nep-cba New Economics Papers
on Central Banking
Issue of 2007‒09‒16
fifty-two papers chosen by
Alexander Mihailov
University of Reading

  1. On the Optimal Choice of a Monetary Policy Instrument By Andrew Atkeson; V. V. Chari; Patrick J. Kehoe
  2. Globalisation and Inflation in OECD Countries By Gernot Pehnelt
  3. Leadership in Groups: A Monetary Policy Experiment By Alan S. Blinder; John Morgan
  4. Information Aggregation in Spatial Committee Games By Vincent Anesi
  5. The Macroeconomic Effects of Oil Price Shocks: Why are the 2000s so different from the 1970s? By Olivier J. Blanchard; Jordi Galí
  6. Three great American disinflations By Michael Bordo; Christopher Erceg; Andrew Levin; Ryan Michaels
  7. Testing Globalization-Disinflation Hypothesis By Calani, Mauricio
  8. The Breakup of the Euro Area By Barry Eichengreen
  9. Europe and Global Imbalances By Gian Maria Milesi-Ferretti; Philip R. Lane
  10. Financing of Global Imbalances By W. Christopher Walker; Maria Teresa Punzi
  11. Current Account Adjustment: Some New Theory and Evidence By Jiandong Ju; Shang-Jin Wei
  12. The optimal inflation target in an economy with limited enforcement By Gaetano Antinolfi; Costas Azariadis; James B. Bullard
  13. Adjustment of the US current account deficit By Kortelainen, Mika
  14. Toward a Bias Corrected Currency Equivalent Index By Kelly, Logan; Barnett, William; Keating, John
  15. Comparing Greenbook and Reduced Form Forecasts using a Large Realtime Dataset By Jon Faust; Jonathan H. Wright
  16. Essential Interest-Bearing Money By Andolfatto, David
  17. Rationalizable Expectations By Elchanan Ben-Porath; Aviad Heifetz
  18. Growth and Inflation Dispersions in EMU: Reasons, the Role of Adjustment Channels, and Policy Implications By Emil Stavrev
  19. A Simple DGE Model for Inflation Targeting By Jaromir Benes; David Vávra; Marta de Castello Branco
  20. Notes on the inflation dynamics of the New Keynesian Phillips Curve By Andreas Hornstein
  21. Money Shocks in a Small Open Economy with Dollarization, Factor Price Rigidities, and Nontradeables By Sarajevs, Vadims
  22. The Impact of Monetary Policy Shocks on Stock Prices: Evidence from Canada and the United States By Yun Daisy Li; Talan B. Iscan; Kuan Xu
  23. What Has Financed Government Debt? By Hess Chung; Eric Leeper
  24. The Discipline-Enhancing Role of Fiscal Institutions: Theory and Empirical Evidence By Xavier Debrun; Manmohan S. Kumar
  25. Fiscal Adjustments: Determinants and Macroeconomic Consequences By Daniel Leigh; Alexander Plekhanov; Manmohan S. Kumar
  26. One for Some or One for All? Taylor Rules and Interregional Heterogeneity By Olivier Coibion; Daniel Goldstein
  27. Win or Lose, It’s the Policy We Choose: Comparative economic performance of the inflation targeters By Beja, Jr., Edsel
  28. Where Have the Monetary Surprises Gone? The Effects of FOMC Statements By Andrew Swiston
  29. Real currency appreciation in accession countries: Balassa-Samuelson and investment demand By Fischer, Christoph
  30. Factor Analysis in a Model with Rational Expectations By Andreas Beyer; Roger E. A. Farmer; Jérôme Henry; Massimiliano Marcellino
  31. Exchange rate regimes and nominal convergence in the CEECs By Järvinen , Marketta
  32. Fiscal Explanations for Inflation: Any Evidence from Transition Economies? By Komulainen, Tuomas; Pirttilä , Jukka
  33. Quasi-fiscal operations of central banks in transition economies By Markiewicz , Malgorzata
  34. Similarity of supply and demand shocks between the Euro area and the CEECs By Fidrmuc, Jarko; Korhonen, Iikka
  35. What Explains Persistent Inflation Differentials Across Transition Economies? By Mark J Flanagan; Felix Hammermann
  36. Measuring Central Bank Independence in Selected Transition Countries and the Disinflation Process By Dvorsky , Sandra
  37. Some empirical tests on the integration of economic activity between the Euro area and the accession countries By Korhonen , Iikka
  38. Interpreting real exchange rate movements in transition countries By Broeck, Mark De; Sløk , Torsten
  39. Investigating the Balassa-Samuelson hypothesis in transition: Do we understand what we see? By Égert , Balázs
  40. Equilibrium Exchange Rates in Transition Countries: Evidence from Dynamic Heterogeneous Panel Models By Kim, Byung-Yeon; Korhonen, Iikka
  41. A forewarning indicator system for financial crises: the case of six Central and Eastern European countries By Irene Andreou; Gilles Dufrénot; Alain Sand; Aleksandra Zdzienicka-Durand
  42. Currency Crises in Emerging Markets: Capital Flows and Herding Behaviour By Komulainen , Tuomas
  43. The quest for a fiscal rule: Italy, 1861-1998 By Ricciuti, Roberto
  44. Money, Barter and Inflation in Russia By Kim, Byung-Yeon; Pirttilä, Jukka; Rautava , Jouko
  45. The role of oil prices and the real exchange rate in Russia's economy By Rautava , Jouko
  46. A Small Macroeconomic Model to Support Inflation Targeting in Israel By Argov, Eyal; Binyamini, Alon; Elkayam, David; Rozenshtrom, Irit
  47. Inflation Targeting in Georgia: Are We There Yet? By Andreas Billmeier; Giorgi Bakradze
  48. Determinants of Inflation in Poland: A Structural Cointegration Approach By Kim , Byung-Yeon
  49. Monetary Policy Rules for Managing Aid Surges in Africa By Edward F. Buffie; Christopher Adam; Catherine A. Pattillo; Stephen A. O'Connell
  50. Substituting a Substitute Currency – The Case of Estonia By Heimonen , Kari
  51. Monetary Policy In Islamic Economic Framework: Case of Islamic Republic of Iran By Kiaee, Hasan
  52. The international transmission of monetary shocks in a dollarized economy: The case of USA and Lebanon By Charbel Cordahi; Jean-François Goux

  1. By: Andrew Atkeson; V. V. Chari; Patrick J. Kehoe
    Abstract: The optimal choice of a monetary policy instrument depends on how tight and transparent the available instruments are and on whether policymakers can commit to future policies. Tightness is always desirable; transparency is only if policymakers cannot commit. Interest rates, which can be made endogenously tight, have a natural advantage over money growth and exchange rates, which cannot. As prices, interest and exchange rates are more transparent than money growth. All else equal, the best instrument is interest rates and the next-best, exchange rates. These findings are consistent with the observed instrument choices of developed and less-developed economies.
