trade: A Panel Data Approach By Ligthart, J.E.; Da Silva, J.
  15. Modelling inflation in China – a regional perspective By Mehrotra, Aaron; Peltonen, Tuomas; Santos Rivera, Alvaro
  16. Output Gaps and Inflation in Mainland China By Stefan Gerlach; Wensheng Peng
  17. Do China's capital controls still bind? Implications for monetary autonomy and capital liberalisation By Guonan Ma; Robert N. McCauley
  18. Monetary Policy and Exchange Rate Regime: Proposal for a Small and Less Developed Economy By Jian Gao; Gang Gong; Xue-Zhong He
  19. Delivering Endogenous Inertia in Prices and Output By Alok Johri
  20. The Robustness and Real Consequences of Nominal Wage Rigidity By Ernst Fehr; Lorenz Goette
  21. An affine macro-finance term structure model for the euro area By Lemke, Wolfgang
  22. International Investment Positions and Exchange Rate Dynamics: A Dynamic Panel Analysis By Michael Binder; Christian Offermanns
  23. Long run effects of money on real consumption and investment in the U.S. By Shelley, Gary; Wallace, Frederick
  24. Global Current Account Imbalances and Exchange Rate Adjustment: The Role of Oil Suppliers Valuation Effects and Interest Rate Changes By Christian M. Oberpriller
  25. Exchange Rates and Global Imbalances: The Importance of Asset Valuation Effects and Interest Rate Changes By Christian M. Oberpriller
  26. Fiscal Policy in a Stock-Flow consistent (SFC) Model: A Comment By Bill Martin
  27. The search for Columbus’ egg - finding a new formula to determine quotas at the IMF By Martin Skala; Christian Thimann; Regine Wölfinger
  28. Volatility dependence across Asia-Pacific on-shore and off-shore U.S. dollar futures markets By Colavecchio , Roberta; Funke, Michael
  29. Financial Integration in East Asia By Hiroshi Fujiki; nd Akiko Terada-Hagiwara
  30. Identifying aggregate supply and demand shocks in South Africa By Stan du Plessis; Ben Smit; Federico Sturzenegger
  31. Central Bank Independence and inflation: the case of Greece By PANAGIOTIDIS, Theodore; TRIAMPELLA, Afroditi
  32. The credibility of the Venezuela crawling-band system By María I. Campos; José L. Torres; Esmeralda Villegas

  1. By: Maurice Obstfeld (University of California, Berkeley (E-mail:
    Abstract: In the face of huge balance of payments surpluses and internal inflationary pressures, China has been in a classic conflict between internal and external balance under its dollar currency peg. Over the longer term, Chinafs large, modernizing, and diverse economy will need exchange rate flexibility and, eventually, convertibility with open capital markets. A feasible and attractive exit strategy from the essentially fixed RMB exchange rate would be a two-stage approach, consistent with the steps already taken since July 2005, but going beyond them. First, establish a limited trading band for the RMB relative to a basket of major trading partner currencies. Set the band so that it allows some initial revaluation of the RMB against the dollar, manage the basket rate within the band if necessary, and widen the band over time as domestic foreign exchange markets develop. The ultimate goal is a floating exchange rate coupled with some relative of inflation targeting. Second, put on hold ad hoc measures of financial account liberalization. They will be less helpful for relieving exchange rate pressures once the yuan/basket rate is allowed to move flexibly within a band, and they are best postponed until domestic foreign exchange markets develop further, the exchange rate is fully flexible, and the domestic financial system has been strengthened and placed fully on a market-oriented basis.
    Keywords: Renminbi, China Currency, China Balance of Payments, Fixed Exchange Rate Exit Strategy
    JEL: F32
    Date: 2007–08
  2. By: Michael Woodford
    Date: 2007–08–24
  3. By: Bennett T. McCallum (Carnegie Mellon University and National Bureau of Economic Research (E-mail:
    Abstract: The Monetary Authority of Singapore (MAS) conducts policy by adjusting the Singapore dollarfs effective exchange rate so as to achieve macroeconomic goals for the economyfs inflation rate and output gap. Estimates of a policy rule of the Taylor type, except with exchange rate appreciation serving as the instrument/indicator variable, substantiate this interpretation. That this rule reflects policy that is much like inflation targeting is evidenced by the absence of any significant role for the real exchange rate as a distinct target variable in addition to inflation and the output gap. Simulations with a dynamic model of a small open economy illustrate that this type of rule can be relatively more advantageous in economies that (like Singapore) are extremely open to international trade. The analysis illustrates that monetary policy and exchange-rate policy are two sides of the same coin, which suggests that assignment of exchange-rate management to a nationfs fiscal authority is an anachronism.
