nep-cba New Economics Papers
on Central Banking
Issue of 2008‒02‒09
forty papers chosen by
Alexander Mihailov
University of Reading

  1. How Important is Money in the Conduct of Monetary Policy? By Michael Woodford
  2. Does a "two-pillar Phillips curve" justify a two-pillar monetary policy strategy? By Michael Woodford
  3. Central Bank Communication and Expectations Stabilization By Stefano Eusepi; Bruce Preston
  4. Robust Inflation-Targeting Rules and the Gains from International Policy Coordination By Paul Levine; Joseph Pearlman; Peter Welz
  5. International transmission and monetary policy cooperation By Günter Coenen; Giovanni Lombardo; Frank Smets; Roland Straub
  6. Identification of New Keynesian Phillips Curves from a Global Perspective By Dees, Stephane; Pesaran, Hashem; Smith, L. Vanessa; Smith, Ron P.
  7. The Fed and the ECB: Why such an apparent difference in reactivity? By Grégory Levieuge; Alexis Penot
  8. To React or Not? Fiscal Policy, Volatility and Welfare in the EU-3 By Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
  9. Adopting Price-Level Targeting under Imperfect Credibility By Oleksiy Kryvtsov; Malik Shukayev; Alexander Ueberfeldt
  10. Changes in the order of integration of US and UK inflation By Andreea Halunga; Denise Osborn; Marianne Sensier
  11. Investigating inflation persistence across monetary regimes By Luca Benati
  12. On the determinants of currency crises: The role of model uncertainty By Jesus Crespo Cuaresma; Tomas Slacik
  13. Markups in the euro area and the US over the period 1981-2004 - a comparison of 50 sectors By Rebekka Christopoulou; Philip Vermeulen
  14. UK inflation: persistance, seasonality and monetary policy By Denise Osborn; Marianne Sensier
  15. Cross-Border Returns Differentials By Stephanie E. Curcuru; Tomas Dvorak; Francis E. Warnock
  16. Contracting Models of the Phillips Curve Empirical Estimates for Middle-Income Countries By Pierre-Richard Agénor and Nihal Bayraktar
  17. Nominal and Real Interest Rates during an Optimal Disinflation in New Keynesian Models By Marcus Hagedorn
  18. Macroeconomic Uncertainty and Performance in the European Union and Implications for the objectives of Monetary Policy By Don Bredin; Stilianos Fountas
  19. Monetary Policy Analysis in a Small Open Credit-Based Economy By Pierre-Richard Agénor; Peter J. Montiel
  20. A Monetary Model with Strong Liquidity Effects By Marcus Hagedorn
  21. Monetary Policy and External Shocks in a Dollarized Economy with Credit Market Imperfections By Koray Alper
  22. Estimating Europe’s Natural Rates from a forward-looking Phillips curve By T. BERGER
  23. The effects of macroeconomic institutions on economic performance in a general equilibrium model By Cuciniello Vincenzo
  24. Solving, Estimating and Selecting Nonlinear Dynamic Models without the Curse of Dimensionality By Viktor Winschel; Markus Krätzig
  25. Business Cycle Analysis with Multivariate Markov Switching Models By Monica Billio; Jacques Anas; Laurent Ferrara; Marco Lo Duca
  26. Models of Stochastic Choice and Decision Theories: Why Both are Important for Analyzing Decisions By Pavlo Blavatskyy; Ganna Pogrebna
  27. Which Structural Parameters Are "Structural"? Identifying the Sources of Instabilities in Economic Models By Inoue, Atsushi; Rossi, Barbara
  28. What Determines the Forward Exchange Rate of the Euro? By Costas Karfakis
  29. Why so much wage restraint in EMU? The role of country size - Integrating trade theory with monetary policy regime accounts By Marzinotto Benedicta
  30. Optimal monetary policy in economies with dual labor markets By Mattesini Fabrizio; Rossi Lorenza
  31. Oil shocks and endogenous markups - results from an estimated euro area DSGE model By Marcelo Sánchez
  32. The Consumption - Real Exchange Rate Anomaly: an Asset Pricing Perspective By Mathias Hoffmann; Thomas Nitschka
  33. Banking Crises By Gerard Caprio, Jr. and Patrick Honohan
  34. Consumption growth, uncovered equity parity and the cross-section of returns on foreign currencies By Thomas Nitschka
  35. Asymmetric Labor Market Institutions in the EMU: positive and normative implications By Mirko Abbritti; Andreas Mueller
  36. Business Cycle Synchronization of the Euro Area with the New and Negotiating Member Countries By Christos S. Savva; Kyriakos C. Neanidis; Denise R. Osborn
  37. Global monitoring with the BIS international banking statistics By Patrick McGuire; Ilhyock Nikola Tarashev
  38. The Carry Trade, Portfolio Diversification, and the Adjustment of the Japanese Yen By Corinne Winters
  39. Inflación y Tipo de Cambio: Chile 1810-2005 By Gert Wagner; José Díaz
  40. The Reduction of Fiscal Space in Zambia?Dutch Disease and Tight-Money Conditionalities By John Weeks

  1. By: Michael Woodford (Columbia University - Department of Economics)
    Abstract: I consider some of the leading arguments for assigning an important role to tracking the growth of monetary aggregates when making decisions about monetary policy. First, I consider whether ignoring money means returning to the conceptual framework that allowed the high inflation of the 1970s. Second, I consider whether models of inflation determination with no role for money are incomplete, or inconsistent with elementary economic principles. Third, I consider the implications for monetary policy strategy of the empirical evidence for a long-run relationship between money growth and inflation. And fourth, I consider reasons why a monetary policy strategy based solely on short-run inflation forecasts derived from a Phillips curve may not be a reliable way of controlling inflation. I argue that none of these considerations provides a compelling reason to assign a prominent role to monetary aggregates in the conduct of monetary policy.