    JEL: E3 E31 E4 E42 E51 E52 E58 E6 E61
    Date: 2007–09
  2. By: Gernot Pehnelt (Friedrich-Schiller University Jena, School of Business and Economics Author-Workplace-Postal: Carl-Zeiss-Str. 3, D-07743 Jena)
    Abstract: During the last two decades, the world has experienced a remarkable process of disinflation, with average inflation rates in industrialized countries falling by 10 percentage points and an even sharper decline of the mean rate of inflation in developing countries. Parallel to the decline in inflation rates, a tremendous increase in economic integration - often referred to as globalisation - has been taking place. In this article, we analyse the effects of globalisation on inflation in OECD countries. We theoretically outline different channels through which globalisation may have influenced inflation dynamics and give an overview on the existing empirical evidence on this issue. In the empirical analysis we show that globalisation has contributed to the disinflation process in OECD countries since the 1980s. Inflation rates became much less prone to domestic parameters, especially the domestic output gap. Global factors such as the output gap of the main trading partners became more important in determining national inflation rates. Furthermore, economic freedom and the degree of globalisation are positively related to the disinflation process. Central bank independence seems to have contributed to the decline in inflation rates among OECD countries process, but the effect is rather modest. Though the inertia of inflation can still be observed, the persistence of inflation has considerably declined since the early 1990s.
    Keywords: inflation, globalisation, openness, panel analysis
    JEL: E30 E31 E58 F41
    Date: 2007–09–10
  3. By: Alan S. Blinder; John Morgan
    Abstract: In an earlier paper (Blinder and Morgan, 2005), we created an experimental apparatus in which Princeton University students acted as ersatz central bankers, making monetary policy decisions both as individuals and in groups. In this study, we manipulate the size and leadership structure of monetary policy decisionmaking. We find no evidence of superior performance by groups that have designated leaders. Groups without such leaders do as well as or better than groups with well-defined leaders. Furthermore, we find rather little difference between the performance of four-person and eight-person groups; the larger groups outperform the smaller groups by a very small margin. Finally, we successfully replicate our Princeton results, at least qualitatively: Groups perform better than individuals, and they do not require more "time" to do so.
    JEL: E52 E58
    Date: 2007–09
  4. By: Vincent Anesi (University of Nottingham)
    Abstract: This paper introduces information aggregation into the standard spatial committee game. We assume that committee members must agree on a decision rule to aggregate their private information on a policy-relevant state of the world. We derive sucient conditions for the ex ante incentive compatible core to be nonempty, and provide some characterization results for incentive compatible core decision rules, called "durable decision rules". In particular, core points of the underlying complete-information game are shown to be constant, durable decision rules of the game with incomplete information if they satisfy some robustness property. Moreover, we show that durable decision rules exist whenever information is Pareto-improving relative to the core of the underlying complete-information game, provided that voters' private signals are weakly informative.
    Keywords: Core existence, Incentive compatibility, Information aggregation, Committee
    JEL: C71 D71 D78 D82
    Date: 2007–08
  5. By: Olivier J. Blanchard; Jordi Galí
    Abstract: We characterize the macroeconomic performance of a set of industrialized economies in the aftermath of the oil price shocks of the 1970s and of the last decade, focusing on the differences across episodes. We examine four different hypotheses for the mild effects on inflation and economic activity of the recent increase in the price of oil: (a) good luck (i.e. lack of concurrent adverse shocks), (b) smaller share of oil in production, (c) more flexible labor markets, and (d) improvements in monetary policy. We conclude that all four have played an important role.
    Keywords: Great moderation, supply shocks, stagflation, monetary policy, real wage rigidities
    JEL: E20 E32 E52
    Date: 2007–08
  6. By: Michael Bordo; Christopher Erceg; Andrew Levin; Ryan Michaels
    Abstract: This paper analyzes the role of transparency and credibility in accounting for the widely divergent macroeconomic effects of three episodes of deliberate monetary contraction: the post-Civil War deflation, the post-WWI deflation, and the Volcker disinflation. Using a dynamic general equilibrium model in which private agents use optimal filtering to infer the central bank's nominal anchor, we demonstrate that the salient features of these three historical episodes can be explained by differences in the design and transparency of monetary policy, even without any time variation in economic structure or model parameters. For a policy regime with relatively high credibility, our analysis highlights the benefits of a gradualist approach (as in the 1870s) rather than a sudden change in policy (as in 1920-21). In contrast, for a policy institution with relatively low credibility (such as the Federal Reserve in late 1980), an aggressive policy stance can play an important signalling role by making the policy shift more evident to private agents.
    Keywords: Monetary policy - United States ; Deflation (Finance)
    Date: 2007
  7. By: Calani, Mauricio
    Abstract: This paper addresses the globalization - disinflation hypothesis from the perspective of a open economy neo keynesian framework. This hypothesis proposes that globalization has changed the long-run inflation process, resulting in a global disinflation. If true, it makes us wonder about the merit of central banks in this phenomenon. Even more, challenges our knowledge that long-run inflation is ultimately a monetary issue. This paper explicitly addresses this hyphotesis, analyzing how different degrees of globalization change the response of output and inflation to supply shocks. To accomplish this, the use of a general equilibrium approach in which we can identify shocks and openness is a must. Globalization is however, a complex process. In this paper I explicitly model globalization just as an openness process. Simulation results suggest that as long as there is one distortion - free market for assets, the discussion about the changed values of price stickiness measures which would affect the long-run inflation process is of reduced importance. It is also suggested that financial integration, and not trade or competition, is the key to understanding the link between globalization and inflation.
