nep-cba New Economics Papers
on Central Banking
Issue of 2007‒11‒03
thirty-one papers chosen by
Alexander Mihailov
University of Reading

  1. Robust Learning Stability with Operational Monetary Policy Rules By George Evans; Seppo Honkapohja
  2. Anticipated Fiscal Policy and Adaptive Learning By George Evans; Seppo Honkapohja; Kaushik Mitra
  3. Will Monetary Policy Become More of a Science? By Frederic S. Mishkin
  4. Optimal Monetary Policy and the Sources of Local-Currency Price Stability By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
  5. Globalization and Inflation Dynamics: the Impact of Increased Competition By Argia M. Sbordone
  6. Explaining the Effects of Government Spending Shocks on Consumption and the Real Exchange Rate By Ravn, Morten O.; Schmitt-Grohé, Stephanie; Uribe, Martín
  7. Price-Level Targeting and Stabilization Policy: A Review By Steve Ambler
  8. The Impact of Milton Friedman on Modern Monetary Economics: Setting the Record Straight on Paul Krugman's "Who Was Milton Friedman?" By Edward Nelson; Anna J. Schwartz
  9. Interest rate versus money supply instruments: on the implementation of Markov-perfect optimal monetary policy By Michael Dotsey; Andreas Hornstein
  11. Optimal Monetary Policy in a Small Open Economy Under Segmented Asset Markets and Sticky Prices By Ruy Lama; Juan Pablo Medina
  12. Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Models By Robert J. Shiller
  13. Fiscal Insurance and Debt Management in OECD Economies By Faraglia, Elisa; Marcet, Albert; Scott, Andrew
  14. Euro area in‡ation persistence in an estimated nonlinear DSGE model By Gianni Amisano; Oreste Tristani
  15. Inflation Expectations of Experts and ECB Communication By Ullrich, Katrin
  16. The High-Frequency Response of the EUR-US Dollar Exchange Rate to ECB Monetary Policy Announcements By Christian Conrad; Michael J. Lamla
  17. The Liquidity Effect in Bank-Based and Market-Based Financial Systems By Johann Scharler
  18. Forecasting Large Datasets with Reduced Rank Multivariate Models By Andrea Carriero; George Kapetanios; Massimiliano Marcellino
  19. Testing the Sticky Information Phillips Curve By Olivier Coibion
  20. The llong road tto EMU:: The long road to EMU: The Economic and Political Reasoning behind Maastricht By Francisco Torres
  21. The Politics of IMF Forecasts By Axel Dreher; Silvia Marchesi; James Raymond Vreeland
  22. Identification of Technology Shocks in Structural VARs By Patrick Fève; Alain Guay
  23. The Response of Hours to a Technology Shock: a Two-Step Structural VAR Approach By Patrick Fève; Alain Guay
  24. The role of other financial intermediaries in monetary and credit developments in the euro area By Philippe Moutot; Dieter Gerdesmeier; Adriana Lojschová; Julian von Landesberger
  25. Oil and the Great Moderation By Antón Nákov; Andrea Pescatori
  26. Sector-specific Markup Fluctuations and the Business Cycle By Alain Gabler
  27. Explaining the Rent-OER Inflation Divergence, 1999-2006 By Robert Poole; Randal Verbrugge
  28. Do Inflation-Linked Bonds Still Diversify? By Marie Brière; Ombretta Signori
  29. Rediscounting Under Aggregate Risk with Moral Hazard By James T. E. Chapman; Antoine Martin
  30. Exact prediction of inflation and unemployment in Japan By Kitov, Ivan
  31. Monetary Policy Operations of Debtor Central Banks in MENA Countries By Schnabl, Gunther; Schobert, Franziska

  1. By: George Evans; Seppo Honkapohja
    Abstract: We consider robust stability under learning of alternative interest-rate rules. By “robust stability” we mean stability of the rational expectations equilibrium, under discounted (constant gain) least-squares learning, for a range of gain parameters. We find that many interest-rate rules are not robust, in this sense, when operational forms of policy rules are employed. Rules are considered operational if they do not depend on contemporaneous values of endogenous aggregate variables. We consider a variety of interest-rate rules, including instrument rules, optimal reaction functions under discretion or commitment, and rules that approximate optimal policy under commitment. For some of the rules that aim to achieve optimal policy, we allow for an interest-rate stabilization motive in the policy objective. The expectations-based rules proposed in Evans and Honkapohja (2003, 2006) deliver robust learning stability. In contrast, many proposed alternatives become unstable under learning even at small values of the gain parameter.
