nep-cba New Economics Papers
on Central Banking
Issue of 2007‒10‒06
34 papers chosen by
Alexander Mihailov
University of Reading

  1. Will monetary policy become more of a science? By Frederic S. Mishkin
  2. Successes and Failures of Monetary Policy Since the 1950s By David Laidler
  3. International Portfolios with Supply, Demand and Redistributive Shocks By Coeurdacier, Nicolas; Kollmann, Robert; Martin, Philippe
  4. Monetary Policy in East Asia: Common Concerns By Marvin Goodfriend
  5. The Economic Impact of Central Bank Transparency: A Survey By Cruijsen, C. van der; Eijffinger, S.C.W.
  6. No-Arbitrage Taylor Rules By Andrew Ang; Sen Dong; Monika Piazzesi
  7. Escaping Nash and Volatile Inflation By Ellison, Martin; Yates, Tony
  8. Twin Deficits, Openness and the Business Cycle By Corsetti, Giancarlo; Müller, Gernot
  9. Monetary Policy, Default Risk and the Exchange Rate By Guimarães, Bernardo; Soares Gonçalves, Carlos Eduardo
  10. CONSTRUCTING HISTORICAL EURO AREA DATA By Heather Anderson; Mardi Dungey; Denise R. Osborn; Farshid Vahid
  11. Learning about Monetary Policy Rules when the Cost Channel Matters By Llosa Gonzalo; Tuesta Vicente
  12. The role of credit aggregates and asset prices in the transmission mechanism: a comparison between the euro area and the US By Sylvia Kaufmann; Maria Teresa Valderrama
  13. Real Wage Rigidities and the Cost of Disinflations By Guido Ascari; Christian Merkl
  14. Instability and nonlinearity in the Euro area Phillips curve. By Alberto Musso; Livio Stracca; Dick van Dijk
  15. Does the Federal Reserve Follow a Non-Linear Taylor Rule? By Kenneth Petersen
  16. Oil Shocks and Optimal Monetary Policy By Montoro Carlos
  17. Heterogeneous Consumers, Demand Regimes, Monetary Policy and Equilibrium Determinacy By Di Bartolomeo, Giovanni; Rossi, Lorenza
  18. Regional real exchange rates and Phillips curves in monetary unions - Evidence from the US and EMU By Jan Marc Berk; Job Swank
  19. Inflation persistence - euro area and new EU Member States. By Michal Franta; Branislav Saxa; Katerina Smidkova
  20. Reserve accumulation: objective or by-product? By Johannes Onno de Beaufort Wijnholds; Lars Søndergaard
  21. A Multivariate Perspective for Modeling and Forecasting Inflation's Conditional Mean and Variance By Matteo Barigozzi; Marco Capasso
  22. Monetary Policy in Dual Currency Environment By Felices Guillermo; Tuesta Vicente
  23. The role of the exchange rate for adjustment in Boom and Bust episodes. By Reiner Martin; Ludger Schuknecht; Isabel Vansteenkiste
  24. The Causes of Excessive Deficits in the European Union By Vítor Castro
  25. Inflation Targeting, Credibility and Confidence Crises By Aloisio Pessoa de Araújo; Rafael Santos
  26. Exchange rate pass-through to export prices: assessing some cross-country evidence By Robert J. Vigfusson; Nathan Sheets; Joseph Gagnon
  27. Using Wavelets to decompose time-frequency economic relations By Luís Francisco Aguiar-Conraria; Maria Joana Soares; Nuno Azevedo
  28. An Asset-Pricing View of External Adjustment By Anna Pavlova; Roberto Rigobon
  29. Monetary Arrangements for Emerging Economies By Aloisio Pessoa de Araújo; Marcia Leon; Rafael Santos
  30. Foreign exchange intervention and central bank independence: The Latin American experience By Nunes, Mauricio; Da Silva, Sergio
  31. A Small Open Economy as a Limit Case of a Two-Country New Keynesian DSGE Model: A Bayesian Estimation With Brazilian Data. By Marcos Antonio C. da Silveira
  32. Efficiency of the Monetary Policy and Stability of Central Bank Preferences. Empirical Evidence for Peru By Rodriguez Gabriel
  33. The international transmission of monetary shocks in a dollarized economy: The case of USA and Lebanon By Jean-François Goux; Charbel Cordahi
  34. Exact prediction of inflation and unemployment in Germany By Kitov, Ivan

  1. By: Frederic S. Mishkin
    Abstract: This paper reviews the progress that the science of monetary policy has made over recent decades. This progress has significantly expanded the degree to which the practice of monetary policy reflects the application of a core set of "scientific" principles. However, there remains, and will likely always remain, elements of art in the conduct of monetary policy.
