nep-cba New Economics Papers
on Central Banking
Issue of 2007‒10‒13
twenty-one papers chosen by
Alexander Mihailov
University of Reading

  1. Job Reallocation, Unemployment and Hours in a New Keynesian Model By Richard W P Holt
  2. Entry rates and risks of the misalignment in EU8 By Tatiana Fic; Ray Barrell; Dawn Holland
  3. The Impact of Foreign Interest Rates on the Economy: The Role of the Exchange Rate Regime By Julian di Giovanni; Jay C. Shambaugh
  4. Fiscal and Monetary Policies and the Cost of Sudden Stops By Michael M. Hutchison; Ilan Noy; Lidan Wang
  5. Estimating the effects of fiscal policy under the budget constraint. By Peter Claeys
  6. Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs By Maurice J. Roche; Michael J. Moore
  7. Testing Uncovered Interest Parity: A Continuous-Time Approach By Diez de los Rios, Antonio; Sentana, Enrique
  8. Sticky Information vs. Sticky Prices: A Horse Race in a DSGE Framework By Trabandt, Mathias
  9. A Theory of the Supply of Inside Money By William Coleman
  10. Estimating a small DSGE model under rational and measured expectations: some comparisons By Paloviita, Maritta
  11. The Stability of the Euro-Demand Function By King Banaian; Artatrana Ratha
  12. Computing Stochastic Dynamic Economic Models with a Large Number of State Variables: A Description and Application of a Smolyak-Collocation Method By Benjamin Malin; Dirk Krueger; Felix Kubler
  13. Assessing Competitiveness and Real Exchange Rate Misalignment in Low-Income Countries By Gabriel Di Bella; Aurelie Martin; Mark Lewis
  14. U.K. Inflation and Relative Prices Over the Last Decade: How Important was Globalization? By Ben Hunt
  15. Macroeconomic policy mix, employment and inflation in a Post-Keynesian alternative to the New Consensus Model By Eckhard Hein; Engelbert Stockhammer
  16. Which nonlinearity in the Phillips curve? The absence of accelerating deflation in Japan By Emmanuel De Veirman
  17. The Effects of Monetary Policy in the Czech Republic: An Empirical Study By Magdalena Morgese Borys; Roman Horváth
  18. Endogenous Monetary Policy Credibility in a Small Macro Model of Israel By Philippe D Karam; Natan P. Epstein; Eyal Argov; Douglas Laxton; David Rose
  19. Threshold Autoregressive Model of Exchange Rate Pass through Effect: The Case of Croatia By Petra Posedel; Josip Tica
  20. An analysis of the informational content of New Zealand data releases: the importance of business opinion surveys By Troy Matheson
  21. The Taylor Rule and the Macroeconomic Performance in Pakistan By Wasim Shahid Malik; Ather Maqsood Ahmed

  1. By: Richard W P Holt
    Abstract: This paper focusses on the reallocation of labour resources in a New Keynesian environment with labour market search and endogenous separations. We show that introduction of variation in hours per worker alters the incentives for intertemporal substitution in a way that generates a more steeply downward sloping Beveridge curve and reduces the tendency to synchronise gross job flows. This also enables the New Keynesian model to capture the interaction of hours and employment at business cycle frequencies. We show that the impact of labour supply elasticity on the slope of the Beveridge curve and the correlation of gross job flows is determined primarily by variation in the response to monetary shocks. When hours variation is suppressed the comovement of job creation with job destruction and of unemployment with vacancies are strongly positive in response to monetary shocks. Whereas with variation in hours both measures of reallocation take on the correct negative sign. We also note that frictions in price adjustment make it possible to account a large part of the variation in unemployment observed in US data, despite the absence of wage rigidity or departures from the Hosios condition which have been proposed to resolve the unemployment variability puzzle identified by Shimer (2005).