    Date: 2007
  2. By: Michael Woodford (Columbia University - Department of Economics)
    Abstract: Arguments for a prominent role for attention to the growth rate of monetary aggregates in the conduct of monetary policy are often based on references to low-frequency reduced-form relationships between money growth and inflation. The "two-pillar Phillips curve" proposed by Gerlach (2004) has recently attracted a great deal of interest in the euro area, where it is sometimes supposed to provide empirical support for the wisdom of a "two-pillar strategy" that uses distinct analytical frameworks to assess shorter-run and longer-run risks to price stability. I show, however, that regression coefficients of the kind reported by Assenmacher-Wesche and Gerlach (2006a) among others are quite consistent with a "new Keynesian" model of inflation determination, in which the quantity of money plays no role in inflation determination, at either high or low frequencies. I also show that empirical results of this kind do not in themselves establish that money growth must be useful in forecasting inflation, either in the short run or over a longer run. Hence they provide little support for the ECB's monetary "pillar."
    Date: 2007
  3. By: Stefano Eusepi (Federal Reserve Bank of New York); Bruce Preston (Columbia University - Department of Economics)
    Abstract: The value of communication in monetary policy is analyzed in a model in which expectations need not be consistent with central bank policy - and, therefore, unanchored - because agents face difficult forecasting problems. When the central bank implements optimal policy without communication, the Taylor principle is not sufficient for macroeconomic stability: expectations are unanchored and self-fulfilling expectations are possible. To mitigate this instability, three communication strategies are contemplated to ensure consistency between private forecasts and monetary policy strategy: i) communicating the precise details of the monetary policy ¿ that is, the variables and coefficients; ii) communicating only the variables on which monetary policy decisions are conditioned; and iii) communicating the inflation target. The first two strategies restore the Taylor principle as a sufficient condition for anchoring expectations. In contrast, in economies with persistent shocks, communicating the inflation target fails to protect against expectations driven fluctuations. These results underscore the importance of communicating the systematic component of monetary policy strategy: announcing an inflation target is not enough to stabilize expectations ¿ one must also announce how this target will be achieved.
    Date: 2007
  4. By: Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University); Peter Welz (Sveriges Riksbank)
    Abstract: This paper empirically assesses the performance of interest-rate monetary rules for interdependent economies characterized by model uncertainty. We set out a two-bloc dynamic stochastic general equilibrium model with habit persistence (that generates output persistence), Calvo pricing and wage-setting with indexing of non-optimized prices and wages (generating inflation persistence), incomplete financial markets and the incomplete pass-through of exchange rate changes. We estimate a linearized form of the model by Bayesian maximum-likelihood methods using US and Euro-zone data. From the estimates of the posterior distributions we then examine monetary policy conducted both independently and cooperatively by the Fed and the ECB in the form of robust inflation-targeting interest-rate rules. Comparing the utility outcome in a closed-loop Nash equilibrium with the outcome from a coordinated design of policy rules, we find a new result: the gains from monetary policy coordination rise significantly when CPI inflation targeting interest-rate rules are designed to account for model uncertainty.
    Keywords: monetary policy coordination, robustness, inflation-targeting interest-rate rules.
    JEL: E52 E37 E58
    Date: 2008–01
  5. By: Günter Coenen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Frank Smets (Corresponding author - European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Roland Straub (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We use a version of the New Area-Wide Model (NAWM) developed at the ECB in order to quantify the gains from monetary policy cooperation. The model is calibrated in order to match a set of empirical moments. We then derive the cooperative and (open-loop) Nash monetary policies, assuming that the central banks’ objectives is to maximize the welfare of the households. Our results show that given the current degree of openness of the US and euro area economies, the gains from monetary policy coordination are small, amounting to 0.03 percent of steady-state consumption. Nevertheless, the gains appear to be sensitive to the degree of openness and further economic integration between the two regions could generate sizable gains from cooperation. For example, increasing the trade shares to 32 percent of GDP in both regions, the gains from cooperation rise to about 1 percent of steady-state consumption. By decomposing the sources of the gains from cooperation with respect to the various shocks, we show that mark-up shocks are the most important source for gains from international monetary policy cooperation. JEL Classification: E32, F41, F42.
