nep-cba New Economics Papers
on Central Banking
Issue of 2008‒01‒05
sixty-six papers chosen by
Alexander Mihailov
University of Reading

  1. The Explanatory Power of Monetary Policy Rules By John B. Taylor
  2. Housing and Monetary Policy By John B. Taylor
  3. Forecast Targeting as a Monetary Policy Strategy: Policy Rules in Practice By Michael Woodford
  4. Optimal simple and implementable monetary and fiscal rules By Stephanie Schmitt-Grohé; Martín Uribe
  5. Simple Monetary Rules Under Fiscal Dominance By Michael Kumhof; Irina Yakadina; Ricardo Nunes
  6. Taylor Rules Cause Fiscal Policy Ineffectiveness By Guido Ascari; Neil Rankin
  7. The PPP Puzzle: What the Data Tell when Allowed to Speak Freely By Katarina Juselius
  8. Testing Hypotheses in an I(2) Model with Applications to the Persistent Long Swings in the Dmk/$ Rate By Søren Johansen; Katarina Juselius; Roman Frydman; Michael Goldberg
  9. Relative Goods’ Prices and Pure Inflation By Reis, Ricardo; Watson, Mark W
  10. Optimal fiscal feedback on debt in an economy with nominal rigidities By Tatiana Kirsanova; Simon Wren-Lewis
  11. Nominal Debt as a Burden on Monetary Policy By Ramon Marimon; Javier Díaz-Giménez; Giorgia Giovannetti; Pedro Teles
  13. The Macroeconomic Effects of Oil Price Shocks: Why are the 2000s so different from the 1970s? By Olivier J. Blanchard; Jordi Galí
  14. Pricing-to-market, trade costs, and international relative prices By Andrew Atkeson; Ariel Burstein
  15. Rare Disasters, Asset Prices, and Welfare Costs By Robert J. Barro
  16. Utility-Based Utility By David Cass
  17. Solving Linear Rational Expectations Models with Lagged Expectations Quickly and Easily By Alexander Meyer-Gohde
  18. Expectational stability in regime-switching rational expectations models By William A. Branch; Troy Davig; Bruce McGough
  19. Productivity and the dollar By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
  20. When is Money Essential? A Comment on Aliprantis, Camera and Puzzello By Ricardo Lagos; Randall Wright
  21. Measuring real value and inflation By Hillinger, Claude
  22. Debt Stabilization Bias and the Taylor Principle: Optimal Policy in a New Keynesian Model with Government Debt and Inflation Persistence By Sven Jari Stehn; David Vines
  23. Current Global Imbalances: Might Keynes Be of Help? By Anna Maria Carabelli; Mario Aldo Cedrini
  24. Taylor Rules for the ECB using Consensus Data By Janko Gorter; Jan Jacobs; Jakob de Haan
  25. Does Money Growth Granger-Cause Inflation in the Euro Area? Evidence from Out-of-Sample Forecasts Using Bayesian VARs By Berger, Helge; Österholm, Pär
  26. What does the yield curve tell us about the Federal Reserve's implicit inflation target? By Taeyoung Doh
  27. Optimal reserve management and sovereign debt By Laura Alfaro; Fabio Kanczuk
  28. DSGE Modeling at the Fund: Applications and Further Developments By Philippe D Karam; Dennis P. J. Botman; Douglas Laxton; David Rose
  29. Should we take inside money seriously? By Livio Stracca
  30. An Ordering of Measures of the Welfare Cost of Inflation in Economies with Interest-Bearing Deposits By Rubens Penha Cysne; David Turchick
  31. A case for interest-rate smoothing By Bask, Mikael
  32. An Economic Evaluation of Empirical Exchange Rate Models By Della Corte, Pasquale; Sarno, Lucio; Tsiakas, Ilias
  33. Monetary policy and core inflation By Michele Lenza
  34. A Party without a Hangover? On the Effects of U.S. Government Deficits By Michael Kumhof; Douglas Laxton
  35. Does too much Transparency of Central Banks Prevent Agents from Using their Private Information Efficiently? By Axel Lindner
  36. (Un)Predictability and Macroeconomic Stability By D'Agostino, Antonello; Giannone, Domenico; Surico, Paolo
  37. Are there oil currencies? The real exchange rate of oil exporting countries By Maurizio Michael Habib; Margarita Manolova Kalamova
  38. Business cycle synchronization and insurance mechanisms in the EU By António Afonso; Davide Furceri
  39. Dynamic Pricing and Imperfect Common Knowledge By Kristoffer Nimark
  40. Avoiding the inflation tax By Huberto M. Ennis
  41. Oil market structure, network effects and the choice of currency for oil invoicing By Elitza Mileva; Nikolaus Siegfried
  42. Optimal monetary policy committee size: Theory and cross country evidence By Szilárd Erhart; Jose-Luis Vasquez-Paz
  43. Investor Overconfidence and the Forward Discount Puzzle By Han, Bing; Hirshleifer, David; Wang, Tracy
  44. The Bank Lending Channel of Monetary Transmission: Does It Work in Turkey? By Petya Koeva Brooks
  45. How the credit channel works: differentiating the bank lending channel and the balance sheet channel By Lamont K. Black; Richard J. Rosen
  46. Securitisation and the bank lending channel By Yener Altunbas; Leonardo Gambacorta; David Marqués
  47. Between The Rock and a Hard Place: Regime Switching in the RelationshipBetween Short-Term Interest Rates and Equity Returns in the UK By Olan T Henry
  48. Permanent Structural Change in the US Short-Term and Long-Term Interest Rates By Chew Lian Chua; Chin Nam Low
  49. Cross-border returns differentials By Stephanie E. Curcuru; Tomas Dvorak; Francis Warnock
  50. China's Changing Trade Elasticities By Jahangir Aziz; Xiangming Li
  51. Effect of IMF Structural Adjustment Programs on Expectations: The Case of Transition Economies By Patrick A. Imam
  52. Reporting biases and survey results - evidence from European professional forecasters By Juan Angel García; Andrés Manzanares
  53. GDP at risk in a DSGE model: an application to banking sector stress testing By Jokivuolle, Esa; Kilponen , Juha; Kuusi, Tero
  54. Financial integration in East Asia By Hiroshi Fujiki; Akiko Terada-Hagiwara
  55. Inflation Transmission in the EMU: A Markov-Switching VECM Analysis By Thams, Andreas
  56. Flat Rate Taxes; A Policy Note By Sandra Hadler; Christine Moloi; Sally Wallace
  57. János Kornai’s Contributions to Economic Analysis By Lindbeck, Assar
  58. Downward wage rigidity for different workers and firms - an evaluation for Belgium using the IWFP procedure By Philip Du Caju; Catherine Fuss; Ladislav Wintr
  60. Measuring the Degree of Central Bank Independence in Egypt By Noha Farrag; Ahmed Kamaly
  61. The Optimal Level of Foreign Reserves in Financially Dollarized Economies: The Case of Uruguay By Fernando M. Goncalves
  62. Identification of Monetary Policy Shocks in the Brazilian Market for Bank Reserves By Adriana Soares Sales; Maria Tannuri-Pianto
  63. Testing fiscal sustainability in Poland : a Bayesian analysis of cointegration By Andrea, SILVESTRINI
  64. What Explains India's Real Appreciation? By Renu Kohli; Sudip Mohapatra
  65. Is Inflation in India an Attractor of Inflation in Nepal? By Edimon Ginting
  66. Estimating Iceland's Real Equilibrium Exchange Rate By Robert Tchaidze

  1. By: John B. Taylor
    Abstract: This paper shows that the theory of monetary policy rules is able to explain, predict, and help understand a variety of phenomenon in macroeconomics and finance, including the Great Moderation, the correlation between exchange rates and interest rates, and the shift in the response of the term structure of interest rates to inflation and output. Although the theory was originally designed for normative reasons, it has turned out to have positive implications which validate it scientifically. And while initially focused on the United States, it has applied equally well in other countries.