    Keywords: Disinflation; Globalization
    JEL: E31 E50
    Date: 2007–08–19
  8. By: Barry Eichengreen
    Abstract: The possibility that the euro area might break up was being raised even before the single currency existed. These scenarios were then lent new life five or six years on, when appreciation of the euro and problems of slow growth in various member states led politicians to blame the European Central Bank for disappointing economic performance. Highly-placed European officials reportedly discussed the possibility that one or more participants might withdraw from the monetary union. How seriously should we take these scenarios? And how significant would be the economic and political consequences? It is unlikely, I argue here, that one or more members of the euro area will leave in the next ten years; total disintegration of the euro area is even more unlikely. While other authors have minimized the technical difficulties of reintroducing a national currency, I suggest that those technical difficulties would be quite formidable. Nor is it certain that the economic problems of the participating member states would be significantly ameliorated by abandoning the euro. And even if there are immediate economic benefits, there would be longer-term political costs.
    JEL: F15 F33
    Date: 2007–09
  9. By: Gian Maria Milesi-Ferretti; Philip R. Lane
    Abstract: Although Europe in the aggregate is a not a major contributor to global current account imbalances, its trade and financial linkages with the rest of the world mean that it will still be affected by a shift in the current configuration of external deficits and surpluses. We assess the macroeconomic impact on Europe of global current account adjustment under alternative scenarios, emphasizing both trade and financial channels. Finally, we consider heterogeneous exposure across individual European economies to external adjustment shocks.
    Keywords: Working Paper , Financial integration , Capital flows , Europe , Current account balances ,
    Date: 2007–06–28
  10. By: W. Christopher Walker; Maria Teresa Punzi
    Abstract: This paper analyzes the determinants of bond flows, now the dominant source of capital inflows, into the United States, as a means of establishing conditions affecting the financing of the U.S. current account deficit. To test the hypothesis that capital flows have become more responsive to changes in relative interest rates and other conditions across borders, a panel data set, showing bond flows from 12 separate jurisdictions into the United States, is constructed for the period 1994-2006 using adjusted U.S. Treasury International Capital Flow (TIC) data. Panel vector autoregression and instrumental variables approaches are used to estimate the impact of changes in interest rate differentials and other fundamentals on capital flows into the U.S. The paper finds evidence for an impact from interest rate differentials to bond inflows that has increased over time. Under one plausible set of theoretical assumptions, the increased sensitivity can be interpreted as resulting from a reduction in home bias on the part of non-US investors.
    Date: 2007–07–23
  11. By: Jiandong Ju; Shang-Jin Wei
    Abstract: This paper aims to provide a theory of current account adjustment that generalizes the textbook version of the intertemporal approach to current account and places domestic labor market institutions at the center stage. In general, in response to a shock, an economy adjusts through a combination of a change in the composition of goods trade (i.e., intra-temporal trade channel) and a change in the current account (i.e., intertemporal trade channel). The more rigid the labor market, the slower the speed of adjustment of the current account towards its long-run equilibrium. Three pieces of evidence are provided that are consistent with the theory.
    JEL: E00 F3 F4
    Date: 2007–09
  12. By: Gaetano Antinolfi; Costas Azariadis; James B. Bullard
    Abstract: We formulate the central bank?s problem of selecting an optimal long-run inflation rate as the choice of a distorting tax by a planner who wishes to maximize discounted utility for a heterogeneous population of infinitely-lived households in an economy with constant aggregate income. Households are divided into cash agents, who store value in currency alone, and credit agents who have access to both currency and loans. The planner?s problem is equivalent to choosing inflation and nominal rates consistent with a resource constraint along with an incentive constraint that ensures credit agents prefer the superior consumption-smoothing power of loans to that of currency. We show that the optimum rate of inflation is positive, and the optimum nominal interest rate is higher than the inflation rate, if the social welfare function weighs credit agents no more than their population fraction.
    Keywords: Inflation (Finance) ; Deflation (Finance) ; Monetary policy - United States
    Date: 2007
  13. By: Kortelainen, Mika (Bank of Finland Research)
    Abstract: We present a two country DGE model and estimate it using Bayesian techniques and euro area and US quarterly data for 1977–2004. In analysing the current accounts we find that a lower US rate of time preference or a higher dollar risk premium could render the deficit sustainable, but that these could push the interest rate to the zero bound. Secondly, we find that fiscal policy is not sufficiently effective to improve the current account although the zero bound is not hit.
    Keywords: current account; zero bound; policy coordination
    JEL: E61 F32
    Date: 2007–09–12
  14. By: Kelly, Logan; Barnett, William; Keating, John
    Abstract: Measuring the economic stock of money, defined to be the present value of current and future monetary service flows, is a difficult asset pricing problem, because most monetary assets yield interest. Thus, an interest yielding monetary asset is a joint product: a durable good providing a monetary service flow and a financial asset yielding a return. The currency equivalent index provides an elegant solution, but it does so by making strong assumptions about expectations of future monetary service flows. These assumptions cause the currency equivalent index to exhibit significant downward bias. In this paper, we propose an extension to the currency equivalent index that will correct for a significant amount of this bias.
    Keywords: Currency Equivalent Index; Monetary Aggregation; Money Stock
    JEL: E49 C43
    Date: 2007–09–09
  15. By: Jon Faust; Jonathan H. Wright
    Abstract: Many recent papers have found that atheoretical forecasting methods using many predictors give better predictions for key macroeconomic variables than various small-model methods. The practical relevance of these results is open to question, however, because these papers generally use ex post revised data not available to forecasters and because no comparison is made to best actual practice. We provide some evidence on both of these points using a new large dataset of vintage data synchronized with the Fed's Greenbook forecast. This dataset consists of a large number of variables, as observed at the time of each Greenbook forecast since 1979. Thus, we can compare real-time large dataset predictions to both simple univariate methods and to the Greenbook forecast. For inflation we find that univariate methods are dominated by the best atheoretical large dataset methods and that these, in turn, are dominated by Greenbook. For GDP growth, in contrast, we find that once one takes account of Greenbook's advantage in evaluating the current state of the economy, neither large dataset methods nor the Greenbook process offers much advantage over a univariate autoregressive forecast.