    Date: 2007
  2. By: David Laidler (University of Western Ontario)
    Abstract: Successes and failures in monetary policy stem mainly from coherence or lack thereof in the monetary order, rather than the tactical skills of policy makers. Crucial here are questions of consistency among the economic ideas that the policy regime embodies, the way in which the economy actually functions, and the beliefs of private agents and policy makers about these matters. These postulates are used to frame accounts of the Bretton Woods System and its collapse, the Great Inflation that followed, the subsequent disappointing performance of money-growth targeting, the breakdown of the Japanese "bubble economy" the onset of theEMS crisis at the beginning of the 1990s, and since then, the launch of the Euro and the apparent success of inflation targeting. Though monetary policy seems rather successful at present, certain weaknesses in currently prevailing monetary orders are noted.
    Keywords: monetary policy; policy regimes; crises; pegged exchange rates; flexible exchange rates; inflation; inflation targets; money supply; central banks, central bank independence.
    JEL: E42 E58 E65 F33
    Date: 2007
  3. By: Coeurdacier, Nicolas; Kollmann, Robert; Martin, Philippe
    Abstract: This paper explains three key stylized facts observed in industrialized countries: 1) portfolio holdings are biased towards local equity; 2) international portfolios are long in foreign currency assets and short in domestic currency; 3) the depreciation of a country‘s exchange rate is associated with a net external capital gain, i.e. with a positive wealth transfer from the rest of the world. We present a two-country, two-good model with trade in stocks and bonds, and three types of disturbances: shocks to endowments, to the relative demand for home vs. foreign goods, and to the distribution of income between labour and capital. With these shocks, optimal international portfolios are shown to be consistent with the stylized facts.
    Keywords: Equity home bias; International portfolios; International risk sharing; Valuation effects
    JEL: F30 F41 G11
    Date: 2007–09
  4. By: Marvin Goodfriend (Professor, Carnegie Mellon University (E-mail:
    Abstract: The paper identifies and evaluates consequences for monetary policy of five features of East Asian development: export orientation, integrated regional trade, bank-dependent finance, the potential for persistent trade surpluses, and the aggressive accumulation of international reserves. The case for a flexible exchange rate is made in terms of the New Neoclassical Synthesis (NNS). NNS logic indicates why fluctuations in "export optimism" create problems for the sustainability of a fixed exchange rate. Cooperative credit policy in East Asia is discussed by analogy to a credit union. The paper outlines problems for monetary policy created by bank-dependent finance in East Asia. A two- country NNS model indicates that a revaluation of the RMB against the dollar is likely to exert little effect on the US trade deficit, although it should help control inflation in China. The paper argues that China can adopt a flexible exchange rate in a few years with modest reforms of its banking system. Finally, the paper considers various reasons for the accumulation of international reserves in East Asia.
    Keywords: East Asia, Monetary Policy, Banking Policy, Exchange Rates, Trade Balance, International Reserves
    JEL: F3 F4
    Date: 2007–09
  5. By: Cruijsen, C. van der; Eijffinger, S.C.W. (Tilburg University, Center for Economic Research)
    Abstract: We provide an up-to-date overview of the literature on the desirabil- ity of central bank transparency from an economic viewpoint. Since the move towards more transparency, a lot of research on its e?ects has been carried out. First, we show how the theoretical literature has evolved, by looking into branches inspired by Cukierman and Meltzer (1986) and by investigating several, more recent, research strands (e.g. coordination and learning). Then, we summarize the empirical literature which has been growing more recently. Last, we discuss whether: -the empirical research resolves all theoretical question marks, -how the ?ndings of the literature match the actual practice of central banks, and -where there is scope for more research.
    Keywords: Central Bank Transparency;Monetary Policy;Survey
    JEL: E31 E52 E58
    Date: 2007
  6. By: Andrew Ang; Sen Dong; Monika Piazzesi
    Abstract: We estimate Taylor (1993) rules and identify monetary policy shocks using no-arbitrage pricing techniques. Long-term interest rates are risk-adjusted expected values of future short rates and thus provide strong over-identifying restrictions about the policy rule used by the Federal Reserve. The no-arbitrage framework also accommodates backward-looking and forward-looking Taylor rules. We find that inflation and output gap account for over half of the variation of time-varying excess bond returns and most of the movements in the term spread. Taylor rules estimated with no-arbitrage restrictions differ from Taylor rules estimated by OLS, and the resulting monetary policy shocks are somewhat less volatile than their OLS counterparts.
