nep-cba New Economics Papers
on Central Banking
Issue of 2008‒03‒01
forty-nine papers chosen by
Alexander Mihailov
University of Reading

  1. Inflation and Unemployment in General Equilibrium By Guillaume Rocheteau; Peter Rupert; Randall Wright
  2. Monetary policy under uncertainty: Min-max vs robust-satisficing strategies By Yakov Ben-Haim; Q. Farooq Akram; Øyvind Eitrheim
  3. Imperfect Central Bank Communication: Information versus By Dale, Spencer; Orphanides, Athanasios; Österholm, Pär
  4. Where Did All the Borrowing Go? A Forensic Analysis of the U.S. External Position By Gian Maria Milesi-Ferretti; Philip R. Lane
  5. Issues in Central Bank Finance and Independence By Ake Lonnberg; Peter Stella
  6. Assessing estimates of the exchange rate pass-through By Ida Wolden Bache
  7. Explaining the Great Moderation - it is not the shocks. By Domenico Giannone; Michele Lenza; Lucrezia Reichlin
  8. Purdah - on the rationale for central bank silence around policy meetings. By Michael Ehrmann; Marcel Fratzscher
  9. Mengerian Saleableness and Commodity Money in a Walrasian Trading Post Example By Ross Starr
  10. Stock market volatility and learning. By Klaus Adam; Albert Marcet; Juan Pablo Nicolini
  11. Policy Uncertainty, Symbiosis, and the Optimal Fiscal and Monetary Conservativeness By Giovanni Di Bartolomeo; Marco Manzo; Francesco Giuli
  12. Can Domestic Policies Influence Inflation? By Ashoka Mody; Franziska Ohnsorge
  13. Real Exchange Rates and Fundamentals: A Cross-Country Perspective By Jaewoo Lee; Gian Maria Milesi-Ferretti; Luca Antonio Ricci
  14. Terms of Trade Shocks and Economic Recovery By Norbert Funke; Patrick A. Imam; Eleonara Granziera
  15. VAR analysis and the Great Moderation. By Luca Benati; Paolo Surico
  16. Openness, Income-Tax Progressivity, and Inflation By Joseph P. Daniels; David D. VanHoose
  17. Do monetary indicators lead euro area inflation? By Boris Hofmann
  18. Inflation Differentials in the EU: A Common ( Factors ) Approach with Implications for EU8 Euro Adoption Prospects By Franziska Ohnsorge; Nada Choueiri; Rachel van Elkan
  19. One Money, Several Cycles? Evaluation of European business cycles using model-based cluster analysis By Crowley, Patrick
  20. Information Transmission and Core Convergence in Quasilinear Economies By Yusuke Kamishiro; Roberto Serrano
  21. How should we think about markets for foreign exchange? By John Pippenger
  22. Monetary exchange rate model: supportive evidence from nonlinear testing procedures By Liew , Venus Khim-Sen; Baharumshah, Ahmad Zubaidi; Habibullah, Muzafar Shah; Midi, Habshah
  23. US Consumer Inflation Expectations: Evidence Regarding Learning, Accuracy and Demographics By Robert D. J. Anderson
  24. The Duration of Capital Account Crises--An Empirical Analysis By David Hofman; Ruben Atoyan; Dimitri Tzanninis; Mauro Mecagni
  25. The Feldstein-Horioka fact. By Domenico Giannone; Michele Lenza
  26. Big Government, High Debt, and Fiscal Adjustment in Small States By Stephanie Medina Cas; Rui Ota
  27. Taylor Rule Under Financial Instability By Martin Cihák; Sofia Bauducco; Ales Bulir
  28. EU framework for safeguarding financial stability: Towards an analytical benchmark for assessing its effectiveness By María J. Nieto; Garry J. Schinasi
  29. Macroeconomic rates of return of public and private investment: crowding-in and crowding-out effects. By António Afonso; Miguel St. Aubyn
  30. Rule-of-thumb consumers, productivity and hours By Francesco Furlanetto; Martin Seneca
  31. Money, Intermediation, and Banking By Andolfatto, David
  32. A Markov-Switching Approach to Measuring Exchange Market Pressure By Francis Y. Kumah
  33. Are sectoral stock prices useful for predicting euro area GDP? By Magnus Andersson; Antonello D’Agostino
  34. On the Informational Role of Prices with Rational Expectations By Cheng-Zhong Qin; Xiaojuan Hu
  35. On Asymmetry of Exchange Rate Volatility in New EU Member and Candidate Countries By Stavarek, Daniel
  36. Alternative Fiscal Rules for Norway By Daniel Leigh; Etibar Jafarov
  37. Nowcasting Norwegian GDP: The role of asset prices in a small open economy By Knut Are Aastveit; Tørres G. Trovik
  38. The reserve fulfilment path of euro area commercial banks - empirical testing using panel data. By Nuno Cassola
  39. On the impact of exchange rate regimes on tourism By María Santana-Gallego; Francisco J. Ledesma-Rodríguez; Jorge V. Pérez-Rodríguez