    Keywords: New Area Wide Model, international policy coordination, DSGE, two-country.
    Date: 2008–01
  6. By: Dees, Stephane (European Central Bank); Pesaran, Hashem (University of Cambridge); Smith, L. Vanessa (University of Cambridge); Smith, Ron P. (Birkbeck College, University of London)
    Abstract: New Keynesian Phillips Curves (NKPC) have been extensively used in the analysis of monetary policy, but yet there are a number of issues of concern about how they are estimated and then related to the underlying macroeconomic theory. The first is whether such equations are identified. To check identification requires specifying the process for the forcing variables (typically the output gap) and solving the model for inflation in terms of the observables. In practice, the equation is estimated by GMM, relying on statistical criteria to choose instruments. This may result in failure of identification or weak instruments. Secondly, the NKPC is usually derived as a part of a DSGE model, solved by log-linearising around a steady state and the variables are then measured in terms of deviations from the steady state. In practice the steady states, e.g. for output, are usually estimated by some statistical procedure such as the Hodrick-Prescott (HP) filter that might not be appropriate. Thirdly, there are arguments that other variables, e.g. interest rates, foreign inflation and foreign output gaps should enter the Phillips curve. This paper examines these three issues and argues that all three benefit from a global perspective. The global perspective provides additional instruments to alleviate the weak instrument problem, yields a theoretically consistent measure of the steady state and provides a natural route for foreign inflation or output gap to enter the NKPC.
    Keywords: New Keynesian Phillips Curve, identification, Global VAR (GVAR), trend-cycle decomposition
    JEL: C32 E17 F37 F42
    Date: 2008–01
  7. By: Grégory Levieuge (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans); Alexis Penot (GATE - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - Ecole Normale Supérieure Lettres et Sciences Humaines)
    Abstract: Compared with the U.S., the amplitude of the European monetary policy rate cycle is strikingly narrow. Is it an evidence of a less reactive ECB? This observation can certainly reflect the preferences and then the strategy of the ECB. But its greater inertia must also be assessed in the light of the singularity of the European structure and of the shocks hitting it. From this perspective, several contributions assert that the nature, size and persistence of shocks mainly explain the different interest rate setting. Therefore, they rely on the idea that both areas share the same monetary policy rule and, more surprising, the same structure. This paper aims at examining this conclusions with an alternative modelling. The results confirm that the euro area and U.S. monetary policy rules are not fundamentally different. But we reject the differences of nature and amplitude of shocks. What is often interpreted as such is in fact the consequence of how distinctly both economies absorb shocks. So differences in the amplitude of the interest rate cycles in both areas are basically explained by structural dissimilarities.
    Keywords: interest rate; macroeconomic shocks; monetary policy rules ; policy activism; structural divergence
    Date: 2008
  8. By: Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
    Abstract: This paper develops a dynamic stochastic general equilibrium model to examine the quantitative macroeconomic implications of counter- cyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity which is the particular market failure justifying policy intervention. We subject the model to productivity shocks and use either government consumption or investment to react to the output gap or the public debt-to-output ratio. If the object of fiscal policy is purely to stabilize output or debt volatility, then our results suggest substantial reductions can be obtained, especially with respect to output. In stark contrast, however, a formal general equilibrium welfare assessment of the volatility implications of these alternative instrument/target combinations reveals the welfare gains from active policy, measured as a share of consumption, to be very modest.
    Keywords: Fiscal Policy, Welfare, Europe
    JEL: E6 H5
    Date: 2007–02
  9. By: Oleksiy Kryvtsov; Malik Shukayev; Alexander Ueberfeldt
    Abstract: This paper measures the welfare gains of switching from inflation-targeting to price-level targeting under imperfect credibility. Vestin (2006) shows that when the monetary authority cannot commit to future policy, price-level targeting yields higher welfare than inflation targeting. We revisit this issue by introducing imperfect credibility, which is modeled as gradual adjustment of the private sector's beliefs about the policy change. We find that gains from switching to pricelevel targeting, if any, are small.
    Keywords: Credibility; Monetary policy framework
    JEL: E31 E52
    Date: 2008
  10. By: Andreea Halunga; Denise Osborn; Marianne Sensier
    Date: 2007
  11. By: Luca Benati (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Under inflation targeting inflation exhibits negative serial correlation in the United Kingdom, and little or no persistence in Canada, Sweden and New Zealand, and estimates of the indexation parameter in hybrid New Keynesian Phillips curves are either equal to zero, or very low, in all countries. Analogous results hold for the Euro area–and for France, Germany, and Italy–under European Monetary Union; for Switzerland under the new monetary regime; and for the United States, the United Kingdom and Sweden under the Gold Standard: under stable monetary regimes with clearly defined nominal anchors, inflation appears to be (nearly) purely forward-looking, so that no mechanism introducing backward-looking components is necessary to fit the data. These results question the notion that the intrinsic inflation persistence found in post-WWII U.S. data–captured, in hybrid New Keynesian Phillips curves, by a significant extent of backward-looking indexation–is structural in the sense of Lucas (1976), and suggest that building inflation persistence into macroeconomic models as a structural feature is potentially misleading. JEL Classification: E31, E42, E47, E52, E58.
