nep-cba New Economics Papers
on Central Banking
Issue of 2008‒02‒16
forty-five papers chosen by
Alexander Mihailov
University of Reading

  1. A Modern Reconsideration of the Theory of Optimal Currency Areas By Giancarlo Corsetti
  2. When does determinacy imply expectational stability? By James B. Bullard; Stefano Eusepi
  3. How Much Inflation is Necessary to Grease the Wheels? By Kim, Jinill; Ruge-Murcia, Francisco J.
  4. The Case for Price Stability, Then and Now: A Retrospective Note on John W. Crow's 1988 Eric J. Hanson Memorial Lecture By David Laidler
  5. Exchange Rate Economics By John Williamson
  6. Challenges in macro-finance modeling By Don Kim
  7. Preventing financial instability and currency crises By Horst Siebert
  8. Macroeconomics: A Survey of Laboratory Research By John Duffy
  9. Oil Price Movements and the Global Economy: A Model-Based Assessment By Selim Elekdag; Rene Lalonde; Douglas Laxton; Dirk Muir; Paolo Pesenti
  10. Macroeconomic Interdependence and the International Role of the Dollar By Linda S. Goldberg; Cédric Tille
  11. A Long Term Perspective on the Euro By Michael D. Bordo; Harold James
  12. Towards a Characterization of Rational Expectations By Itai Arieli
  13. On policy interactions among nations: when do cooperation and commitment matter? By Hubert Kempf; Leopold von Thadden
  14. Varieties and the Transfer Problem: The Extensive Margin of Current Account Adjustment By Giancarlo Corsetti; Philippe Martin; Paolo Pesenti
  15. International competition and inflation: a New Keynesian perspective By Luca Guerrieri; Christopher Gust; David Lopez-Salido
  16. Measuring U.S. international relative prices: a WARP view of the world By Charles P. Thomas; Jaime Marquez; Sean Fahle
  17. CAN EXCHANGE RATES FORECAST COMMODITY PRICES? By Chen, Yu-chin; Rogoff, Kenneth; Rossi, Barbara
  18. International Trade in Durable Goods: Understanding Volatility, Cyclicality, and Elasticities By Charles Engel; Jian Wang
  19. Monetary policy actions and long-run inflation expectations By Michael T. Kiley
  20. On Financial Markets Incompleteness, Price Stickiness, and Welfare in a Monetary Union By Stéphane Auray; Aurélien Eyquem
  21. Nominal and real wage flexibility in EMU By Arpaia, Alfonso; Pichelmann, Karl
  22. Learning within a Markovian Environment By Javier Rivas
  23. US Inflation Dynamics 1981-2007: 13,193 Quarterly Observations By Gregor W. Smith
  24. Preference Heterogeneity in Monetary Policy Committees By RIBONI, Alessandro; RUGE-MURCIA, Francisco J.
  25. Short-Run Adjustment in a Global Model of Current Account Imbalances By Rudiger von Arnim
  26. Is Volatility Good for Growth? Evidence from the G7 By Elena Andreou; Alessandra Pelloni; Marianne Sensier
  27. The TIPS yield curve and inflation compensation By Refet S. Gürkaynak; Brian Sack; Jonathan H. Wright
  28. Rare Disasters and Exchange Rates By Emmanuel Farhi; Xavier Gabaix
  29. Sticky Prices, Sticky Wages, and also Unemployment By Miguel Casares
  30. Why Do Central Banks Push for Structural Reforms? The Case of a Reform in the Labor Market By Álvaro Aguiar; Ana Paula Ribeiro
  31. The Business Cycle Implications of Reciprocity in Labor Relations By Jean-Pierre Danthine; André Kurmann
  32. The dynamic interaction of order flows and the CAD/USD exchange rate By Nikola Gradojevic; Christopher J. Neely
  33. Co-movements between US and UK stock prices: the roles of macroeconomic information and time-varying conditional correlations By Nektarios Aslanidis; Denise R. Osborn; Marianne Sensier
  34. Bank core deposits and the mitigation of monetary policy By Lamont Black; Diana Hancock; Wayne Passmore
  35. Accountability in Complex Organizations: World Bank Responses to Civil Society By Alnoor Ebrahim; Steve Herz
  36. Two pitfalls of linearization methods By Jinill Kim; Sunghyun Henry Kim
  37. Nominal mortgage contracts and the effects of inflation on portfolio allocation By Joseph B. Nichols
  38. Efficiency in banking: theory, practice, and evidence By Joseph P. Hughes; Loretta J. Mester
  39. Exchange Rate Policies: Fact or Fiction in the Rise of High Performance Asian Economies By Turan Subasat
  40. Quantitive Inflation Perceptions and Exectations of Italian Consumers By Marco Malgarini
  41. Excess liquidity, oligopolistic loan markets and monetary policy in LDCs By Tarron Khemraj
  42. Extending an SVAR Model of the Australian Economy By Mardi Dungey; Adrian Pagan
  43. Estimating Central Bank Behavior in Emerging Markets: The Case of Turkey By Hatipoglu, Ozan; Alper, C. Emre
  44. The Price Setting Behavior in Colombia: Evidence from PPI Micro Data By Juan Manuel Julio; Héctor Manuel Zárate
  45. Monetary Policy Transparency in Pakistan: An Independent Analysis By Wasim Shahid Malik; Musleh-ud Din

  1. By: Giancarlo Corsetti
    Abstract: What can be learnt from revisiting the Optimal Currency Areas (OCA) theory 50 years from its birth, in light of recent advances in open economy macro and monetary theory? This paper presents a stylized micro-founded model of the costs of adopting a common currency, relative to an ideal benchmark in which domestic monetary authorities pursue country-specific efficient stabilization. Costs from (a) limiting monetary autonomy and (b) giving up exchange rate flexibility are examined in turn. These costs will generally be of the same magnitude as the costs of the business cycle. However, to the extent that exchange rates do not perform the stabilizing role envisioned by traditional OCA theory, a common monetary policy can be as efficient as nationally differentiated policies, even when shocks are strongly asymmetric, provided that the composition of aggregate spending tends to be symmetric at unionwide level. Convergence in consumption (and spending) patterns thus emerges as a possible novel attribute of countries participating in an efficient currency area.