    Date: 2007–10–04
  2. By: Tatiana Fic (National Bank of Poland); Ray Barrell (National Institute of Economic and Social Research, London); Dawn Holland (National Institute of Economic and Social Research, London)
    Abstract: New member states will join the EMU in the coming years. Setting the central parity has been and will be a challenging task, as there is a considerable amount of uncertainty, both from a theoretical and an empirical perspective, surrounding the determination of the optimal exchange rate. In effect, the probability of misalignment of the entry rate can be a non-zero one. Given the possible - if not inevitable - misspecification of the equilibrium rate it is thus advisable to focus on the effects of a misalignment of the entry rate for the economy, as it has implications for countries’ both real and nominal convergence. An overvalued exchange rate would have an adverse impact on a country’s competitiveness and its growth, while an undervalued currency would contribute to an overheating of the economy and an excessive inflation. The objective of this paper is to better understand the role of the entry rates for short run inflation and GDP developments and their implications for the inflation criterion and the real convergence process. Having estimated equilibrium exchange rates for the eight out of ten countries that entered the EU in May 2004: Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Slovenia and Slovakia we conduct simulations showing what their adjustments to equilibrium would be if their entry rates deviated from the optimal ones.
  3. By: Julian di Giovanni; Jay C. Shambaugh
    Abstract: It is often argued that many economies are affected by conditions in foreign countries. This paper explores the connection between interest rates in major industrial countries and annual real output growth in other countries. The results show that high foreign interest rates have a contractionary effect on annual real GDP growth in the domestic economy, but that this effect is centered on countries with fixed exchange rates. The paper then examines the potential channels through which major-country interest rates affect other economies. The effect of foreign interest rates on domestic interest rates is the most likely channel when compared with other possibilities, such as a trade effect.
    JEL: F3 F4
    Date: 2007–10
  4. By: Michael M. Hutchison (Department of Economics, University of California, Santa Cruz); Ilan Noy (Department of Economics, University of Hawaii at Manoa); Lidan Wang (Risk Management, HSBC Credit Card Services, California)
    Abstract: This article investigates the effects of macroeconomic policy (monetary and fiscal) on output growth during financial crises characterized by a “sudden stop” in net capital inflows in developing and emerging market economies. We investigate 83 sudden stop crises in 77 countries over 1982-2003 using a baseline empirical model to control for the various determinants of output losses during sudden stop crises. Extending the baseline model to account for policies-- contractionary as well as expansionary-- we measure the marginal effects of policy on output losses. Simple descriptive statistics indicate no apparent correlation between the costs of financial crises and the economic policies pursed at the time. Once controlling for various pre-conditions and other factors, however, we find that monetary and fiscal tightening at the time of a sudden stop crisis significantly worsens output losses.
    Keywords: Output losses, financial crises, sudden stops, fiscal policy, financial policy
    JEL: E52 E62 F32 F43 O16
  5. By: Peter Claeys (Faculty of Economics, University of Barcelona.)
    Abstract: I reconsider the short-term effects of fiscal policy when both government spending and taxes are allowed to respond to the level of public debt. I embed the long-term government budget constraint in a VAR, and apply this common trends model to US quarterly data. The results overturn some widely held beliefs on fiscal policy effects. The main finding is that expansionary fiscal policy has contractionary effects on output and inflation. Ricardian effects may dominate when fiscal expansions are expected to be adjusted by future tax rises or spending cuts. The evidence supports RBC models with distortionary taxation. We can discard some alternative interpretations that are based on monetary policy reactions or supply-side effects.
    Keywords: fiscal policy, sustainability, spending, taxes, common trends, SVAR.
    JEL: E42 E63 E65
    Date: 2007–07
  6. By: Maurice J. Roche (Economics, National University of Ireland, Maynooth); Michael J. Moore (Queen's University Belfast, Northern Ireland)
    Abstract: We present a simple framework in which both the exchange rates disconnect and forward bias puzzles are simultaneously resolved. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habit persistence is modeled using Campbell Cochrane preferences with 'deep' habits. By deep habits, we mean habits defined over goods rather than countries. The model is simulated using the artificial economy methodology. It offers a neo-classical explanation of the Meese-Rogoff puzzle and mimics the failure of fundamentals to explain nominal exchange rates in a linear setting. Finally, the model naturally generates the negative slope in the standard forward market regression.
    Keywords: Exchange Rate Puzzles; Forward Foreign Exchange; Habit Persistence
    JEL: F31 F41 G12
    Date: 2007
  7. By: Diez de los Rios, Antonio; Sentana, Enrique
    Abstract: Nowadays researchers can choose the sampling frequency of exchange rates and interest rates. If the number of observations per contract period is large relative to the sample size, standard GMM asymptotic theory provides unreliable inferences in UIP regression tests. We specify a bivariate continuous-time model for exchange rates and forward premia robust to temporal aggregation, unlike the discrete time models in the literature. We obtain the UIP restrictions on the continuous-time model parameters, which we estimate efficiently, and propose a novel specification test that compares estimators at different frequencies. Our empirical results based on correctly specified models reject UIP.