    Keywords: Inflation, European Monetary Union, inflation targeting, Gold Standard, Lucas critique, median-unbiased estimation, Markov Chain Monte Carlo.
    Date: 2008–01
  12. By: Jesus Crespo Cuaresma; Tomas Slacik
    Abstract: We tackle explicitly the issue of model uncertainty in the framework of binary variable models of currency crises. Using Bayesian model averaging techniques, we assess the robustness of the explanatory variables proposed in the recent literature for both static and dynamic models. Our results indicate that the variables belonging to the set of macroeconomic fundamentals proposed by the literature are very fragile determinants of the occurrence of currency crises. The results improve if the crisis index identifies a crisis period (defined as the period up to a year before a crisis) instead of a crisis occurrence. In this setting, the extent of real exchange rate misalignment and financial market indicators appear as robust determinants of crisis periods.
    Keywords: Forecasting, model averaging, Bayesian econometrics, exchange rates.
    JEL: F31 F34 E43
  13. By: Rebekka Christopoulou (DG-Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Philip Vermeulen (DG-Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper provides estimates of price-marginal cost ratios or markups for 50 sectors in 8 euro area countries and the US over the period 1981-2004. The estimates are obtained applying the methodology developed by Roeger (1995) on the EU KLEMS March 2007 database. Five stylized facts are derived. First, perfect competition can be rejected for almost all sectors in all countries; markup ratios are generally larger than 1. Second, average markups are heterogenous across countries. Third, markups are heterogeneous across sectors, with services having higher markups on average than manufacturing. Fourth, services sectors generally have higher markups in the euro area than the US, whereas the pattern is the reverse for manufacturing. Fifth, there is no evidence that there is a broad range change in markups from the eighties to the nineties. JEL Classification: D43, L11.
    Keywords: Price, marginal cost, markup.
    Date: 2008–01
  14. By: Denise Osborn; Marianne Sensier
    Date: 2007
  15. By: Stephanie E. Curcuru; Tomas Dvorak; Francis E. 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, using a monthly dataset on the foreign equity and bond portfolios of U.S. investors and the U.S. equity and bond portfolios of foreign investors, we find that the returns differential for portfolio securities is near zero, far smaller than previously reported. Examining all U.S. claims and liabilities (portfolio securities as well as direct investment and banking), we find that previous estimates of large differentials are biased upward. The bias owes to computing implied returns from an internally inconsistent dataset of revised data; original data produce a much smaller differential. We also attempt to 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. Overall, we find no evidence that the U.S. can count on earning substantially more on its claims than it pays on its liabilities.
    JEL: F3 G1
    Date: 2008–02
  16. By: Pierre-Richard Agénor and Nihal Bayraktar
    Abstract: This paper provides empirical estimates of contracting models of the Phillips curve for eight middle-income developing countries (Chile, Colombia, Korea, Malaysia, Mexico, Morocco, Tunisia, and Turkey). Following an analytical review, a variety of models with one and more leads and lags are estimated using two-step GMM techniques. Nested and non-nested tests are used to select a specification for each country, and in-sample predictive capacity and stability are analyzed. Higher-dimension models tend to perform better than parsimonious models with one lead and one lag. Except for Colombia and Korea, backward-looking behavior has a relatively larger impact on inflation dynamics. World oil prices and relative input prices have a limited effect, whereas borrowing costs are significant for Korea and Mexico.
    Date: 2008
  17. By: Marcus Hagedorn
    Abstract: Central bankers' conventional wisdom suggests that nominal interest rates should be raised to implement a lower inflation target. In contrast, I show that the standard New Keynesian monetary model predicts that nominal interest rates should be decreased to attain this goal. Real interest rates, however, are virtually unchanged. These results also hold in recent vintages of New Keynesian models with sticky wages, price and wage indexation and habit formation in consumption.
    Keywords: Disinflation, Optimal Monetary Policy, Nominal and Real Interest Rates
    JEL: E41 E43 E51 E52
    Date: 2007–12
  18. By: Don Bredin (School of Business, University College Dublin); Stilianos Fountas (Department of Economics, University of Macedonia)
    Abstract: We use a very general bivariate GARCH-M model and monthly data on EU countries covering the 1962-2003 period to test for the impact of real (output growth) and nominal (inflation) macroeconomic uncertainty on inflation and output growth. Our evidence supports a number of important conclusions. First, in the majority of countries uncertainty regarding the output growth rate is related to the average growth rate and the effect in several countries is negative. Second, contrary to expectations, inflation uncertainty in several cases improves the output growth performance of an economy implying that the focus of European monetary policy strategy on stabilising inflation rather than output growth may be misplaced. Third, inflation and output uncertainty have a mixed effect on inflation. Our conclusions are based on adopting both a structural and a reduced form bivariate GARCH model. These results imply that macroeconomic uncertainty may even improve macroeconomic performance. Finally, we also and statistically significant evidence of regime switching for both inflation and output growth volatility throughout the sample.