    Keywords: Optimum Currency Area, optimal monetary policy, costs of business cycle, exchange rate regime, international policy cooperation, New Open Economy Macroeconomics
    JEL: E31
    Date: 2008
  2. By: James B. Bullard; Stefano Eusepi
    Abstract: We study the connections between determinacy of rational expectations equilibrium, and expectational stability or learnability of that equilibrium, in a relatively general New Keynesian model. Adoption of policies that induce both determinacy and learnability of equilibrium has been considered fundamental to successful policy in the literature. We ask what types of economic assumptions drive differences in the necessary and sufficient conditions for the two criteria. Our framework is sufficiently flexible to encompass lags in information, alternative pricing assumptions, a cost channel for monetary policy, and either Euler equation or infinite horizon approaches to learning. We are able to isolate conditions under which determinacy does and does not imply learnability, and also conditions under which long horizon forecasts make a clear difference to conclusions about expectational stability. The sharpest result is that informational delays break equivalence connections between determinacy and learnability.
    Keywords: Rational expectations (Economic theory)
    Date: 2008
  3. By: Kim, Jinill; Ruge-Murcia, Francisco J.
    Abstract: This paper studies Tobin's proposition that inflation "greases" the wheels of the labor market. The analysis is carried out using a simple dynamic stochastic general equilibrium model with asymmetric wage adjustment costs. Optimal inflation is determined by a benevolent government that maximizes the households' welfare. The Simulated Method of Moments is used to estimate the nonlinear model based on its second-order approximation. Econometric results indicate that nominal wages are downwardly rigid and that the optimal level of grease inflation for the U.S. economy is about 1.2 percent per year, with a 95% confidence interval ranging from 0.2 to 1.6 percent.
    Keywords: Oimal inflation, asymmetric adjustment costs, nonlinear dynamics
    JEL: E4 E5
    Date: 2007
  4. By: David Laidler (University of Western Ontario)
    Abstract: John Crow's 1988 Hanson Lecture argued for making price stability the goal of Canada's monetary policy, but in the early 1990s, political and economic circumstances led policy makers to settle for a 2 percent inflation target instead. The recently instituted review of the Inflation Control Program has put price stability on the policy menu again, and the current relevance of Crow's 1988 case is assessed in the light of the past 20 years' experience.
    Keywords: price stability; inflation targeting; Bank of Canada; monetary policy
    JEL: E42 E58 E61
    Date: 2008
  5. By: John Williamson (Peterson Institute for International Economics)
    Abstract: The paper summarizes the current theory of how a floating exchange rate is determined, dividing the subject into what determines the steady state and what determines the transition to steady state. The inadequacies of this model are examined, and an alternative “behavioral” model, which recognizes that the foreign exchange market is populated by both fundamentalists and chartists is presented. It is argued that the main importance of understanding the foreign exchange market for development strategy is to permit a correct appraisal of the dangers of Dutch disease. Empirically it seems that from the standpoint of promoting development it is preferable to have a mildly undervalued rate. The paper concludes by examining implications for exchange rate regimes.
    Keywords: Exchange rates; behavioral model; Dutch disease
    JEL: F31 F43 O24
    Date: 2008–02
  6. By: Don Kim
    Abstract: This paper discusses various challenges in the specification and implementation of “macro-finance” models in which macroeconomic variables and term structure variables are modeled together in a no-arbitrage framework. I classify macro-finance models into pure latent-factor models (“internal basis models”) and models which have observed macroeconomic variables as state variables (“external basis models”), and examine the underlying assumptions behind these models. Particular attention is paid to the issue of unspanned short-run fluctuations in macro variables and their potentially adverse effect on the specification of external basis models. I also discuss the challenge of addressing features like structural breaks and time-varying inflation uncertainty. Empirical difficulties in the estimation and evaluation of macro-finance models are also discussed in detail.
    Date: 2008
  7. By: Horst Siebert
    Abstract: Financial crises can have a severe impact on the real side of the economy with countries losing up to 20 percent of GDP. The paper studies rules that prevent financial instability and currency crises. These include institutional arrangements for a solid banking system, prudent regulations and appropriate principles of monetary policy. The paper studies the role of the IMF in light of the past experience in preventing currency crises and a systemic breakdown of the world’s financial system and points out necessary IMF reforms. It discusses how the IMF should adjust to the structural changes in the world economy.