    JEL: C32 C53 E32 E37
    Date: 2007–09
  16. By: Andolfatto, David
    Abstract: In this paper, I provide a rationale for why money should earn interest; or, what amounts to the same thing, why risk-free claims to non-interest-bearing money should trade at discount. I argue that interest-bearing money is essential when individual money balances are private information. The analysis also suggests one reason for why it is sufficient (as well as necessary) for interest to be paid only on large money balances; or equivalently, why bonds need only be issued in large denominations.
    Keywords: Money; Bonds; Monetary Policy; Friedman Rule
    JEL: E4
    Date: 2007–09–07
  17. By: Elchanan Ben-Porath; Aviad Heifetz
    Date: 2007–09–03
  18. By: Emil Stavrev
    Abstract: This paper's analysis of growth and inflation dispersions in the euro area reveals several findings. First, these dispersions have declined appreciably since EMU; remaining dispersions are small but persistent, relating mainly to country-specific shocks, not differences in the transmission of common shocks. Second, the different behavior of interest rates just before and after the introduction of the euro has contributed significantly to growth dispersions. However, this has been a one-off shock whose effects, particularly on construction, should be declining over time. Third, financial sector integration could do much more to insure countries against shocks and increase consumption smoothing.
    Keywords: Working Paper , Euro Area ,
    Date: 2007–07–17
  19. By: Jaromir Benes; David Vávra; Marta de Castello Branco
    Abstract: The paper presents a DGE model designed as a core projection tool to support monetary policy in inflation-targeting (IT) emerging market economies. The paper uses a particularly simple and flexible general equilibrium model structure that can be amended to account for various phenomena that often complicate policy analysis in emerging markets, such as persistent trends in relative prices. The model's calibration is intuitive and can draw on the vast experience many countries have with calibrating small 'gap' models of monetary policy transmission. Moreover, the definition of the model's steady state in terms of nominal expenditure ratios, rather than levels of real variables, allows for the easy use of the model in a regular forecast production cycle in an IT central bank. The paper tests the model's properties on recent Turkish data, demonstrating that the main stylized features relevant for monetary policy making are well captured by the model.
    Date: 2007–08–03
  20. By: Andreas Hornstein
    Abstract: These notes contain the derivations for results stated without proof in Hornstein (2007). First, I derive the log-linear approximation of the inflation dynamics in the Calvo-model with elements of backward-looking pricing when the approximation takes place around a positive average inflation rate. I derive a version of the "hybrid" New Keynesian Phillips Curve (NKPC) that can be estimated using standard GMM techniques. Second, I characterize the inflation dynamics implied by the NKPC when marginal cost follows an AR(1) process. For this purpose I derive the autocorrelation and crosscorrelation structure of inflation.
    Date: 2007
  21. By: Sarajevs, Vadims (BOFIT)
    Abstract: The impact of an unanticipated monetary shock in a small open economy with dollarization, factor price rigidities, and nontradeables is re-examined in an optimizing intertemporal general equilibrium model. The framework of an earlier study is extended to incorporate foreign real money balances into the repre-sentative agent's utility function and to account for the phenomenon of dollarization so characteristic of transition economies. The major finding is that in the event of small monetary shocks, the presence of dollarization does not alter the outcome that relates the sign of response of consumption, current account balance, and other macroeconomic variables to the difference between intertemporal and intratemporal elasticities of substitutions of the total consumption index. The solution also shows that the elasticity of intertemporal substitution of money services and the share of traded goods in total consumption - a proxy for openness of the economy - are the crucial parameters in determining the response and the possibility of overshooting of the model variables, with economic openness playing a stabilizing role for the econ-omy in the event of monetary shocks.
    Keywords: new open-economy macroeconomics; monetary shocks; dollarization; factor price rigidities; nontradeables; current account
    JEL: F31 F32 F41 F47
    Date: 2007–09–13
  22. By: Yun Daisy Li; Talan B. Iscan; Kuan Xu (Department of Economics, University of Western Ontario; Department of Economics, Dalhousie University; Department of Economics, Dalhousie University)
    Keywords: monetary policy shocks; stock prices; open economy; structural vector autoregressive model
    Date: 2007–09–12
  23. By: Hess Chung (Indiana University Bloomington); Eric Leeper (Indiana University Bloomington)
    Abstract: Equilibrium models imply that the real value of debt in the hands of the public must equal the expected present-value of surpluses. Empirical models of fiscal policy typically do not impose this condition and often do not even include debt. Absence of debt from empirical models can produce non-invertible representations, obscuring the true present-value relation, even if it holds in the data. First, we show that small VAR models of fiscal policy may not be invertible and that expanding the information set to include government debt has quantitatively important implications. Then we impose the present-value condition on an identified VAR and characterize the way in which the present-value support of debt varies across types of fiscal shocks. The role of expected primary surpluses in supporting innovations to debt depends on the nature of the shock. Debt is supported almost entirely by changes in the present-value of surpluses for some fiscal shocks, but for other fiscal shocks surpluses fail to adjust, leaving a large role for expected changes in discount rates. Horizons over which debt innovations are financed are long---on the order of 50 years or more.
    Keywords: fiscal policy, present-value restriction, taxes, government spending
    JEL: E6
    Date: 2007–09
  24. By: Xavier Debrun; Manmohan S. Kumar
    Abstract: This paper discusses the role of fiscal institutions, including budget rules and non-partisan agencies, in enhancing fiscal discipline. A dynamic model of fiscal policy shows that optimal institutions lack credibility unless the costs to bypass them are sufficiently high. In our model, a combination of complete budgetary transparency and strong democratic accountability suffice to establish credibility. Under incomplete budgetary transparency, accountable governments may also use institutions as a signal of competence to increase their reelection chances, which in turn erodes the penchant for excessive deficits. In light of the theory, empirical tests of the effectiveness of institutions are undertaken. The results further emphasize that analysis should pay due attention to simultaneity bias (because disciplined governments may be more likely to adopt strict institutions). Also, interactions among different fiscal institutions, and between the latter and key features of the political system need to be explored further.
