nep-cba New Economics Papers
on Central Banking
Issue of 2007‒11‒17
forty-four papers chosen by
Alexander Mihailov
University of Reading

  1. Inertia in Taylor Rules By John Driffill; Zeno Rotondi
  2. Is Time ripe for price level path stability? By Vitor Gaspar; Frank Smets; David Vestin
  3. Optimal Monetary Policy and the Sources of Local-Currency Price Stability By Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
  4. Inflation Targeting - a Framework for Communication By Maria Demertzis; Nicola Viegi
  5. Convergence and anchoring of yield curves in the euro area. By Michael Ehrmann; Marcel Fratzscher; Refet S. Gürkaynak; Eric T. Swanson
  6. Social value of public information - testing the limits to transparency. By Michael Ehrmann; Marcel Fratzscher
  7. Political Business Cycles in the New Keynesian Model By Fabio Milani
  8. Testing Uncovered Interest Parity: A Continuous-Time Approach By Antonio Diez de los Rios; Enrique Sentana
  9. Disaggregate Real Exchange Rate Behaviour By Giorgio Fazio; Ronald MacDonald; Peter McAdam
  11. What can probability forecasts tell us about inflation risks? By Juan Angel Garcia; Andres Manzanares
  12. Financial Market Integration and World Economic Stabilization toward Purchasing Power Parity By Tatsuyoshi Okimoto; Katsumi Shimotsu
  13. The Importance of Being Vigilant: Has ECB Communication Influenced Euro Area Inflation Expectations? By David-Jan Jansen; Jakob de Haan
  14. Does high money growth put the inflation target at further risk? By Tim Congdon
  15. Euro Area Inflation: Aggregation Bias and Convergence By Joseph P. Byrne; Norbert Fiess
  16. Exchange rate pass-through to trade prices - the role of non-linearities and asymmetries. By Matthieu Bussiere
  17. RBCs and DSGEs:The Computational Approach to Business Cycle Theory and Evidence By Özer Karagedikli; Troy Matheson; Christie Smith; Shaun P. Vahey
  18. Euro Area Inflation Differentials: Unit Roots, Structural Breaks and Non-Linear Adjustment By Alberto Montagnoli; Andros Gregoriou; Alexandros Kontonikas
  19. Spill-over effects of monetary policy: a progress report on interest rate convergence in Europe By Fladung, Michael
  20. Expenditure-Switching Effect and the Choice of Exchange Rate Regime By Wei Dong
  21. Evolving U.S. monetary policy and the decline of inflation predictability. By Luca Benati; Paolo Surico
  22. Great Moderation(s) and U.S. Interest Rates: Unconditional Evidence By James M. Nason; Gregor W. Smith
  23. Markov-Perfect Optimal Fiscal Policy: The Case of Unbalanced Budgets By Salvador Ortigueira; Joana Pereira
  24. What do we really know about fiscal sustainability in the EU? A panel data diagonostic. By Antonio Afonso; Christophe Rault
  25. Do real interest rates converge? Evidence from the European Union By Michael G. Arghyrou; Andros Gregoriou; Alexandros Kontonikas
  26. Bank Failures in Theory and History: The Great Depression and Other "Contagious" Events By Charles W. Calomiris
  27. The long road to EMU: The Economic and Political Reasoning behind Maastricht By Francisco Torres
  28. Keynesian AD-AS Vadis? By Toichiro Asada; Carl Chiarella; Peter Flaschel; Christian R. Proaño
  29. The Costs to Consumers of a Depreciated Conversion Rate to the Euro By Marques, Luis B
  30. Welfare Implications of Exchange Rate Changes By Marques, Luis B
  31. IMF Support and Inter-regime Exchange rate Volatility By Ivo J.M. Arnold; Ronald MacDonald; Casper G. de Vries
  32. Canada's Pioneering Experience with a Flexible Exchange Rate in the 1950s:(Hard) Lessons Learned for Monetary Policy in a Small Open Economy By Michael D. Bordo; Ali Dib; Lawrence Schembri
  33. How Persistent are International Capital Flows? By Vahagn Galstyan
  34. On the conditions of validity of the value input-output model By De MESNARD, Louis
  35. Central banking in the iberian peninsula: a comparison By Pablo Martin Aceña
  36. The Economic Effects of Energy Price Shocks By Kilian, Lutz
  37. The Undisclosed Renminbi Basket: Are The Markets Telling Us Something About Where The Renminbi - US Dollar Exchange Rate Is Going? By Funke, Michael; Gronwald, Marc
  38. The Implementation of Monetary Policy in New Zealand: What Factors Affect the 90-Day Bank Bill Rate? By Alfred V. Guender; Oyvinn Rimer
  39. The Political Economy of Exchange Rate in Brazil By Cristina Terra
  40. The Contribution of Sectoral Productivity Differentials to Inflation in Greece By Heather D. Gibson; Jim Malley
  41. Modelling Ireland’s exchange rates: from EMS to EMU. By Edward J. O'Brien; Derek Bond; Michael J. Harrison
  42. Measures of Monetary Policy Stance: The Case of Pakistan By Sajawal Khan; Abdul Qayyum
  43. Zimbabwe’s Black Market for Foreign Exchange By Albert Makochekanwa
  44. Zimbabwe’s Hyperinflation Money Demand Model By Albert Makochekanwa

  1. By: John Driffill (School of Economics, Mathematics & Statistics, Birkbeck); Zeno Rotondi
    Abstract: The inertia found in econometric estimates of interest rate rules is a continuing puzzle. Many reasons for it have been offered, though unsatisfactorily, and the issue remains open. In the empirical literature on interest rate rules, inertia in setting interest rates is typically modeled by specifying a Taylor rule with the lagged policy rate on the right hand side. We argue that inertia in the policy rule may simply reflect the inertia in the economy itself, since optimal rules typically inherit the inertia present in the model of the economy. Our hypothesis receives some support from US data. Hence we agree with Rudebusch (2002) that monetary inertia is, at least partly, an illusion, but for different reasons.