    Keywords: Financial instability, rules for monetary stability, hedge funds, exchange rate crises, IMF, IMF quotas
    JEL: E5 F33 G2 P00
    Date: 2008–02
  8. By: John Duffy
    Abstract: This chapter surveys laboratory experiments addressing macroeconomic phenomena. The first part focuses on experimental tests of the microfoundations of macroeconomic models discusing laboratory studies of intertemporal consumption/savings decisions, time (in)consistency of preferences and rational expectations. Part two explores coordination problems of interest to macroeconomists and mechanisms for resolving these problems. Part three looks at experiments in specific macroeconomic sectors including monetary economics, labor economics, international economics as well-as large scale, multi-sector models that combine several sectors simultaneously. The final section addresses experimental tests of macroeconomic policy issues.
    JEL: C9 E0
    Date: 2008–02
  9. By: Selim Elekdag; Rene Lalonde; Douglas Laxton; Dirk Muir; Paolo Pesenti
    Abstract: We develop a five-region version (Canada, a group of oil exporting countries, the United States, emerging Asia and Japan plus the euro area) of the Global Economy Model (GEM) encompassing production and trade of crude oil, and use it to study the international transmission mechanism of shocks that drive oil prices. In the presence of real adjustment costs that reduce the short- and medium-term responses of oil supply and demand, our simulations can account for large endogenous variations of oil prices with large effects on the terms of trade of oil-exporting versus oil-importing countries (in particular, emerging Asia), and result in significant wealth transfers between regions. This is especially true when we consider a sustained increase in productivity growth or a shift in production technology towards more capital- (and hence oil-) intensive goods in regions such as emerging Asia. In addition, we study the implications of higher taxes on gasoline that are used to reduce taxes on labor income, showing that such a policy could increase world productive capacity while being consistent with a reduction in oil consumption.
    JEL: E66 F32 F47
    Date: 2008–02
  10. By: Linda S. Goldberg; Cédric Tille
    Abstract: The U.S. dollar holds a dominant place in the invoicing of international trade, along two complementary dimensions. First, most U.S. exports and imports invoiced in dollars. Second, trade flows that do not involve the United States are also substantially invoiced in dollars, an aspect that has received relatively little attention. Using a simple center-periphery model, we show that the second dimension magnifies the exposure of periphery countries to the center's monetary policy, even when direct trade flows between the center and the periphery are limited. When intra-periphery trade volumes are sensitive to the center's monetary policy, the model predicts substantial welfare gains from coordinated monetary policy. Our model also shows that even though exchange rate movements are not fully efficient, flexible exchange rates are a central component of optimal policy.
    JEL: F3 F4
    Date: 2008–02
  11. By: Michael D. Bordo; Harold James
    Abstract: This study grounds the establishment of EMU and the euro in the context of the history of international monetary cooperation and of monetary unions, above all in the U.S., Germany and Italy. The purpose of national monetary unions was to reduce transactions costs of multiple currencies and thereby facilitate commerce; to reduce exchange rate volatility; and to prevent wasteful competition for seigniorage. By contrast, supranational unions, such as the Latin Monetary Union or the Scandinavian Currency Union were conducted in the broader setting of an international monetary order, the gold standard. There are closer parallels between EMU and national monetary unions. Historical monetary unions also were associated with fiscal unions (fiscal federalism). Both fiscal and monetary unions were an important part of the process of political unification. In the past, central banks, and the currencies they managed, have been discredited or put under severe strain as a result of: severe or endemic fiscal problems creating pressures for the monetization of public debt; low economic growth may produce demands for central banks to pursue more expansionary policies; regional strains producing a demand for different monetary policies to adjust to particular regional pressures; severe crises of the financial system; and tensions between the international and the domestic role of a leading currency. In particular, there is the possibility for the EMU that low rates of growth will produce direct challenges to the management of the currency, and a demand for a more politically controlled and for a more expansive monetary policy. Such demands might arise in some parts or regions or countries of the euro area, but not in others and would lead to a politically highly difficult discussion of monetary governance.
    JEL: F02 F33 N20
    Date: 2008–02
  12. By: Itai Arieli
    Date: 2008–02–10
  13. By: Hubert Kempf; Leopold von Thadden
    Abstract: This paper offers a framework to study commitment and cooperation issues in games with multiple policymakers. To reconcile some puzzles in the recent literature on the nature of policy interactions among nations, we prove that games characterized by different commitment and cooperation schemes can admit the same equilibrium outcome if certain spillover effects vanish at the common solution of these games. We provide a detailed discussion of these spillovers, showing that, in general, commitment and cooperation are nontrivial issues. Yet in linear-quadratic models with multiple policymakers, commitment and cooperation schemes are shown to become irrelevant under certain assumptions. The framework is sufficiently general to cover a broad range of results from the recent literature on policy interactions as special cases, both within monetary unions and among fully sovereign nations.
    Date: 2008
  14. By: Giancarlo Corsetti; Philippe Martin; Paolo Pesenti
    Abstract: Most analyses of the macroeconomic adjustment required to correct global imbalances ignore net exports of new varieties of goods and services and do not account for firms' entry in the product market. In this paper we revisit the macroeconomics of trade adjustment in the context of the classic 'transfer problem,' using a model where the set of exportables, importables and nontraded goods is endogenous. We show that exchange rate movements associated with adjustment are dramatically lower when the above features are accounted for, relative to traditional macromodels. We also find that, for reasonable parameterizations, consumption and employment (hence welfare) are not highly sensitive to product differentiation, and change little regardless of whether adjustment occurs through movements in relative prices or quantities. This result warns against interpreting the size of real depreciation associated with trade rebalancing as an index of macroeconomic distress.