    Keywords: Inflation, Output growth, Macroeconomic uncertanty
    JEL: C22 C52 E31 E52
    Date: 2008–01
  19. By: Pierre-Richard Agénor; Peter J. Montiel
    Abstract: This paper describes a simple framework for monetary policy analysis in a small open economy where bank credit is is the only source of external finance. At the heart of the model is the link between banks' lending rates (which incorporate a premium over and above the marginal cost of borrowing) and firms' net worth. In contrast to models in the Stiglitz-Weiss or Kiyotaki-Moore tradition, the supply of bank loans is perfectly elastic at the prevailing rate. The central bank sets the refinance rate and provides unlimited access to liquidity at that rate. The model is used to study the effects of changes in official interest rates, under both fixed and flexible exchange rates. Various extensions are also discussed, including income effects, the cost channel, the role of land as collateral, and dollarization.
    Date: 2007
  20. By: Marcus Hagedorn
    Abstract: This paper studies the joint business cycle dynamics of in ation, money growth, nominal and real interest rates and the velocity of money. I extend and estimate a standard cash and credit monetary model by adding idiosyncratic preference shocks to cash consumption as well as a banking sector. The estimated model accounts very well for the business cycle data, a finding that standard monetary models have not been able to generate. I find that the quantitative performance of the model is explained through substantial liquidity effects.
    Keywords: Money, Banking, Monetary Transmission Mechanism, Liquidity, Business Cycles
    JEL: E31 E32 E41 E42 E51
    Date: 2007–12
  21. By: Koray Alper
    Abstract: Using different combinations of culture, development and openness to international trade, we test the variability in the incidences of corruption at different stages of development or in other words the non-linearities in the relationship between corruption and development. We employ formal threshold model developed by Hansen (2000), and unlike the existing literature, we find that: (1) non-linear models that search for the break points in the relationship between corruption and development are statistically preferable than linear regressions; (2) the effect of development at any stage is much lower than that has been suggested by studies using linear regressions approach; (3) both culture and openness do not affect corruption directly; rather they have an effect on the location of break points in the relationship between corruption and development.
    Date: 2007
  22. By: T. BERGER
    Abstract: This paper re-estimates potential output, the NAIRU, and the core inflation rate using aggregated euro area data. The empirical model consists of a Phillips curve linking inflation to unemployment. An Okun-type relationship is used to link the output gap to cyclical unemployment. Using recent developments in the field of New Keyenesian economics, the Phillips curve is forward-looking. The model further accounts for new developments in unobserved component models by allowing (i) for correlation between shocks to the trend and the cycle and (ii) structural breaks in the drift of potential output.
    Date: 2008–01
  23. By: Cuciniello Vincenzo
    Abstract: This paper analyzes the relation between inflation, output and government size by reexamining the time inconsistency of optimal monetary and fiscal policies in a general equilibrium model with staggered timing structure for the acquisition of nominal money a la Neiss (1999), and public expenditure financed by means of a distortive tax. It focuses on how macroeconomic institutions may affect output, inflation and taxation when monetary and fiscal policies strategically interact in presence of monopolistic distortions in labor markets. It is shown that, with pre determined wage setting, fiscal and monetary policy are subject to a time inconsistency problem, and the equilibrium rate of inflation is above the Friedman rule while the equilibrium tax rate is below the efficient level. In particular, the discretionary rate of inflation is nonmonotonically related to the natural output, positively related to government size, and negatively related to conservatism. Finally, a regime with commitment is always welfare improving over a regime with discretion.
    Date: 2008–02
  24. By: Viktor Winschel; Markus Krätzig
    Abstract: We present a comprehensive framework for Bayesian estimation of structural nonlinear dynamic economic models on sparse grids. TheSmolyak operator underlying the sparse grids approach frees global approximation from the curse of dimensionality and we apply it to a Chebyshev approximation of the model solution. The operator also eliminates the curse from Gaussian quadrature and we use it for the integrals arising from rational expectations and in three new nonlinear state space filters. The filters substantially decrease the computational burden compared to the sequential importance resampling particle filter. The posterior of the structural parameters is estimated by a new Metropolis-Hastings algorithm with mixing parallel sequences. The parallel extension improves the global maximization property of the algorithm, simplifies the choice of the innovation variances, allows for unbiased convergence diagnostics and for a simple implementation of the estimation on parallel computers. Finally, we provide all algorithms in the open source software JBendge4 for the solution and estimation of a general class of models.