    Keywords: exchange rate, inflation targeting, instrument variable, target variable, open economy, monetary policy
    JEL: E42 E58 F31 F41
    Date: 2007–08
  4. By: Agathe Côté
    Abstract: In November 2006, the Bank of Canada announced its intention to lead a concerted research program over the next few years on the type of monetary policy framework that would best contribute to the economic well-being of Canadians in the decades ahead. The research will focus on two broad questions: whether economic welfare might be improved by targeting a rate of inflation lower than 2 per cent, and whether economic welfare might be improved by moving from an inflation-targeting (IT) framework to some form of price-level targeting (PLT). This paper focuses on the second question. The author provides an overview of the main conclusions in the literature on the relative merits of replacing IT with PLT, identifies some key outstanding questions, and outlines the Bank's research program. The author concludes that, compared with the conventional wisdom that prevailed a decade ago, recent analysis is more promising for PLT. Nevertheless, the models that have been used so far often ignore some of the key potential benefits, or some of the key potential costs, associated with PLT. More research is needed before one can draw strong conclusions.
    Keywords: Monetary policy framework
    JEL: E52 E58
    Date: 2007
  5. By: Bauer, Christian; De Grauwe, Paul; Reitz, Stefan
    Abstract: We present a simple behavioral model with chartists and fundamentalists and analyze their trading behavior in a floating regime and in a target zone regime. Regarding the floating regime the model replicates the well-known stylized facts like excessive volatility, fat tails, volatility clustering and the exchange rate disconnect. When introducing a credible target zone the exchange rate remains for a considerably long period in the center of the band albeit the fundamental exchange rate does not exhibit mean reversion tendencies. The resulting hump-shaped distribution of the exchange rate greatly reduces the frequency of central bank intervention. The introduction of a target zone regime significantly reduces exchange rate volatility by decreasing speculative activity in the FX market.
    Keywords: Exchange rate, heterogeneous agents, target zones
    JEL: F31 F41
    Date: 2007
  6. By: Michael B Devereux (Centre for Economic Policy Research, University of British Columbia, and International Monetary Fund (E-mail: devm@
    Abstract: Although emerging market Asian economies have experienced high growth without crises for close to a decade, many commentators find the large buildup of foreign exchange reserves among these economies both puzzling and evidence of incipient global imbalances. This paper reviews some of the experience of Asian countries over the last decade. We focus on the degree to which Asian economies have experienced financial globalization, meaning that their gross external asset and liability positions have grown significantly. In particular, while Asian economies have become significant gross creditors in bonds and other fixed income assets, their liability position in equity and FDI assets has also grown significantly. We show that a simple dynamic general equilibrium model of portfolio choice in an emerging market economy can account for this trend remarkably well.
    Keywords: Asia, Financial Globalization, FDI, Foreign Exchange Rate Reserves
    JEL: E52 E58 F41
    Date: 2007–08
  7. By: Kathryn M. E. Dominguez (University of Michigan and NBER); Freyan Panthaki (London School of Economics)
    Abstract: Intervention operations are used by governments to manage their exchange rates but officials rarely confirm their presence in the market, leading inevitably to erroneous reports in the financial press. There are also reports of what we term, unrequited interventions, interventions that the market expects but do not materialize. In this paper we examine the effects of various types of intervention news on intra-day exchange rate behavior. We find that unrequited interventions have a statistically significant influence on returns, volatility and order flow, suggesting that the expectation of intervention, even when governments do not intervene, can affect currency values.
    JEL: F31 F33 G15
    Date: 2007
  8. By: Lutz Kilian (University of Michigan and CEPR); Alessandro Rebucci (International Monetary Fund); Nikola Spatafora (International Monetary Fund)
    Abstract: This paper studies the effects of demand and supply shocks in the global crude oil market on several measures of countries’ external balance, including the oil trade balance, the non-oil trade balance, the current account and changes in net foreign assets (NFA) during 1975– 2004. We explicitly take a multilateral and global perspective. In addition to the United States, the Euro area and Japan, we consider a number of regional aggregates including oil-exporting economies and middle-income oil-importing economies. Our first result is that the effect of oil shocks on the merchandise trade balance and the current account, which depending on the source of the shock can be large, depends critically on the response of the non-oil trade balance, and differs systematically between the United States and other oil importing countries. Second, using the Lane-Milesi-Ferretti NFA data set, we document the presence of large and systematic (if not always statistically significant) valuation effects in response to oil shocks, not only for the United States, but also for other oil-importing economies and for oil exporters. Our estimates suggest that increased international financial integration will tend to cushion the effect of oil shocks on NFA positions for major oil exporters and for the United States, but may amplify it for other oil importers.