    Keywords: Monetary Policy, Interest Rate Rules, Taylor rule, Interest Rate Smoothing, Monetary Policy Inertia, Predictability of Interest Rates, Term Structure, Expectations Hypothesis
    JEL: E52 E58
    Date: 2007–11
  2. By: Vitor Gaspar (Banco de Portugal, R. Francisco Ribeiro, 2, 1150-165 Lisboa, Portugal.); Frank Smets (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); David Vestin (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: In the paper, we provide a critical and selective survey of arguments relevant for the assessment of the case for price level path stability (PLPS). Using a standard hybrid new Keynesian model we argue that price level stability provides a natural framework for monetary policy under commitment. There are two main arguments in favour of a PLPS regime. First, it helps overall macroeconomic stability by making expectations operate like automatic stabilizers. Second, under a price level path stability regime, changes in the price level operate like an intertemporal adjustment mechanism, reducing the magnitude of required changes in nominal interest rates. Such a property is particularly relevant as a means to alleviate the importance of the zero bound on nominal interest rates. We also review and discuss the arguments against price level path stability. Finally, we also found, using the Smets and Wouters (2003) model which includes a wide variety of frictions and is estimated for the euro area, that the price level is stationary under optimal policy under commitment. The results obtain when the quasi-difference of inflation is used in the loss function, as in the hybrid new Keynesian model. Overall, the arguments in favour of or against price level path stability depend on the degree of dependence of private sector expectations on the characteristics of the monetary policy regime. JEL Classification: E52, D83.
    Keywords: Price Level Stability, Expectations, Adaptive Learning.
    Date: 2007–10
  3. By: Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
    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 favour 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.
    Keywords: exchange rate pass-through; optimal monetary policy; price discrimination; price dispersion; real exchange rates
    JEL: F31 F33 F41
    Date: 2007–11
  4. By: Maria Demertzis; Nicola Viegi
    Abstract: More than a monetary policy strategy, we interpret inflation targeting as a framework for communication. We model monetary policy as an information game between the Bank and private agents. Our analysis shows how the provision of an explicit numerical inflation objective overcomes potential information imperfections by providing a focal point for agents who form expectations. Furthermore, the combination of the target and the tolerance bands around it communicated, provide a very clear framework with which to evaluate monetary policy outcomes. A successful Central Bank then builds up credibility and a credible Central Bank is in a better position to be successful in subsequent periods. We show how (and when) inflation targeting exploits this self-reinforcing loop to help the Central Bank endure large and long-lasting shocks. Last, we show that a trade-off emerges when choosing the band-width: too narrow bands provide a focal point but reduce the likelihood of inflation being ‘successful'. Too wide bands on the other hand, lead easier to success but at the risk of failing to provide a clear focal point. We thus derive the optimal band-width for different scenarios.
    Keywords: Monetary Policy; Communication; Focal Points; Credibility; Optimal Band-Width.
    JEL: C71 C78 E52
    Date: 2007–10
  5. By: Michael Ehrmann (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Refet S. Gürkaynak (CEPR and Bilkent University, 06800 Bilkent, Ankara, Turkey.); Eric T. Swanson (Federal Reserve Bank of San Francisco, 101 Market Street, San Francisco, CA 94105, USA.)
    Abstract: We study the convergence of European bond markets and the anchoring of inflation expectations in euro area countries using high-frequency bond yield data for France, Germany, Italy and Spain. We find that Economic and Monetary Union (EMU) has led to substantial convergence in euro area sovereign bond markets in terms of interest rate levels, unconditional daily fluctuations, and conditional responses to major macroeconomic data announcements. Our findings also suggest a substantial increase in the anchoring of long-term inflation expectations since EMU, particularly for Italy and Spain, which since monetary union have seen their long-term interest rates become much lower, much less volatile, and much better anchored in response to news. Finally, the reaction of far-ahead forward interest rates to macroeconomic announcements has converged substantially across euro area countries and even been eliminated over time, thus underlining not only market integration but also the credibility that financial markets attach to monetary policy in the euro area. JEL Classification: E52, E58.
    Keywords: Bond markets, euro area, EMU, convergence, anchoring, credibility, monetary policy.
    Date: 2007–10
  6. By: Michael Ehrmann (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: Transparency has become an almost universal virtue among central banks. The paper tests empirically, for the case of the Federal Reserve, two hypotheses about central bank transparency derived from the debate of Morris and Shin (2002) and Svensson (2006). First, the paper finds that the precision of communication is a key determinant of the predictability of both FOMC decisions as well as the future policy path. Second, the effectiveness of communication is found to depend on the market environment. Specifically, a given statement may enhance predictability in an environment of high market uncertainty, but may reduce it when uncertainty is low. The findings underline the limits to transparency and stress the need for communication to be flexible and adjust to market conditions in order for central banks to achieve their ultimate objectives. JEL Classification: E52, E58, D82.