    Keywords: Exchange Rates; Forward Premium Puzzle; Hausman Test; Interest Rates; Orstein-Uhlenbeck Process; Temporal Aggregation
    JEL: F31 G15
    Date: 2007–10
  8. By: Trabandt, Mathias (Research Department, Central Bank of Sweden)
    Abstract: How can we explain the observed behavior of aggregate inflation in response to e.g. monetary policy changes? Mankiw and Reis (2002) have proposed sticky information as an alternative to Calvo sticky prices in order to model the conventional view that i) inflation reacts with delay and gradually to a monetary policy shock, ii) announced and credible disinflations are contractionary and iii) inflation accelerates with vigorous economic activity. I use a fully-fledged DSGE model with sticky information and compare it to Calvo sticky prices, allowing also for dynamic inflation indexation as in Christiano, Eichenbaum, and Evans (2005). I find that sticky information and sticky prices with dynamic inflation indexation do equally well in my DSGE model in delivering the conventional view.
    Keywords: sticky information; sticky prices; inflation indexation; DSGE
    JEL: E00 E30
    Date: 2007–06–01
  9. By: William Coleman
    Abstract: This paper advances a theory of the supply of inside money that is squarely based on optimisation, and which sets out from the question, 'As outside money has an opportunity cost that a mere promise to pay outside money does not, why is outside money used at all?'. The theory identifies the nominal rate of return on capital as the key determinant of the supply of inside money. So just as the nominal rate of return on capital is the cost of demanding money, so the nominal rate of return is identified here as the reward for supplying (inside) money. And just as the demand for money is negatively related to the nominal rate of return on capital, so the supply of inside money is positively related to the nominal rate of return on capital.
    JEL: E42 E51
    Date: 2007–09
  10. By: Paloviita, Maritta (Bank of Finland Research)
    Abstract: Using European panel data and GMM system estimation, we explore the empirical performance of the standard three-equation New Keynesian macro model under different informational assumptions. As a benchmark, we consider the performance of the model under rational expectations and revised (final) data. Alternatively, instead of imposing rational expectations hypothesis we use real- time information, ie Consensus Economics survey data, to generate empirical proxies for expectations in the model and the current output gap in the Taylor rule. We demonstrate that, contrary to the assumption of rational expectations, the errors in measured expectations and real-time current output gaps are positively autocorrelated. We produce evidence that the use of real-time variables (including measured expectations) improves the empirical performance of the New Keynesian model. Relaxation of the rational expectations hypothesis makes a noticeable difference for the parameters of the New Keynesian model, especially in the Taylor rule.
    Keywords: DSGE model; survey expectations; GMM system estimation; expectations; estimation
    JEL: C52 E20 E52
    Date: 2007–10–03
  11. By: King Banaian; Artatrana Ratha (Department of Economics, St. Cloud State University)
    Abstract: While the empirical literature on money demand is vast by any standards, it is relatively silent when it comes to the Euro, a major currency in the world. This hampers efforts, for example, to determine whether or not the European Central Bank can target monetary aggregates for inflation control. The difficulty has come from the lack of information about euro-wide monetary behavior, relying instead on speculative techniques for aggregating country-level data from previous periods of the European exchange rate mechanism. Now that we have six years of monthly data points, we investigate the stability of various Euro-zone monetary aggregates using the Bound Testing Procedure of Cointegration proposed by Pesaran et al. (2001) and study their policy implications.
    Keywords: money demand, euro, cointegration
    JEL: E41
    Date: 2007–08
  12. By: Benjamin Malin; Dirk Krueger; Felix Kubler
    Abstract: We describe a sparse grid collocation algorithm to compute recursive solutions of dynamic economies with a sizable number of state variables. We show how powerful this method may be in applications by computing the nonlinear recursive solution of an international real business cycle model with a substantial number of countries, complete insurance markets and frictions that impede frictionless international capital flows. In this economy the aggregate state vector includes the distribution of world capital across different countries as well as the exogenous country-specific technology shocks. We use the algorithm to efficiently solve models with 2, 4, and 6 countries (i.e., up to 12 continuous state variables).