    Keywords: Commitment, interest-rate setting, adaptive learning, stability, determinacy.
    JEL: E52 E31 D84
    Date: 2007–10
  2. By: George Evans; Seppo Honkapohja; Kaushik Mitra
    Abstract: We consider the impact of anticipated policy changes when agents form expectations using adaptive learning rather than rational expectations. To model this we assume that agents combine limited structural knowledge with a standard adaptive learning rule. We analyze these issues using two well-known set-ups, an endowment economy and the Ramsey model. In our set-up there are important deviations from both rational expectations and purely adaptive learning. Our approach could be applied to many macroeconomic frameworks.
    Keywords: Taxation, expectations, Ramsey model.
    JEL: E62 D84 E21 E43
    Date: 2007–08
  3. 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: in other words, substantial judgment will always be needed to achieve desirable outcomes on both the inflation and employment fronts. However, as case studies discussed here suggest, even through art will always be a key element in the conduct of monetary policy, the more it is informed by good science, the more successful monetary policy will be.
    JEL: E2 E44 E52 E58
    Date: 2007–10
  4. By: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
    Abstract: We analyze the policy trade-offs generated by local currency price stability of imports in economies where upstream producers strategically interact with downstream firms selling the final goods to consumers. We study the effects of staggered price setting at the downstream level on the optimal price (and markup) chosen by upstream producers and show that downstream price movements affect the desired markup of upstream producers, magnifying their price response to shocks. We revisit the international dimensions of optimal monetary policy, unveiling an argument in favor of consumer price stability as the main prescription for monetary policy. Since stable consumer prices feed back into a low volatility of markups among upstream producers, this contains inefficient deviations from the law of one price at the border. However, efficient stabilization of different CPI components will not generally result into perfect stabilization of headline inflation. National policies optimally respond to the same shocks in a similar way, thus containing volatility of the terms of trade, but not necessarily of the real exchange rate. The latter will be more volatile, among other things, the larger the home bias in expenditure and the content of local inputs in consumer goods.
    JEL: F31 F33 F41 F42
    Date: 2007–10
  5. By: Argia M. Sbordone
    Abstract: This paper analyzes the potential effect of global market competition on inflation dynamics. It does so through the lens of the Calvo model of staggered price-setting, which implies that inflation depends on expected future inflation and a measure of marginal costs. I modify the assumption of a constant elasticity of demand, standard in this model, to provide a channel through which an increase in the number of traded goods may affect the degree of strategic complementarity in price setting, and hence alter the dynamic response of inflation to marginal costs. I first discuss the behavior of the variables that drive the impact of trade openness on this response, and then I evaluate whether an increase in the variety of traded goods of the size observed in the US in the `90s might have a sizable quantitative impact. I find that it is difficult to argue that such an increase in trade should have generated an increase in US market competition leading to a decline in the slope of the inflation-marginal cost relation.
    JEL: E31
    Date: 2007–10
  6. By: Ravn, Morten O.; Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: Using panel structural VAR analysis and quarterly data from four industrialized countries, we document that an increase in government purchases leads to an expansion in output and private consumption, a deterioration in the trade balance, and a depreciation of the real exchange rate (i.e., a decrease in the domestic CPI relative to the exchange-rate adjusted foreign CPI). We propose an explanation for these observed effects based on the deep habit mechanism. We estimate the key parameters of the deep-habit model employing a limited information approach. The predictions of the estimated deep-habit model fit well the observed responses of output, consumption, the trade balance, and the real exchange rate to an unanticipated government spending shock. In addition, the deep-habit model predicts that in response to an anticipated increase in government spending consumption and wages fail to increase on impact, which is consistent with the empirical evidence stemming from the narrative identification approach. In this way, the deep-habit model reconciles the findings of the SVAR and narrative literatures on the effects of government spending shocks.