    Keywords: Communication, transparency, monetary policy, predictability, effectiveness, Federal Reserve.
    Date: 2007–10
  7. By: Fabio Milani (Department of Economics, University of California-Irvine)
    Abstract: This paper tests various Political Business Cycle theories in a New Keynesian model with a monetary and fiscal policy mix. All the policy coefficients, the target levels of inflation and the budget deficit, the firms' frequency of price setting, and the standard deviations of the structural shocks are allowed to depend on 'political' regimes: a pre-election vs. post-election regime, a regime that depends on whether the President (or the Fed Chairman) is a Democrat or a Republican, and a regime under which the President and the Fed Chairman share party affiliation in pre-election quarters or not. The model is estimated using full-information Bayesian methods. The assumption of rational expectations is relaxed: economic agents can learn about the effect of political variables over time. The results provide evidence that several coefficients depend on political variables. The best-fitting specification is one that allows coefficients to depend on a pre-election vs. non-election regime. Monetary policy becomes considerably more inertial before elections and fiscal policy deviations from a simple rule are more common. The results overall support the view of an independent Fed that avoids taking policy decisions right before elections. There is some evidence, however, that policies become more expansionary before elections, but this evidence seems to disappear in the post-1985 sample. The estimates also indicate that firms similarly delay their price-setting decisions until after the upcoming Presidential election.
    Keywords: Political Business Cycles; Opportunistic Cycles; Partisan Cycles; Monetary and Fiscal Policy; Adaptive Learning; Bayesian Estimation
    JEL: C11 D72 E32 E52 E58 E63
    Date: 2007–11
  8. By: Antonio Diez de los Rios; Enrique Sentana
    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; Econometric and statistical methods
    JEL: F31 G15
    Date: 2007
  9. By: Giorgio Fazio; Ronald MacDonald; Peter McAdam
    Abstract: In this paper, we re-examine the “PPP Puzzle” using sectoral disaggregated data. Specifically, we first analyse the mean reversion speeds of real exchange rates for a number of different sectors in eleven industrial economies and then focus on relating these rates to variables identified in the literature as key determinants of CPI-based real exchange rates, namely: the trade balance, productivity and the mark up. In particular, we seek to understand to what extent the relationships existing at the aggregate level are borne out at the disaggregate level. We believe that this analysis can help shed light on the PPP puzzle.
    Keywords: Real Exchange Rates, Sectoral Prices, Panel Data Methods
    JEL: F31 F41 C33
    Date: 2007–07
  10. By: Giorgio Fazio; Ronald MacDonald; Jacques Melitz
    Abstract: In this paper we test the well-known hypothesis of Obstfeld and Rogoff (2000) that trade costs are the key to explaining the so-called Feldstein-Horioka puzzle. Our approach has a number of novel features. First, we focus on the interrelationship between trade costs, the trade account and the Feldstein-Horioka puzzle. Second, we use the gravity model to estimate the effect of trade costs on bilateral trade and, third, we show how bilateral trade can be used to draw inferences about desired trade balances and desired intertemporal trade. Our econo-metric results provide strong support for the Obstfeld and Rogoff hypothesis and we are also able to reconcile our results with the so-called home bias puzzle.
    Keywords: Feldstein-Horioka puzzle; trade costs; gravity model; home bias puzzle; current account; trade balance
    JEL: F10 F32
    Date: 2007–07
  11. By: Juan Angel Garcia (European Central Bank,Capital Markets and Financial Structure Division, Kaiserstraße 29, 60311 Frankfurt, Germany.); Andres Manzanares (European Central Bank,Risk Management Division, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: We show that international consumption risk sharing is significantly improved by capital flows, especially portfolio investment. Concomitantly, we show that poor institutions hamper risk sharing, but to an extent that decreases with openness. In particular, risk sharing is prevalent even among economies with poor institutions, provided they are open to international markets. This is consistent with the view that the prospect of retaliation may deter expropriation of foreign capital, even in institutional environments where it is possible. This deterrent is anticipated by investors, who act to diversify risk. By contrast, capital flows headed for closed economies with poor institutions are designed and constrained so as to limit the cost incurred in case of expropriation, and thus achieve little risk sharing. Finally, we show this non-linearity continues to be present in the determinants of international capital flows themselves. Institutions are crucial in attracting capital for closed economies, but are barely relevant in open ones. JEL Classification: C16, C42, E31, E47.
    Keywords: Inflation risk, inflation expectations, Survey of Professional Forecasters (SPF), skew-normal distribution, power divergence estimators.
    Date: 2007–10
  12. By: Tatsuyoshi Okimoto (Yokohama National University); Katsumi Shimotsu (Queen's University)
    Abstract: Purchasing power parity (PPP) is one of the most important, but empirically controversial theories in international macroeconomics. Although many researchers believe that some variant of PPP holds in the long run, there are diverse empirical results regarding the PPP hypothesis. We examine the PPP hypothesis from an alternate point of view: We investigate the possibility of financial market integration, and world economic stabilization toward PPP, by examining the change in the persistence of PPP deviations during the last three decades. We employ a fractional integration framework, which provides a powerful tool to detect changes in the persistence for highly persistent time series. First, we test the null hypothesis of no decline in the persistence of PPP deviations. The test rejects the null at the 10% significance level for 11 out of 17 countries, thus providing strong support for financial market integration and world economic stabilization toward PPP. Second, we examine the dynamics of the persistence of PPP deviations during the last three decades through rolling-window estimation. Our results show that the persistence of PPP deviations has decreased gradually, and that many real exchange rates have experienced a sharp drop in their persistence once samples starting in the mid-1980s are used. Interestingly, this timing almost coincides with the timing of U.S./world economic stabilization reported by other studies. We also examine the relation between the persistence of PPP deviations and de facto measures of financial integration by Lane and Milesi-Ferretti (2006). We confirm that they are strongly correlated for all countries. This finding suggests that the recent promotion of financial integration is one of the main sources of the decline in the persistence of PPP deviations.