    JEL: F32 F41
    Date: 2008–02
  15. By: Luca Guerrieri; Christopher Gust; David Lopez-Salido
    Abstract: We develop and estimate an open economy New Keynesian Phillips curve (NKPC) in which variable demand elasticities give rise to changes in desired markups in response to changes in competitive pressure from abroad. A parametric restriction on our specification yields the standard NKPC, in which the elasticity is constant, and there is no role for foreign competition to influence domestic inflation. By comparing the unrestricted and restricted specifications, we provide evidence that foreign competition plays an important role in accounting for the behavior of inflation in the traded goods sector. Our estimates suggest that foreign competition has lowered domestic goods inflation about 1 percentage point over the 2000-2006 period. Our results also provide evidence against demand curves with a constant elasticity in the context of models of monopolistic competition.
    Date: 2008
  16. By: Charles P. Thomas; Jaime Marquez; Sean Fahle
    Abstract: In this paper we construct a new measure of U.S. prices relative to those of its trading partners and use it to reexamine the behavior of U.S. net exports. Our measure differs from existing measures of the dollar's real effective exchange rate (REER) in that it explicitly incorporates both the difference in price levels between the United States and developing economies and the growing importance of these developing economies in world trade. Unlike existing REERs, our measure shows that relative U.S. prices have increased significantly over the past 15 years. In terms of simple correlations, the relationship between our measure of relative prices and U.S. net exports is much more coherent than that between existing REERs and net exports. To explore this relationship further, we use our measure to construct an index of foreign prices relevant for U.S. export volumes and reexamine several export equations. We find that export equations with the new index dominate those with previous measures in terms of in-sample fit, out-of-sample fit, and parameter constancy. In addition, we find that with the new index of foreign prices the estimated elasticity of U.S. exports with respect to foreign income is a good bit higher than the unitary elasticity found in previous studies using other price measures. This has implications for U.S. current account adjustment.
    Date: 2008
  17. By: Chen, Yu-chin; Rogoff, Kenneth; Rossi, Barbara
    Abstract: This paper studies the dynamic relationship between exchange rate fluctuations and world commodity price movements. Taking into account parameter instability, we demonstrate surprisingly robust evidence that exchange rates predict world commodity price movements, both in-sample and out-of-sample. Because commodity prices are exogenous to the exchange rates we consider, we are able to overcome the identification problems that plague the existing empirical exchange rate literature. Because our finding that exchange rates predict future commodity prices can be given a true causal interpretation, it provides the most concrete support yet for the importance of selected macroeconomic fundamentals in determining exchange rates. As an important by-product of our analysis, we show that exchange rate-based forecasts may be a viable alternative for predicting future commodity price movements.
    Keywords: Exchange rates, forecasting, commodity prices, random walk
    JEL: C52 C53 F31 F47
    Date: 2008
  18. By: Charles Engel; Jian Wang
    Abstract: Data for OECD countries document: 1. imports and exports are about three times as volatile as GDP; 2. imports and exports are pro-cyclical, and positively correlated with each other; 3. net exports are counter-cyclical. Standard models fail to replicate the behavior of imports and exports, though they can match net exports relatively well. Inspired by the fact that a large fraction of international trade is in durable goods, we propose a two-country two-sector model, in which durable goods are traded across countries. Our model can match the business cycle statistics on the volatility and comovement of the imports and exports relatively well. In addition, the model with trade in durables helps to understand the empirical regularity noted in the trade literature: home and foreign goods are highly substitutable in the long run, but the short run elasticity of substitution is low. We note that durable consumption also has implications for the appropriate measures of consumption and prices to assess risk-sharing opportunities, as in the empirical work on the Backus-Smith puzzle. The fact that our model can match data better in multiple dimensions suggests that trade in durable goods may be an important element in open-economy macro models.
    JEL: E32 F3 F4
    Date: 2008–02
  19. By: Michael T. Kiley
    Abstract: The degree to which inflation expectations are anchored at long horizons is important for many issues in macroeconomics and finance. There has been little research examining observable measures of long-run inflation expectations. We investigate the evolution of survey measures of long-run inflation expectations in the United States. Our analysis emphasizes the role of a time-varying inflation objective of monetary policymakers. This focus makes monetary policy actions a key determinant of long-run inflation expectations. Our results have important implications for work on inflation dynamics, monetary policy rules, the costs of disinflation, and the term structure of interest rates.
    Date: 2008
  20. By: Stéphane Auray; Aurélien Eyquem
    Abstract: In this paper, we measure the welfare costs/gains associated with financial market incompleteness in a monetary union. To do this, we build on a two-country model of a monetary union with sticky prices subject to asymmetric productivity shocks. For most plausible values of price stickiness, we show that asymmetric shocks under incomplete financial markets give rise to a lower volatility of national inflation rates, which proves welfare improving with respect to the situation of complete financial markets. The corresponding welfare gains are equivalent to an average increase of 1.8% of permanent consumption.