    Keywords: Countercyclical Mark-ups; Deep Habits; Government Spending Shocks; Real exchange rate movements
    JEL: E30 F42
    Date: 2007–10
  7. By: Steve Ambler
    Abstract: The author surveys recent articles on the costs and benefits of price-level targeting versus inflation targeting, focusing on the benefits and costs of price-level targeting as a tool for stabilization policy. He reviews papers that examine how price-level targeting affects the short-run trade-off between output and inflation variability by influencing expectations of future inflation. The author looks at the implications of this argument for assigning an objective based on price-level targeting to a central bank that is unable to commit to its future policies. He discusses some recent papers that examine how price-level targeting can help to avoid the zero-bound problem, and papers that examine the incentives created by price-level targeting to change the degree of indexation of private contracts.
    Keywords: Monetary policy framework
    JEL: E31 E32 E52
    Date: 2007
  8. By: Edward Nelson; Anna J. Schwartz
    Abstract: Paul Krugman's essay "Who Was Milton Friedman?" seriously mischaracterizes Friedman's economics and his legacy. In this paper we provide a rejoinder to Krugman on these issues. In the course of setting the record straight, we provide a self-contained guide to Milton Friedman's impact on modern monetary economics and on today's central banks. We also refute the conclusions that Krugman draws about monetary policy from the experiences of the United States in the 1930s and of Japan in the 1990s.
    JEL: E31 E51 E58
    Date: 2007–10
  9. By: Michael Dotsey; Andreas Hornstein
    Abstract: Currently there is a growing literature exploring the features of optimal monetary policy in New Keynesian models under both commitment and discretion. With respect to time consistent policy, the literature focuses on solving for allocations. Recently, however, King and Wolman (2004) have examined implementation issues involved under time consistent policy when the monetary authority chooses nominal money balances. Surprisingly, they find that equilibria are no longer unique under a money stock regime. Indeed, there exist multiple steady states. Dotsey and Hornstein find that King and Wolman's conclusion of non-uniqueness of Markov-perfect equilibria is sensitive to the instrument of choice. If, instead, the monetary authority chooses the nominal interest rate rather than nominal money balances, there exists a unique Markov-perfect steady state and point-in-time equilibria are unique as well. Thus, in King and Wolman's language, monetary policy is implementable using an interest rate instrument while it is not implementable using a money stock instrument.
    Keywords: Markov processes ; Monetary policy ; Money supply
    Date: 2007
  10. By: Svan Jari Stehn; David Vines
    Abstract: Leith and Wren-Lewis (2007) have shown that government debt is returned to its pre-shock level in a New Keynesian model under optimal discretionary policy. This has two important implications for monetary and fiscal policy. First, in a high-debt economy, it may be optimal for discretionary monetary policy to cut the interest rate in response to a cost-push shock - thereby violating the Taylor principle - although this will not be true if inflation is significantly persistent. Second, the optimal fiscal response to such a shock is more active under discretion than commitment, whatever the degree of inflation persistence.
    JEL: E52 E60 E61 E63
    Date: 2007–10
  11. By: Ruy Lama; Juan Pablo Medina
    Abstract: This paper studies optimal monetary policy in a two-sector small open economy model under segmented asset markets and sticky prices. We solve the Ramsey problem under full commitment, and characterize the optimal monetary policy in a calibrated version of the model. The findings of the paper are threefold. First, the Ramsey solution mimics the allocations under flexible prices. Second, under the optimal policy the volatility of non-tradable inflation is close to zero. Third, stabilizing nontradable inflation is optimal regardless of the financial structure of the small open economy. Even for a moderate degree of price stickiness, implementing a monetary policy that mitigates asset market segmentation is highly distortionary. This last result suggests that policymakers should resort to other policy instruments in order to correct financial imperfections.