    Date: 2007–07–18
  25. By: Daniel Leigh; Alexander Plekhanov; Manmohan S. Kumar
    Abstract: The paper analyzes the determinants of success of recent fiscal consolidations in the OECD countries as well as the short-run and long-run effects of fiscal adjustments on economic activity by looking at fourteen case studies, panel data for OECD countries, and the results of simulations using a non-Ricardian multi-country dynamic general equilibrium model. The study finds that while fiscal consolidations tend to have short-run contractionary effects, they can be expansionary in the long run, provided that they do not rely excessively on cuts in productive government expenditure. They can also create positive spillover effects for the rest of the world.
    Date: 2007–07–23
  26. By: Olivier Coibion (Department of Economics, College of William and Mary); Daniel Goldstein (Department of Economics, Pennsylvania State University)
    Abstract: We document a novel empirical phenomenon: both the US Federal Reserve and the European Central Bank appear to set interest rates partly in response to regional disparities in unemployment rates. This result is remarkably robust – particularly for the US – even after controlling for a wide variety of factors, including the central bank’s information set and a battery of explanatory variables. Furthermore, including measures of interregional unemployment dispersion improves the precision of the estimates of the central banks’ responses to aggregate inflation and unemployment rates. Moreover, inclusion of the variance of unemployment across regions brings each bank’s policies with respect to macroeconomic aggregates into alignment with each other. We propose three models in which central bank policymaking is influenced by disparities across regions. Testing specific implications of these models suggests that each bank’s approach to policy may differ in fundamental ways.
    Keywords: Regional Heterogeneity, Monetary Policy, Taylor Rules
    JEL: E5 E6
    Date: 2007–09–11
  27. By: Beja, Jr., Edsel
    Abstract: The inflation-growth relationship for the inflation targeters is estimated for the period 2001-2006. The results show that inflation is negatively correlated with economic growth, while the indicators for aggregate demand and aggregate supply are positively correlated with economic growth. The findings suggest that a combination of economic policies is more fruitful than a singular focus on inflation targeting. This conclusion is applicable to the case of the Philippines, where inflation is often driven by aggregate supply-linked factors rather than demand-linked factors.
    Keywords: Inflation targeting; inflation-growth tradeoff
    JEL: E30
    Date: 2007–04–25
  28. By: Andrew Swiston
    Abstract: This paper examines the impact of central bank communication on market expectations of monetary policy and long-term interest rates by comparing Federal Open Market Committee (FOMC) action dates when a policy statement was made to dates before statements were issued. Increased communication has been associated with a reduction in the magnitude of short-term monetary surprises; a greater flow of information about the long-term path of policy that is distinct from the short-term surprise; and a larger role for these long-term surprises in the determination of long-term interest rates.
    Keywords: Working Paper , United States ,
    Date: 2007–07–26
  29. By: Fischer, Christoph (BOFIT)
    Abstract: The Balassa-Samuelson effect is usually seen as the prime explanation of the continuous real appreciation of central and east European (CEE) transition countries' currencies against their western counterparts. The response of a small country's real exchange rate to various shocks is derived in a simple model. It is shown that productivity shocks work not only through a Balassa-type supply channel but also through an investment demand channel. Therefore, empirical evidence apparently in favour of Balassa-Samuelson effects may require a re-interpretation. The model is estimated for a panel of CEE countries. The results are consistent with the model, plausibly explain the observed real appreciation and support the existence of the proposed investment demand channel.
    Keywords: real exchange rate; Balassa-Samuelson effect; transition economies; panel
    JEL: C33 F31 F41
    Date: 2007–09–11
  30. By: Andreas Beyer; Roger E. A. Farmer; Jérôme Henry; Massimiliano Marcellino
    Abstract: DSGE models are characterized by the presence of expectations as explanatory variables. To use these models for policy evaluation, the econometrician must estimate the parameters of expectation terms. Standard estimation methods have several drawbacks, including possible lack or weakness of identification of the parameters, misspecification of the model due to omitted variables or parameter instability, and the common use of inefficient estimation methods. Several authors have raised concerns over the implications of using inappropriate instruments to achieve identification. In this paper we analyze the practical relevance of these problems and we propose to combine factor analysis for information extraction from large data sets and GMM to estimate the parameters of systems of forward looking equations. Using these techniques, we evaluate the robustness of recent findings on the importance of forward looking components in the equations of a standard New-Keynesian model.
    JEL: E5 E52 E58
    Date: 2007–09
  31. By: Järvinen , Marketta (BOFIT)
    Abstract: This paper examines, in the context of future EMU membership of the Central and Eastern European countries (CEECs), the interaction between fiscal policy and the price level in different exchange rate regimes. The theoretical framework is based on the Fiscal Theory of the Price Level (FTPL). The results show that a credibly fixed exchange rate is inconsistent with fiscal irresponsibility, while adopting the common currency enables the conduct of irresponsible policies with the result that a rise in the level of debt by one member country raises the common price level of the whole union.
    Keywords: exchange rate regimes; inflation; fiscal theory of the price level; transition economies
    JEL: E00 F33 O57
    Date: 2007–09–11
  32. By: Komulainen, Tuomas (BOFIT); Pirttilä , Jukka (BOFIT)
    Abstract: Recent arguments, motivated partly by the new fiscal theory of price level, suggest that fiscal deficits undermine price stability in transition economies. This paper addresses these claims by examining vector-autoregressive models of inflation for three crisis-hidden transition economies (Bulgaria, Romania and Russia). The results indicate that while fiscal deficits have increased inflation in Bulgaria to a certain extent, this has not been the case in Romania and Russia. Even in the Bulgarian case, the usual money aggregate has proven more influential to inflation than fiscal deficits. The analysis based on this method therefore suggests that monetary policy plays an influential role in inflation determination in these countries. In other words, inflationary financing of deficits, rather than deficits themselves, accounts for inflation.
    Keywords: fiscal policy; inflation; vector autoregressive models; transition economies
    Date: 2007–09–13
  33. By: Markiewicz , Malgorzata (BOFIT)
    Abstract: This paper reviews issues associated with quasi-fiscal operations (QFO) of central banks in a sample of countries in Central and Eastern Europe and the former Soviet Union. The concern is the problem of transparency in fiscal and monetary accounts when the central bank undertakes quasi-fiscal operations and the government falls short of providing full coverage of fiscal operations. QFO can also jeopardize monetary policy designed to maintain price stability. A simple framework is developed to estimate the extent of QFO. In some cases, the magnitude of QFO is significant in indicating underestimation of fiscal deficit figures. We claim that the lack of transparency in fiscal accounts of transition countries warrants serious concern.