    JEL: E43 E44 E52 G12
    Date: 2007–09
  7. By: Ellison, Martin; Yates, Tony
    Abstract: Why is inflation so much lower and at the same time more stable in developed economies in the 1990s, compared with the 1970s? This paper suggests that the United Kingdom, United States and other countries may have escaped from a volatile inflation equilibrium. Our argument builds on the story proposed by Tom Sargent in The conquest of American inflation, where the fall in inflation in the 1980s was attributed to the changing beliefs informing monetary policy. To explain the escape in inflation volatility, we unwind one of Sargent's simplifications and allow the monetary authority to react to some of the shocks in the economy. In this new model, a revised account of recent history is that when the evidence turned against the existence of a long-run inflation-output trade-off in the 1980s there was an escape from high inflation, but the authorities were also persuaded to stop using changes in inflation to offset shocks. Inflation and inflation volatility therefore escaped in tandem. Our analysis also sheds some light on why the escape in inflation occurred at the time it did. Our model, like the Sargent model it derives from, omits the revolution in institutional design and understanding that underpins monetary policy. So the gloomy predictions for the future derived from a literal reading of it are likely to be unfounded.
    Keywords: beliefs; escapes; Phillips curve; volatility
    JEL: E2 E3
    Date: 2007–09
  8. By: Corsetti, Giancarlo; Müller, Gernot
    Abstract: In this paper, we study the co-movement of the government budget balance and the trade balance at business cycle frequencies. In a sample of 10 OECD countries we find that the correlation of the two time series is negative, but less so in more open economies. Moreover, for the US the cross-correlation function is S-shaped. We analyze these regularities taking the perspective of international business cycle theory. First, we show that a standard model delivers predictions broadly in line with the evidence. Second, we show that conditional on spending shocks the model predicts a perfect correlation of the budget balance and the trade balance. Yet, the effect of spending shocks on the trade balance is contained if an economy is not very open to trade.
    Keywords: Business Cycle; Fiscal Policy; Openness; Twin Deficits
    JEL: E32 F41 F42
    Date: 2007–09
  9. By: Guimarães, Bernardo; Soares Gonçalves, Carlos Eduardo
    Abstract: In a country with high probability of default, higher interest rates may render the currency less attractive if sovereign default is costly. This paper develops that intuition in a simple model and estimates the effect of changes in interest rates on the exchange rate in Brazil using data from the dates surrounding the monetary policy committee meetings and the methodology of identification through heteroskedasticity. Indeed, we find that unexpected increases in interest rates tend to lead the Brazilian currency to depreciate. It follows that granting more independence to a central bank that focus solely on inflation is not always a free-lunch.
    Keywords: default; exchange rate; identification through heteroskedasticity; monetary policy
    JEL: E5 F3
    Date: 2007–09
  10. By: Heather Anderson; Mardi Dungey; Denise R. Osborn; Farshid Vahid
    Abstract: Time series analysis for the Euro Area requires the availability of sufficiently long historical data series, but the appropriate construction methodology has received little attention. The benchmark dataset, developed by the European Central Bank for use in its Area Wide Model (AWM), is based on fixed-weight aggregation across countries with historically distinct monetary policies and financial markets of varying international importance. This paper proposes a new methodology, based on the historical distance from monetary integration between core and periphery countries, for producing back-dated monetary and financial series for the Euro Area. The impact of using the new methodology versus the AWM data is illustrated through a structural VAR analysis and estimates of an international DSGE model. An important advantage of the new methodology is that it can be applied to develop appropriate series as new member countries join the Euro Area.
    JEL: C82 C43 E58
    Date: 2007–10
  11. By: Llosa Gonzalo (UCLA); Tuesta Vicente (Banco Central de Reserva del Perú)
    Abstract: We study how the stability of rational expectations equilibrium may be affected by monetary policy when agents learn using adaptive learning (E-stability concept) and the cost channel of monetary policy matters. We focus on both instrumental taylor-type rules and optimal rules. We show, analytically, that standard instrument rules -contemporaneous and forecast based rules - can easily induce indeterminacy and expectational instability when the cost channel is present. Overall, a naive application of the Taylor principle in this setting could be misleading. Regarding optimal rules, we find that "expectational-based" rules, under discretion and commitment, do not always induce determinate and E-stable equilibrium. This result stands in contrast to the findings of Evans and Honkapohja (2003) for for the baseline “New Keynessian" model.