  40. Why is Canada's Price Level So Predictable? By Vladimir Klyuev; Ondra Kamenik; Heesun Kiem; Douglas Laxton
  41. GCC Monetary Union and the Degree of Macroeconomic Policy Coordination By Bassem Kamar; Samy Ben Naceur
  42. Forecasting inflation with dynamic factor model – the case of Poland By Jacek Kotlowski
  43. Looking for a break in Spanish Inflation Data in the early eighties and assessing persistence By Maria Teresa Mota; Mariana Alves da Cunha; Carlos Santos
  44. Financial Liberalisation and the Effectiveness of Monetary Policy on House Prices in South Africa By Kasai Ndahiriwe; Rangan Gupta
  45. Implications of Oil Inflows for Savings and Reserve Management in the CEMAC By Paulo Flavio Nacif Drummond
  46. Exchange Market Pressure in African Lusophone Countries By Macedo, Jorge Braga de; Pereira, Luis Brites; Reis, Afonso Mendonça
  47. Local Currency Debt Markets in the West African Economic and Monetary Union By Amadou N. R. Sy
  48. Real interest rate parity: evidence from East Asian economies relative to China By Liew , Venus Khim-Sen; Ling, Tai-Hu
  49. A Modelling of Ghana's Inflation Experience: 1960–2003 By Mathew Kofi Ocran

  1. By: Guillaume Rocheteau (none); Peter Rupert (University of California, Santa Barbara); Randall Wright (University of Pennsylvania)
    Abstract: When labor is indivisible, there exist efficient outcomes with some agents randomly unemployed (Rogerson 1988). We integrate this idea into the modern theory of monetary exchange, where some trade occurs in centralized markets and some in decentralized markets (as in Lagos and Wright 2006). This delivers a general equilibrium model of unemployment and money, with explicit microeconomic foundations. We show the implied relation between inflation and unemployment can be positive or negative, depending on simple preference conditions. Our Phillips Curve provides a long-run, exploitable, trade off for monetary policy; it turns out, however, that the optimal policy is the Freidman rule.
    Keywords: inflation, unemployment, Phillips Curve,
    Date: 2007–08–01
  2. By: Yakov Ben-Haim (Technion-Israel Institute of Technology); Q. Farooq Akram (Norges Bank (Central Bank of Norway)); Øyvind Eitrheim (Norges Bank (Central Bank of Norway))
    Abstract: We study monetary policy under uncertainty. A policy which ameliorates a worst case may differ from a policy which maximizes robustness and satisfices the performance. The former strategy is min-maxing and the latter strategy is robust-satisficing. We show an “observational equivalence” between robust-satisficing and min-maxing. However, there remains a “behavioral difference” between robust-satisficing and min-maxing. Policy makers often wish to respect specified bounds on target variables. The robust-satisficing policy can be more (and is never less) robust, and hence more dependable, than the min-max policy. We illustrate this in an empirical example where monetary policy making amounts to selecting the coefficients of a Taylor-type interest rate rule, subject to uncertainty in the persistence of shocks to inflation.
    Keywords: Knightian uncertainty, robustness, info-gap decision theory, monetary policy, minmax policy, robust-satisficing policy.
    JEL: E52 E58
    Date: 2007–12–05
  3. By: Dale, Spencer (Board of Governors of the Federal Reserve System); Orphanides, Athanasios (Central Bank of Cyprus); Österholm, Pär (Department of Economics)
    Abstract: Much of the information communicated by central banks is noisy or imperfect. This paper considers the potential benefits and limitations of central bank communications in a model of imperfect knowledge and learning. It is shown that the value of communicating imperfect information is ambiguous. If the public is able to assess accurately the quality of the imperfect information communicated by a central bank, such communication can inform and improve the public`s decisions and expectations. But if not, communi-cating imperfect communication has the potential to mislead and distract. The risk that imperfect communication may detract from the publics understanding should be considered in the context of a central banks communications strategy. The risk of distraction means the central bank may prefer to focus its communi-cation policies on the information it knows most about. Indeed, conveying more certain information may improve the public`s under-standing to the extent that it "crowds out" a role for communicating imperfect information.