    Keywords: quasi-fiscal operations; transition economy and transparency
    Date: 2007–09–12
  34. By: Fidrmuc, Jarko (BOFIT); Korhonen, Iikka (BOFIT)
    Abstract: We assess the correlation of supply and demand shocks between the countries of the euro area and the accession countries in the 1990s. Shocks are recovered from estimated structural VAR models of output growth and inflation. We find that some accession countries have a quite high correlation of the underlying shocks with the euro area. However, even for many advanced accession countries, the shocks remain significantly more idiosyncratic. Furthermore, many EU countries seem to have a much higher correlation with the core euro area countries than in the previous decades. Continuing integration within the EU seems to have aligned the business cycles of these countries as well.
    Keywords: optimum currency area; EMU; EU enlargement; structural VAR
    JEL: E32 F42
    Date: 2007–09–13
  35. By: Mark J Flanagan; Felix Hammermann
    Abstract: Panel estimates based on 19 transition economies suggests that some central banks may aim at comparatively high inflation rates mainly to make up for, and to perhaps exploit, lagging internal and external liberalization in their economies. Out-of-sample forecasts, based on expected developments in the underlying structure of these economies, and assuming no changes in institutions, suggest that incentives may be diminishing, but not to the point where inflation levels below 5 percent could credibly be announced as targets. Greater economic liberalization would help reduce incentives for higher inflation, and enhancements to central bank independence could help shield these central banks from pressures.
    Date: 2007–07–31
  36. By: Dvorsky , Sandra (BOFIT)
    Abstract: The paper measures the degree of legal and actual central bank independence (CBI) in five Central and Eastern European transition economies striving for EU accession, namely the Czech Republic, Hungary, Poland, Slovakia and Slovenia (CEEC-5). The degree of legal CBI is measured by applying the two most widely used indices, the Cukierman and the Grilli-Masciandaro-Tabellini (GMT) indices. Moreover, the turnover rate of central bank governors is used as a proxy to measure actual CBI. The paper gives an interpretation of computed results, comparing the findings with those of other authors and earlier calculations. Furthermore, the indices on legal and actual CBI themselves are critically reviewed, in particular against the background of the Maastricht Treaty requirements, which in practice constitute the driving force for any amendment of central bank laws in the CEEC-5. Moreover, the role of CBI in bringing down inflation in the CEEC-5 at different stages of transition is briefly discussed. The paper concludes that the overall degree of legal CBI is comparatively high in all countries examined, while the measured turnover rates of governors do not seem to fully reflect the degree of actual CBI in the CEEC-5. Looking at the role of CBI in the disinflation process at different stages of transition, the main causes for inflation seem to have been beyond the direct control of the central bank. A high degree of CBI, together with a reasonable mix of fiscal and monetary policies as well as structural reforms, will be necessary for the CEEC-5 to meet all requirements for joining the EU and, in a more distant future, for adopting the euro.
    Keywords: transition; central bank independence; disinflation
    Date: 2007–09–13
  37. By: Korhonen , Iikka (BOFIT)
    Abstract: This note looks at the correlation of short-term business cycles in the euro area and the EU accession countries. The issue is assessed with the help of vector autoregressive models. There are clear differences in the degree of correlation between accession countries. For Hungary and Slovenia, euro area shocks can explain a large share of variation in industrial production, while for some countries this influence is much smaller. For the latter countries, the results imply that joining the monetary union could entail reasonably large costs, unless their business cycles converge closer to the euro area cycle. Generally, for smaller countries the relative influence of the euro area business cycle is larger. Also, it is found that the most advanced accession countries are at least as integrated with the euro area business cycle as some small present member countries of the monetary union.
    Keywords: optimal currency area; monetary union; EU enlargement
    JEL: E32 F15 F42
    Date: 2007–09–13
  38. By: Broeck, Mark De (BOFIT); Sløk , Torsten (BOFIT)
    Abstract: Several transition countries have experienced strong real exchange rate appreciations. This paper tests the hypothesis that these appreciations reflect underlying productivity gains in the tradable sector. Using panel data over the period 1993–98, the results show clear evidence of productivity-driven exchange rate movements in the central and eastern European and Baltic countries. Transition countries, particularly the EU accession countries that have begun to catch up, can expect to experience further productivity-driven real exchange rate appreciations. Evidence from a large cross-section of non-transition countries indicates that catching up by one percent will be associated with a 0.4 percent real appreciation.
    Keywords: real exchange rates; transition; Balassa-Samuelson effects
    JEL: F30 G14 G15 P34
    Date: 2007–09–12
  39. By: Égert , Balázs (BOFIT)
    Abstract: This paper studies the Balassa-Samuelson effect in the Czech Republic, Hungary, Poland, Slovakia and Slovenia. Time series and panel cointegration techniques are used to show that the BS effect works reasonably well in these transition economies during the period 1991:Q1 to 2001:Q2. However, productivity growth does not fully translate into price in-creases due to the structure of CPI indexes. We thus argue that productivity growth will not hinder the ability of the five EU accession candidates to meet the Maastricht criterion on inflation in the medium term. Moreover, the observed appreciation of the CPI-deflated real exchange rate is found to be systematically higher compared to the real appreciation justi-fied by the Balassa-Samuelson effect, particularly in the cases of the Czech Republic and Slovakia. This may be partly explained by the trend appreciation of the tradable-goods-price-based real exchange rate, increases in non-tradable sector prices due to price liberali-sation and demand-side pressures, and the evolution of the nominal exchange rate due to the exchange rate regime and magnitude of capital inflows.