    Keywords: fractional integration, PPP, real exchange rate, financial integration
    JEL: C14 C22 F31 F36
    Date: 2007–10
  13. By: David-Jan Jansen; Jakob de Haan
    Abstract: Using daily data on inflation-indexed bonds, we find evidence of a negative relationship between ECB communication regarding risks to price stability - measured on the basis of the frequency and strength of the keyword ‘vigilance' - and changes in euro area break-even inflation. However, this result is only found for the second half of 2005. At that time, the start of a tightening of ECB monetary policy was increasingly likely. This suggests that communication should be closely in line with policy actions before it can be effective. Still, we also find that the economic significance of this type of communication has been small.
    Keywords: central bank communication; ECB; inflation expectations 
    JEL: C71 C78 E52
    Date: 2007–10
  14. By: Tim Congdon
    Date: 2007–10
  15. By: Joseph P. Byrne; Norbert Fiess
    Abstract: EMU monetary policy targets aggregate Euro Area inflation. Concerns are growing that a focus on aggregate inflation may cause national inflation rates to diverge. While different explanations for diverging aggregate Euro Area inflation have been brought forward, the very impact of aggregation on divergence has however not been studied. We find a striking difference in convergence depending on the level of aggregation. While aggregate national inflation rates are diverging, disaggregate inflation rates are converging. We find that aggregation appears to bias evidence towards non-convergence. Our results are consistent with prominent theoretical and empirical evidence on aggregation bias
    Keywords: Euro Area Inflation; Aggregation Bias; Convergence
    JEL: C12 C22 E31
    Date: 2007–10
  16. By: Matthieu Bussiere (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: A standard assumption in the empirical literature is that exchange rate pass-through is both linear and symmetric, implying that (a) large and small exchange rate changes and (b) appreciations and depreciations have an effect of the same magnitude, proportionally. This paper tests these assumptions for export and import prices in the G7 economies. It focuses on non-linearities in the reaction of profit margins to exchange rate movements, which may arise from the presence of price rigidities and switching costs. To this end, nonlinearities are characterised by augmenting a standard linear model with polynomial functions of the exchange rate and with interactive dummy variables. The presence of such non-linearities is confirmed by formal statistical tests. Overall, the results suggest that non-linearities and asymmetries in the exchange rate pass-through cannot be ignored, especially on the export side, although their magnitude varies noticeably across countries. JEL Classification: C22, C51, F14, F31.
    Keywords: Exchange Rate Pass-Through, Non-linear Model, Trade Prices.
    Date: 2007–10
  17. By: Özer Karagedikli; Troy Matheson; Christie Smith; Shaun P. Vahey (Reserve Bank of New Zealand)
    Abstract: Real Business Cycle (RBC) and Dynamic Stochastic General Equilibrium (DSGE) methods have become essential components of the macroeconomist’s toolkit. This literature review stresses recently developed (often Bayesian) techniques for computation and inference, providing a supplement to the Romer (2006) textbook treatment which stresses theoretical issues. Many computational aspects are illustrated with reference to the simple divisible labour RBC model familiar to graduate students from King, Plosser and Rebelo (1988), Christiano and Eichenbaum (1992), Campbell (1994) and Romer (2006). Code and US data to replicate the computations are provided on the Internet, together with a number of appendices providing background details.
    JEL: C11 C22 E17 E32 E52
    Date: 2007–11
  18. By: Alberto Montagnoli; Andros Gregoriou; Alexandros Kontonikas
    Abstract: This paper examines the time series properties of inflation differentials in twelve EMU countries. We compute three alternative measures of inflation differentials using deviations from the policy reference value implied by the Maastricht Treaty, the ECB target, and deviations from the EMU average inflation. The evidence from standard linear unit root tests indicate that inflation differentials are highly persistent. However, when we account for endogenously determined structural breaks, we obtain greater support for stationarity. In addition, when we allow for the possibility that inflation differentials can be charterised by a non-linear mean reverting process we find evidence of stationarity. Our empirical results suggest that once we allow for structural breaks or non-linearities, inflation differentials do not consistently intensify real divergence in the euro area
    Keywords: EMU, ESTAR models; Inflation; Structural break; Unit root tests
    JEL: C22 E31
    Date: 2007–06
  19. By: Fladung, Michael
    Abstract: This study examines differences in the interest rate response to an ECB policy impulse in the euro area, the new EU-member states, and in the other non-eurozone EU countries in order to gauge the degree of interest rate alignment in Europe. To this end, PANIC, a Panel Analysis of Non-stationarity in I diosyncratic and Common components, is employed in a structural factor set-up. Under the assumption that the ECB sets the short end of the yield curve, the analysis shows that : (i) The response of Europe’s money and government bond markets to new information can be summarized by two common stochastic trends and one stationary common factor, which together explain more than 68% of the overall variation of the two market segments; (ii) one of the factor innovations can be associated with the ECB’s policy stance, which strongly affects the short end of the euro area’s yield curve; (iii) compared to the euro area, the short-term market segments in the new EU-member states react, on average, 12% more weakly to the monetary policy signal, whereas these countries’ long-term government bond yields respond up to 25% more strongly to such a common innovation.