    JEL: E43 E52
    Date: 2007–12
  2. By: John B. Taylor
    Abstract: Since the mid-1980s, monetary policy has contributed to a great moderation of the housing cycle by responding more proactively to inflation and thereby reducing the boom bust cycle. However, during the period from 2002 to 2005, the short term interest rate path deviated significantly from what this two decade experience would suggest is appropriate. A counterfactual simulation with a simple model of the housing market shows that this deviation may have been a cause of the boom and bust in housing starts and inflation in the last two years. Moreover, a significant time series correlation between housing price inflation and delinquency rates suggests that the poor credit assessments on subprime mortgages may also have been caused by this deviation.
    JEL: E22 E43 E52
    Date: 2007–12
  3. By: Michael Woodford
    Abstract: Forecast targeting is an innovation in central banking that represents an important step toward more rule-based policymaking, even if it is not an attempt to follow a policy rule of any of the types that have received primary attention in the theoretical literature on optimal monetary policy. This paper discusses the extent to which forecast targeting can be considered an example of a policy rule, and the conditions under which it would represent a desirable rule, with a view to suggesting improvements in the approaches currently used by forecast-targeting central banks. Particular attention is given to the intertemporal consistency of forecast-targeting procedures, the assumptions about future policy that should be used in constructing the forecasts used in such procedures, the horizon with which the target criterion should be concerned, the relevance of forecasts other than the inflation forecast, and the degree of robustness of a desirable target criterion for monetary policy to changing circumstances.
    JEL: E52 E58
    Date: 2007–12
  4. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper computes welfare-maximizing monetary and fiscal policy rules in a real business cycle model augmented with sticky prices, a demand for money, taxation, and stochastic government consumption. We consider simple feedback rules whereby the nominal interest rate is set as a function of output and inflation and taxes are set as a function of total government liabilities. We implement a second-order accurate solution to the model. We have several main findings. First, the size of the inflation coefficient in the interest rate rule plays a minor role for welfare. It matters only insofar as it affects the determinacy of equilibrium. Second, optimal monetary policy features a muted response to output. More importantly, interest rate rules that feature a positive response to output can lead to significant welfare losses. Third, the welfare gains from interest rate smoothing are negligible. Fourth, optimal fiscal policy is passive. Finally, the optimal monetary and fiscal rule combination attains virtually the same level of welfare as the Ramsey optimal policy.
    Date: 2007
  5. By: Michael Kumhof; Irina Yakadina; Ricardo Nunes
    Abstract: Is aggressive monetary policy response to inflation feasible in countries that suffer from fiscal dominance? We find that if nominal interest rates are allowed to respond to government debt, even aggressive rules that satisfy the Taylor principle can produce unique equilibria. However, resulting inflation is extremely volatile and zero lower bound on nominal interest rates is frequently violated. Within the set of feasible rules the optimal response to inflation is highly negative, and more aggressive inflation fighting is inferior from a welfare point of view. The welfare gain from responding to fiscal variables is minimal compared to the gain from eliminating fiscal dominance.
    Keywords: Monetary policy , Inflation , Interest rates , Debt , Government expenditures ,
    Date: 2007–12–07
  6. By: Guido Ascari; Neil Rankin
    Abstract: With the aim of constructing a dynamic general equilibrium model where fiscal policy can operate as a demand management tool, we develop a framework which combines staggered prices and overlapping generations based on uncertain lifetimes. Price stickiness plus lack of Ricardian Equivalence could be expected to make tax cuts, financed by increasing government debt, effective in raising short-run output. Surprisingly, in our baseline model this fails to occur. We trace the cause to the assumption that monetary policy is governed by a Taylor Rule. If monetary policy is instead governed by a money supply rule, fiscal policy effectiveness is restored.
    Keywords: staggered prices, overlapping generations, fiscal policy effectiveness, Taylor Rules.
    JEL: E62 E63
    Date: 2007–11
  7. By: Katarina Juselius (Department of Economics, University of Copenhagen)
    Abstract: The persistent movements away from long-run benchmark values in real exchange rates, dubbed the PPP puzzle, observed in many real exchange rates during periods of currency float have been subject to much empirical research without resolving the puzzle. The paper demonstrates how the cointegrated VAR approach by grouping together components of similar persistence can be used to uncover structures in the data that ultimately may help to explain theoretically the forces underlying such puzzling movements. The charaterization of the data into components which are empirically I(0), I(1), and I(2) is shown to be a powerful organizing principle allowing us to structure the data in long-run, medium-run, and short-run behavior. Its main advantage is the ability to associate persistent movements away from fundamental benchmark values in one variable/relation with similar persistent movements somewhere else in the economy.
    Keywords: cointegrated VAR, I(2); deterministic componenets; persistent movements
    JEL: C32 C50 F41
    Date: 2007–10
  8. By: Søren Johansen (Department of Economics, University of Copenhagen); Katarina Juselius (Department of Economics, University of Copenhagen); Roman Frydman (New York University); Michael Goldberg (University of New Hampshire)
    Abstract: This paper discusses a number of likelihood ratio tests on long-run relations and common trends in the I(2) model and provide new results on the test of overidentifying restrictions on β’xt and the asymptotic variance for the stochastic trends parameters, α⊥1: How to specify deterministic components in the I(2) model is discussed at some length. Model specification and tests are illustrated with an empirical analysis of long and persistent swings in the foreign exchange market between Germany and USA. The data analyzed consist of nominal exchange rates, relative prices, US inflation rate, two long-term interest rates and two short-term interest rates over the 1975-1999 period. One important aim of the paper is to demonstrate that by structuring the data with the help of the I(2) model one can achieve a better understanding of the empirical regularities underlying the persistent swings in nominal exchange rates, typical in periods of floating exchange rates
    Keywords: PPP puzzle; forward premium puzzle; cointegrated VAR; likelihood inference
    JEL: C32 C52 F41
    Date: 2007–12
  9. By: Reis, Ricardo; Watson, Mark W
    Abstract: This paper uses a dynamic factor model for the quarterly changes in consumption goods’ prices to separate them into three components: idiosyncratic relative-price changes, aggregate relative-price changes, and changes in the unit of account. The model identifies a measure of “pure” inflation: the common component in goods’ inflation rates that has an equiproportional effect on all prices and is uncorrelated with relative price changes at all dates. The estimates of pure inflation and of the aggregate relative-price components allow us to re-examine three classic macro-correlations. First, we find that pure inflation accounts for 15-20% of the variability in overall inflation, so that most changes in inflation are associated with changes in goods’ relative prices. Second, we find that the Phillips correlation between inflation and measures of real activity essentially disappears once we control for goods’ relative-price changes. Third, we find that, at business-cycle frequencies, the correlation between inflation and money is close to zero, while the correlation with nominal interest rates is around 0.5, confirming previous findings on the link between monetary policy and inflation
    Keywords: Dynamic Factor Models; Inflation; Phillips relation; Relative prices
    JEL: C32 C43 E31
    Date: 2007–12
  10. By: Tatiana Kirsanova; Simon Wren-Lewis
    Abstract: We examine the impact of different degrees of fiscal feedback on debt in an economy with nominal rigidities where monetary policy is optimal. We look at the extent to which different degrees of fiscal feedback enhance or detract from the ability of the monetary authorities to stabilize output and inflation. Using an objective function derived from utility, we find the optimal level of fiscal feedback to be small. A clear discontinuity exists in the behavior of monetary policy and welfare on either side of this optimal level. As the extent of fiscal feedback increases, optimal monetary policy becomes less active because fiscal feedback tends to deflate inflationary shocks. However, this fiscal stabilization is less efficient than monetary policy, so welfare declines. In contrast, if fiscal feedback falls below some critical value, optimal monetary policy becomes strongly passive, and this passive monetary policy leads to a sharp deterioration in welfare.