    Keywords: Monetary Policy Rules, Cost Channel, Indeterminacy
    JEL: C23 O40 O47
    Date: 2007–08
  12. By: Sylvia Kaufmann (Oesterreichische Nationalbank, Economic Studies Division, Otto-Wagner-Platz 3, 1090 Vienna, Austria.); Maria Teresa Valderrama (Oesterreichische Nationalbank, Economic Studies Division, Otto-Wagner-Platz 3, 1090 Vienna, Austria.)
    Abstract: We analyze the interaction between credit and asset prices in the transmission of shocks to the real economy. We estimate a Markov switching VAR for the euro area and the US, including additionally GDP, CPI and a short-term interest rate. We find evidence for two distinct states in both regions. For the euro area, we find a regime which is correlated to the business cycle and which captures periods of very low real credit growth at the end of recessions. However, during this regime credit markets and asset price markets do not impede economic recovery. In the other regime, we do find a procyclical effect of credit and asset price shocks on GDP. Shocks in both variables explain each about 20% of GDP’s forecast error variance after four years. Credit shocks have a positive effect on inflation and explain about 35% of the forecast error variance, which confirms that credit aggregates contain information about the monetary stance. The effect of asset price shocks on inflation is insignificant and their share in explaining the forecast error variance negligible. For the US, regime 1 captures periods of stable GDP growth, and low and stable inflation, combined with accelerating asset prices. We find procyclical effects of credit and asset price shocks on GDP only in regime 2. Shocks in both variables explain about the same share (20%) of GDP forecast error variance, whereby the share explained by asset price shocks is about two and a half times larger than in regime 1. Shocks to credit and asset prices have no significant effect on CPI and explain each about 10% of its forecast error variance in both regimes. This is consistent with the view that monetary policy may achieve price stability without necessarily achieving financial stability. JEL Classification: C11, C32, E32, E44.
    Keywords: Asymmetry, asset prices, financial system, lending, transmission mechanism.
    Date: 2007–09
  13. By: Guido Ascari (University of Pavia); Christian Merkl (IfW, University of Kiel and IZA)
    Abstract: This paper analyzes the cost of disinflations under real wage rigidities in a micro-founded New Keynesian model. The consensus is that real wage rigidities can be a useful mechanism to induce the inflation persistence that is absent in the standard Calvo model. Real wage rigidities thus generate a slump in output after a credible disinflationary policy. This consensus is flawed, since it depends on analyzing the model in a linearized framework. Once nonlinearities are taken into account, the results change dramatically, both qualitatively and quantitatively. Real wage rigidities imply neither inflation persistence, nor output costs of disinflations. Real wage rigidities actually create a boom after a permanent reduction in the inflation target of the monetary policy.
    Keywords: disinflation, sticky prices, real wage rigidities, nonlinearities
    JEL: E31 E50
    Date: 2007–09
  14. By: Alberto Musso (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Livio Stracca (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Dick van Dijk (Econometric Institute, Erasmus University Rotterdam, P.O. Box 1738, NL-3000 DR Rotterdam, The Netherlands.)
    Abstract: This paper provides a comprehensive analysis of the functional form of the euro area Phillips curve over the past three decades. In particular, compared to previous literature we analyse the stability of the relationship in detail, especially as regards the possibility of a time-varying mean of inflation. Moreover, we conduct a sensitivity analysis across different measures of economic slack. Our main findings are two. First, there is strong evidence of time variation in the mean and slope of the Phillips curve occurring in the early to mid 1980s, but not in inflation persistence once the mean shift is allowed for. As a result of the structural change, the Phillips curve became flatter around a lower mean of inflation. Second, we find no significant evidence of non-linearity, in particular in relation to the output gap. JEL Classification: E52, E58.
    Keywords: Inflation, output gap, structural change, asymmetry, smooth transition model.