    Keywords: Factor Models, Common Stochastic Trends, Interest Rate Channel, New Member States, Mixed Data Sampling
    JEL: C33 E52 G15
    Date: 2007
  20. By: Wei Dong
    Abstract: The author investigates the quantitative importance of the expenditure-switching effect by developing and estimating a structural sticky-price model nesting both producer currency pricing (PCP) and local currency pricing (LCP) settings. The author aims to provide empirical evidence of the magnitude of the benefits to be gained from exchange rate flexibility in terms of expenditure switching, and to contribute to the ongoing debate regarding the optimal exchange rate regime. In the author's model, the size of the expenditure-switching effect is determined by the degree of price stickiness, the fraction of firms employing PCP versus LCP, the distribution margin, and the elasticity of substitution between domestic and foreign tradable goods. The model is estimated for three small open economies: Australia, Canada, and the United Kingdom. The empirical results suggest that, among the three countries, the magnitude of the expenditure switching by domestic agents is relatively small for the United Kingdom, and comparatively large for Canada; the distribution margin in the United Kingdom is exceptionally high, which limits the degree of domestic expenditure switching initiated by nominal exchange rate movements. Moreover, expenditure switching by foreign distributors is comparatively small for Australia and Canada, since a larger fraction of Australian and Canadian firms adopt LCP for their export pricesetting.
    Keywords: Exchange rate regimes; International topics
    JEL: F3 F4
    Date: 2007
  21. By: Luca Benati (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Paolo Surico (External Monetary Policy Committee Unit, Bank of England, Threadneedle Street, London, EC2R 8AH, United Kingdom.)
    Abstract: Using a structural VAR with time-varying parameters and stochastic volatility on post-WWII U.S. data, we document a striking negative correlation between the evolution of the long-run coefficient on inflation in the monetary rule and the evolution of the persistence and predictability of inflation relative to a trend component. Using a standard sticky-price model, we show that a more aggressive policy stance towards inflation causes a decline in inflation predictability, providing a possible interpretation for the findings of the structural VAR. JEL Classification: E37, E52, E58.
    Keywords: Bayesian time-varying VARs, sign restrictions, frequency domain, Great Inflation, predictability.
    Date: 2007–10
  22. By: James M. Nason (Federal Reserve Bank of Atlanta); Gregor W. Smith (Queen's University)
    Abstract: The US economy experienced a Great Moderation sometime in the mid-1980s -- a fall in the volatility of output growth -- at the same time as a fall in both the volatility of inflation and the average rate of inflation. We put this moderation in historical perspective by comparing it to the post-WWII moderation. According to theory, the statistical moments -- both real and nominal -- that shift during these moderations in turn influence interest rates. We examine the predictions for shifts in the unconditional average of US interest rates. A central finding is that such shifts probably were due to changes in average inflation rather than to those in the variances of inflation and consumption growth.
    Keywords: great moderation, asset pricing
    JEL: E32 E43 N12
    Date: 2007–11
  23. By: Salvador Ortigueira; Joana Pereira
    Abstract: We study optimal income taxation and public debt policy in a neoclassical economy populated by infinitely-lived households and a benevolent government. The government makes sequential decisions on the provision of a valued public good, on income taxation and the issue of public debt. We characterize and compute Markov-perfect optimal fiscal policy in this economy with two payoff-relevant state variables: physical capital and public debt. We find two stable, steady-state equilibria: one with no income taxation and positive government asset holdings, and another with positive taxation and public debt issuances. We prove that the two steady states are associated with different policy rules, which implies a multiplicity of (expectation-driven) Markov-perfect equilibria.
    Keywords: Optimal taxation; optimal public debt; Markov-perfect equilibrium; Time-consistent policy
    JEL: E61 E62 H21 H63
    Date: 2007
  24. By: Antonio Afonso (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Christophe Rault (Université d’Orléans, LEO, CNRS, UMR 6221, Rue de Blois-B.P.6739, 45067 Orléans Cedex 2, France.)
    Abstract: We assess the sustainability of public finances in the EU15 over the period 1970-2006 using stationarity and cointegration analysis. Specifically, we use panel unit root tests of the first and second generation allowing in some cases for structural breaks. We also apply modern panel cointegration techniques developed by Pedroni (1999, 2004), generalized by Banerjee and Carrion-i-Silvestre (2006) and Westerlund and Edgerton (2007), to a structural long-run equation between general government expenditures and revenues. While estimations point to fiscal sustainability being an issue in some countries, fiscal policy was sustainable both for the EU15 panel set, and within subperiods (1970-1991 and 1992-2006). JEL Classification: C23, E62, H62, H63.
    Keywords: Intertemporal budget constraint, fiscal sustainability, EU, panel unit root, panel cointegration.
    Date: 2007–10
  25. By: Michael G. Arghyrou; Andros Gregoriou; Alexandros Kontonikas
    Abstract: We test for real interest parity (RIP) in the EU25 area. Our contribution is two-fold: First, we account for the previously overlooked effects of structural breaks on real interest rate differentials. Second, we test for RIP against the EMU average. For the majority of our sample countries we obtain evidence of real interest rate convergence towards the latter. Convergence, however, is a gradual process subject to structural breaks, typically falling close to the launch of the euro. Our findings have important implications relating to the single monetary policy and the progress new EU members have achieved towards joining the euro.