    Date: 2007
  11. By: Ramon Marimon; Javier Díaz-Giménez; Giorgia Giovannetti; Pedro Teles
    Abstract: We characterize the optimal sequential choice of monetary policy in economies with either nominal or indexed debt. In a model where nominal debt is the only source of time inconsistency, the Markov-perfect equilibrium policy implies the progressive depletion of the outstanding stock of debt, until the time inconsistency disappears. There is a resulting welfare loss if debt is nominal rather than indexed. We also analyze the case where monetary policy is time inconsistent even when debt is indexed. In this case, with nominal debt, the sequential optimal policy converges to a time-consistent steady state with positive -- or negative -- debt, depending on the value of the intertemporal elasticity of substitution. Welfare can be higher if debt is nominal rather than indexed and the level of debt is not too high.
    JEL: E40 E50 E58 E60
    Date: 2007–12
  12. By: Mardi Dungey; Renee Fry
    Date: 2007–12
  13. By: Olivier J. Blanchard; Jordi Galí
    Abstract: We characterize the macroeconomic performance of a set of industrialized economies in the aftermath of the oil price shocks of the 1970s and of the last decade, focusing on the differences across episodes. We examine four different hypotheses for the mild effects on inflation and economic activity of the recent increase in the price of oil: (a) good luck (i.e. lack of concurrent adverse shocks), (b) smaller share of oil in production, (c) more flexible labor markets, and (d) improvements in monetary policy. We conclude that all four have played an important role.
    Date: 2007–08
  14. By: Andrew Atkeson; Ariel Burstein
    Abstract: Data on international relative prices from industrialized countries show large and systematic deviations from relative purchasing power parity. We embed a model of imperfect competition and variable markups in some of the recently developed quantitative models of international trade to examine whether such models can reproduce the main features of the fluctuations in international relative prices. We find that when our model is parameterized to match salient features of the data on international trade and market structure in the U.S., it reproduces deviations from relative purchasing power parity similar to those observed in the data because firms choose to price-to-market. We then examine how pricing-to-market depends on the presence of international trade costs and various features of market structure.
    Keywords: Prices ; Pricing ; Macroeconomics - Econometric models
    Date: 2007
  15. By: Robert J. Barro
    Abstract: A representative-consumer model with Epstein-Zin-Weil preferences and i.i.d. shocks, including rare disasters, accords with key asset-pricing observations. If the coefficient of relative risk aversion equals 3-4, the model accords with observed equity premia and risk-free real interest rates. If the intertemporal elasticity of substitution is greater than one, an increase in uncertainty lowers the price-dividend ratio for equity, whereas a rise in the expected growth rate raises this ratio. In a model with endogenous saving, more uncertainty lowers the saving ratio (because substitution effects dominate). The match with major features of asset pricing suggests that the model is a reasonable candidate for assessing the welfare cost of aggregate consumption uncertainty. In the baseline simulation, the welfare cost of disaster risk is large -- society would be willing to lower real GDP by as much as 20% each year to eliminate the small chance of major economic collapses. The welfare cost from usual economic fluctuations is much smaller, though still important, corresponding to lowering GDP by around 1.5% each year.
    JEL: E2 G12 O4
    Date: 2007–12
  16. By: David Cass (Department of Economics, University of Pennsylvania)
    Abstract: A major virtue of von Neumann-Morgenstern utilities, for example, in the theory of general financial equilibrium (GFE), is that they ensure time consistency: consumption-portfolio plans (for the future) are in fact executed (in the future) — assuming that there is perfect foresight about relevant endogenous variables. This paper proposes an alternative to expected utility, one which also delivers consistency between plan and execution — and more. In particular, the formulation affords an extremely natural setting for introducing extrinsic uncertainty. The key idea is to divorce the concept of filtration (of the state space) from any considerations involving probability, and then concentrate attention on nested utilities of consumption looking forward from any date-event: utility today depends only on consumption today and prospective utility of consumption tomorrow, utility tomorrow depends only on consumption tomorrow and prospective utility of consumption the day after tomorrow, and so on.
    Keywords: Utility theory, Expected utility, Time consistency, Extrinsic uncertainty, Cass-Shell Immunity Theorem
    JEL: D61 D81 D91
    Date: 2007–12–15
  17. By: Alexander Meyer-Gohde
    Abstract: A solution method is derived in this paper for solving a system of linear rationalexpectations equation with lagged expectations (e.g., models incorporating sticky information) using the method of undetermined coefficients for the infinite MA representation. The method applies a combination of a Generalized Schur Decomposition familiar elsewhere in the literature and a simple system of linear equations when lagged expectations are present to the infinite MA representation. Execution is faster, applicability more general, and use more straightforward than with existing algorithms. Current methods of truncating lagged expectations are shown to not generally be innocuous and the use of such methods are rendered obsolete by the tremendous gains in computational efficiency of the method here which allows for a solution to floating-point accuracy in a fraction of the time required by standard methods. The associated computational application of the method provides impulse responses to anticipated and unanticipated innovations, simulations, and frequency-domain and simulated moments.
    Keywords: Lagged expectations; linear rational expectations models; block tridiagonal; Generalized Schur Form; QZ decomposition; LAPACK
    JEL: C32 C63
    Date: 2007–12
  18. By: William A. Branch; Troy Davig; Bruce McGough
    Abstract: Regime-switching rational expectations models, in which the parameters of the model evolve according to a nite state Markov process, have properties that differentiate them from linear models. Issues that are well understood in linear contexts, such as equilibrium determinacy and stability under adaptive learning, re-emerge in this new context. This paper outlines these issues and de nes two classes of equilibria that emerge from regime-switching models. The distinguishing feature between the two classes is whether the conditional density of the endogenous state variables depends on past regimes. An assumption on whether agents condition their expectations on past regimes has important implications for determinacy and equilibrium dynamics. The paper addresses the stability properties of the different classes of equilibria under adaptive learning, extending the learning literature to a non-linear framework.
    Keywords: Rational expectations (Economic theory)
    Date: 2007
  19. By: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
    Abstract: This paper investigates the role of shocks to U.S. productivity and demand in driving the real value of the dollar, and the dynamics of the U.S. trade balance. Using sign restrictions based on robust predictions by standard theory, we identify shocks that increase domestic labor productivity and output in manufacturing (our measure of U.S. tradables), relative to an aggregate of other industrial countries including the rest of the G7, while driving down (up in the case of demand) the relative price of tradables (in accord to Harrod-Balassa-Samuelson effects). Consistent with previous results based on different methodologies, we find that positive productivity differentials raise U.S. consumption and investment relative to the rest of the world, and deteriorate net exports; both the U.S. real exchange rate and the U.S. terms of trade appreciate in response to these shocks. Demand shocks also appreciate the dollar, but have negligible effects on absorption and the trade balance. These findings question a common view in the literature, that a country's terms of trade deteriorate when its tradables supply grows, providing a mechanism to contain differences in national wealth even if productivity level do not converge. They also provide an empirical contribution to the current debate on the adjustment of the U.S. current account position. Contrary to widespread presumptions, productivity growth in the U.S. tradable sector does not necessarily improve the U.S. trade deficit, nor deteriorate the U.S. terms of trade, at least in the short and medium run.