    Keywords: Transparency; Forecasts; Learning
    JEL: E52 E58
    Date: 2008–02–25
  4. By: Gian Maria Milesi-Ferretti; Philip R. Lane
    Abstract: The deterioration in the U.S. net external position in recent years has been much smaller than the extensive net borrowing associated with large current account deficits would have suggested. This paper examines the sources of discrepancies between net borrowing and accumulation of net liabilities for the U.S. economy over the past 25 years. In particular, it highlights and quantifies the role played by net capital gains on the U.S. external portfolio and 'residual adjustments' in explaining this discrepancy. It discusses whether these 'residual adjustments' are likely to be originating from measurement errors in external assets and liabilities, financial flows, or capital gains, and explores the implications of these conjectures for the U.S. financial account and external position.
    Keywords: Borrowing , United States , Capital flows , Current account deficits ,
    Date: 2008–02–01
  5. By: Ake Lonnberg; Peter Stella
    Abstract: Conventional economic policy models focus only on selected elements of the central bank balance sheet, in particular monetary liabilities and sometimes foreign reserves. The canonical model of an "independent" central bank assumes that it chooses money (or an interest rate), unconstrained by a need to generate seignorage for itself or government. While a long line of literature has emphasized the dangers of fiscal dominance influencing the conduct of monetary policy the idea that an independent central bank could be constrained in achieving its policy objectives by its own balance sheet situation is a relatively novel idea considered in this paper. If one accepts this potential constraint as a valid concern, the financial strength of the central bank as a stand alone entity becomes highly relevant for ascertaining monetary policy credibility. We consider several strands of evidence that clearly indicate fiscal backing for central banks cannot be assumed and hence financial independence is relevant to operational independence. First we examine 135 central bank laws to illustrate the variety of legal approaches adopted with respect to central bank financial independence. Second, we examine the same data set with regard to central bank recapitalization provisions to show that even in cases where the treasury is nominally responsible for maintaining the central bank financially strong, it may do so in purely a cosmetic fashion. Third, we show that, in actual practice, treasuries have frequently not provided central banks with genuine financial support on a timely basis leaving them excessively reliant on seignorage to finance their operations and/or forcing them to abandon policy objectives.
    Keywords: Central banks , Capital account , Capital flows ,
    Date: 2008–02–08
  6. By: Ida Wolden Bache (Norges Bank (Central Bank of Norway))
    Abstract: This paper uses Monte Carlo techniques to address the question: are structural VAR estimates of exchange rate pass-through a useful tool to evaluate macroeconomic models of open economies? The data generating process is a small open economy DSGE model with incomplete pass-through. The results suggest that (i) the pass-through estimates obtained from a first-differenced VAR exhibit a systematic downward bias; (ii) by contrast, estimates derived from a low order vector equilibrium correction model are fairly accurate; but (iii) standard cointegration tests have low power to detect the cointegration relations implied by the DSGE model.
    Keywords: Exchange rate pass-through, structural VAR, DSGE models, cointegration
    JEL: C32 C52 F41
    Date: 2008–01–11
  7. By: Domenico Giannone (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Michele Lenza (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Lucrezia Reichlin (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper shows that the explanation of the decline in the volatility of GDP growth since the mid-eighties is not the decline in the volatility of exogenous shocks but rather a change in their propagation mechanism. JEL Classification: E32, E37, C32, C53.
    Keywords: Shocks, Information, Great Moderation.
    Date: 2008–02
  8. By: Michael Ehrmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Despite substantial differences in monetary policy and communication strategies, many central banks share the practice of purdah, a self-imposed guideline of abstaining from communication around policy meetings or other important events. This practice is remarkable, as it seems to contradict the virtue of transparency by requiring central banks to withhold information precisely when it is sought after intensely. However, imposing such a limit to communication has often been justified on grounds that such communication may create excessive market volatility and unnecessary speculation. This short paper assesses the purdah for the Federal Reserve. The empirical results confirm the conjecture that financial markets are substantially more sensitive to central bank communication around policy meetings. Short-term interest rates react three to four times more strongly to statements in the purdah before FOMC meetings than during other times, and market volatility increases (compared to a volatility reduction induced by statements otherwise). The findings thus offer relevant insights about the limits to central bank transparency. JEL Classification: E58, E52, E43.
    Keywords: Purdah; communication, transparency, monetary policy, interest rates, effectiveness, Federal Reserve.