    Keywords: real interest rate parity; convergence, structural breaks; EU; EMU
    JEL: F21 F32 C15 C22
    Date: 2007–06
  26. By: Charles W. Calomiris
    Abstract: Bank failures during banking crises, in theory, can result either from unwarranted depositor withdrawals during events characterized by contagion or panic, or as the result of fundamental bank insolvency. Various views of contagion are described and compared to historical evidence from banking crises, with special emphasis on the U.S. experience during and prior to the Great Depression. Panics or "contagion" played a small role in bank failure, during or before the Great Depression-era distress. Ironically, the government safety net, which was designed to forestall the (overestimated) risks of contagion, seems to have become the primary source of systemic instability in banking in the current era.
    JEL: E5 G2 N2
    Date: 2007–11
  27. By: Francisco Torres (IEE - Universidade Católica Portuguesa and INA)
    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: 2007–11
  28. By: Toichiro Asada (Chuo University); Carl Chiarella (School of Finance and Economics, University of Technology, Sydney); Peter Flaschel (Faculty of Economics, University of Bielefeld); Christian R. Proaño (Faculty of Economics, University of Bielefeld)
    Abstract: We formulate a dynamic AD-AS model based on gradually adjusting wages and prices, perfect foresight of current inflation rates and adaptive expectations concerning the inflation climate in which the economy operates. The model consists of a wage and a price Phillips curve, a dynamic IS curve as well as a dynamic employment adjustment equation (Okun?s law) and a Taylor interest rate rule. The model can be reduced to a 3D dynamical system by a suitable choice of the Taylor rule and implies strong stability results, in particular for an appropriately chosen interest rate policy rule. Through instrumental variables GMM system estimation with aggregate time series data for the U.K. economy, we obtain parameter estimates which support the specification of our theoretical model and its stability implications. We contrast these results with the standard (formally similarly structured) New Keynesian model with staggered wage and price setting where determinacy of the dynamics represents a severe problem and where (if determinacy can be achieved) inertia-free stability is obtained by the very choice of the solution method.
    Keywords: AS-AD; wage and price Phillips curve; real wage dynamics; stability; monetary policy
    JEL: E24 E31 E32
    Date: 2007–11–01
  29. By: Marques, Luis B
    Abstract: This paper measures the welfare cost to consumers of the bloc of Central and Eastern European Countries (CEEC), plus Malta and Cyprus, of choosing a de- preciated conversion rate when joining the European Monetary Union. For this, I present and solve an appropriately calibrated small open economy model where a euro-denominated bond and the equity on a traded goods sector are traded internationally. I show that the cost of depreciating the domestic currency against the euro by 20%, at the time of joining the European Monetary Union, entails a cost of approximately 1.65% in terms of lost lifetime utility (measured in equivalent units of consumption).
    Keywords: trade effect; valuation effect; wealth effect; exchange rate.
    JEL: F41 F47 F31
    Date: 2007–08
  30. By: Marques, Luis B
    Abstract: This paper measures the welfare implications of a depreciation of the US dollar against the euro using a dynamic equilibrium model. I calibrate a simple two country stochastic endowment economy with trade in goods and financial assets and exogenous variations in the exchange rate. The model displays both a trade channel effect and an asset channel effect after a change in the value of the exchange rate. The welfare loss coming from the trade channel translates into the relatively higher price that consumers have to pay for imports. The asset channel effect arises from three sources. One is the traditional valuation effect associated with US debt being denominated mostly in dollars. The other two novel effects are: (1) the dollar value of investors net worth, mostly denominated in local currency, increases more in Europe than in the US; (2) asset prices change, causing a portfolio rebalancing effect which results in a fall in the share of world assets owned by the US. I show that a dollar depreciation has potentially large negative welfare effects as measured by the net present value of future consumption. After a temporary 10% depreciation of the dollar, with a half-life of one year, I calculate a 0.25% decrease in lifetime aggregate consumption for the US consumer.
    Keywords: trade effect; valuation effect; wealth effect; exchange rate; dynamic equilibrium model; welfare.
    JEL: F41 F47 F31
    Date: 2007–03
  31. By: Ivo J.M. Arnold; Ronald MacDonald; Casper G. de Vries
    Abstract: A widely held notion is that freely floating exchange rates are excessively volatile when moving from fixed to floating exchange rates. We re-examine the data and conclude that the disparity between the fundamentals and exchange rate volatility is more apparent than real, especially when the Deutsche Mark, rather than the dollar, is chosen as the numeraire currency. We argue and demonstrate that in inter-regime comparisons one has to account for certain ‘missing variables’ which compensate for the fundamental variables’ volatility under fixed exchange rates. We show that IMF credit support is a crucial compensating variable.
    Keywords: Exchange rates; Exchange rate regimes; Excess volatility; IMF credit
    JEL: F31
    Date: 2007–06
  32. By: Michael D. Bordo; Ali Dib; Lawrence Schembri
    Abstract: This paper revisits Canada's pioneering experience with floating exchange rate over the period 1950-1962. It examines whether the floating rate was the best option for Canada in the 1950s by developing and estimating a New Keynesian small open economy model of the Canadian economy. The model is then used to conduct a counterfactual analysis of the impact of different monetary policies and exchange rate regimes. The main finding indicates that the flexible exchange rate helped reduce the volatility of key macro-economic variables. The Canadian monetary authorities, however, clearly did not understand all of the implications of conducting monetary policy under a flexible exchange rate and a high degree of capital mobility. The paper confirms that monetary policy was more volatile in the post-1957 period and Canada's macroeconomic performance suffered as a result.