    Keywords: Trade ; Dollar
    Date: 2007
  20. By: Ricardo Lagos; Randall Wright
    Date: 2007–12–26
  21. By: Hillinger, Claude
    Abstract: The most important economic measures are monetary. They have many different names, are derived in different theories and employ different formulas. Yet, they all attempt to do basically the same thing: to separate a change in nominal value into a ‘real part’ due to the changes in quantities and an inflation due to the changes of prices. Examples are: real national product and its components, the GNP deflator, the CPI, various measures related to consumer surplus, as well as the large number of formulas for price and quantity indexes that have been proposed. The theories that have been developed to derive these measures are largely unsatisfactory. The axiomatic theory of indexes does not make clear which economic problem a particular formula can be used to solve. The economic theories are for the most part based on unrealistic assumption. For example, the theory of the CPI is usually developed for a single consumer with homothetic preferences and then applied to a large aggregate of diverse consumers with non-homothetic preferences. In this paper I develop a unitary theory that can be used in all situations in which monetary measures have been used. The theory implies a uniquely optimal measure which turns out to be the Törnqvist index. I review, and partly re-interpret the derivations of this index in the literature and provide several new derivations. The paper also covers several related topics, particularly the presently unsatisfactory determination of the components of real GDP.
    Keywords: consumer price index; consumer surplus; money metric; price and quantity indexes; welfare measurement
    Date: 2007–12–16
  22. By: Sven Jari Stehn; David Vines
    Abstract: We analyse optimal monetary and fiscal policy in a New-Keynesian model with public debt and inflation persistence. Leith and Wren-Lewis (2007) have shown that optimal discretionary policy is subject to a 'debt stabilization bias' which requires debt to be returned to its pre-shock level. This finding has two important implications for optimal discretionary policy. Firstly, as Leith and Wren-Lewis have shown, optimal monetary policy in an economy with high steady-state debt cuts the interest rate in response to a cost-push shock - and therefore violates the Taylor principle. We show that this striking result is not true with high degrees of inflation persistence. Secondly, we show that optimal fiscal policy is more active under discretion than commitment at all degrees of inflation persistence and all levels of debt.
    Keywords: Working Paper , Public debt , Monetary policy , Fiscal policy , Inflation , Economic stabilization ,
    Date: 2007–08–22
  23. By: Anna Maria Carabelli; Mario Aldo Cedrini (SEMEQ Department - Faculty of Economics - University of Eastern Piedmont)
    Abstract: A large number of interpretations has been proposed for current global imbalances, with a variety of future scenarios for world economy. The perspective here adopted tries to be fully respectful of the assumption of global economic interdependence as well as to cope with the complexity of a political, and not exclusively an economic, problem. By the use of the three alternatives outlined by Keynes in his 1945 memorandum "Overseas Financial Policy in Stage III" for the restart of multilateralism at a global level, we propose to rearrange views about current imbalances according to the unilateral, bilateral or multilateral nature of the adjustment they propose - if any - for their unwinding. Comparisons are made between Keynes's "Starvation Corner" and "gloomy views", together with scenarios suggesting the need of unilateral adjustments. Keynes's "Temptation" is used to analyse views stating that global imbalances are sustainable due either to the working of market mechanisms, related to the strength of the American economy, or to the (tacit) agreement of a "revived Bretton Woods system". The parallel with Keynes's "Justice" leads to consider views highlighting shared responsibilities for the imbalances and prompting for collective actions to reduce them.
    Keywords: Global imbalances, Adjustment dynamics, US economy, John Maynard Keynes
    JEL: F32 F01 B31 F50
    Date: 2007–11
  24. By: Janko Gorter; Jan Jacobs; Jakob de Haan
    Abstract: We estimate Taylor rules for the euro area using Consensus expectations for inflation and output growth and we compare these estimates with more conventional specifications in which actual outcomes are used. According to the model with Consensus data, the ECB takes expected inflation and expected output growth into account in setting interest rates, while in the more conventional model specification the coefficient of inflation is not significantly different from zero. Only when using survey data we find that the ECB's policy has been stabilizing. Finally, using a framework suggested by English et al. (2003), we find support for both policy inertia and serially correlated errors in ECB Taylor rules.
    Keywords: Taylor rule; ECB; real-time data; policy inertia; serial correlation
    JEL: C22 E52
    Date: 2007–12
  25. By: Berger, Helge (Department of Economics, Free University Berlin); Österholm, Pär (Department of Economics)
    Abstract: We use a mean-adjusted Bayesian VAR model as an out-of-sample forecasting tool to test whether money growth Granger-causes inflation in the euro area. Based on data from 1970 to 2006 and forecasting horizons of up to 12 quarters, there is surprisingly strong evidence that including money improves forecasting accuracy. The results are very robust with regard to alternative treatments of priors and sample periods. That said, there is also reason not to overemphasize the role of money. The predictive power of money growth for inflation is substantially lower in more recent sample periods compared to the 1970s and 1980s. This cautions against using money-based inflation models anchored in very long samples for policy advice.
    Keywords: Granger Causality; Monetary Aggregates; Monetary Policy; European Central Bank
    JEL: E47 E52 E58
    Date: 2007–12–17
  26. By: Taeyoung Doh
    Abstract: This paper studies the time variation of the Federal Reserve’s in ation target between 1960 and 2004 using both macro and yield curve data. I estimate a New Keynesian dynamic stochastic general equilibrium model in which the in ation target follows a random-walk process. I compare estimation results obtained from both macroeconomic and yield curve data, two estimates obtained with only macro data, in order to determine what the yield curve tells us about the in ation target. In the joint estimation, the estimated in ation target is much higher during the mid 1980s than in the corresponding macro estimation. Also, some part of the decline in the in ation target during the early or the mid 1980s seems to be perceived as temporary when private agents have to lter out the random walk part of the in ation target from the composite in ation target. My ndings suggest that nancial market participants were skeptical of the Fed’s commitment to low in ation even after the Volcker disin ation period of the early 1980s.
    Keywords: Interest rates ; Inflation (Finance)
    Date: 2007
  27. By: Laura Alfaro; Fabio Kanczuk
    Abstract: Most models currently used to determine optimal foreign reserve holdings take the level of international debt as given. However, given the sovereign's willingness-to-pay incentive problems, reserve accumulation may reduce sustainable debt levels. In addition, assuming constant debt levels does not allow addressing one of the puzzles behind using reserves as a means to avoid the negative effects of crisis: why do not sovereign countries reduce their sovereign debt instead? To study the joint decision of holding sovereign debt and reserves, we construct a stochastic dynamic equilibrium model calibrated to a sample of emerging markets. We obtain that the optimal policy is not to hold reserves at all. This finding is robust to considering interest rate shocks, sudden stops, contingent reserves and reserve dependent output costs.
    Keywords: Debt ; Default (Finance)
    Date: 2007
  28. By: Philippe D Karam; Dennis P. J. Botman; Douglas Laxton; David Rose
    Abstract: Researchers in policymaking institutions have expended significant effort to develop a new generation of macro models with more rigorous microfoundations. This paper provides a summary of the applications of two of these models. The Global Economy Model is a quarterly model that features a large assortment of nominal and real rigidities, which are necessary to create plausible short-run dynamics. However, because this model is based on a representative-agent paradigm, its Ricardian features make it unsuitable to study many fiscal policy issues. The Global Fiscal Model, which is an annual model that uses an overlappinggenerations structure, has been designed to analyze the longer-term consequences of alternative fiscal policies.
    Keywords: Working Paper , Fiscal policy , Economic models , Monetary policy ,
    Date: 2007–08–17
  29. By: Livio Stracca (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper presents a dynamic general equilibrium model with sticky prices, in which "inside" money, made out of commercial banks’ liabilities, plays an active, structural role role. It is shown that, in such a model, an inside money shock has a well-defined meaning. A calibrated version of the model is shown to generate small, but non-negligible effects of inside money shocks on output and inflation. I also simulate the effect of a banking crisis in the model. Moreover, I find that it is optimal for monetary policy to react to such shocks, although reacting to inflation alone does not result in a significant welfare loss. JEL Classification: E43.