    JEL: C68 C88 F41
    Date: 2007–10
  13. By: Gabriel Di Bella; Aurelie Martin; Mark Lewis
    Abstract: Assessing a country's competitiveness routinely starts with an analysis of the real exchange rate. However, in low-income countries, empirical analysis of the real exchange rate is often subject to important limitations that seriously weaken the results. This paper summarizes the methodologies used to assess real exchange rate misalignments and discusses the range of obstacles common to low-income countries. Recognizing the importance of using a wide range of indicators for assessing competitiveness in low-income countries, the paper discusses alternative competitive measures and then proposes a template of indicators to allow for a systematic assessment of competitiveness in low-income countries. The template is then used to rank countries according to their competitiveness performance in 2006.
    Keywords: Export competitiveness , Real effective exchange rates , Low-income developing countries , Working Paper ,
    Date: 2007–08–17
  14. By: Ben Hunt
    Abstract: In this paper, the IMF's new Global Economy Model (GEM) is used to estimate the relative importance of a number of factors argued to explain the differences in the trends in core inflation and relative prices in the United Kingdom, the Euro Area and the United States. The simulation results indicate that while the direct effect of globalization has had a larger effect in the United Kingdom than in either the United States or the Euro Area, it explains only a portion of the developments and U.K. specific factors played an important role.
    Keywords: Inflation , United Kingdom , Prices , Globalization , Economic models , Working Paper ,
    Date: 2007–08–30
  15. By: Eckhard Hein (Macroeconomic Policy Institute (IMK), Hans Boeckler Foundation, Duesseldorf); Engelbert Stockhammer (Department of Economics, Vienna University of Economics & B.A.)
    Abstract: New Consensus Models (NCMs) have been criticised by Post-Keynesians (PKs) for a variety of reasons. The paper presents a model that synthesises several of the PK arguments. The model consists of three classes: rentiers, firms and workers. It has a short-run inflation barrier derived from distribution conflict between these classes, which is endogenous in the medium run. Distribution conflict does not only affect inflation but also income shares. On the demand side the income classes have different saving propensities. We apply a Kaleckian investment function with expected sales and internal funds as major determinants. The paper analyses short-run stability and includes medium-run endogeneity channels for the Non-Accelerating-Inflation-Rate-of-Unemployment (NAIRU): persistence mechanisms in the labour market, adaptive wage and profit aspirations, investment in capital stock and cost effects of interest rate changes. The model is used to analyse NCM and PK policy assignments and policy rules. We argue that improved employment without increasing inflation will be possible, if macroeconomic policies are coordinated along the following lines: The central bank targets distribution, wage bargaining parties target inflation and fiscal policies are applied for short- and medium-run real stabilisation purposes.
    JEL: E12 E20 E52 E61
    Date: 2007–10
  16. By: Emmanuel De Veirman (Reserve Bank of New Zealand)
    Abstract: It is standard to model the output-inflation trade-off as a linear relationship with a time-invariant slope. We assess empirical evidence for three types of nonlinearity in the short-run Phillips curve. At an empirical level, we aim to discover why large negative output gaps in Japan during the period 1998-2002 did not lead to accelerating deflation, but instead coincided with stable, albeit moderately negative, inflation. We document that this episode is most convincingly interpreted as reflecting a gradual flattening of the Phillips curve. Our analysis sheds light on the determinants of the time-variation in the Phillips curve slope. Our results suggest that, in any economy where trend inflation is substantially lower (or substantially higher) today than in past decades, time-variation in the slope of the short-run Phillips curve has become too important to ignore.
    JEL: C22 C32 E31 E32
    Date: 2007–09
  17. By: Magdalena Morgese Borys (CERGE-EI); Roman Horváth (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Czech National Bank)
    Abstract: In this paper, we examine the effects of Czech monetary policy on the economy within VAR and the structural VAR framework. We document well-functioning transmission mechanism similar to the euro area countries, especially in terms of persistence of monetary policy shocks. Subject to various sensitivity tests, we find that contractionary monetary policy shock has a negative effect on the degree of economic activity and price level, both with a peak response after one year or so. Regarding the prices at the sectoral level, tradables adjust faster than non-tradables, which is in line with microeconomic evidence on price persistence. There is a rationale in using the real-time output gap instead of current GDP growth as using the former results in much more precise estimates. There is no evidence for price puzzle within the system. The results indicate a rather persistent appreciation of domestic currency after monetary tightening with a gradual depreciation afterwards.