    Keywords: Balassa-Samuelson effect; productivity; real exchange rate; transition; panel cointegration
    JEL: E31 F31 O11 P17
    Date: 2007–09–11
  40. By: Kim, Byung-Yeon (BOFIT); Korhonen, Iikka (BOFIT)
    Abstract: We use a dynamic heterogeneous panel model to estimate real equilibrium exchange rates for advanced transition countries. Our method is based on out-of-sample estimations from middle-income and high-income countries, and we use a pooled mean group estimator. We find that exchange rates have converged in recent years in five transition countries (Czech Republic, Hungary, Poland, Slovakia, and Slovenia) with real equilibrium exchange rates expressed in the US dollars. However, we also find that the currencies of the transition countries studied are substantially overvalued if real effective exchange rates are used.
    Keywords: exchange rates; transition economies; dynamic heterogeneous panel estimations
    JEL: C33 F31 P27
    Date: 2007–09–12
  41. By: Irene Andreou (GATE CNRS); Gilles Dufrénot (Université Paris 12, GREQAM); Alain Sand (GATE CNRS); Aleksandra Zdzienicka-Durand (GATE CNRS)
    Abstract: We propose a measure of the probability of crises associated with an aggregate indicator, where the percentage of false alarms and the proportion of missed signals can be combined to give an appreciation of the vulnerability of an economy. In this perspective, the important issue is not only to determine whether a system produces true predictions of a crisis, but also whether there are forewarning signs of a forthcoming crisis prior to its actual occurrence. To this end, we adopt the approach initiated by Kaminsky, Lizondo and Reinhart (1998), analyzing each indicator and calculating each threshold separately. We depart from this approach in that each country is also analyzed separately, permitting the creation of a more “custom-made” early warning system for each one.
    Keywords: composite indicator, currency crisis, early warning system
    JEL: F31 F47
    Date: 2007–04
  42. By: Komulainen , Tuomas (BOFIT)
    Abstract: This study shows that due to herding behaviour and possible capital outflows, emerging market countries are vulnerable to multiple equilibria situations and currency crises. It uses a model by Jeanne (1997), where currency crises can be formed by multiple equilibria and self-fulfilling expectations. We determine the country fundamentals according to balance of payments approach. In this study we introduce capital flows, which depend from crisis probability, into the model. The capital flows are further assumed to follow herding behaviour, which produces a reason and mechanism for the large capital outflows witnessed during the recent crises. The range of country fundamentals, where self-fulfilling crises are possible, is now larger than without capital flows and herding behaviour. Consequently, the country fundamentals have to be better, if the country wants to stay totally out of crises. The model further points out lender interdependence as one shortcoming in the current structure of international capital markets. An empirical application of the model to the Mexican and Asian crises shows that when the possible capital outflows are included, the fundamentals of most emerging market countries were inside the range of multiple equilibria in 1994 and 1996, and so self-fulfilling crises were possible.
    Date: 2007–09–13
  43. By: Ricciuti, Roberto
    Abstract: The Italian fiscal history is characterised by a number of fiscal consolidations. In this paper we characterise fiscal policy in terms of non-linear deterministic processes. We find that government spending and taxes can be described as being non-linear trend stationary processes instead of unit roots. A long run equilibrium relationship - a non-linear co-trend - does exist between the two series, fulfilling the intertemporal government budget constraint. We interpret this result as evidence of a long run fiscal rule that different policy makers have adopted, putting public finance in balance.
    Keywords: taxes, government expenditure, intertemporal government budget constraint, non-linear trend stationarity, non-linear co-trending
    JEL: E62 H62 N10
    Date: 2007–09
  44. By: Kim, Byung-Yeon (BOFIT); Pirttilä, Jukka (BOFIT); Rautava , Jouko (BOFIT)
    Abstract: Using a macroeconometric framework, this paper analyses relationships among money, barter and inflation in Russia during the transition period. Following the development of a theoretical framework that introduces barter in a standard small open economy macro model, we estimate our model using structural cointegration and vector error correction methods. Our findings suggest that barter has resulted partly from output losses and partly from a reduction in real money balances, but to a lesser extent. There is some evidence that the effect of barter on prices is less than that of money. We also find that increases in barter are affected by banking failure. Our results imply that a macro model that excludes barter fails to capture all the relevant information for inference on money and inflation in Russia.
    Keywords: barter; money; inflation; cointegration; error-correction mechanism; Russia
    Date: 2007–09–13
  45. By: Rautava , Jouko (BOFIT)
    Abstract: Most people seem to think that Russia's economy and fiscal situation are still crucially tied up with international oil prices and the exchange rate of the rouble, although this view has recently been challenged by some analysts. Empirical research on this topic is, however, scanty. In this paper, the impact of international oil prices and the real exchange rate on Russia's economy and fiscal policy is analysed using VAR methodology and cointegration techniques. The research period covered is 1995:Q1 - 2001:Q3. The results indicate that in the long run a 10% permanent increase (decrease) in international oil prices is associated with a 2.2% growth (fall) in the level of Russian GDP. Respectively, a 10% real appreciation (depreciation) of the rouble is associated with a 2.4% decline (increase) in the level of output. These long-run equilibrium relationships also have a significant impact on short-run dynamics through an error-correction mechanism. The estimation results confirm also a strong dependence of fiscal revenues on output and oil price fluctuations. Estimated parameters and diagnostic statistics do not indicate that Russia's dependence on oil and the real exchange rate would somehow have weakened in recent years.
    Keywords: Russian economy; fiscal policy; oil; real exchange rate; VAR; cointegration
    Date: 2007–09–11
  46. By: Argov, Eyal; Binyamini, Alon; Elkayam, David; Rozenshtrom, Irit
    Abstract: This study presents a small New Keynesian model of Israel’s economy describing the relationships among the main variables relevant to the transmission mechanism of monetary policy. The model encompasses three structural equations––for inflation, the output gap, and the exchange rate––and an interest rate rule, that describes how the interest rate should be adjusted in order to eventually achieve the inflation target. The theory underlying the model is broadly in line with the current monetary theory prevailing in academia and central banks. The model is small, yet it includes the main channels through which the central bank’s interest rate affects inflation in a small open economy. An important advantage of a small model is its ability to describe, clearly and simply, the interrelation between the main variables that are related to the transmission mechanism of the monetary policy, while maintaining theoretical coherence. The model presented is intended to serve as an operational tool that can aid policy makers to assess the interest rate path required to achieve the inflation target, but it can also serve others interested in monitoring monetary developments or in forecasting the evolution of the relevant variables. The model can also help to focus the monetary-policy discussion and enhance the communication between the various entities, both within and outside the central bank, involved in monetary policy and its outcomes. To improve the forecasting ability of the model, in formulating the equations we tried to strike a balance between the need to maintain economic logic and the need to obtain an adequate empirical description of the relation between the relevant variables. The parameters of the model were estimated using quarterly data of Israel’s economy in the years 1992 to 2005.