    Keywords: Endogenous money, inside money, monetary policy, dynamic general equilibrium models, deposit in advance constraint.
    Date: 2007–12
  30. By: Rubens Penha Cysne (EPGE/FGV); David Turchick
    Date: 2007–12
  31. By: Bask, Mikael (Bank of Finland Research)
    Abstract: The aim of this paper is to determine whether it would be desirable from the perspective of macroeconomic balance for central banks to take account of nominal exchange rate movements when framing monetary policy. The theoretical framework is a small, open DSGE economy that is closed by a Taylor rule for the monetary authority, and a determinate REE that is least-squares learnable is defined as a desirable outcome in the economy. When the policy rule contains contemporaneous data on the output gap and the CPI inflation rate, the monetary authority does not have to consider the exchange rate as long as there is sufficient inertia in policy-making. In fact, due to a parity condition on the international asset market, interest-rate smoothing and a response to changes in the nominal exchange rate are perfectly intersubstitutable in monetary policy. In other words, we give a rationale for the monetary authority to focus on the change in the nominal interest rate rather than its level in policy-making. Thus, we have a case for interest-rate smoothing.
    Keywords: determinacy; E-stability; foreign exchange; inertia; Taylor rule
    JEL: E52 F31
    Date: 2007–12–19
  32. By: Della Corte, Pasquale; Sarno, Lucio; Tsiakas, Ilias
    Abstract: This paper provides a comprehensive evaluation of the short-horizon predictive ability of economic fundamentals and forward premia on monthly exchange rate returns in a framework that allows for volatility timing. We implement Bayesian methods for estimation and ranking of a set of empirical exchange rate models, and construct combined forecasts based on Bayesian Model Averaging. More importantly, we assess the economic value of the in-sample and out-of-sample forecasting power of the empirical models, and find two key results: (i) a risk averse investor will pay a high performance fee to switch from a dynamic portfolio strategy based on the random walk model to one which conditions on the forward premium with stochastic volatility innovations; and (ii) strategies based on combined forecasts yield large economic gains over the random walk benchmark. These two results are robust to reasonably high transaction costs.
    Keywords: Bayesian MCMC Estimation; Bayesian Model Averaging; Economic Value; Exchange Rates; Forward Premium; Monetary Fundamentals; Volatility
    JEL: F31 F37 G11
    Date: 2007–12
  33. By: Michele Lenza (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper studies optimal monetary policy responses in an economy featuring sectorial heterogeneity in the frequency of price adjustments. It shows that a central bank facing heterogeneous nominal rigidities is more likely to behave less aggressively than in a fully sticky economy. Hence, the supposedly excessive caution in the conduct of monetary policy shown by central banks could be partly explained by the existence of a relevant sectorial dispersion in the frequency of price adjustments. JEL Classification: F31, F4, G1.
    Keywords: Exchange rate, US dollar, cross-rates, shocks heterogeneity, global distribution, transmission channels.
    Date: 2007–12
  34. By: Michael Kumhof; Douglas Laxton
    Abstract: This paper develops a 2-country New Keynesian overlapping generations model suitable for the joint evaluation of monetary and fiscal policies. We show that a permanent increase in U.S. government deficits raises the world real interest rate and significantly increases U.S. current account deficits, especially in the medium- to long-run. A simultaneous increase in non-U.S. savings lowers the world real interest rate and further increases U.S. current account deficits. We show that conventional infinite horizon models are ill-equipped to deal with issues that involve permanent changes in public or private sector savings rates.
    Keywords: Budget deficits , United States , Working Paper , Taxes , Public debt , Economic models ,
    Date: 2007–08–21
  35. By: Axel Lindner
    Abstract: This paper analyses in a simple global games framework welfare effects of different communication strategies of a central bank: it can either publish no more than its overall assessment of the economy or be more transparent, giving detailed reasons for this assessment. The latter strategy is shown to be superior because it enables agents to use private information and to be less dependent on common knowledge. This result holds true even if the strategies of agents are strategic complements, for which case it has been argued that too much transparency might induce agents to neglect their private knowledge.
    Date: 2007–12
  36. By: D'Agostino, Antonello; Giannone, Domenico; Surico, Paolo
    Abstract: The ability of popular statistical methods, the Federal Reserve Greenbook and the Survey of Professional Forecasters to improve upon the forecasts of inflation and real activity from naive models has declined significantly during the most recent period of greater macroeconomic stability. The decline in the predictability of inflation is associated with a break down in the predictive power of real activity, especially in the housing sector. The decline in the predictability of real activity is associated with a break down in the predictive power of the term spread.
    Keywords: Fed Greenbook; forecasting models; predictability; Survey of Professional Forecasts
    JEL: C22 C53 E37 E47
    Date: 2007–12
  37. By: Maurizio Michael Habib (European Central Bank, Directorate General International and European Relations, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Margarita Manolova Kalamova (Social Science Research Center Berlin (WZB), Reichpietschufer 50, D-10178 Berlin, Germany.)
    Abstract: This paper investigates whether the real oil price has an impact on the real exchange rates of three main oil-exporting countries: Norway, Russia and Saudi Arabia. We create our measure of the real effective exchange rates for Norway and Saudi Arabia (1980-2006) and for Russia (1995-2006), testing if real oil prices and productivity differentials against 15 OECD countries influence exchange rates. In the case of Russia it is possible to establish a positive long-run relationship between the real oil price and the real exchange rate. However, we find virtually no impact of the real oil price on the real exchange rates of Norway and Saudi Arabia. The diverse exchange rate regimes cannot help in explaining the different empirical results on the impact of oil prices across countries, which instead may be due to other policy responses, namely the accumulation of net foreign assets and their sterilisation, and specific institutional characteristics. JEL Classification: F31, C22.
    Keywords: Real exchange rate, oil price, purchasing power parity, terms of trade, oil exporting countries.
    Date: 2007–12
  38. By: António Afonso (Directorate General Economics, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Davide Furceri (University of Illinois at Chicago, Department of Economics (M/C 144), University of Illinois at Chicago, 601 S. Morgan Street, Chicago, 60607, Illinois, USA.)
    Abstract: In this paper we provide a positive exercise on past business-cycle correlations and risk sharing in the European Union, and on the ability of insurance mechanisms and fiscal policies to smooth income fluctuations. The results suggest in particular that while some of the new Member States have well synchronized business cycles, for some of the other countries, business cycles are not yet well synchronized with the euro area’s business cycle, and risk-sharing mechanisms may not provide enough insurance against shocks. JEL Classification: E32, E42, F41, F42.
    Keywords: EU, optimum currency areas, business cycle synchronization, insurance mechanisms.
    Date: 2007–12
  39. By: Kristoffer Nimark (Reserve Bank of Australia)
    Abstract: This paper introduces private information into the dynamic pricing decision of firms in an otherwise standard new Keynesian model by adding an idiosyncratic component to firms’ marginal costs. The model can then replicate two stylised facts about price changes: aggregate inflation responds gradually and with inertia to shocks, while at the same time price changes of individual goods can be quite large. The inertial behaviour of inflation is driven by privately informed firms strategically ‘herding’ on the public information contained in the observations of lagged aggregate variables. The model also matches the average duration between price changes found in the data and it nests the standard new Keynesian Phillips curve as a special case. To solve the model, the paper derives an algorithm for solving a class of dynamic models with higher-order expectations.