    Date: 2007–09
  15. By: Kenneth Petersen (University of Connecticut)
    Abstract: The Taylor rule has become one of the most studied strategies for monetary policy. Yet, little is known whether the Federal Reserve follows a non-linear Taylor rule. This paper employs the smooth transition regression model and asks the question: does the Federal Reserve change its policy-rule according to the level of inflation and/or the output gap? I find that the Federal Reserve does follow a non-linear Taylor rule and, more importantly, that the Federal Reserve followed a non-linear Taylor rule during the golden era of monetary policy, 1985-2005, and a linear Taylor rule throughout the dark age of monetary policy, 1960-1979. Thus, good monetary policy is associated with a non-linear Taylor rule: once inflation approaches a certain threshold, the Federal Reserve adjusts its policy-rule and begins to respond more forcefully to inflation.
    Keywords: Taylor rule, Federal Reserve, non-linearity, monetary policy
    JEL: E4 E5
    Date: 2007–09
  16. By: Montoro Carlos (Banco Central de Reserva del Perú and LSE)
    Abstract: This paper investigates how monetary policy should react to oil shocks in a microfounded model with staggered price-setting and oil as a non-produced input in the production function. We extend Benigno and Woodford (2005) to obtain a second order approximation to the expected utility of the representative household when the steady state is distorted and the economy is hit by oil price shocks. The main result is that oil price shocks generate a trade-off between inflation and output stabilisation when oil has low substitutability in production. Therefore, it becomes optimal to the monetary authority to stabilise partially the effects of oil shocks on inflation and some inflation is desirable. We also find, in contrast to Benigno and Woodford (2005), that this trade-off remains even when we eliminate the effects of monopolistic distortions from the steady state. Our results also shed light on how technological improvements which reduces the dependence on oil, also reduce the impact of oil shocks on the economy. This can explain why oil shocks have lower impact on inflation in the 2000s in contrast to the 1970s. Since oil has become easier to substitute with other renewable resources, the impact of oil shocks has been dampened.
    Keywords: Optimal Monetary Policy, Welfare, Second Order Solution, Oil Price Shocks, Endogenous Trade-off.
    JEL: D61 E61
    Date: 2007–08
  17. By: Di Bartolomeo, Giovanni; Rossi, Lorenza
    Abstract: This paper investigates the effects of monetary policy in presence of heterogeneous consumers. We study the effectiveness (quantitative effects) of monetary policy and equilibrium determinacy properties of a New Keynesian DSGE model where a fraction of households cannot smooth consumption. We show that two-demand regimes can emerge (according to the “slope” of IS curve) and that the main unconventional results, stressed by recent literature, only hold in the unconventional case of an IS curve positively sloped.
    Keywords: Heterogeneous consumers; liquidity constraints; determinacy; demand regimes
    JEL: E61 E63
    Date: 2005–09–05
  18. By: Jan Marc Berk; Job Swank
    Abstract: We study price level convergence within the US and EMU, using panel estimates of regional Phillips curves of the hybrid New-Keynesian type. The estimated half lives of deviations from trend PPP are around three years for US regions and two years for euro area countries. The start of EMU had no noticeable influence on PPP convergence in the euro area. Where nominal exchange rates accounted for the bulk of the adjustment process before 1999, this role was taken over by relative prices thereafter. Notwithstanding clear evidence of forward-lookingness, inflation persistence is substantial in both monetary unions, especially in the US.
    Keywords: Inflation; monetary union; purchasing power parity
    JEL: E31 E52 F41
    Date: 2007–09
  19. By: Michal Franta (Czech National Bank and CERGE-EI, P.O. Box 882, Politickych veznu 7, 111 21 Praha 1, Czech Republic.); Branislav Saxa (Czech National Bank and CERGE-EI, P.O. Box 882, Politickych veznu 7, 111 21 Praha 1, Czech Republic.); Katerina Smidkova (Czech National Bank, Na Prikope 28, 115 03 Prague 1.)
    Abstract: Is inflation persistence in the new EU Member States (NMS) comparable to that in the euro area countries? We argue that persistence may not be as different between the two country groups as one might expect. We confirm that one should work carefully with the usual estimation methods when analyzing the NMS, given the scope of the convergence process they went through. We show that due to frequent breaks in inflation time series in the NMS, parametric statistical measures assuming a constant mean deliver substantially higher persistence estimates for the NMS than for the euro area countries. Employing time-varying mean leads to the reversal of this result and suggests similar or lower inflation persistence for the NMS compared to euro area countries. Structural measures show that backward-looking behavior may be more important component in explaining inflation dynamics in the NMS than in the euro area countries. JEL Classification: E31, C22, C11, C32.
    Keywords: Inflation persistence, new Member States, time-varying mean, New Hybrid Phillips curve.