    Keywords: Dynamic Stochastic General Equilibrium (DSGE) Models, Bayesian Time Series Econometrics, Curse of Dimensionality
    JEL: C11 C13 C15 C32 C52 C63 C68 C87
    Date: 2008–02
  25. By: Monica Billio (Department of Economics, University Of Venice Cà Foscari); Jacques Anas (Coe Rexecode, Paris); Laurent Ferrara (Banque de Frances); Marco Lo Duca (European Central Bank)
    Abstract: The class of Markov switching models can be extended in two main directions in a multivariate framework. In the first approach, the switching dynamics are introduced by way of a common latent factor. In the second approach a VAR model with parameters depending on one common Markov chain is considered (MSVAR). We will extend the MSVAR approach allowing for the presence of specific Markov chains in each equation of the VAR (MMSVAR). In the MMSVAR approach we also explore the introduction of correlated Markov chains which allow us to evaluate the relationships among phases in different economies or sectors and introduce causality relationships, which allow a more parsimonious representation. We apply our model to study the relationship between cyclical phases of the industrial production in the US and Euro zone. Moreover, we construct a MMS model to explore the cyclical relationship between the Euro zone industrial production and the industrial component of the European Sentiment Index.
    Keywords: Economic cycles, Multivariate models, Markov switching models, Common latent factors, Causality, Euro-zone
    JEL: C50 C32 E32
    Date: 2007
  26. By: Pavlo Blavatskyy; Ganna Pogrebna
    Abstract: Economic research offers two traditional ways of analyzing decision making under risk. One option is to compare the goodness of fit of different decision theories using the same model of stochastic choice. An alternative way is to vary models of stochastic choice combining them with only one or two decision theories. This paper proposes to look at the bigger picture by comparing different combinations of decision theories and models of stochastic choice. We select a menu of seven popular decision theories and embed each theory in five models of stochastic choice including tremble, Fechner and random utility model. We find that the estimated parameters of decision theories differ significantly when theories are combined with different models. Depending on the selected model of stochastic choice we obtain different ranking of decision theories with regard to their goodness of fit to the data. The fit of all analyzed decision theories improves significantly when they are embedded in a Fechner model of heteroscedastic truncated errors (or random utility model in a dynamic decision problem).
    Keywords: Fechner model, random utility, tremble, expected utility theory, risk
    JEL: C93 D81
    Date: 2007–04
  27. By: Inoue, Atsushi; Rossi, Barbara
    Abstract: The objective of this paper is to identify which parameters of a model are stable over time. Existing procedures can only be used to test whether a given subset of parameters is stable, and cannot be used to find which subset of parameters is stable. We propose a new procedure that is informative on the nature of instabilities affecting economic models, and sheds light on the economic interpretation and causes of such instabilities. Furthermore, our procedure provides clear guidelines on which parts of the model are reliable for policy analysis and which are possibly mis-specified. Our empirical findings suggest that instabilities during the Great Moderation were mainly concentrated in Euler and IS equations as well as in monetary policy. Such results offer important insights to guide the future theoretical development of macroeconomic models.
    Keywords: Instability, Model Evaluation, Great Moderation
    JEL: E32 E52 E58 C22 C52
    Date: 2008
  28. By: Costas Karfakis (Department of Economics, University of Macedonia)
    Abstract: This study examines the determinants of the forward exchange rate of the euro in the context of the “modern approach” for five currency combinations. The co-integration analysis suggests that speculation has played a minor role and arbitrage played a major role in determining the forward exchange rate of the euro.
    Keywords: Euro, Forward Exchange Rate, Arbitrage, Speculation, Co-integration
    JEL: F31 F37
    Date: 2008–02
  29. By: Marzinotto Benedicta
    Abstract: Using theoretical models about the interaction between monetary policy-making and wage bargaining institutions, some researchers had been predicting an acceleration in wage growth under EMU (Iversen and Soskice 1998; Iversen et al 2000; Cukierman and Lippi 2001). However, the empirical evidence shows that, after the formation of the monetary union, wage growth has remained under control or even decelerated. Of the numerous explanations advanced to account for this trend, the most promising seems the one proposed by Posen and Gould (2006), who argue that behind the generalised shift towards wage restraint is enhanced monetary credibility in EMU. Whilst building on a similar argument, this paper adds to it in important respects. First, I show that the effects of a monetary union depend on labour market institutions. Second, and most originally, I argue that a strategic interaction between the ECB and non-atomistic labour unions is possible only in the case of large countries, whose price behaviour can potentially affect EU-13 inflation. This leads to the main finding behind this paper, namely that the relationship between wage growth and economy size is hump-shaped, with wage restraint more present in large and small countries, and less so in countries of intermediate size. Differently from a large country like Germany, small economies are free riders with respect to the monetary regime, but they care nonetheless for cost competitiveness, even if to different degrees. On the other hand, intermediate countries are trapped “inbetween” because neither do they believe capable of affecting euro-zone inflation, nor do they look at cost competitiveness as key to their economic survival.