    Keywords: Monetary union, Asymmetric shocks, Price stickiness, Financial market incompleteness, welfare
    JEL: E51 E58 F36 F41
    Date: 2007
  21. By: Arpaia, Alfonso; Pichelmann, Karl
    Abstract: Both common macroeconomic shocks and country-specific developments have subjected the flexibility of wage setting mechanisms in the euro area to a stress test in recent years. Against this background, this paper takes a fresh look at wage flexibility in EMU and attempts to draw a few lessons from the experience of the early years. First, we set the stage for the analysis by providing a brief description of the stylised facts regarding nominal and real wage and unit labour cost developments in the euro area over the recent business cycle. Then, the paper presents an empirical assessment of wage inertia based on new econometric estimates of a Phillips-curve type wage equation across euro area countries and offers an interpretation of the main findings with respect to nominal and real wage flexibility. Finally, we investigate the cyclical responsiveness of relative competitive positions among euro area countries. We conclude that from a bird's eye perspective euro area wage and labour cost dynamics have been quite benign in the past couple of years. However, our estimates suggest that persistent cross-country differences in wage and labour cost developments have not always reflected warranted adjustment needs; they are rather indicative of an eventually insufficient degree of nominal and real wage flexibility in the euro area.
    Keywords: Phillips curve; nominal and real rigidities; unit labour costs; EMU
    JEL: J0 J30 E30 E31
    Date: 2007–06
  22. By: Javier Rivas
    Abstract: We investigate learning in a setting where each period a population has to choose between two actions and the payoff of each action is unknown by the players. The population learns according to reinforcement and the environment is non-stationary, meaning that there is correlation between the payoff of each action today and the payoff of each action in the past. We show that when players observe realized and foregone payoffs, a suboptimal mixed strategy is selected. On the other hand, when players only observe realized payoffs, a unique action, which is optimal if actions perform different enough, is selected in the long run. When looking for efficient reinforcement learning rules, we find that it is optimal to disregard the information from foregone payoffs and to learn as if only realized payoffs were observed.
    Keywords: Adaptive Learning, Markov Chains, Non-stationarity, Reinforcement Learning
    JEL: C73
    Date: 2008
  23. By: Gregor W. Smith (Queen's University)
    Abstract: The new Keynesian Phillips curve (NKPC) restricts multivariate forecasts. I estimate and test it entirely within a panel of professional forecasts, thus using the time-series, cross-forecaster, and cross-horizon dimensions of the panel. Estimation uses 13,193 observations on quarterly US inflation forecasts since 1981. The main finding is a significantly larger weight on expected future inflation than on past inflation, a finding which also is estimated with much more precision than in the standard approach. Inflation dynamics also are stable over time, with no decline in inflation inertia from the 1980s to the 2000s. But, as in historical data, identifying the output gap is difficult.
    Keywords: forecast survey, new Keynesian Phillips curve
    JEL: E31 E37 C23
    Date: 2008–02
  24. By: RIBONI, Alessandro; RUGE-MURCIA, Francisco J.
    Abstract: This short paper employs individual voting records of the Monetary Policy Committee (MPC) of the Bank of England to study heterogeneity in policy preferences among committee members. The analysis is carried out using a simple generalization of the standard Neo Keynesian framework that allows members to dier in the weight they give to output compared with in ation stabilization and in their views regarding optimal inflation and natural output. Results indicate that, qualitatively, MPC members are fairly homogeneous in their policy preferences, but that there are systematic quantitative dierences in their policy reaction functions that are related to the nature of their membership and career background.
    Keywords: Committees, reaction functions, Bank of England
    Date: 2007
  25. By: Rudiger von Arnim (New School for Social Research, New York, NY)
    Keywords: short-run adjustment; current account; imbalances
    Date: 2007–05–31
  26. By: Elena Andreou; Alessandra Pelloni; Marianne Sensier
    Abstract: We provide empirical support for a DSGE model with nominal wage stickiness where growth is driven by learning-by-doing and money shocks and their variance are allowed to impact on long-run output growth. In our theoretical model the variance of monetary shocks has a negative effect on growth, while output volatility is good for growth as a positive relationship exists. Utilising a bivariate GARCH-M model we test the empirical conditional mean and variance relationships of nominal money and production growth rates in the G7 countries. We corroborate the theoretical model predictions with evidence from Bonferroni multiple tests across the G7.
    Date: 2008
  27. By: Refet S. Gürkaynak; Brian Sack; Jonathan H. Wright
    Abstract: For over ten years, the U.S. Treasury has issued index-linked debt. Federal Reserve Board staff have fitted a yield curve to these indexed securities at the daily frequency from the start of 1999 to the present. This paper describes the methodology that is used and makes the estimates public. Comparison with the corresponding nominal yield curve allows measures of inflation compensation (or breakeven inflation rates) to be computed. We discuss the interpretation of inflation compensation and its relationship to inflation expectations and uncertainty, offering some empirical evidence that these measures are affected by an inflation risk premium that varies considerably at high frequency. In addition, we also find evidence that inflation compensation was held down in the early years of the sample by a premium associated with the illiquidity of TIPS at the time. We hope that the TIPS yield curve and inflation compensation data, which are posted here and will be updated periodically, will provide a useful tool to applied economists.