    JEL: E32 E37 F31 F32 N01
    Date: 2007–11
  33. By: Vahagn Galstyan
    Abstract: This paper documents the dynamic properties of the current account, trade balance and international capital flows. For this purpose, three different approaches are taken: probit, non-parametric estimation and an asymmetric autoregression. The probabilistic approach shows that, in general, deficits and net inflows tend to be more persistent than surpluses and net outflows. This result is robust to either specification of pooled and country-specific probits. Current account reversals have a significant effect on the persistence of capital flows, especially in developing countries. The latter also have more persistent deficits and net inflows than industrial countries. The results of non-parametric estimation are in line with the results obtained from the probit. In the case of asymmetric autoregression, we find that surpluses are more persistent than deficits: although the probability of remaining in a surplus state is lower, the scale of surpluses tends to show more persistence than the scale of deficits.
    Date: 2007–11–09
  34. By: De MESNARD, Louis (LEG - CNRS UMR 5118 - Université de Bourgogne)
    Abstract: The general aim of this paper is to show that even the simplest economic models may be largely trivial. One discusses how a value input-output model can be derived from a physical input-output model. In the physical input-output model, variables are physical quantities and prices and in the value input-output model, variables are quantities in currency units and price indexes. One demonstrates that the value model must be biperiodical, that is, never a-periodic as assumed by Leontief, and that price indexes must replace prices. Hence, two variants of the model are possible: (i) the operational model where the price indexes are the solution of the value model for the base year and (ii) the true model where the current prices solve the physical model for the current year. It is impossible to decide which model is the best. Both models diverge generally unless some strong hypotheses are made: stability of the vertically integrated physical coefficients of labor, or even stability of the physical structure itself. Working on an aperiodic value model is not innocent even if virtually all scholars and practitioners use to do by operational necessity. The results could be generalized to SAM models or to the SNA’s rectangular input-output model.
    Keywords: Input-Output, Leontief, Price Index, Make-Use, SAM
    JEL: C67 D57
    Date: 2007–11
  35. By: Pablo Martin Aceña
    Abstract: The paper explores the similiraties and differences between the origin, behavior and evolution of the central banks of Portugal and Spain. Portugal and Spain are two countries that share the same peninsular space in the west corner of Europe. Though different in size and population, the political, social and economic history of both nations offer more similarities than differences. In the financial sphere, he resemblances are remarkable. Both nations exhibit very low levels of financial intermediation, as measured by the ratio between total bank deposits and GDP. Another common feature of both Iberian nations is the dominance exerted by a sole institution. However, we also find some divergences between the financial structures of the two countries that are worth noting. Three differences merit our particular attention in this paper. The first diversity refers to the distinct composition of the quantity of money. The monetary regime is the second difference between the two countries (Portugal joined the gold standard while Spain remained off the gold standard). Finally, the Bank of Portugal and the Bank of Spain exhibit also significant contrasts in their behavior as central banks.
    Date: 2007–10
  36. By: Kilian, Lutz
    Abstract: Large fluctuations in energy prices have been a distinguishing characteristic of the U.S. economy since the 1970s. Turmoil in the Middle East, rising energy prices in the U.S. and evidence of global warming recently have reignited interest in the link between energy prices and economic performance. This paper addresses a number of the key issues in this debate: What are energy price shocks and where do they come from? How responsive is energy demand to changes in energy prices? How do consumers’ expenditure patterns evolve in response to energy price shocks? How do energy price shocks affect real output, inflation, stock markets and the balance-of-payments? Why do energy price increases seem to cause recessions, but energy price decreases do not seem to cause expansions? Why has there been a surge in gasoline prices in recent years? Why has this new energy price shock not caused a recession so far? Have the effects of energy price shocks waned since the 1980s and, if so, why? As the paper demonstrates, it is critical to account for the endogeneity of energy prices and to differentiate between the effects of demand and supply shocks in energy markets, when answering these questions.
    Keywords: Asymmetry; Causality; Channels of transmission; Crude oil; Elasticity; Gasoline; Price shocks; Propagation
    JEL: E21 Q43
    Date: 2007–11
  37. By: Funke, Michael (BOFIT); Gronwald, Marc (BOFIT)
    Abstract: On 21 July 2005 China adopted an undisclosed basket exchange rate regime. We formally assess and envisage the gradual evolution of the renminbi over time. We utilize nonlinear dependencies in the renminbi exchange rate and describe the smooth transition of the renminbi/U.S. dollar (RMB/USD) exchange rate using the family of time-varying autoregressive (TV-AR) models. Specifically, the nonlinear models allow for a smooth transition from one optimal level to another. Our estimation results imply that the RMB/USD exchange rate will likely be about 7.42 RMB/USD in summer/autumn 2008.