    Keywords: Wage restraint, collective wage bargaining, EMU, openness, international trade
    JEL: J31 J51 E50 F15 F41
    Date: 2008–02
  30. By: Mattesini Fabrizio; Rossi Lorenza
    Abstract: We analyze, in this paper, a DSGE New Keynesian model with indivisible labor where firms may belong to two different final goods producing sectors: one where wages and employment are determined in competitive labor markets and the other where wages and employment are the result of a contractual process between unions and ?rms. Bargaining between firms and monopoly unions implies real wage rigidity in the model and, in turn, an endogenous trade-o¤ between output stabilization and inflation stabilization. We show that the negative effect of a productivity shock on inflation and the positive effect of a cost-push shock is crucially determined by the proportion of firms that belong to the competitive sector. The larger is this number, the smaller are these effects. We derive a welfare based objective function as a second order Taylor approximation of the expected utility of the economy’s representative agent and we analyze optimal monetary policy. We show that the larger is the number of firms that belong to the competitive sector, the smaller should be the response of the nominal interest rate to exogenous productivity and cost-push shocks. If we consider, however, an instrument rule where the interest rate must react to inflationary expectations, the rule is not affected by the structure of the labor market. The results of the model are consistent with a well known empirical regularity in macroeconomics, i.e. that employment volatility is larger than real wage volatility.
    Date: 2008–02
  31. By: Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper estimates a linearised DSGE model for the euro area. The model is New Keynesian and allows for a role for oil usage and endogenous price markups. We find that the price markup reacts positively to the ratio of expected discounted profits to current output, which is normally seen to give rise to a "countercyclical" markup. The importance of shocks to monetary policy and oil prices is estimated to have declined in the post-1990 period, in line with the higher predictability of policy and the fall in the persistence and - to a lesser extent - variability of oil disturbances. Counterfactual exercises show that oil efficiency gains would alleviate the inflationary and contractionary consequences of oil shocks, while higher wage flexibility would help ease the impact on real output at the expense of wider fluctuations in inflation. Finally, the rise in price markups induced by an oil disturbance is not found to considerably amplify the inflationary and contractionary effects of the shock. JEL Classification: C15, E31, E32, E37.
    Keywords: Estimated DSGE models, euro area, oil shocks, endogenous markup.
    Date: 2008–01
  32. By: Mathias Hoffmann; Thomas Nitschka
    Abstract: Idiosyncratic consumption risk explains more than 60 percent of the cross-sectional variation in quarterly exchange rate changes and currency returns. Our results are obtained from data of 13 industrialized countries and are based on an international version of the consumption capital asset pricing model (CCAPM) in which we account for international consumption heterogeneity. We use this framework to dissect the consumption-exchange rate anomaly, the empirical fact that international variation in purchasing power alone does not appear to account for differences in consumption growth rates across countries. As an explanation for this phenomenon, we explore the presence of currency risk premia that also lead to departures from uncovered interest parity (UIP). We decompose the cross-sectional variation in consumption into one component that is due to cross-country differences in inflation rates and a second component that is due to international variation in nominal interest rates. We interpret these factors as indicators of goods and financial market segmentation respectively. We find that both help account to virtually equal parts for the cross-section of exchange rate changes. Interestingly, the price of aggregate consumption risk has declined over the 1990s, in line with a growing literature that documents a growing internationalisation of country portfolios over this period.
    Keywords: Uncovered interest rate parity, consumption CAPM, international financial integration, consumption risk sharing
    JEL: E21 F30 G12
    Date: 2007–09
  33. By: Gerard Caprio, Jr. and Patrick Honohan
    Abstract: The history of banking around the world has been punctuated by frequent systemic crises. Not all crises are the same with distinct roles being played at different times by mismanagement, government interference and macroeconomic shocks. This review draws on experience from developing countries as well as advanced economies. It identifies common features of crises in recent decades, describes how costly they have been (especially in developing countries) in terms of fiscal burden and impact on macroeconomic growth. It proceeds to outline the conceptual issues identified by theoreticians and considers appropriate policy responses. A lull in the new millennium led to optimism that banking crises might be a thing of the past, but the events of recent months have shown such optimism to be unwarranted.
    Date: 2008–01–31
  34. By: Thomas Nitschka
    Abstract: Lagged foreign stock returns in excess of the U.S. stock market return are informative about quarterly exchange rate movements. A past high foreign stock return relative to the U.S. signals a foreign currency depreciation and hence low returns on the foreign currency. Conditional on stock return differentials, the consumption-based CAPM (CCAPM) explains the cross-sectional dispersion in U.S. dollar exchange rates. The CCAPM captures more than 40 percent of the variation in foreign currency returns scaled with the respective stock return differential on a country-by-country basis.
    Keywords: Consumption-based CAPM, foreign currency return, uncovered equity parity
    JEL: F31 G12
    Date: 2007–11
  35. By: Mirko Abbritti; Andreas Mueller
    Abstract: How do labor market institutions affect the volatility and persistence of inflation and unemployment in a monetary union? What are the implications for monetary policy? This paper sets up a DSGE currency union model with unemployment, hiring frictions and real wage rigidities. The model provides a rigorous but tractable framework for the analysis of the functioning of a currency union characterized by asymmetric labor market institutions. Positively, we find that inflation and unemployment differentials depend strongly on the underlying labor market structure: the hiring friction lowers the persistence and increases the volatility of the inflation differential whereas real wage rigidities imply more persistence and variability in output and unemployment differentials. Normatively, we find that macroeconomic stabilization is easier when labor market frictions are high and real wage rigidities are low. This has important implications for optimal monetary policy: The optimal inflation target should give a higher weight to regions with more sclerotic labor markets and more flexible real wages.