    Date: 2008
  28. By: Emmanuel Farhi; Xavier Gabaix
    Abstract: We propose a new model of exchange rates, which yields a theory of the forward premium puzzle. Our explanation combines two ingredients: the possibility of rare economic disasters, and an asset view of the exchange rate. Our model is frictionless, has complete markets, and works for an arbitrary number of countries. In the model, rare worldwide disasters can occur and affect each country's productivity. Each country's exposure to disaster risk varies over time according to a mean-reverting process. Risky countries command high risk premia: they feature a depreciated exchange rate and a high interest rate. As their risk premium mean reverts, their exchange rate appreciates. Therefore, currencies of high interest rate countries appreciate on average. To make the notion of disaster risk more implementable, we show how options prices might in principle uncover latent disaster risk, and help forecast exchange rate movements. We then extend the framework to incorporate two factors: a disaster risk factor, and a business cycle factor. We calibrate the model and obtain quantitatively realistic values for the volatility of the exchange rate, the forward premium puzzle regression coefficients, and near-random walk exchange rate dynamics. Finally, we solve a model of stock markets across countries, which yields a series of predictions about the joint behavior of exchange rates, bonds, options and stocks across countries. The evidence from the options market appears to be supportive of the model.
    JEL: E43 E44 F31 G12 G15
    Date: 2008–02
  29. By: Miguel Casares (Departamento de Economía-UPNA)
    Abstract: This paper shows a New Keynesian model where wages are set at the value that matches household´s labor supply with firm´s labor demand. Subsequently, wage stickiness brings industry-level unemployment fluctuations. After aggregation, the rate of wage in?ation is negatively related to unemployment, as in the original Phillips (1958) curve, with an additional term that provides forward-looking dynamics. The supply-side of the model can be captured with dynamic expressions equivalent to those obtained in Erceg, Henderson, and Levin (2000), though with different slope coefficients. Impulse-response functions from a technology shock illustrate the inter-actions between sticky prices, sticky wages and unemployment.
    Keywords: new Keynesian model, sticky wages, unemployment
    JEL: E12 E24 E32 J30
    Date: 2008
  30. By: Álvaro Aguiar (CEMPRE, Faculdade de Economia, Universidade do Porto, Portugal); Ana Paula Ribeiro (CEMPRE, Faculdade de Economia, Universidade do Porto, Portugal)
    Abstract: In spite of being mainly concerned with stabilization policies, central banks in many developed countries often advocate the necessity of structural reforms. In turn, demand-side policies - such as monetary policy - can often help improving the political support of reforms (two-handed-approach). By arguing that labor market reforms influence the effectiveness of monetary policy, we assess if central banks have incentives to help promoting such reforms. In order to identify the channels through which the effects of the reform impinge on the effectiveness of monetary policy, we add stylized features of the labor market to a standard New Keynesian model for monetary policy analysis. In this framework, a labor market reform is modeled as a structural change inducing a permanent shift in the flexible prices unemployment and output levels. The reform-induced adjustments, under different sources of macroeconomic and reform implementation inertias, are then compared across different monetary policy rules. We find that, in general, labor market reform increases the effectiveness of monetary policy as a demand-management instrument. However, conditional to the presence of different inertias, the reform process can bring about transition stabilization costs, depending on the monetary policy rule. Choosing a particular monetary policy rule, as well as the business cycle timing of the reform, are means to reduce such costs.
    Keywords: Monetary policy effectiveness; Monetary policy rules; Labor market reform; New-Keynesian models
    JEL: E24 E52 E58
    Date: 2008–02
  31. By: Jean-Pierre Danthine; André Kurmann
    Abstract: We develop a reciprocity-based model of wage determination and incorporate it into a moder dynamic general equilibrium framework. We estimate the model and find that, among potential determinants of wage policy, rent-sharing (between workers and firms) and a measure of wage entitlement are critical to fit the dynamic responses of hours, wages and inflation to various exogenous shocks. Aggregate employment conditions (measuring workers' outside option), on the other hand, are found to play only a negligible role in wage setting. These results are broadly consistent with micro-studies on reciprocity in labor relations but contrast with traditional efficiency wage models which emphasize aggregate labor market variables as the main determinant of wage setting. Overall, the empirical fit of the estimated model is at least as good as the fit of models postulating nominal wage contracts. In particular, the reciprocity model is more successful in generating the sharp and significant fall of inflation and nominal wage growth in response to a neutral technology shock.
    Keywords: Efficiency wages, Reciprocity, Estimated DSGE models
    JEL: E24 E31 E32 E52 J50
    Date: 2007
  32. By: Nikola Gradojevic; Christopher J. Neely
    Abstract: We explore the relationship between disaggregated order flow, the Canada/U.S. dollar (CAD/USD) market and U.S. macroeconomic announcements. Three types of CAD order flow and the CAD/USD are cointegrated. Financial order flow appears to contemporaneously drive the CAD/USD while commercial order flow seems to contemporaneously respond to exchange rate movements. Past order flow and lagged exchange rates strongly explain most types of order flow. Despite this predictability and the contemporaneous correlation of order flow with exchange rate returns, exchange rate returns are not predictable by either statistical or economic criteria (trading rule). This negative finding contrasts with that of Rime et al (2007), who use a different data set. There is strong evidence of structural breaks in the order-flow-exchange rate systems in 1994, 1996-1997 and 1999-2000.