    Keywords: China; renminbi; de facto exchange rate regime; TV-AR model; TV-AR-GARCH mode
    JEL: C22 F31 F37
    Date: 2007–11–06
  38. By: Alfred V. Guender (University of Canterbury); Oyvinn Rimer
    Abstract: This paper discusses the implementation of monetary policy in New Zealand and its flow-on effects on the 90-day bank bill rate over the 1999-2005 period. The effects of external factors are considered as well. Our findings indicate that the maturity spectrum ratio exerted a positive effect on the 90-day rate while the allotment ratio did not. This interest rate had a tendency to revert to the level set by its Australian counterpart. No such link exists between the NZ 90-day rate and the US 90-day rate. Neither the maturity spectrum nor the allotment ratio contributed to the volatility of the New Zealand 90-day rate.
    Keywords: 90-Day Bank Bill Rate; Open-Market Operations; Allotment Ratio; Maturity Spectrum Ratio; Foreign Interest Rate Linkage
    JEL: E5
    Date: 2007–10–29
  39. By: Cristina Terra
    Date: 2007–10
  40. By: Heather D. Gibson; Jim Malley
    Date: 2007–10
  41. By: Edward J. O'Brien (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Derek Bond (University of Ulster, Cromore Road, Coleraine, Co.Londonderry, BT52 1SA, United Kingdom.); Michael J. Harrison (School of Economics, University College Dublin, Belfield, Dublin 4, Ireland.)
    Abstract: This paper attempts to model the nominal and real exchange rate for Ireland, relative to Germany and the UK from 1975 to 2003. It offers an overview of the theory of purchasing power parity (Ppp), focusing particularly on likely sources of nonlinearity. Potential difficulties in placing the analysis in the standard I(1)/I(0)framework are highlighted and comparisons with previous Irish studies are made. Tests for fractional integration and nonlinearity, including random field regressions, are discussed and applied. The results obtained highlight the likely inadequacies of the standard cointegration and Star approaches to modelling, and point instead to multiple structural changes models. Using this approach, both bilateral nominal exchange rates are effectively modelled, and in the case of Ireland and Germany, Ppp is found to be valid not only in the long run, but also in the medium term. JEL Classification: C22, C51, F31, F41.
    Keywords: Purchasing power parity, fractional Dickey-Fuller tests, smooth transition, autoregression, random field regression, multiple structural changes models.
    Date: 2007–10
  42. By: Sajawal Khan (Pakistan Institute of Development Economics, Islamabad.); Abdul Qayyum (Pakistan Institute of Development Economics, Islamabad.)
    Abstract: In this paper we construct two measures of the monetary policy stance. The stance of monetary policy, regarded as a quantitative measure of whether the policy is too tight, neutral, or too loose relative to objectives of stable prices and output growth, is useful and important for at least two reasons. First, it helps the authority (central bank) to determine the course of monetary policy needed to keep the objective (goals) within the target range. Secondly, a quantitative measure of the stance is important for an empirical study of the transmission of monetary policy actions through the economy. Measuring the stance of the monetary policy free from any criticism, however, is not an easy task. As pointed out by Gecchetti (1994), “there seems to be no way to measure monetary actions that does not raise serious objections”. Our results show that an individual coefficient Monetary Condition Index (MCI) performs better than both the summarised MCI coefficient and the Overall measure proposed by Bernanke and Mihov (1998). The results show that in the 21-year period from 1984 to 2004, the demand shocks have dominated for about eight years. The MCI (IS-Individual coefficient) can explain six of them. However, it indicates the negative demand shock in two years as neutral. The other two measures, however, fail to capture demand shocks most of the time. This analysis suggests that the MCI (IS-Individual coefficient) plays an important role in determining output and inflation when the economy is not dominated by supply shocks. The results also show that supply shocks are dominant in the case of Pakistan. Furthermore, the exchange rate channel is more important than the interest rate channel.
    Keywords: Monetary Policy Measures, Monetary Condition Index, Composite Measures
    JEL: E42 E52 E58
    Date: 2007
  43. By: Albert Makochekanwa (Department of Economics, University of Pretoria)
    Abstract: This paper looks into the changes of the black market premium for foreign exchange in Zimbabwe. Generally, the black market for foreign exchange arises as a direct consequence of the adoption of exchange rate controls in many developing economies facing substantial macroeconomic imbalances. Despite its negative impact on Zimbabwe’s economy, this market has not, so far, attracted the attention of researchers. The research attempts to describe the functioning of the black market and find out the determinants of the parallel premium based on a stock-flow model as well as to investigate whether inflation Granger causes the parallel exchange rate. Estimated results reveal that the determinants of the black market premium are international foreign reserves, real exchange rate, lagged values of the black market premium, expected rate of devaluation, money supply and inflation. On the other hand, inflation and black market are found to Granger-cause each other during the period under consideration.
    Keywords: Black Market Exchange Rate, Black Market Premium, Foreign Exchange Controls, Cointegration, Granger Causality
    JEL: F31 C23
    Date: 2007–07
  44. By: Albert Makochekanwa (Department of Economics, University of Pretoria)
    Abstract: The research attempts to empirically study the demand for money, especially the magnitudes of the price expectation and real cash balance adjustment for Zimbabwe. Price expectation and real cash balance adjustment models are estimated. The results show that both the interest rate and the rate of change in prices are relevant variables for explaining the variations in the demand for real cash balances in Zimbabwe. Overall, the findings suggest that the Zimbabwean hyperinflation does not appear to have been a self- generating process independent of money supply.
    Keywords: Hyperinflation, Real Cash Balances, Price Expectation, Equilibrium, Error Correction Model
    JEL: E41 P24 E51
    Date: 2007–07

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.