    Keywords: Working Paper , Monetary policy , Prices , Financial assets , Markets , Economic models ,
    Date: 2007–09–17
  12. By: Robert J. Shiller (Cowles Foundation, Yale University)
    Abstract: There has been a widespread perception in the past few years that long-term asset prices are generally high because monetary authorities have effectively kept long-term interest rates, which the market uses to discount cash flows, low. This perception is not accurate. Long-term interest rates have not been especially low. What has changed to produce high asset prices appears instead to be changes in popular economic models that people actually rely on when valuing assets. The public has mostly forgotten the concept of "real interest rate." Money illusion appears to be an important factor to consider.
    Keywords: Long-term interest rates, Stock prices, Housing prices, Real interest rates, Liquidity, Money illusion
    JEL: G12
    Date: 2007–10
  13. By: Faraglia, Elisa; Marcet, Albert; Scott, Andrew
    Abstract: Assuming the role of debt management is to provide hedging against fiscal shocks we consider three questions: i) what indicators can be used to assess the performance of debt management? ii) how well have historical debt management policies performed? and iii) how is that performance affected by variations in debt issuance? We consider these questions using OECD data on the market value of government debt between 1970 and 2000. Motivated by both the optimal taxation literature and broad considerations of debt stability we propose a range of performance indicators for debt management. We evaluate these using Monte Carlo analysis and find that those based on the relative persistence of debt perform best. Calculating these measures for OECD data provides only limited evidence that debt management has helped insulate policy against unexpected fiscal shocks. We also find that the degree of fiscal insurance achieved is not well connected to cross country variations in debt issuance patterns. Given the limited volatility observed in the yield curve the relatively small dispersion of debt management practices across countries makes little difference to the realised degree of fiscal insurance.
    Keywords: Bond Markets; Debt Management; Fiscal Insurance; Fiscal Policy
    JEL: E43 E62 H62 H63
    Date: 2007–10
  14. By: Gianni Amisano (European Central Bank, University of Brescia and The Rimini Centre for Economics Analysis, Rimini, Italy.); Oreste Tristani (European Central Bank.)
    Abstract: We estimate the approximate nonlinear solution of a small DSGE model on euro area data, using the conditional particle …lter to compute the model likelihood. Our results are consistent with previous …ndings, based on simulated data, suggesting that this approach delivers sharper inference compared to the estimation of the linearised model. We also show that the nonlinear model can account for richer economic dynamics: the impulse responses to structural shocks vary depending on initial conditions selected within our estimation sample.
    Keywords: DSGE models, in‡ation persistence, second order approximations, sequential Monte Carlo, Bayesian estimation.
    JEL: C11 C15 E31 E32 E52
    Date: 2007–07
  15. By: Ullrich, Katrin
    Abstract: The communication policy of the European Central Bank attracts a lot of attention from financial markets. This paper analyses the informational content of the monthly introductory statements of the ECB president explaining interest rate decisions with regard to inflation expectations of financial market experts for the euro area from February 1999 to June 2007. Estimations are conducted for the influence of ECB communication on expectations formation besides other macroeconomic variables. As the results indicate, the indicator measuring the informational content of ECB rhetoric contributes to the explanation of inflation expectations formation.
    Keywords: inflation expectations formation, central bank communication, Carlson-Parkin method, survey expectations
    JEL: D83 D84 E52 E58
    Date: 2007
  16. By: Christian Conrad (Department of Management, Technology, and Economics, ETH Zurich); Michael J. Lamla (Department of Management, Technology, and Economics, ETH Zurich)
    Abstract: We investigate the impact of the European Central Bank's monetary policy an- nouncements on the level and volatility of the EUR-US Dollar exchange rate em- ploying an AR-FIGARCH specification. Using high-frequency data we estimate the individual and complementary effects of the release of the interest rate decision, the ECB's introductory statement and the question and answer session. Surprise interest rate changes explain the movements in the exchange rate immediately after press release. During the introductory statement, communication with respect to future price developments is most relevant and has two important functions: (i) it explains the previously announced decision and (ii) it serves as a guide for the future path of monetary policy.