    Keywords: Oil prices; External Balances; Oil demand Shocks; Oil supply Shocks; International Financial Integration.
    JEL: F32 F36 O16 O57 Q43
    Date: 2007
  9. By: Mihailov, Alexander; Ullrich, Katrin
    Abstract: The democratic accountability of policymaking institutions which are autonomous within delegated mandates has not received as much attention as their independence. We analyze in a theoretical model the effects of accountability in the form of possible overriding of economic policy decisions by the government under different degrees of independence of expert committees conducting monetary and fiscal policy. The equilibrium outcomes of such alternative institution-design frameworks are compared according to key macroeconomic performance criteria. Our results stress the trade-off between anchoring inflation expectations on target and output stabilization that is not solved with accountability.
    Keywords: Independence, accountability, monetary policy, fiscal policy, expert committees, institution design
    JEL: E52 E58 E61 E63
    Date: 2007
  10. By: Szilárd Erhart; Jose Luis Vasquez-Paz
    Abstract: Theoretical and empirical studies of different sciences suggest that an optimal committee consists of roughly 5-9 members, although it can swell mildly under specific circumstances. This paper develops a conceptual model in order to analyze the issue in case of monetary policy formulation. The optimal monetary policy committee (MPC) size varies according to the uncertainty of MPC members’ information influenced by the size of the monetary zone and overall economic stability. Our conceptual model is backed up with econometric evidence using a survey of 85 countries. The MPC size of large monetary zones (EMU, USA, Japan) is close to the estimated optimal level, but there exist several smaller countries with too many or too few MPC members.
    JEL: E50 E58
    Date: 2007–03
  11. By: Dino Gerardi (Cowles Foundation, Yale University); Leeat Yariv (CalTec)
    Abstract: The goal of this paper is to illustrate the significance of information acquisition in mechanism design. We provide a stark example of a mechanism design problem in a collective choice environment with information acquisition. We concentrate on committees that are comprised of agents sharing a common goal and having a joint task. Members of the committee decide whether to acquire costly information or not at the outset and are then asked to report their private information. The designer can choose the size of the committee, as well as the procedure by which it selects the collective choice, i.e., the correspondence between agents’ reports and distributions over collective choices. We show that the ex-ante optimal device may be ex-post inefficient, i.e., lead to suboptimal aggregation of information from a statistical point of view. For particular classes of parameters, we describe the full structure of the optimal mechanisms.
    Keywords: Collective choice, Mechanism design, Information acquisition
    JEL: D71 D72 D78
    Date: 2007–05
  12. By: Plasmans, J.E.J.; Fornero, J.; Michalak, T. (Tilburg University, Center for Economic Research)
    Abstract: Numerical simulations of the two-country sectoral model are provided for a relatively large number of structural shocks as domestic and foreign productivity shocks in final tradables and non-tradables, money demand shocks and a shock in the exchange rate. Such a model is well suited for monetary policy analysis at the international level and risk analysis.
    Keywords: New Keynesian open economy model;tradable and non-tradable sectors;final and intermediate goods;log-linearization.
    JEL: E31 D21 F41 P24
    Date: 2007
  13. By: Juan Angel Garcia (Europena Central Bank); Adrian van Rixtel (Banco de España)
    Abstract: Inflation-linked bond markets have experienced significant growth in recent years. This growth is somewhat surprising, for inflation-linked bonds cannot be considered a financial innovation and their development has taken place in a period of historically low global inflation and inflation expectations. In this context, the purpose of this paper is twofold. First, it provides a selective survey of the key arguments for and against the issuance of inflation-linked debt, and some of the factors that help to understand their recent growth. Second, it illustrates the use of these instruments to better monitor investors’ inflation expectations and growth prospects from a central bank perspective.