    Keywords: transmission, VAR, real-time data, sectoral prices
    JEL: E52 E58 E31
    Date: 2007–10
  18. By: Philippe D Karam; Natan P. Epstein; Eyal Argov; Douglas Laxton; David Rose
    Abstract: This paper extends a small linear model of the Israeli economy to allow for nonlinearities in the inflation-output process that arise from convexity in the Phillips curve and endogenous monetary policy credibility. We find that the dynamic responses to shocks in the extended model more closely resemble features in the data from the period 2001?03. In particular, the extended model does a much better job in accounting for the deterioration in monetary policy credibility and the output costs of regaining monetary policy credibility once it has been lost.
    Keywords: Monetary policy , Israel , Inflation targeting , Economic models , Working Paper ,
    Date: 2007–08–30
  19. By: Petra Posedel (Faculty of Economics and Business, University of Zagreb); Josip Tica (Faculty of Economics and Business, University of Zagreb)
    Abstract: In this paper exchange rate pass-through effect in Croatia is estimated with nonlinear (asymmetric) threshold autoregressive model (TAR). In total 12285 regressions is estimated and a strong case of nonlinearity with single threshold is proven. According to our estimation there is a threshold at 2.69% of monthly change of nominal exchange rate of German mark (Euro) and the way in which nominal exchange rate affects inflation is asymmetric around it. Below the threshold, effect of change in nominal exchange rate on inflation is statistically insignificant and above the threshold the effect is strong and significant.
    Keywords: threshold autoregressive model, pass-through effect, exchange rate, inflation, nonlinear econometrics
    JEL: E31 E58 F31
    Date: 2007–10–01
  20. By: Troy Matheson (Reserve Bank of New Zealand)
    Abstract: We examine the informational content of New Zealand data releases using a parametric dynamic factor model estimated with unbalanced real-time panels of quarterly data. The data are categorised into 21 different release blocks, allowing us to make 21 different factor model forecasts each quarter. We compare three of these factor model forecasts for real GDP growth, CPI inflation, non-tradable CPI inflation, and tradable CPI inflation with real-time forecasts made by the Reserve Bank of New Zealand each quarter. We find that, at some horizons, the factor model produce forecasts of similar accuracy to the Reserve Bank’s forecasts. Analysing the marginal value of each of the data releases reveals the importance of the business opinion survey data – the Quarterly Survey of Business Opinion and the National Bank’s Business Outlook survey – in determining how factor model predictions, and the uncertainty around those predictions, evolves through each quarter.
    JEL: E52 E58 C33 C53
    Date: 2007–09
  21. By: Wasim Shahid Malik (Pakistan Institute of Development Economics, Islamabad.); Ather Maqsood Ahmed (Central Board of Revenue, Islamabad.)
    Abstract: A widely agreed proposition in modern economics is that policy rules have greater advantage over discretion in improving economic performance. Simple monetary policy instrument rules are feasible options for developing countries lacking the pre-requisites for more sophisticated targeting rules. Notwithstanding the focus of modern literature on the issue, the State Bank of Pakistan (SBP) has never declared itself to be following any type of rule. Surprisingly, this topic has remained out of research focus (among the academia and the practitioners) in Pakistan. This is the first attempt to deal with a rule-based monetary policy strategy in the case of the SBP. We have estimated the Taylor rule and simulated the economy using this rule as a monetary policy strategy. Our results indicate that the SBP has not been following the Taylor rule. In fact, the actual policy can be taken as an extreme deviation from it. On the other hand, counterfactual simulation confirms that macroeconomic performance can be improved, in terms of stability in inflation and output, when a simple Taylor rule is adopted. In this regard the parameter values (especially the inflation target) in the rule must be set according to the conditions of the economy under consideration rather than by relying on the ones suggested by the Taylor rule.
    Keywords: Taylor Rule, Macroeconomic Performance, Counterfactual Simulation
    JEL: E47 E31 E52
    Date: 2007

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