    Keywords: Foreign exchange rates
    Date: 2008
  33. By: Nektarios Aslanidis; Denise R. Osborn; Marianne Sensier
    Abstract: This paper develops an open-economy intertemporal growth model with We provide evidence on the sources of co-movement in monthly US and UK stock returns by investigating the role of macroeconomic and financial variables in a model with time-varying correlations. Cross-country communality in response is uncovered, with changes in US Federal Funds rate, UK bond yields and oil prices having negative effects in both markets. These effects do not, however, explain the marked increase in correlations from around 2000, which we attribute to time variation in the correlations of shocks to these markets. A regime-switching model captures this time variation well and shows the correlations increase dramatically around 1999-2000
    Date: 2008
  34. By: Lamont Black; Diana Hancock; Wayne Passmore
    Abstract: We consider the business strategy of some banks that provide relationship loans (where they have loan origination and monitoring advantages relative to capital markets) with core deposit funding (where they can pass along the benefit of a sticky price on deposits). These "traditional banks" tend to lend out less than the deposits they take in, so they have a "buffer stock" of core deposits. This buffer stock of core deposits can be used to mitigate the full effect of tighter monetary policy on their bank-dependent borrowers. In this manner, the business strategy of "traditional banks" acts as a "core deposit mitigation channel" to provide funds to bank-dependent borrowers when there are monetary shocks. In effect, there is no bank lending channel of monetary policy associated with these traditional banks. ; In contrast, other banks mainly rely on managed liabilities that are priced at market rates. These banks do not have to shift from insured deposits to managed liabilities in response to tighter monetary policy. At the margin, their loans are already funded with managed liabilities. For these banks as well, there is no unique bank lending channel of monetary policy. ; The only banks that are likely to raise loan rates substantially in response to an increase in the federal funds rate are banks with a high proportion of relationship loans that are close to a loan-to-core deposit ratio of one. These banks must substitute higher cost nondeposit liabilities, which have an external finance premium, for core deposits, which do not because of deposit insurance. Some of these banks may also face higher marginal costs as their loan-to-core deposit ratio approaches one because of the costs associated with lending to default-prone relationship borrowers. It is among these banks (which we refer to as high relationship lenders), and only these banks, that we find evidence of a bank lending channel - they significantly reduce lending in response to a monetary contraction. Importantly, these banks hold only a small fraction of U.S. banking assets. Thus, in the United States, the bank lending channel seems limited in scope and importance, mainly because so few banks that specialize in relationship lending switch from core deposits to managed liabilities in response to changes in interest rates.
    Date: 2007
  35. By: Alnoor Ebrahim (Harvard Business School, General Management Unit); Steve Herz (Lotus Global Advocacy)
    Abstract: Civil society actors have been pushing for greater accountability of the World Bank for at least three decades. This paper outlines the range of accountability mechanisms currently in place at the World Bank along four basic levels: (1) staff, (2) project, (3) policy, and (4) board governance. We argue that civil society organizations have been influential in pushing for greater accountability at the project and policy levels, particularly through the establishment and enforcement of social and environmental safeguards and complaint and response mechanisms. But they have been much less successful in changing staff incentives for accountability to affected communities, or in improving board accountability through greater transparency in decision making, more representative vote allocation, or better parliamentary scrutiny. In other words, although civil society efforts have led to some gains in accountability with respect to Bank policies and projects, the deeper structural features of the institution - the incentives staff face and how the institution is governed- remain largely unchanged.
    Date: 2007–10
  36. By: Jinill Kim; Sunghyun Henry Kim
    Abstract: This paper illustrates two types of pitfalls in using linearization methods. First, if constraints are linearized before deriving optimality conditions, the derived conditions are not correct up to first order. Second, even when the behavior of the economy is correct to the first order, applying this behavior to welfare implications may lead to incorrect results.
    Date: 2007
  37. By: Joseph B. Nichols
    Abstract: Households who wish to extract home equity through refinancing their mortgage face a hidden transaction cost. The real value of the fixed nominal mortgage payment declines over time with inflation. The change in the real value of the mortgage payments from taking on a new mortgage is positive and an increasing function of inflation; higher inflation thus discourages households from re-balancing their portfolio as frequently as they would otherwise. The life cycle model developed in this paper demonstrates how the share of total wealth held in housing is sensitive to the rate of inflation, even when perfectly anticipated. Households hold larger positions in home equity earlier in the life cycle and smaller positions later in the life cycle as the rate of inflation increases.
    Date: 2007
  38. By: Joseph P. Hughes; Loretta J. Mester
    Abstract: Great strides have been made in the theory of bank technology in terms of explaining banks’ comparative advantage in producing informationally intensive assets and financial services and in diversifying or offsetting a variety of risks. Great strides have also been made in explaining sub-par managerial performance in terms of agency theory and in applying these theories to analyze the particular environment of banking. In recent years, the empirical modeling of bank technology and the measurement of bank performance have begun to incorporate these theoretical developments and yield interesting insights that reflect the unique nature and role of banking in modern economies. This paper gives an overview of two general empirical approaches to measuring bank performance and discusses some of the applications of these approaches found in the literature.
    Keywords: Banks and banking - Research
    Date: 2008
  39. By: Turan Subasat (Department of Economics, Izmir University of Economics)
    Abstract: Many economists believe that the nature of exchange rate management was an important reason for rapid economic growth in East Asia. In this view, Asian countries avoided extreme exchange rate appreciations and kept their nominal exchange rates close to market clearing levels. In contrast, the inappropriate exchange rate policies pursued by many Latin American and African countries in the late 1970s and 1980s contributed a great deal towards their poor economic performance. This paper challenges the above views on the type of exchange rate policies adopted by the East Asian, Latin American and African countries. The empirical evidence fails to prove that the exchange rate policies of the East Asian economies were significantly different from those of other developing countries.