    Keywords: central banks, monetary policy, inflation-linked bonds, break-even inflation rates
    JEL: E44 E52 E58 G10
    Date: 2007–08
  14. By: Ligthart, J.E.; Da Silva, J. (Tilburg University, Center for Economic Research)
    Abstract: The paper empirically investigates the determinants of currency invoicing in Dutch goods trade with OECD countries. To this end, a currency-share systems approach is employed, which is applied to quarterly panel data for 1987?1998. One of the key findings is that a country?s share of producer currency pricing falls if demand in the foreign export market falls. In addition, we find that the better developed the partner country?s banking sector and the larger its share in world trade, the lower is the share of Dutch guilder invoicing. A higher expected rate of inflation in the partner country increases Dutch guilder invoicing. The depth of the foreign exchange market of a currency, a country?s share in world trade, and a country being part of the European Union are key determinants of vehicle currency use.
    Keywords: invoicing currency;Grassman?s law;exchange rate risk;local currency pricing;producer currency pricing;vehicle currencies
    JEL: F14 F31
    Date: 2007
  15. By: Mehrotra, Aaron (BOFIT); Peltonen, Tuomas (BOFIT); Santos Rivera, Alvaro (BOFIT)
    Abstract: We model provincial inflation in China during the reform period. In particular, we are interested in the ability of the hybrid New Keynesian Phillips Curve (NKPC) to capture the inflation process at the provincial level. The study highlights differences in inflation formation and shows that the NKPC provides a reasonable description of the inflation process only for the coastal provinces. A probit analysis suggests that the forward-looking inflation component and the output gap are important inflation drivers in provinces that have advanced most in marketisation of the economy and have most likely experienced excess demand pressures. These results have implications for the relative effectiveness of monetary policy across the Chinese provinces.
    Keywords: China; inflation; regional; New Keynesian Philips Curve; GMM
    JEL: C22 E31
    Date: 2007–08–29
  16. By: Stefan Gerlach (Bank for International Settlements); Wensheng Peng (Hong Kong Monetary Authority)
    Abstract: We estimate output gaps using three methods for Mainland China on annual data spanning 1982-2003. The estimates are similar and appear to co-move with inflation. Standard Phillips curves, however, do not fit the data well. This may reflect the omission of some important variable(s) such as the effect of price deregulation, trade liberalisation and/or changes in the exchange rate regime. We reestimate the Phillips curves assuming that there is an unobserved variable that follows an AR(2) process. The modified model fits the data much better and accounts for some of the surprising features of the simple Phillips curve estimates.
    Keywords: output gap, Phillips curve, China, omitted variab les
    JEL: C22 E30 E40 E53
    Date: 2005–11
  17. By: Guonan Ma; Robert N. McCauley
    Abstract: The paper argues that China's capital controls remain substantially binding. This has allowed the Chinese authorities to retain some degree of short-term monetary autonomy, despite the fixed exchange rate up to July 2005. Although the Chinese capital controls have not been watertight, we find sustained and significant gaps between onshore and offshore renminbi interest rates and persistent dollar/renminbi interest rate differentials during the period of a de facto dollar peg. While some cross-border flows do respond to market expectations and relative yields, they have not been large enough to equalise onshore and offshore renminbi yields.
    Keywords: Foreign exchange market, capital flows, capital controls, monetary policy, financial stability and the Chinese economy
    Date: 2007–08
  18. By: Jian Gao (China Development Bank); Gang Gong (School of Economics and Management, Tsinghua University); Xue-Zhong He (School of Finance and Economics, University of Technology, Sydney)
    Abstract: We investigate monetary policy under the assumption that a country?s capital market is ?open? under the WTO framework while the exchange rate is fixed. Our purpose is to determine if it is possible in this case for the economy to maintain an effective monetary policy for stabilizing the domestic economy. For this, we suggest two institutional restrictions. Given the restrictions, we demonstrate within a macro-dynamic model that monetary policy can still be effective. The implication of such an institutional design for an exchange rate regime is also discussed with special reference to small and less development economies.
    Keywords: open economy trilemma; macroeconomic stability; exchange rate regime
    JEL: E12 E32 C62
    Date: 2007–07–01
  19. By: Alok Johri
    Abstract: This paper presents a DGE model in which aggregate price level inertia is generated endogenously by the optimizing behaviour of price setting ?rms. All the usual sources of inertia are absent here ie., all fi?rms are simultaneously free to change their price once every period and face no adjustment costs in doing so. Despite this, the model generates persistent movements in aggregate output and in?ation in response to a nominal shock. Two modi?cations of a standard one-quarter pre-set price model deliver these results: learning-by-doing and habit formation in leisure.