    Date: 2007–09
  20. By: Johannes Onno de Beaufort Wijnholds (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Lars Søndergaard (World Bank 1818 H St N.W., Washington D.C. USA.)
    Abstract: This paper examines whether the level of reserves in emerging market countries has become excessive. It presents a discussion of “adequacy” versus “excessive” levels of reserves, and presents calculations of reserve adequacy for a large number of emerging market countries. Two categories of countries can be distinguished: i) those whose reserves have grown on account of a need for self-insurance against financial crises, and which tend to be reasonably in line with adequacy measures (mainly Latin American countries and countries in central and eastern Europe), and ii) those whose reserve accumulation is nowadays primarily the result of rapid export-led growth supported by a lack of exchange rate flexibility. This is especially the case for several emerging Asian countries, whose reserve levels have grown far beyond what can reasonably considered adequate. Various opinions on Asian exchange rate and reserves policies are examined, and the costs and benefits of currency undervaluation are assessed. Attention is also paid to the composition of the reserves. The paper concludes by bringing together the various strands of the analysis and enumerating the main implications of largescale reserve accumulation for the international monetary system. JEL Classification: F31, F41.
    Keywords: International reserve accumulation, emerging markets.
    Date: 2007–09
  21. By: Matteo Barigozzi; Marco Capasso
    Abstract: We test the importance of multivariate information for modelling and forecasting in- flation's conditional mean and variance. In the literature, the existence of inflation's conditional heteroskedasticity has been debated for years, as it seemed to appear only in some datasets and for some lag lengths. This phenomenon might be due to the fact that inflation depends on a linear combination of economy-wide dynamic common fac- tors, some of which are conditionally heteroskedastic and some are not. Modelling the conditional heteroskedasticity of the common factors can thus improve the forecasts of inflation's conditional mean and variance. Moreover, it allows to detect and predict con- ditional correlations between inflation and other macroeconomic variables, correlations that might be exploited when planning monetary policies. The Dynamic Factor GARCH (DF-GARCH) by Alessi et al. [2006] is used here to exploit the relations between inflation and the other macroeconomic variables for inflation fore- casting purposes. The DF-GARCH is a dynamic factor model as the one by Forni et al. [2005], with the addition of an equation for the evolution of static factors as in Giannone et al. [2004] and the assumption of heteroskedastic dynamic factors. When comparing the Dynamic Factor GARCH with univariate models and with the classical dynamic factor models, the DF-GARCH is able to provide better forecasts both of inflation and of its conditional variance.
    Keywords: Inflation, Factor Models, GARCH
    Date: 2007–10–01
  22. By: Felices Guillermo (Bank of England); Tuesta Vicente (Central Reserve Bank of Peru)
    Abstract: We develop a small open economy general equilibrium model with sticky prices and partial dollarization -a situation where both domestic and foreign currencies coexist. We derive a tractable representation of the model in terms of domestic inflation and the output gap in which a trade-off, which depends on the degree of dollarization, arises endogenously due to the presence of foreign interest rate shocks. We use this framework to show analytically how higher degrees of dollarization induce larger volatilities of the output gap and inflation, thus hampering a central bank’s effectiveness in stabilizing the economy. Our impulse-response functions show that the transmission of such shocks has a positive (negative) effect on inflation and negative (positive) effect on the output gap when money aggregates and consumption are complements (substitutes). We also show that a standard Taylor rule guarantees real determinacy of the rational expectations equilibrium. Finally, we demonstrate that a higher degree of dollarization reduces the determinacy region when the overall money aggregate and consumption are substitutes.
    Keywords: Dollarization, Currency Substitution, Policy trade-off, Staggered Price Setting, Open Economy.
    JEL: E50 E52 F00 F30 F41
    Date: 2007–04
  23. By: Reiner Martin (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Ludger Schuknecht (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Isabel Vansteenkiste (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: Numerous countries have experienced boom-bust episodes in asset prices in the past 20 years. This study looks at stylised facts and conducts statistical and econometric analysis for such episodes, distinguishing between industrialised countries that experienced external adjustment (via real effective exchange rate depreciation during busts) and those that relied on an internal adjustment process (and experienced no depreciation). The study finds that different adjustment experiences are correlated with the degree of macroeconomic imbalances and balance sheet problems. Internal adjustment seems more prevalent when financial vulnerabilities, excess demand and competitiveness loss remain relatively contained in the boom. In the bust, internal adjusters experience more protracted but less deep downturns than external adjusters as imbalances unwind more slowly. Some Central and East European EU Member States are currently experiencing strong credit and asset price growth in conjunction with rapid economic expansion. Against this background the experience of other countries may raise awareness of related policy challenges. JEL Classification: E32, E63, E65.