    Keywords: higher-order expectations; idiosyncratic marginal cost; price dynamics; new Keynesian Phillips curve
    JEL: E30 F41
    Date: 2007–12
  40. By: Huberto M. Ennis
    Abstract: This paper is extensively revised from WP 05-10. I study the effects of inflation on the purchasing behavior of buyers in an economy where money is essential for certain transactions (as in Lagos and Wright, 2005). A long-standing intuition in this subject is that when inflation increases, agents try to spend their money holdings speedily. The standard framework fails to capture this kind of effect (see Lagos and Rocheteau, 2005). I propose a simple modification of the model that improves it in this dimension. I assume that buyers can rebalance their money holdings only sporadically (i.e., not every period). With this minimal change in the environment, I show that higher inflation induces some buyers to spend their money faster by frontloading their consumption, searching more intensively for transactions, and buying low-quality goods. In this way, the model is able to reproduce distortions in the pattern of transactions that, traditionally, have played an important role in the evaluation of the cost ofinflation.
    Keywords: Inflation (Finance) ; Money
    Date: 2007
  41. By: Elitza Mileva; Nikolaus Siegfried
    Abstract: A recurring theme in recent years in the debate on the international role of currencies has been the possiblity of pricing oil in euro. This paper contributes to these debates by providing a detailed review of the empirical evidence regarding the market for crude oil and current oil invoicing practices. It introduces a network effect model to identify the conditions under which a parallel invoicing in different currencies would be possible. The paper also includes a simulation designed to illustrate the dynamics of the currency choice of oil invoicing.
    Date: 2007–12
  42. By: Szilárd Erhart (Magyar Nemzeti Bank); Jose-Luis Vasquez-Paz (Banco Central de Reserva del Peru)
    Abstract: Theoretical and empirical studies of different sciences suggest that an optimal committee consists of roughly 5-9 members, although it can swell mildly under specific circumstances. This paper develops a conceptual model in order to analyze the issue in case of monetary policy formulation. The optimal monetary policy committee (MPC) size varies according to the uncertainty of MPC members’ information influenced by the size of the monetary zone and overall economic stability. Our conceptual model is backed up with econometric evidence using a 2006 survey of 85 countries. The survey is available for further research and published on the web. The MPC size of large monetary zones (EMU, USA, Japan) is close to the estimated optimal level, but there exist several smaller countries with too many or too few MPC members.
    Keywords: monetary policy committe, mpc size, decision making.
    JEL: E50 E58
    Date: 2007
  43. By: Han, Bing; Hirshleifer, David; Wang, Tracy
    Abstract: This paper offers an explanation for the forward discount puzzle in foreign exchange markets based upon investor overconfidence. In our model, overconfident individuals overreact to their information about future inflation differential. The spot and the forward exchange rates differentially reflect such overreaction; as a result, the forward discount forecasts reversal in the spot rate. With plausible parameter values, the model explains the magnitude of the forward discount puzzle and stylized facts about how the forward discount bias varies with time horizon and time-series versus cross-sectional test method. Furthermore, the model generates new empirical predictions about the relation between the forward discount bias to foreign exchange trading volume, exchange rate volatility and predictability, as well as the degree of violation of the relative Purchasing Power Parity.
    Keywords: Uncovered Interest Parity; forward discount puzzle; inflation differential; investor overconfidence; exchange rate overshooting; market efficiency; Purchasing Power Parity.
    JEL: G14 G12 G15 F31
    Date: 2005–06
  44. By: Petya Koeva Brooks
    Abstract: Does the bank lending channel of monetary transmission work in Turkey? Using the May- June 2006 financial turbulence as an exogenous shock that prompted a significant tightening of monetary policy, this paper examines the loan supply response of Turkey's banks, depending on their balance sheet characteristics. The empirical results indicate that banks can play a role in Turkey's monetary transmission mechanism. Specifically, bank liquidity is found to have a significant effect on loan supply in Turkey. This suggests that the effect of monetary policy in Turkey can be propagated by the banking sector, depending on its liquidity position.
    Keywords: Liquidity , Turkey , Interest rates on loans ,
    Date: 2007–12–10
  45. By: Lamont K. Black; Richard J. Rosen
    Abstract: The credit channel of monetary policy transmission operates through changes in lending. To examine this channel, we explore how movements in the real federal funds rate affect bank lending. Using data on individual loans from the Survey of Terms of Bank Lending, we are able to differentiate two ways the credit channel can work: by affecting overall bank lending (the bank lending channel) and by affecting the allocation of loans (the balance sheet channel). We find evidence consistent with the operation of both internal credit channels. During periods of tight monetary policy, banks adjust their stock of loans by reducing the maturity of loan originations and they reallocate their short-term loan supply from small firms to large firms. These results are stronger for large banks than for small banks.
    Date: 2007
  46. By: Yener Altunbas (Centre for Banking and Financial Studies, University of Wales, Bangor, Gwynedd LL57 2DG, United Kingdom.); Leonardo Gambacorta (Banca d’Italia, Economic Outlook and Monetary Policy Department, Via Nazionale 91, I-00184 Rome, Italy.); David Marqués (Correspondence author: European Central Bank, Monetary Policy Directorate, Capital Markets and Financial Structure Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The dramatic increase in securitisation activity has modified the functioning of credit markets by reducing the fundamental role of liquidity transformation performed by financial intermediaries. We claim that the changing role of banks from “originate and hold” to “originate, repackage and sell” has also modified banks’ abilities to grant credit and the effectiveness of the bank lending channel of monetary policy. Using a large sample of European banks, we find that the use of securitisation appears to shelter banks’ loan supply from the effects of monetary policy. Securitisation activity has also strengthened the capacity of banks to supply new loans but this capacity depends upon business cycle conditions and, notably, upon banks’ risk positions. In this respect, the recent experience of the sub-prime mortgage loans crisis is very instructive. JEL Classification: E44, E55.
    Keywords: Asset securitisation, bank lending channel, monetary policy.
    Date: 2007–12
  47. By: Olan T Henry
    Abstract: We examine the relationship between short term interest rates and UK equity returns using a two regime Markov Switching EGARCH model. We find one high-return, low variance regime in which the conditional variance of equity returns responds persistently but symmetrically to equity return innovations. In the other, low-mean, highvariance, regime there is evidence that equity volatility responds asymmetrically and without persistence to shocks to equity returns. There is evidence of a regime dependent relationship between shorter maturity interest rate differentials and equity return volatility. Furthermore, there is evidence that events in the money markets influence the probability of transition across regimes
    Keywords: Regime switching; Time varying transition probabilities; Newsimpact surfaces; Asymmetric volatility; Interest Rate Spreads
    JEL: G0 C5
    Date: 2007
  48. By: Chew Lian Chua (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne); Chin Nam Low (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)
    Abstract: This paper uses a time-varying error correction model to examine the structural changes in the rate of adjustment to the long-run equilibrium and the cointegrating vector of the US short- and long-term interest rates. We show that agents’ expectations of interest rate movements vary according to policy changes as reflected by changes in the direction of movements of the underlying parameters.
    Date: 2007–08
  49. By: Stephanie E. Curcuru; Tomas Dvorak; Francis Warnock
    Abstract: Were the U.S. to persistently earn substantially more on its foreign investments ("U.S. claims") than foreigners earn on their U.S. investments ("U.S. liabilities"), the likelihood that the current environment of sizeable global imbalances will evolve in a benign manner increases. However, we find that the returns differential of U.S. claims over U.S. liabilities is far smaller than previously reported and, importantly, is near zero for portfolio equity and debt securities. For portfolio securities, we confirm our finding using a separate dataset on the actual foreign equity and bond portfolios of U.S. investors and the U.S. equity and bond portfolios of foreign investors; in the context of equity and bond portfolios we find no evidence that the U.S. can count on earning more on its claims than it pays on its liabilities. Finally, we reconcile our finding of a near zero returns differential with observed patterns of cumulated current account deficits, the net international investment position, and the net income balance.