    Keywords: European Central Bank, monetary policy announcements, communication, exchange rate, expectations, long memory GARCH processes
    JEL: C22 E52 E58 F31
    Date: 2007–09
  17. By: Johann Scharler (Department of Economics, Johannes Kepler University Linz, Austria)
    Abstract: This paper assesses how the financial system influences the strength of the liquidity effect in a calibrated limited participation model of the monetary transmission mechanism. The model suggests that bankbased systems should be characterized by smaller liquidity effects since monetary injections are spread out over a larger number of firms.
    Keywords: limited participation; transmission mechanism; financial systems
    JEL: E32 E52 E58
    Date: 2007–10
  18. By: Andrea Carriero (Queen Mary, University of London); George Kapetanios (Queen Mary, University of London); Massimiliano Marcellino (IEP-Bocconi University, IGIER and CEPR)
    Abstract: The paper addresses the issue of forecasting a large set of variables using multivariate models. In particular, we propose three alternative reduced rank forecasting models and compare their predictive performance with the most promising existing alternatives, namely, factor models, large scale bayesian VARs, and multivariate boosting. Specifically, we focus on classical reduced rank regression, a two-step procedure that applies, in turn, shrinkage and reduced rank restrictions, and the reduced rank bayesian VAR of Geweke (1996). As a result, we found that using shrinkage and rank reduction in combination rather than separately improves substantially the accuracy of forecasts, both when the whole set of variables is to be forecast, and for key variables such as industrial production growth, inflation, and the federal funds rate.
    Keywords: Bayesian VARs, Factor models, Forecasting, Reduced rank
    JEL: C11 C13 C33 C53
    Date: 2007–10
  19. By: Olivier Coibion (Department of Economics, College of William and Mary)
    Abstract: I consider the empirical evidence for the sticky information model of Mankiw and Reis (2002) relative to the basic sticky price model, conditional on historical measures of inflation forecasts. Overall, the evidence is unfavorable to the sticky information model of price-setting: the estimated structural parameters are inconsistent with an underlying sticky information model and the sticky-information Phillips Curve is statistically dominated by the New Keynesian Phillips Curve. I find that the poor performance of the sticky information approach is driven by two key elements. First, predicted inflation in the sticky information model places substantial weight on old forecasts of inflation. Because these consistently underestimate inflation in the 1970s and overestimate inflation since the 1980s, particularly at long forecast horizons, predicted inflation from the sticky information model inherits these patterns. Second, predicted inflation from the sticky information model is excessively smooth.
    Keywords: Sticky Information, Expectations, Inflation
    JEL: E30 E37
    Date: 2007–10–21
  20. By: Francisco Torres (Universidade Moderna de Lisboa,Universidade Católica)
    Abstract: This paper aims to examine whether the economic and political reasoning behind Maastricht is consistent with earlier approaches to monetary integration. In doing so, it revisits the intellectual debate on monetary integration in Europe at different stages. It concludes that Economic and Monetary Union (EMU) as agreed at Maastricht reflected a compromise between two different but converging preferences, in the context of the experience of the European Monetary System (EMS) and other developments in national and European politics as well as in economic thought, on the role of monetary policy and institutions; the fall of the Berlin Wall may have added a new political dimension that might have made it easier to agree on the blueprint and on the calendar for the realisation of EMU. The various (political and economic) motivations for the convergence of initially different views on the role of monetary policy and successive interpretations of the objectives of EMU are discussed within the wider context of the process of European integration.