    Keywords: Booms and busts, external and internal adjustment, exchange rates, financial imbalances, competitiveness.
    Date: 2007–09
  24. By: Vítor Castro (Universidade do Minho - NIPE)
    Abstract: Several studies have identified the factors that cause public deficits in industrial democracies. They consider that economic, political and institutional factors play an important role in the understanding of those deficits. However, the study of the determinants of excessive deficits remains practically unexplored. Since excessive deficits can have large negative spillover effects when countries are forming a monetary union without a centralised budget – as it is the case for a group of European countries – this paper tries to explore that gap in the literature by identifying the main causes of excessive deficits and the ways of avoiding them. Binary choice models are estimated over a panel of 15 European Union countries for the period 1970-2006, where an excessive deficit is defined as a deficit higher than 3% of GDP. Results show that a weak fiscal stance, low economic growth, the timing of parliamentary elections and majority left-wing governments are the main causes of excessive deficits in the EU countries. Moreover, the institutional constraints imposed after Maastricht over the EU countries’ fiscal policy have succeeded in reducing the probability of excessive deficits in Europe, especially in small countries. Therefore, this study concludes that supranational fiscal constraints, national efforts to reduce public debts, growth promoting policies and mechanisms to avoid political opportunism and partisan effects are essential factors for an EU country to avoid excessive deficits. Finally, the results presented in this paper raise the idea that a good strategy for the EU countries to avoid excessive deficits caused by the opportunistic behaviour of their policymakers would be to schedule elections for the beginning or the end of the year.
    Keywords: Excessive public deficits; European Union; Political opportunism; Binary choice models
    JEL: E62 H6 O52
    Date: 2007
  25. By: Aloisio Pessoa de Araújo (EPGE/FGV); Rafael Santos
    Date: 2007–09
  26. By: Robert J. Vigfusson; Nathan Sheets; Joseph Gagnon
    Abstract: A growing body of empirical work has found evidence of a decline in exchange rate pass-through to import prices in a number of industrial countries. Our paper complements this work by examining pass-through from the other side of the transaction; that is, we assess the exchange rate sensitivity of export prices (denominated in the exporter's currency). We first sketch out a streamlined analytical model that highlights some key factors that determine pass-through. Using this model as reference, we find that the prices charged on exports to the United States are more responsive to the exchange rate than is the case for export prices to other destinations, which is consistent with results in the literature suggesting that import price pass-through in the U.S. market is relatively low. We also find that moves in the exchange rate sensitivity of export prices over time have been significantly affected by country and region-specific factors, including the Asian financial crisis (for emerging Asia), deepening integration with the United States (for Canada), and the effects of the 1992 ERM crisis (for the United Kingdom).
    Date: 2007
  27. By: Luís Francisco Aguiar-Conraria (Universidade do Minho - NIPE); Maria Joana Soares (Universidade do Minho - Departamento de Matemática); Nuno Azevedo (Universidade do Porto - Faculdade de Ciências)
    Abstract: Economic agents simultaneously operate at different horizons. Many economic processes are the result of the actions of several agents with different term objectives. Therefore, economic time-series is a combination of components operating on different frequencies. Several questions about the data are connected to the understanding of the time-series behavior at different frequencies. While Fourier analysis is not appropriate to study the cyclical nature of economic time-series, because these are rarely stationary, wavelet analysis performs the estimation of the spectral characteristics of a time-series as a function of time. In spite of all its advantages, wavelets are hardly ever used in economics. The purpose of this paper is to show that cross wavelet analysis can be used to directly study the interactions different time-series in the time-frequency domain. We use wavelets to analyze the impact of interest rate price changes on some macroeconomic variables: Industrial Production, Inflation and the monetary aggregates M1 and M2. Specifically, three tools are utilized: the wavelet power spectrum, wavelet coherency and wavelet phase-difference. These instruments illustrate how the use of wavelets may help to unravel economic time-frequency relations that would otherwise remain hidden.
    Keywords: Monetary policy, time-frequency analysis, non-stationary time series, wavelets, cross wavelets, wavelet coherency.