    Keywords: Endogenous price stickiness, Business Cycles, Inflation, Nominal rigidities, Learning-by-doing, Habit formation, Propagation mechanisms, Persistence.
    JEL: E3
    Date: 2007–08
  20. By: Ernst Fehr; Lorenz Goette
    Abstract: Recent studies found evidence for nominal wage rigidity during periods of relatively high nominal GDP growth. It has been argued, however, that in an environment with low nominal GDP growth, when nominal wage cuts become customary, workers’ opposition to nominal cuts would erode and, hence, firms would no longer hesitate to reduce nominal pay. If this argument is valid nominal wage rigidity is largely irrelevant because in a high-growth environment there is little need to cut nominal pay while in a low-growth environment the necessary cuts would occur. To examine this argument we use data from Switzerland where nominal GDP growth has been very low for many years in the 1990s. We find that the rigidity of nominal wages is a robust phenomenon that does not vanish in a low growth environment. In addition, it constitutes a considerable obstacle to real wage adjustments. In the absence of downward nominal rigidity, real wages would indeed be quite responsive to unemployment. Moreover, the wage sweep-ups caused by nominal rigidity are strongly correlated with unemployment suggesting that downward rigidity of nominal wages indeed contributes to unemployment.
    Date: 2007–06
  21. By: Lemke, Wolfgang
    Abstract: A joint model of macroeconomic and term structure dynamics is specified and estimated for the euro area. The model comprises a backward-looking Phillips curve, a dynamic IS equation, a monetary policy rule as well as a specification of the dynamics of trend growth and the natural real interest rate. Under the condition of no arbitrage, yields of all maturities are affine functions of the macroeconomic driving forces. With the exception of a shock to potential output growth, the response of short-term yields to macroeconomic shocks is generally stronger than that of long-term yields. Impulse responses of all bond yields are fairly persistent, which reflects the persistence of their macroeconomic driving forces. Across the whole maturity spectrum, about ninety percent of the variation in yields is explained jointly by monetary policy shocks and shocks to the natural real rate of interest; the relative contribution of the latter shock increases with time to maturity. Cost-push shocks explain at most eight percent, while shocks to the output gap play an even less important role.
    Keywords: affine term structure models, monetary policy, euro area
    JEL: E32 E43 G12
    Date: 2007
  22. By: Michael Binder (Frankfurt University and CFS); Christian Offermanns (Frankfurt University and Deutsche Bundesbank)
    Abstract: In this paper we revisit medium- to long-run exchange rate determination, focusing on the role of international investment positions. To do so, we develop a new econometric framework accounting for conditional long-run homogeneity in heterogeneous dynamic panel data models. In particular, in our model the long-run relationship between effective exchange rates and domestic as well as weighted foreign prices is a homogeneous function of a country’s international investment position. We find rather strong support for purchasing power parity in environments of limited negative net foreign asset to GDP positions, but not outside such environments. We thus argue that the purchasing power parity hypothesis holds conditionally, but not unconditionally, and that international investment positions are an essential component to characterizing this conditionality. Finally, we adduce evidence that whether deterioration of a country’s net foreign asset to GDP position leads to a depreciation of that country’s effective exchange rate depends on its rate of inflation relative to the rate of inflation abroad as well as its exposure to global shocks.
    Keywords: Exchange Rate Determination, International Financial Integration, Dynamic Panel Data Models
    JEL: F31 F37 C23
    Date: 2007–08–23
  23. By: Shelley, Gary; Wallace, Frederick
    Abstract: This paper tests for long run neutrality (LRN) of money with respect to real expenditures in the U.S. over the 1947-2004 period. Real consumption and investment expenditures, as well as their broadly defined components, are examined. We also test for the effects of money on long run reallocations of GDP among durables, nondurables, and services. The time series characteristics of each variable are rigorously investigated. This is followed by application of the LRN test, introduced by Fisher and Seater (1993), to each real expenditures series. Although rejections of LRN occur in a number of studies, our results support long run neutrality of money with respect to real expenditures regardless of the level of data aggregation.