    Keywords: Exchange rate policy, Trade policy, East Asian Miracle, exports growth, economic growth
    JEL: F1 O24
    Date: 2008–02
  40. By: Marco Malgarini (ISAE - Institute for Studies and Economic Analyses)
    Abstract: Since February 2003 ISAE collects quantitative inflation opinions, within its monthly survey on Italian consumers. Data confirms the severe overestimation of inflation already emerged in previous studies. Quantitative replies are in line with more traditional qualitative evaluations, indicating that overestimation is not a sort of random outcome derived from casual answers. A first explanation calls for inadequate knowledge of inflation statistics: however, scarce information does not explain per se overestimation. Indeed, overestimation varies across personal characteristics and it is strongly correlated with assessments on economic conditions, with those being more optimistic generally showing lower inflation opinions. It is possible that given a scarce statistical knowledge consumers attribute to high inflation an “economic distress” mainly determined by slow growth of disposable income and psychological factors linked to socio-economic conditions.
    Keywords: Inflation Expectations, Survey data
    JEL: D12 D8 E31
    Date: 2008–01
  41. By: Tarron Khemraj
    Abstract: Evidence about commercial banks’ liquidity preference says the following about the loan market in LDCs: (i) the loan interest rate is a minimum mark-up rate; (ii) the loan market is characterized by oligopoly power; and (iii) indirect monetary policy, a cornerstone of financial liberalization, can only be effective at very high interest rates that are likely to be deflationary. The minimum rate is a mark-up over an exogenous foreign interest rate, marginal transaction costs and a risk premium. The paper utilizes and extends the oligopoly model of the banking firm. A calibration exercise tends to replicate the observed stylized facts.
    Keywords: excess bank liquidity, oligopoly loan market, monetary policy
    JEL: O10 O16 E52 G21 L13
    Date: 2008–02
  42. By: Mardi Dungey; Adrian Pagan
    Abstract: Dungey and Pagan (2000) present an SVAR model of the Australian economy which models macro-economic outcomes as transitory deviations from a deterministic trend. In this paper we extend that model in two directions. Firstly, we relate it to an emerging literature on DSGE modelling of small open economies. Secondly, we allow for both transitory and permanent components in the series and show how this modification has an impact upon the design of macroeconomic models.
    Date: 2008–01–10
  43. By: Hatipoglu, Ozan; Alper, C. Emre
    Abstract: Design of policy rules for an an emerging market central bank (EMCB) operating in an inflation-targeting framework presents additional challenges beyond those for describing the behavior of a central bank in a developed economy. Even though an inflation-targeting regime entails abolishing the exchange rate target in favor of an inflation target, it is more difficult for an EMBC to ignore movements in exchange rates given the relatively shallow depth of financial markets and the the high degree of dollarization. Additionally the EMCB may be forced to change the pursued exchange rate regime following a capital account reversal so that linear Taylor rules may be inadequate for describing EMCB reactions. We develop an empirical framework that addresses these issues and propose a new methodology to estimate unobserved variables such as expected inflation and potential output within the rule. Specifically, we employ a structural, nonlinear Kalman filter algorithm to estimate time-dependent parameters and unobserved variables, and we experiment with various exchange rate mechanisms that can be employed by an EMCB. This approach allows us to track any changes in EMCB behavior - including regime shifts - following a switch to inflation targeting. Using post-2001 data from Turkey, which is a fairly dollarized small open economy, we document that the Central Bank of Turkey has given relatively more importance to the inflation gap than to the output gap or to exchange rates, but not until some time after it had switched to an inflation-targeting framework.
    Keywords: Dual Extended Kalman Filter; Taylor Rule; inflation targeting; emerging markets
    JEL: C32 C50 E52
    Date: 2007
  44. By: Juan Manuel Julio; Héctor Manuel Zárate
    Abstract: In this paper we explore the price setting behavior of Colombian producers and importers using a unique database containing the monthly price reports underlying the Colombian PPI from Jun-1999 to Oct-2006. We focus on five particular questions: 1. Are prices sticky or flexible? 2. Is a price increase more likely than a decrease? 3. Are price changes synchronized? 4. Is the pricing rule state or time dependent? 5. Are price changes sizable? Answers to these questions provide some of the micro fundamentals for the design of monetary policy in this country.
    Keywords: Price Setting Behavior, Nominal Price Rigidities, Producers Price Index. Classification JEL: E31; E52; E58.
  45. By: Wasim Shahid Malik (Pakistan Institute of Development Economics, Islamabad); Musleh-ud Din (Pakistan Institute of Development Economics, Islamabad)
    Abstract: This paper analyses monetary policy transparency of the central bank (SBP) using the Eijffinger and Geraats (2006) index. The results show that the SBP scores 4.5 out of 15, which is lower than any of the central banks’ score in Eijffinger and Geraats (2006). The SBP is completely opaque on the procedural issues, whereas it is the least transparent in the policy transparency. On the political and the economic matters, the SBP is partially transparent. An area where the SBP is quite transparent, with moderate score, is operational transparency. In comparison with the other central banks, the SBP is at par with some of the central banks in political and operational transparency but ranks behind in all other respects.
    Keywords: Monetary Policy Transparency, State Bank of Pakistan, Developing Countries
    JEL: E52 E58
    Date: 2008

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