    Keywords: International finance
    Date: 2007
  50. By: Jahangir Aziz; Xiangming Li
    Abstract: China's sectoral trade composition, product quality mix, and import content of processing exports have all changed substantially during the past decade. This has rendered trade elasticities estimated using aggregate data highly unstable, with more recent data pointing to significantly higher demand and price elasticities. Sectoral differences in these parameters are also very wide. All this suggests greater caution in using historical data to simulate the response of the China's economy to external shocks and exchange rate changes. Analyses based on models whose estimated coefficients largely reflect the China of the 1980s and 1990s are likely to turn out to be wrong, perhaps even dramatically.
    Keywords: Trade , China, People's Republic of , Balance of trade , Exchange rates ,
    Date: 2007–11–29
  51. By: Patrick A. Imam
    Abstract: We analyze the effect of IMF programs on economic agents' expectations about the economy in transitional countries using survey data from the Central and Eastern Eurobarometer poll, an annual general public survey monitoring the evolution of public opinion from 1990 to 1997. Previous studies, in contrast, have looked at indirect measures, such as capital flows or yield spreads, to assess the impact of IMF programs on economic expectations. Using a multinomial probit model, we find that IMF loans appear to have a strong effect on agent expectations in the early years, through the inflow of real money, and through the signaling effect. IMF programs during periods of collapsing growth appear to reinforce underlying expectations for the future; they are associated with positive expectations for those with an optimistic outlook and negative expectations for those with a negative outlook. Once recovery is underway, and economic uncertainty diminishes, it appears that IMF programs cease to have a statistically significant effect on the expectations of economic agents. This suggests that IMF programs have the biggest impact on expectations during periods of great uncertainty and less of an impact when countries are subject to minor shocks.
    Keywords: Structural adjustment , Transition economies , Capital flows ,
    Date: 2007–11–14
  52. By: Juan Angel García (Capital Markets and Financial Structure Division, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Andrés Manzanares (Risk Management Division, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Using data from the ECB's Survey of Professional Forecasters, we investigate the reporting practices of survey participants by comparing their point predictions and the mean/median/mode of their probability forecasts. We find that the individual point predictions, on average, tend to be biased towards favourable outcomes: they suggest too high growth and too low inflation rates. Most importantly, for each survey round, the aggregate survey results based on the average of the individual point predictions are also biased. These findings cast doubt on combined survey measures that average individual point predictions. Survey results based on probability forecasts are more reliable. JEL Classification: C42, E31, E47.
    Keywords: Point estimates, subjective probability distributions, Survey of Professional Forecasters (SPF), survey methods.
    Date: 2007–12
  53. By: Jokivuolle, Esa (Bank of Finland Research); Kilponen , Juha (Bank of Finland Research); Kuusi, Tero (Helsinki School of Economics)
    Abstract: We suggest a complementary tool for financial stability analysis based on stochastic simulation of a dynamic stochastic general equilibrium model (DSGE) of the macro economy. The paper relates to financial stability research in which financial aggregates crucial to financial stability are modelled as functions of macroeconomic variables. In these models, stress tests for eg banking sector loan losses can be generated by considering adverse scenarios of macro variables. A DSGE model provides a systematic way of generating coherent macro scenarios which can be given a rigorous economic interpretation. The approach is illustrated using a DSGE model of the Finnish economy and a simple model of Finnish banking sector loan losses.
    Keywords: DSGE models; financial stability; loan losses; stress testing
    JEL: E13 E37 G21 G28
    Date: 2007–12–19
  54. By: Hiroshi Fujiki; Akiko Terada-Hagiwara
    Abstract: This paper examines the degree of integration into world financial markets and the impacts on several key macroeconomic variables of selected East Asian economies, and draws policy implications. According to our analysis, the degrees of integration into world financial markets in those economies are increasing. Regarding the impacts of increasing integration into world financial markets on several macroeconomic variables, we find three results. First, casual two-way plots among macroeconomic variables do not support the theoretical prediction of reduction in relative consumption volatility. Second, the saving-investment correlation is higher than those of in Euro area economies. Third, the degrees of smoothing of idiosyncratic shock by cross-holding of financial assets are lower than Euro area economies. Those results suggest two policy implications. First, there's some room for improvement in welfare gains in those economies by further risk sharing. Second, holding all other conditions given, the increasing integration into world financial markets alone is unlikely to provide a sound ground for a currency union in East Asia at this stage.
    Date: 2007
  55. By: Thams, Andreas
    Abstract: This paper analyzes the transmission of inflation across the five largest economies in the European Monetary Union, i.e. France, Germany, Italy, Netherlands and Spain. We use monthly CPI inflation rates for the period 1970-2006. Given the long observation period and the continuing economic integration of Europe’s economies, we first try to investigate, if there were changes in inflation dynamics in these countries using univariate Markov-switching models. To assess the inflation transmission mechanism, we first establish a long-run relationship between the five countries using cointegration methods. As implied by the results of the univariate models, we allow for changes in the adjustment coefficients of the cointegrating relationships and the short-run dynamics. Using a Markov-switching vector error correction model we find evidence for multiple regime switches during the early 1970s till the mid 1980s. Exactly during this period we find evidence for Germany being weakly exogenous, which highlights the dominance of German monetary policy at this time. Since the mid-1980s we find evidence for a stable transmission mechanism both in the long- and the short-run characterized by a low degree of inflation persistence.
    Keywords: Inflation transmission; monetary integration; MS-VECM; cointegration; euro area
    JEL: E31 E30 E50
    Date: 2007–11
  56. By: Sandra Hadler; Christine Moloi (Andrew Young School of Policy Studies); Sally Wallace (Andrew Young School of Policy Studies, Georgia State University)
    Abstract: The objective of this paper is to provide an assessment of flat tax policies for policy makers. To do this, the paper reviews the theoretical impacts of a flat tax - how might a flat tax affect a country's tax administration, revenue generation, and economy - as well as the experience of countries that have recently introduced flat taxes. This subject is particularly timely, since in recent years the ‘flat tax' has developed an aura as a panacea for some of the ills of tax policy and tax administration. In particular, it has been seen as a vehicle to simplify tax systems both in OECD countries, whose tax systems have become overly complicated with time, and in transition countries, as they have struggled to introduce western-style taxation systems. Some flat tax proponents argue that countries with a weak tax administration and/or those encumbered by complicated tax systems may benefit more from moving to a flat rate income tax than a major reform of its tax system, such as moving to a broader consumption based tax.
    Keywords: Flat tax, Flat rax rate, tax system
    Date: 2007–03–01
  57. By: Lindbeck, Assar (Research Institute of Industrial Economics (IFN))
    Abstract: The publication of János Kornai’s memoirs, By Force of Thought, provides an excellent opportunity to remind ourselves of Kornai’s great contributions to economic research. This paper discusses both his basic research strategy and some of his main research results. Kornai has usually dealt with great, system-oriented issues, and he has been more inspired by real-world observations than by scholarly work by others. The paper also emphasizes that Kornai’s two most celebrated characterizations of real world socialist economies – "shortage economies" and production units with "soft budget constraints" – are analytically closely connected. Kornai also, in his more recent works, regards the centralized political system during communism as the basic explanation for the centralized nature of the economic system in these countries.
    Keywords: Socialism; Soft Budget Constraints; Shortage Economy; Economic Centralization
    JEL: B24 B31 L10 P20
    Date: 2007–12–03
  58. By: Philip Du Caju (Research Department, National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.); Catherine Fuss (Research Department, National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.); Ladislav Wintr (Research Department, National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.)