    Keywords: Money neutrality; consumption; investment
    JEL: E52 E20
    Date: 2006–03
  24. By: Christian M. Oberpriller
    Abstract: The present paper extends the Obstfeld and Rogoff (2005) framework of current account imbalances by the oil exporting countries as a fourth region. It sets the stage for a variety of analysis that can be conducted within a four-region-setting that accounts for the importance of OPEC as a major current account surplus provider in the process of narrowing global current account imbalances. We find that including the oil exporting countries as an additional region consisting of OPEC and Russia lowers the adjustment effects predicted by Obstfeld and Rogoff. Depending on different assumptions on how global imbalances might be eliminated, our model predicts a real dollar depreciation in the range of 29.9 to 52.6 percent.
    Keywords: current account, exchange rates, global imbalances
    JEL: F31 F32 F41
    Date: 2007–07
  25. By: Christian M. Oberpriller
    Abstract: This paper analyzes two effects which might have an important impact on a reduction of global external imbalances. These are valuation effects on the one hand and interest rate effects on the other hand. We use a four-region model that is based on the models by Obstfeld and Rogoff (2005) and Oberpriller (2007) to analyze the difference in the occurring exchange rate changes with and without valuation and interest rate effects under two different scenarios of narrowing global imbalances. The outcome is a reduced need for real dollar depreciation because the United States will largely benefit from valuation gains on their foreign assets while the effect that stems from interest rate changes works in the opposite direction but is not as strong as the valuation effect. The magnitude of valuation and interest rate effects reduce the need for real exchange rate depreciation by two to four percentage points.
    Keywords: current account, exchange rates, valuation effects, global imbalances
    JEL: F31 F32 F41
    Date: 2007–07
  26. By: Bill Martin
    Abstract: This comment provides a simple analytical exposition of the stock-flow consistent closed economy model used by Godley and Lavoie (2007b) to argue a case for fiscal stabilization policy. We show that the government spending stabilisation rule proposed by Godley and Lavoie (GL) is equivalent to an optimal-output budget deficit rule that automatically ensures budget solvency as long as private sector saving behaviour is itself stable. Assuming a non-inflationary full-employment objective, we derive an optimal government-spending rule. We endorse GL's view that fiscal policy needs to be "appropriate" if monetary policy is to be actively pursued. The main requirement of fiscal policy is a government debt rule to avoid instabilities arising from the accumulation of debt interest payments. Godley and Lavoie (2007a) simulate such instabilities but do not propose a solution. We do so and derive an optimal monetary rule. The theoretical substitutability of policy rules raises important questions about the wisdom of macroeconomic stabilization strategies that relegate fiscal policy to a purely supporting role.
    Keywords: Stock-flow consistency, fiscal policy, monetary policy, fiscal solvency, optional policy rules.
    JEL: E12 E62 F41
    Date: 2007–06
  27. By: Martin Skala (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Christian Thimann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Regine Wölfinger (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The present paper does not claim to solve the Columbus’ egg conundrum. There even may not be a “silver bullet” formula that would convince the entire membership. However, there may be a simpler, more transparent formula that produces more intuitive and more equitable results for the distribution of quotas across the membership. The paper aims to provide an extensive, comprehensive and hopefully useful overview of the various technical issues involved in choosing an appropriate quota formula. It offers a detailed analysis of the current quota system, illustrating its functioning and showing which countries and groups are most under and over-represented. It also puts forward an analysis of the various avenues of reform that are currently under discussion. To illustrate the main directions of the current reform efforts, it presents three benchmark formulae that could be useful in these discussions. This paper has been motivated by ongoing work at the European Central Bank (ECB) on issues related to the IMF and the international monetary system. The ECB has also been asked to support EU Member States’ reflections on quota reform by providing technical analysis of different options through various simulations. The motivation to write the paper has been inspired by the analysis provided during 2006 and 2007 to the Subcommittee on IMF and related issues (SCIMF) of the Economic and Financial Committee of the EU, and the numerous discussions with SCIMF members that offered helpful insights into this complex matter, which are gratefully acknowledged. The issue of quotas and IMF governance is also of interest to the ECB itself. The implications of the current debate on the set-up and the operation of the IMF will have an important bearing on the functioning of the international monetary system and the global economy, in which the euro area as the world’s largest trading partner and the euro as the world’s second international currency play a significant role and have an important stake. Although the euro area is not a member country of the IMF, all its participating countries are IMF members, and the ECB has observer status at the IMF’s Executive Board. Nevertheless, it should be stressed that any views expressed in this paper are solely those of the authors and should not be seen as the official views of the ECB.