    Date: 2007
  28. By: Anna Pavlova; Roberto Rigobon
    Abstract: Recent evidence on the importance of cross-border equity flows calls for a rethinking of the standard theory of external adjustment. We introduce equity holdings and portfolio choice into an otherwise conventional open-economy dynamic equilibrium model. Our model is simple and admits a closed-form solution regardless of whether financial markets are complete or incomplete. We find that the excessive emphasis put in the literature on solving models with incomplete markets for the sole purpose of obtaining nontrivial implications for the current account is misplaced. We revisit the current debate on the relative importance of the standard vs. the capital-gains-based (or "valuation'') channels of the external adjustment and establish that in our framework they are congruent. Our model's implications are consistent with a number of intriguing stylized facts documented in the recent empirical literature.
    JEL: F31 F36 G12 G15
    Date: 2007–10
  29. By: Aloisio Pessoa de Araújo (EPGE/FGV); Marcia Leon; Rafael Santos
    Date: 2007–09
  30. By: Nunes, Mauricio; Da Silva, Sergio
    Abstract: Employing data from 13 Latin American countries, we find that greater central bank independence is associated with lesser intervention in the foreign exchange market, and also with leaning-against-the-wind intervention. We also find that the structural reforms that occurred in Latin America mostly in the 1990s helped to reduce the need for foreign exchange intervention.
    Keywords: central bank independence; foreign exchange intervention; Latin America
    JEL: F31 F41
    Date: 2007–09–29
  31. By: Marcos Antonio C. da Silveira
    Abstract: We build a two-country version of the DSGE model in Gali & Monacelli (2005), which extends for a small open economy the new Keynesain model used as tool for monetary policy analysis in closed economies. A distinctive feature of the model is that the terms of trade enters directly into the new Keynesian Phillips curve as a new pushing-cost variable feeding the inflation, so that there is no more the direct relationship between marginal cost and output gap that characterizes the closed economies. Unlike most part of the literature, we derive the small domestic open economy as a limit case of the two-coutry model, rather than assuming exogenous processes for the foreign variables. This procedure preserves the role played by foreign nominal frictions in the way as international monetary policy shocks are conveyed into the small domestic economy. Using the Bayesian approach, the small-economy case is estimated with Brazilian data and impulse-response functions are build to analyse the dynamic effects of structural shocks.
    Date: 2006–12
  32. By: Rodriguez Gabriel (Universidad of Ottawa and Central Bank of Peru)
    Abstract: Following the approach suggested by Favero and Rovelli (2003), I estimate a three-equations system for different sub-samples for Peru. The results indicate that the preferences of the monetary authority have changed between the diffeerent regimes. In particular, the parameter associated to the implicit target of in‡ation has been reduced significantly. The macroeconomic conditions from the side of the aggregate demand have been more favorable than those related to the aggregate supply. The standard deviation of the monetary rule suggests that it has been conducted successfully in the last regime.
    Keywords: Interest Rate Rule, Structural Breaks, Inflation Target-ing, Output Gap, Preferences, Macroeconomic Shocks
    JEL: C2 E5
    Date: 2007–05
  33. By: Jean-François Goux (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Charbel Cordahi (Université Saint Esprit de Kaslik (USEK) - [Université Saint Esprit de Kaslik (USEK)])
    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
    Date: 2007–07
  34. By: Kitov, Ivan
    Abstract: Potential links between inflation, (t), and unemployment, UE(t), in Germany have been examined. There exists a consistent (conventional) Phillips curve despite some changes in monetary policy. This Phillips curve is characterized by a negative relation between inflation and unemployment with the latter leading the former by one year: UE(t-1) = -1.50(t) + 0.116. Effectively, growing unemployment has resulted in decreasing inflation since 1971, i.e. for the period where GDP deflator observations are available. The relation between inflation and unemployment is statistically reliable with R2=0.86, where unemployment spans the range from 0.01 to 0.12 and inflation, as represented by GDP deflator, varies from -0.01 to 0.07. A linear and lagged relationship between inflation, unemployment and labor force has been also obtained for Germany. Changes in labor force level are leading unemployment and inflation by five and six year, respectively. Therefore this generalized relationship provides a natural prediction of inflation at a six-year horizon, as based upon current estimates of labor force level. The goodness-of-fit for the relationship is 0.87 for the period between 1971 and 2006, i.e. including the periods of high inflation and disinflation.
    Keywords: inflation; unemployment; labor force; prediction; Germany
    JEL: J64 E52 C53 E31
    Date: 2007–09–30

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