    Abstract: This paper evaluates the extent of downward nominal and real wage rigidity for different categories of workers and firms using the methodology recently developed by the International Wage Flexibility Project (Dickens and Goette, 2006). The analysis is based on an administrative data set on individual earnings, covering one-third of employees of the private sector in Belgium over the period 1990-2002. Our results show that Belgium is characterised by strong real wage rigidity and very low nominal wage rigidity, consistent with the Belgian wage formation system of full indexation. Real rigidity is stronger for white-collar workers than for blue-collar workers. Real rigidity decreases with age and wage level. Wage rigidity appears to be lower in firms experiencing downturns. Finally, smaller firms and firms with lower job quit rates appear to have more rigid wages. Our results are robust to alternative measures of rigidity. JEL Classification: J31.
    Keywords: Wage rigidity, matched employer-employee data.
    Date: 2007–12
  59. By: Horobet , Alexandra; Ilie, Livia
    Abstract: The theoretical linkages between exchange rates and stock prices are microeconomic as well as macroeconomic in nature and may be observed on the short- and long-run. The paper examines the interactions between the exchange rates and stock prices in Romania, after 1997, taking into account the change in the monetary regime occurred in 2005 – the shift towards inflation targeting. The analysis uses bivariate cointegration and Granger causality tests, applied on daily and monthly exchange rates and stock prices data collected over the 1999 to 2007 period. Three types of exchange rates are used: the nominal effective exchange rates of the Romanian leu, the bilateral nominal exchange rates of the leu against the US dollar and the euro, and the real effective exchange rates of the leu. In terms of stock prices, the BET and BET-C indices of the Bucharest Stock Exchange are used, denominated in the local currency.
    Keywords: exchange rates; stock exchange; cointegration; Granger causality
    JEL: F30 G10
    Date: 2007–10
  60. By: Noha Farrag (Faculty of Management Technology, The German University in Cairo); Ahmed Kamaly (American University in Cairo)
    Abstract: The past few years have witnessed a trend of increased delegation of authority to central banks. Increasing central bank independence is a recommended strategy for governments to establish a credible commitment to price stability as the final objective of the monetary authority, even at the cost of other objectives that may be more appealing to the political authorities. Existing literature on measuring central bank independence focuses on developed countries where quantifying the independence of central banks is easier, since quantifying the legal charter is sufficient to reflect the degree of central bank independence. However, in developing countries this task is thorny as quantifying the legal charter is often insufficient, since laws are often incomplete, ambiguous, or simply not respected. Thus, quantifying other indicators that reflect actual practice is required to capture any divergence between legal and actual practices. This paper attempts to quantify the degree of independence in the central bank of Egypt (CBE), from both a legal and behavioural context, since its establishment in 1961 until 2004. The study uses four indices in line with the work of Jacome (2001), Cukierman, et al. (1992), and Cukierman and Webb (1995), where each index is designed in such a way to capture a somewhat different aspect of independence. This study captures the discrepancies between the degree of independence conferred to the CBE by law and actual practice. The empirical findings of this paper offers insights about the direction of efforts that should be made to enhance central bank independence which is the key to achieving price stability and the stability of the financial system in general.
    Keywords: Central bank independence, Central Bank of Egypt, price stability, central bank credibility, indices of central bank independence, monetary policy
    JEL: E42 E52 E58
    Date: 2007–12
  61. By: Fernando M. Goncalves
    Abstract: This paper extends the framework derived by Jeanne and Rancière (2006) by explicitly incorporating the dollarization of bank deposits into the analysis of the optimal level of foreign reserves for prudential purposes. In the extended model, a sudden stop in capital flows occurs in tandem with a run on dollar deposits. Reserves can smooth consumption in a crisis but are costly to carry. The resulting expression for the optimal level of reserves is calibrated for Uruguay, a country with high dollarization of bank deposits. The baseline calibration indicates that the gap between actual and optimal reserves has declined sharply since the 2002 crisis due to a substantial reduction in vulnerabilities. While the results suggest that reserves are now near optimal levels, further accumulation may be desirable going forward, partly because banks' currently high liquidity levels are likely to decline as the credit recovery matures.
    Keywords: Foreign exchange reserves , Uruguay , Dollarization , Financial crisis , Crisis prevention ,
    Date: 2007–11–29
  62. By: Adriana Soares Sales; Maria Tannuri-Pianto
    Abstract: We estimate an identified VAR (SVAR) with contemporaneous restrictions derived from a model of the market for bank reserves, which allows us to disentangle monetary policy shocks from demand shocks for reserves in Brazil. The main results are: i) the Central Bank of Brazil acts in order to smooth the bank reserve market interest rate (Selic); ii) the spread between the Selic rate and the discount rate provides information to estimate the demand curve for borrowed reserves; iii) overidentifying restrictions show that we cannot reject, for any period or model, the interest rate operational target hypothesis, even during the fixed exchange rate regime; iv) the impulse response functions show that shocks to the demand for reserves and to borrowed reserves generate statistically significant responses in real output and the inflation rate; v) all models display the liquidity effect and a small inflation rate puzzle.
    Date: 2007–12
  63. By: Andrea, SILVESTRINI
    Abstract: Fiscal sustainability is a central topic for most of the transition economics of Eastern Europe. This paper focuses on a particular country : Poland. The main purpose is to investigate, empirically, whether the post-transition fiscal policy is consistent with the intertemporal budget constraint, used as a formal theoretical framework. To test debt stabilization, the empirical analysis is made in two steps in which different inferential approaches are adopted. In the first step we perform the preliminary unit roots analysis and the selection of the cointegation rank using parametric and bootstrap procedures. In the second step we apply Bayesian inference to the estimation of the cointegrating vector and of the adjustment parameters. In this way, we experiment the usefulness of Bayesian inference in precisely assessing the magnitude of the cointegrating vector. Moreover, we show to what extent the likelihood of the data is important in revising the available prior information, relying on numerical integration techniques.
    Keywords: Bayesian inference, fiscal sustainability, cointegration, bootstrap
    JEL: C11 C32 E62
    Date: 2007–12–06
  64. By: Renu Kohli; Sudip Mohapatra
    Abstract: We examine the evolution of nontradable and tradable prices in the Indian economy over 1980-2002 and find widening differentials: the real exchange rate has been appreciating. This might seem unsurprising, since India's rapid per capita income growth suggests Balassa-Samuelson factors at play. However, after 1990, the tradable-nontradable labor productivity gap, the driver of real appreciation according to Balassa-Samuelson, virtually disappeared. So what explains the real appreciation? Assessing the role of both demand and supply factors, we find that demand pressures arising from higher income growth accounted for much of the relative price increase during the post-reform period. Falling import prices also contributed significantly, along with an increase in government spending.
    Keywords: Inflation , India , Real effective exchange rates , Exchange rate policy , Productivity ,
    Date: 2007–11–29
  65. By: Edimon Ginting
    Abstract: The paper attempts to answer some important questions around the inflationary process in Nepal, particularly the transmission of inflation from India. Because the Nepali currency is pegged to the Indian rupee and the two countries share an open border, price developments in Nepal would be expected to mirror to those in India. The results show that inflation in India and inflation in Nepal tend to converge in the long run. Our estimates indicate that the passthrough of inflation from India to Nepal takes about seven months. The paper draws some implications for the conduct of monetary policy in Nepal.
    Keywords: Inflation , Nepal , India , Currency pegs ,
    Date: 2007–11–30
  66. By: Robert Tchaidze
    Abstract: Given recent developments in Iceland, this paper evaluates its real exchange rate disequilibrium. It discusses three approaches to estimating the equilibrium values and suggests that the adjustment needed to bring the real exchange rate in line with fundamentals is in the range of 15-25 percent, although timing and manner of this adjustment is unclear.
    Keywords: Working Paper , Iceland ,
    Date: 2007–12–14

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