    Date: 2007–08
  28. By: Colavecchio , Roberta (BOFIT); Funke, Michael (BOFIT)
    Abstract: This paper estimates switching autoregressive conditional heteroscedasticity (SWARCH) time series models for weekly returns of nine Asian forward exchange rates. We find two regimes with different volatility levels, whereby each regime displays considerable persistence. Our analysis provides evidence that the knock-on effects from China´s U.S. dollar future rates upon other Asian countries have been modest, in that little evidence exists for co-dependence of volatility regimes.
    Keywords: China; renminbi; Asia; forward exchange rates; non-deliverable forward market; SWARCH models
    JEL: C22 F31 F36
    Date: 2007–08–29
  29. By: Hiroshi Fujiki (Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; nd Akiko Terada-Hagiwara (Institute for Monetary and Economic Studies, Bank of Japan)
    Abstract: This paper examines the degree of integration into world financial markets and the impacts on several key macroeconomic variables of selected East Asian economies, and draws policy implications. According to our analysis, the degrees of integration into world financial markets in those economies are increasing. Regarding the impacts of increasing integration into world financial markets on several macroeconomic variables, we find three results. First, casual two-way plots among macroeconomic variables do not support the theoretical prediction of reduction in relative consumption volatility. Second, the saving-investment correlation is higher than those of the euro area economies. Third, the degrees of smoothing of idiosyncratic shock by cross-holding of financial assets are lower than the euro area economies. These results suggest two policy implications. First, there is some room for improvement in welfare gains in those economies by means of further risk sharing. Second, holding all other conditions equal, the increasing integration into world financial markets alone is unlikely to provide a sound ground for a currency union in East Asia at this stage.
    Keywords: Exchange rate regime, financial integration, risk sharing
    JEL: F33 F36
    Date: 2007–08
  30. By: Stan du Plessis (Department of Economics, Stellenbosch University); Ben Smit (Bureau of Economic Research, Stellenbosch University); Federico Sturzenegger (Kennedy School of Government, Harvard University)
    Abstract: This paper uses a structural VAR methodology to identify aggregate demand and supply shocks to real output for the South African economy. Demand shocks, in turn, are separated into fiscal and monetary shocks. The model is estimated with quarterly data over two overlapping samples: 1960Q2-2006Q4 and 1983Q4-2006Q4. The identified (structural) shocks were used in a historical decomposition to split output into a measure of potential output (resulting from the evolution of supply shocks) and a measure of the business cycle (the gap between actual and potential output). This measure of potential output suggests a significant decline relative to trend in the years prior to the political transition of 1994 and a swift reversal thereafter. The paper presents evidence from three sources to support its identification of aggregate supply and demand shocks. These sources are the following: theory consistent impulse response functions; a close match between the implied measure of the business cycle and independent information about the South African business cycle; and a demonstration of the close match between the identified series of aggregate supply shocks and important historical events in the decades prior to and following 1994 that have been identified by economic historians as important shocks to the South African economy.
    Keywords: South Africa, aggregate supply, aggregate demand, monetary policy, fiscal policy, potential output, long-run restrictions
    JEL: C25 C41 E32
    Date: 2007
  31. By: PANAGIOTIDIS, Theodore; TRIAMPELLA, Afroditi
    Abstract: This paper discusses the argument for Central Bank Independence (CBI) in the case of Greece. Using a time series approach and the last data available before Greece joined the EMU , the hypothesis that Central Bank Independence is important for controlling inflation is examined. Employing two indices, which serve as proxies for CBI, LegalCBI and TOR, the inverse relationship between CBI and inflation was confirmed. The interactions between the variability of inflation and CBI were also investigated. Furthermore, evidence was found to suggest that the rate of turnover Granger causes inflation.
    Date: 2006–01–01
  32. By: María I. Campos; José L. Torres; Esmeralda Villegas
    Abstract: This paper studies the credibility of the Venezuela crawling-band exchange rate regime during the period July, 1996-February, 2002. We show that, introducing some modifications, the credibility analysis widely applied to target zone regimes can also be used in studying the credibility of crawling- band regimes. In analyzing the credibility of the Venezuela crawling band, first we use the so-called simple credibility tests developed by Svensson (1991). Additionally, we estimate the expected rate of realignment using the drift- adjustment method. Both the credibility tests and the drift-adjustment method give similar results, showing that the crawling-band system was highly credible during the period.
    Date: 2006–04–01

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