    Keywords: MacroeconomicModel; Inflation Targeting; New Keynesian Model
    JEL: E5 E4
    Date: 2007–07
  47. By: Andreas Billmeier; Giorgi Bakradze
    Abstract: This paper evaluates whether Georgia is ready to adopt inflation targeting (IT), a monetary policy framework that several emerging markets have adopted recently. After reviewing selected prerequisites for successfully implementing IT, the paper focuses on whether one specific precondition is in place-an empirically stable monetary transmission mechanism. Building on a baseline VAR model, it presents several extensions to explore the various channels using causality tests, impulse responses, and variance decompositions. The paper finds that once the central bank overcomes some institutional and operational weaknesses and establishes a more reliable transmission mechanism, it could adopt IT over the medium term.
    Keywords: Inflation targeting , Georgia , Monetary policy , Monetary transmission mechanism , Working Paper ,
    Date: 2007–08–02
  48. By: Kim , Byung-Yeon (BOFIT)
    Abstract: Using cointegration and error-correction models, this paper analyses the relative impacts of the monetary, labour and foreign sectors on Polish inflation from 1990 to 1999. Following the development of a theoretical framework, we use a structural system approach in which cointegration relationships are used to derive deviations from steady-state levels. The deviations are interpreted as excess demand pressure on inflation in a given sector and subsequently incorporated in order to determine the short-run dynamics of Polish inflation. The results suggest that the labour and external sectors dominated the determination of Polish inflation during the above period, but their effects have been opposite since 1994. The appreciation of the domestic currency contributed to reducing inflation, while excessive wage increases prevented inflation from decreasing to a lower level. The monetary sector appears not to have exerted influence on inflation, suggesting monetary policy has been passive.
    Keywords: inflation; cointegration; error correction mechanism; Poland
    Date: 2007–09–13
  49. By: Edward F. Buffie; Christopher Adam; Catherine A. Pattillo; Stephen A. O'Connell
    Abstract: Since the turn of the century, aid flows to Africa have increased on average and become more volatile. As a result, policymakers, particularly in post-stabilization countries where inflation has only recently been brought under control, have been increasingly preoccupied with how best to deploy the available instruments of monetary policy without yielding on hard-won inflation gains. We use a stochastic simulation model, in which private sector currency substitution effects play a central role, to examine the properties of alternative monetary and fiscal policy strategies in the face of volatile aid flows. We show that simple monetary rules, specifically an (unsterilized) exchange rate crawl and a 'reserve buffer plus float'-under which the authorities set a time-varying reserve target corresponding to the unspent portion of aid financing and allow the exchange rate to float freely once this reserve target is satisfied-have attractive properties relative to a range of alternative strategies including those involving heavy reliance on bond sterilization or a commitment to a 'pure' exchange rate float.
    Date: 2007–07–26
  50. By: Heimonen , Kari (BOFIT)
    Abstract: This study evaluates substitution of foreign currency balances in Estonia, a transition economy neighbouring countries participating in EMU. The focus is on substitution between dollar and euro balances in the three basic functions of money - unit of account, store of value and means of payment. While traditional models for currency substitution concentrate on substitution between a domestic currency and aggregate foreign currency balances, we look for substitution between the dollar and the euro or euro-related foreign currency balances. We find substitution between dollarization and euroization to be asymmetric in the short run, which suggests that inertia, irreversibility and ratchet effects favour the euro. No significant evidence of asymmetries in the long run was detected. In general, the traditional model for currency substitution explains the dynamics of the euro and dollar as substitute foreign currencies.
    Keywords: euro; dollar; currency substitution; currency demand
    Date: 2007–09–13
  51. By: Kiaee, Hasan
    Abstract: Abstract When we accept money and its functions in the Islamic economic framework, the same as all other economic systems, we should consider monetary policy as an important available tool for governments to pursuit macroeconomic objectives. But the problem is that, in the conventional economic system, the interest rate plays a critical role for executing monetary policy while in the Islamic economic framework, interest rate is forbidden according to Shariah rules and we are not allowed to use interest based instruments for monetary policy. The dominant view between Islamic scholars is that, since interest based instruments like open market operation is forbidden in Islamic economics, hear, we should only use monetary aggregate instruments like credit ceiling for executing monetary policy. But in reality, many Islamic countries do not restrict theirselves to only monetary aggregate instruments; instead, they use widely profit rate instruments like Musharakah certificates as a substitute for interest based instruments. What we discuss in this paper is the explanation for this gap between theory and practice in the monetary policy of Islamic economic system. Comparing interest based instruments and monetary aggregate instruments from economic point of view shows that, when we use interest based instruments, there is more macroeconomic stability in goods and money markets after executing monetary policy. This advantage of interest based instruments over monetary aggregate instruments has made monetary officials of Islamic countries like Islamic republic of Iran, use extensively profit rate instruments like Musharakah certificates for executing monetary policy.
    Keywords: Islamic Economics; Islamic Monetary Policy; Iranian Monetary System
    JEL: E52 E43
    Date: 2007–04–13
  52. By: Charbel Cordahi (Université Saint Esprit de Kaslik (USEK), Kaslik); Jean-François Goux (GATE CNRS)
    Abstract: We show that an American monetary shock wields an influence, though limited, over the Lebanese output in accordance with the literature advances. However, as we are waiting for a stronger transmission of U.S. short-term rates to Lebanese short-term rates, we notice that this transmission is weak in the first year. The result can be explained by the presence of pricing-to-market. After the end of the first year, we find the traditional result where the increase in the American interest rate is transmitted integrally to the Lebanese interest rate. We recognize this phenomenon as the dollarization effect.
    Keywords: interest rate - International transmission - law of one price - monetary shock - purchasing power parity
    JEL: E3 E4 F3 F4
    Date: 2007–07

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