    Keywords: Economic and Monetary Union; Bretton Woods; European integration; Werner plan; European Monetary System; inflation; convergence of preferences; epistemic communities; currency crisis; monetary sovereignty; Maastricht treaty; convergence requirements.
    JEL: N14 E52 E58 E61 E65
    Date: 2007
  21. By: Axel Dreher (KOF Swiss Economic Institute, ETH Zurich); Silvia Marchesi (University of Milano-Bicocca, Department of Economics); James Raymond Vreeland (Yale University, Department of Political Science, USA)
    Abstract: Using panel data for 157 countries over the period 1999-2005 we empirically investigate the politics involved in IMF economic forecasts. We find a systematic bias in growth and inflation forecasts. Our results indicate that countries voting in line with the US in the UN General Assembly receive lower inflation forecasts. As the US is the Fund’s major shareholder, this result supports the hypothesis that the Fund’s forecasts are not purely based on economic considerations. We further find inflation forecasts are systematically biased downwards for countries with greater IMF loans outstanding relative to GDP, indicating that the IMF engages in “defensive forecasting.” Countries with a fixed exchange rate regime also receive low inflation forecasts. Considering the detrimental effects that inflation can have under such an exchange rate regime, we consider this evidence consistent with the Fund’s desire to preserve economic stability.
    Keywords: IMF, Economic Forecasts, Political Influence
    JEL: C23 D72 F33 F34
    Date: 2007–10
  22. By: Patrick Fève; Alain Guay
    Abstract: The usefulness of SVARs for developing empirically plausible models is actually subject to many controversies in quantitative macroeconomics. In this paper, we propose a simple alternative two step SVARs based procedure which consistently identifies and estimates the effect of permanent technology shocks on aggregate variables. Simulation experiments from a standard business cycle model show that our approach outperforms standard SVARs. The two step procedure, when applied to actual data, predicts a significant short-run decrease of hours after a technology improvement followed by a delayed and hump-shaped positive response. Additionally, the rate of inflation and the nominal interest rate displays a significant decrease after a positive technology shock.
    Keywords: SVARs, long-run restriction, technology shocks, consumption to output ratio, hours worked
    JEL: C32 E32
    Date: 2007
  23. By: Patrick Fève; Alain Guay
    Abstract: The response of hours worked to a technology shock is an important and a controversial issue in macroeconomics. Unfortunately, the estimated response is generally sensitive to the specification of hours in SVARs. This paper uses a simple two-step approach in order to consistently estimate technology shocks from a SVAR model and the response of hours that follow this shock. The first step considers a SVAR model with a set of relevant stationary variables, but excluding hours. Given a consistent estimate of technology shocks in the first step, the response of hours to this shock is estimated in a second step. When applied to US data, the two-step approach predicts a short-run decrease of hours after a technology improvement followed by a hump-shaped positive response. This result is robust to the specification of hours, different sample periods, measures of hours and output and to the variables included in the VAR in the first step.
    Keywords: SVARs, long-run restriction, technology shocks, consumption to output ratio, hours worked
    JEL: C32 E32
    Date: 2007
  24. By: Philippe Moutot (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Dieter Gerdesmeier (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Adriana Lojschová (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Julian von Landesberger (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Monetary growth has increased significantly in the euro area in recent years, raising concerns about the risks to price stability. Viewed from a sectoral perspective, this increase reflects to a large extent the deposit holdings of other financial intermediaries (OFIs). This paper presents analytical work on the role of OFIs in monetary and credit developments in the euro area. Although, at the moment, some shortcomings in the data available – such as the lack of long time series data – seriously limit the analysis of the role of OFIs in monetary and credit aggregates, it seems clear that OFIs have gained considerable importance in recent years, not only as a factor affecting monetary developments, but also for the functioning of the financial system. This gain in importance may be due to financial deregulation and liberalisation, as well as financial innovation. These developments are reflected in the integration and deepening of euro area financial markets, as well as in investors’ attitude to risk.