    Date: 2007–12
  36. By: Christos S. Savva; Kyriakos C. Neanidis; Denise R. Osborn
    Abstract: We examine business cycle synchronizations between the euro area and the recently acceded EU and currently negotiating countries. Strong evidence is uncovered of time-variation in the degree of comovement between the cyclical components of monthly industrial production indicators for each of these countries with a euro area aggregate, which is then modeled through a bivariate VAR-GARCH specification with a smoothly time-varying correlation that allows for structural change. Where required to account for the observed time-variation in correlations, a double smooth transition conditional correlation model is used to capture a second structural change event. After allowing for dynamics, we find that all new EU members and negotiating countries have at least doubled their business cycle synchronization with the euro area, or changed from negative to positive correlations, since the early 1990s. Furthermore, some have exhibited U-curved or hump-shaped business cycle correlation patterns. The results point to great variety in timing and speed of the correlation shifts across the country sample.
    Date: 2007
  37. By: Patrick McGuire; Ilhyock Nikola Tarashev
    Abstract: This paper illustrates various applications of the BIS international banking statistics. We first compare international bank flows to measures of real activity and liquidity and show that the international banking system is becoming a more important conduit for the transfer of capital across countries. We then use network analysis tools to construct a bird's eye view of the structure of the international banking market and to identify key financial hubs. Linking this information with balance of payments statistics helps to better understand the role of banks in the financing of current account flows, for example the recycling of petrodollars and Asian surpluses. Finally, the paper illustrates how the BIS statistics can be used to analyse internationally active banks' foreign exposures to credit risk and, thus, spot vulnerabilities in the international banking market.
    Date: 2008–02
  38. By: Corinne Winters
    Abstract: In this paper, the author considers whether fundamentals or other factors can explain the yen's ongoing weakness. In particular, the importance of capital outflows due to the carry trade and longer-term portfolio investment outflows, which may be delaying the adjustment of the yen, are investigated. A simple portfolio model is developed, composed of a speculative component and a minimum variance portfolio, to address the underlying motivation for capital outflows from Japan over the past ten years. The author's main findings suggest that a substantial portion of outflows may be attributed to diversification. Furthermore, given that considerable 'home bias' remains in Japanese households' portfolios, the results suggest that capital outflows from households, largely driven by diversification, may continue to dampen a long-run appreciation of the yen going forward. That said, evidence of substantial speculative outflows, through carry trades, complicates the outlook for the yen.
    Keywords: Exchange rates; International topics; Recent economic and financial developments
    JEL: F21 F31 F32 G11
    Date: 2008
  39. By: Gert Wagner (Instituto de Economía. Pontificia Universidad Católica de Chile.); José Díaz (Instituto de Economía. Pontificia Universidad Católica de Chile.)
    Abstract: During the last two centuries Chile had three official monetary units of account, where changes from one to the other can be seen as related to price level variations stretching over many years . For description and analysis this prolonged but also highly variable inflation environment will require previous adjustment of time series expressed in current monetary terms. The present document discusses sources and explains the construction of price level indicators stretching over this long time period, both for wholesale and consumer prices. It also refers to exchange rate series and explains how a unique price is obtained in periods of multiple rate policy. Finally, various indicators for the real exchange rate are brought together.
    Keywords: price level indicators, exchange rate series, Chile
    JEL: E31 F3 N00 N16
    Date: 2008
  40. By: John Weeks (Professor Emeritus, School of Oriental and African Studies, University of London)
    Abstract: During 2005-2006, appreciation of the Kwacha, Zambia?s currency, had a significant negative impact on public income. This exchange-rate effect received little notice in the debate over macroeconomic policy. The appreciation reduced fiscal space largely because of binding IMF conditionalities on monetary polices. The fiscal effect had two major revenue components: a fall in the domestic-currency income equivalent of official development assistance and a fall in trade taxes. In 2005, the negative effect on the public budget of the Kwacha appreciation was largely balanced by the positive impact on reducing external debt service. This positive impact ended, however, with debt relief and was almost zero after 2005. Obviously, these revenue effects, though little noticed, had negative implications for Zambia?s ability to achieve the MDGs. The Zambia experience underscores some important general lessons. It indicates, for example, the necessity to coordinate fiscal, monetary and exchange-rate policy in order to achieve sustained growth, employment generation and poverty reduction. Most important, this experience is also a clear example of the dysfunctional consequences of having low-inflation targets rule monetary policy. In the context of currency appreciation, setting limits on the domestic money supply prevents effective exchange-rate management. This necessarily creates, as a by-product, larger fiscal deficits and, consequently, more public borrowing. And these negative fiscal consequences could significantly constrict the resources that some developing countries need to achieve the MDGs.
    Keywords: The Reduction of Fiscal Space in Zambia?Dutch Disease and Tight-Money Conditionalities
    Date: 2008–01

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