    Date: 2007–10
  25. By: Antón Nákov (Banco de España); Andrea Pescatori (Federal Reserve Bank of Cleveland)
    Abstract: We assess the extent to which the great US macroeconomic stability since the mid-1980s can be accounted for by changes in oil shocks and the oil share in GDP. To do this we estimate a DSGE model with an oil-producing sector before and after 1984 and perform counterfactual simulations. We nest two popular explanations for the Great Moderation: (1) smaller (non-oil) real shocks; and (2) better monetary policy. We find that the reduced oil share accounted for as much as one-third of the inflation moderation, and 13% of the growth moderation, while smaller oil shocks accounted for 11% of the inflation moderation and 7% of the growth moderation. This notwithstanding, better monetary policy explains the bulk of the inflation moderation, while most of the growth moderation is explained by smaller TFP shocks.
    Keywords: Great Moderation, oil shocks, Bayesian estimation, counterfactual simulations
    JEL: E32 E52 Q43
    Date: 2007–10
  26. By: Alain Gabler
    Abstract: The counter-cyclicality in the relative price of equipment investment which is observed in the U.S. has been attributed to equipment-specific productivity shocks. Cross-country evidence indicates that a number of countries experience sizeable delays between a surge in equipment production and a fall in its relative price, which is difficult to reconcile with sector-specific shocks. I show that in the presence of sector specific, time-varying markups, relative price movements arise as a direct consequence of consumption smoothing, even if all shocks are aggregate, while barriers to firm entry lead to delays in relative price responses. A calibrated version of the model explains around one-third of the relative price fluctuations which are observed in the U.S., as well as the qualitative differences in the behaviour of this relative price across countries.
    Keywords: endogenous markups; firm entry and exit; relative prices
    JEL: E25 E32 D43
    Date: 2007
  27. By: Robert Poole (U.S. Bureau of Labor Statistics); Randal Verbrugge (U.S. Bureau of Labor Statistics)
    Abstract: Between 1999 and 2006, there were two episodes during which inflation in the Rent index in the CPI diverged markedly from inflation in the index for Owner’s Equivalent Rent (OER); early in 2007, these series began to diverge again. Such divergence often prompts many to question CPI methods. A key difference between these two series is that OER indexes are based upon rents which have received a utilities adjustment – an adjustment which is necessary because the OER index is intended to track pure rent-of-shelter, not shelter-plus-utilities. Critics have claimed that the Rent-OER inflation divergences stem from an inappropriate utilities adjustment. This claim is false. In this paper, we decompose the Rent-OER inflation differential into its various determinants, and explore the multiple causes of this divergence over time. There is only one divergence episode – of only six months duration – which is primarily attributable to the utilities adjustment procedure. Indeed, the utilities adjustment sometimes reduced potential divergence between the two series. Instead, the main culprit is rental market segmentation; that is, different rent inflation rates were experienced by different parts of the rental market. Before 2003, the Rent-OER inflation divergence mainly resulted from divergent rental inflation rates within metropolitan areas: areas with a higher proportion of renters experienced higher rental inflation. After 2004, similar divergent inflation across metropolitan areas resulted in higher Rent inflation. Compared to other units, rent control units experienced higher inflation in 2004 (and, to a lesser extent, before mid-2001 and in 2006), which increased Rent inflation but not OER inflation. Finally, in early 2007, there was a sizable divergence between OER and Rent inflation, driven mostly by divergent rental inflation rates within metropolitan areas; the extent of the divergence only becomes evident once the effect of the utilities adjustment is accounted for.
    Keywords: Owners' Equivalent Rent, Utilities Adjustment, Rental Market Segmentation, Rent Control, Inflation Measurement, Core Inflation
    JEL: R31 R21 E31 C81 C82 O47
    Date: 2007–10
  28. By: Marie Brière (Centre Emile Bernheim, Solvay Business School, Université Libre de Bruxelles, Brussel and Credit Agricole Asset Management SGR, Paris.); Ombretta Signori (Credit Agricole Asset Management SGR, Paris.)
    Abstract: This paper examines the dynamics of conditional volatilities and correlations of three asset classes: inflation-linked (IL) bonds, nominal bonds and equities in the United States and Europe for the period 1997-2007. Using a DCC-MVGARCH model, we highlight the significant change that has taken place in the dynamics of correlations and volatilities since 2003. Inflation-linked bonds have become much more volatile and, at the same time, much more highly correlated with nominal bonds. Monthly portfolio optimization since 1997, using our estimates of conditional correlations and volatilities, clearly demonstrates the decreasing weight of inflation-linked bonds in an optimal allocation. This weighting should now be partially reallocated to equities in a US portfolio, while in Europe, the decreased weight of IL bonds is redistributed, with about one-third going to equities and two-thirds to nominal bonds.
    Keywords: inflation-linked bonds, optimal allocation, portfolio choice, conditional volatility, conditional correlation.
    JEL: G11 G12
    Date: 2007–10
  29. By: James T. E. Chapman; Antoine Martin
    Abstract: Freeman (1999) proposes a model in which discount window lending and open market operations have different effects. This is important because in most of the literature, these policies are indistinguishable. However, Freeman's argument that the central bank should absorb losses associated with default to provide risk-sharing stands in stark contrast to the concern that central banks should limit their exposure to credit risk. We extend Freeman's model by introducing moral hazard. With moral hazard, the central bank should avoid absorbing losses and Freeman's argument breaks down. However, we show that policies resembling discount window lending and open market operations can still be distinguished in this new framework. The optimal policy is for the central bank to make a restricted number of creditors compete for funds. By restricting the number of agents, the central bank can limit the moral hazard problem. By making them compete with each other, the central bank can exploit market information that reveals the state of the economy.
    Keywords: Payment, clearing, and settlement systems; Financial markets; Central bank research
    JEL: G20 E58
    Date: 2007
  30. By: Kitov, Ivan
    Abstract: Past and future evolution of inflation, p(t), and unemployment, UE(t), in Japan is modeled. Both variables are represented as linear functions of the change rate of labor force level. These models provide an accurate description for disinflation in the 1990s and deflationary period in the 2000s. In Japan, there exists a statistically reliable (R2=0.68) Phillips curve. This Phillips curve is characterized by a negative relation between inflation and unemployment and their synchronous evolution: UE(t) = -0.94p(t) + 0.045. Effectively, growing unemployment has resulted in decreasing inflation since 1982. A linear and lagged generalized relationship between inflation, unemployment and labor force has been also obtained for Japan: p(t) = 2.8*dLF(t)/LF(t) + 0.9*UE(t) - 0.0392. Labor force projections allow a reliable prediction of inflation and unemployment in Japan: CPI inflation will be negative (between -0.5% and -1% per year) during the next 40 years. Unemployment will increase from 4.0% in 2010 to 5.3% in 2050
    Keywords: inflation; unemployment; labor force; modeling; Japan
    JEL: E24 J20 O11 E27
    Date: 2007–10
  31. By: Schnabl, Gunther; Schobert, Franziska
    Abstract: The paper analyses the monetary policy operations of central banks in the Middle East and North Africa (MENA). We distinguish the pattern of monetary policy operations of the liquidity providing central banks of the large industrialized countries (creditor central banks) and the liquidity absorb-ing central banks of emerging market economies (debtor central banks). Many debtor central banks provide liquidity through foreign exchange intervention in reaction to foreign exchange inflows. If the respective liquidity expansion is regarded as a threat to domestic price and financial stability, liquidity is partly absorbed through sterilization operations. The paper finds that most MENA coun-tries are debtor central banks due to a general pattern of excessive liquidity creation as well as due to country specific reasons.
    Keywords: Emerging Markets; Debtor Central Banks; Foreign Exchange Inflows; Sterilization.
    JEL: F31
    Date: 2007–10

This nep-cba issue is ©2007 by Alexander Mihailov. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.