    Date: 2008–02
  9. By: Ross Starr (University of California, San Diego)
    Abstract: In an economy with commodity-pairwise trading posts and transaction costs, commodity money is endogenously determined in general equilibrium. Absent double coincidence of wants, the low-transaction cost commodity (with the narrowest proportional bid/ask price spread) becomes the common medium of exchange.
    Keywords: trading post, transaction cost, commodity money, bid/ask spread, medium of exchange,
    Date: 2008–01–01
  10. By: Klaus Adam (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Albert Marcet (Institut d’Anàlisi Economica CSIC, Universitat Autònoma de Barcelona, 08193 Bellaterra, Spain.); Juan Pablo Nicolini (Universidad Torcuato di Tella, Miñones 2177, Capital Federal, (C1428ATG) Argentina.)
    Abstract: Introducing bounded rationality into a standard consumption based asset pricing model with a representative agent and time separable preferences strongly improves empirical performance. Learning causes momentum and mean reversion of returns and thereby excess volatility, persistence of price-dividend ratios, long-horizon return predictability and a risk premium, as in the habit model of Campbell and Cochrane (1999), but for lower risk aversion. This is obtained, even though we restrict con- sideration to learning schemes that imply only small deviations from full rationality. The .ndings are robust to the particular learning rule used and the value chosen for the single free parameter introduced by learning, provided agents forecast future stock prices using past information on prices. JEL Classification: G12, D84.
    Keywords: Asset pricing, learning, near-rational price forecasts.
    Date: 2008–02
  11. By: Giovanni Di Bartolomeo (University of Teramo); Marco Manzo; Francesco Giuli
    Abstract: This paper extends a well-known macroeconomic stabilization game between monetary and fiscal authorities introduced by Dixit and Lambertini (American Economic Review, 93: 1522-1542) to multiplicative (policy) uncertainty. We find that even if fiscal and monetary authorities share a common output and inflation target (i.e. the symbiosis assumption), the achievement of the common targets is no longer guaranteed; under multiplicative uncertainty, in fact, a time consistency problem arises unless policymakers¢ output target is equal to the natural level.
    Keywords: Monetary-fiscal policy interactions, uncertainty, symbiosis.
    JEL: E61 E63
    Date: 2008–02–17
  12. By: Ashoka Mody; Franziska Ohnsorge
    Abstract: Globalization operates not only by reducing domestic pressures on inflation but also by reducing the scope of domestic authorities to influence the pace of inflation. First, as markets are integrated, the common, cross-border sources of inflation increase, reducing the extent of domestically-generated inflation. Based on a methodology identifying common time and sectoral trends, we find this to be especially the case in the countries of the eurozone, with their longer histories of product market integration. Second, even the domestically-generated component of inflation may be difficult to manipulate. Policies act, especially in the shortrun, through managing domestic demand. But the relationship between domestic demand (proxied by the output gap and unit labor cost growth) and inflation has been weak, constrained in part by trade openness. Moreover, the domestic component of inflation contains a country-specific international catch-up process that generates price equalization across countries. The evidence is that catch-up has accelerated with increasing market integration. Thus, for the eurozone economies, there may be limits on the use of fiscal and labor market policies to contain inflation. The new member states may not have policy leverage to meet the Maastricht inflation limit necessary for entering the eurozone. Casestudies show that fiscal consolidation needed to comply with the inflation criterion can be large and sustained only briefly to get under the Maastricht wire.
    Keywords: Inflation , Globalization , Euro , Markets ,
    Date: 2007–11–08
  13. By: Jaewoo Lee; Gian Maria Milesi-Ferretti; Luca Antonio Ricci
    Abstract: This paper employs newly constructed measures for productivity differentials, external imbalances, and commodity terms of trade to estimate a panel cointegrating relationship between real exchange rates and a set of fundamentals for a sample of 48 industrial countries and emerging markets. It finds evidence of a strong positive relation between the CPI-based real exchange rate and commodity terms of trade. The estimated impact of productivity growth differentials between traded and nontraded goods, while statistically significant, is small. Increases in net foreign assets and in government consumption tend to be associated with appreciating real exchange rates.
    Keywords: Real effective exchange rates , Productivity , Trade ,
    Date: 2008–01–30
  14. By: Norbert Funke; Patrick A. Imam; Eleonara Granziera
    Abstract: This paper identifies factors that contribute to a fast recovery in growth after persistent negative terms of trade shocks, using a sample of 159 countries for 1970-2006. The results suggest that policies matter. Fast recoveries are fairly robustly related to real exchange rate depreciation and improvements in government stability and the institutional environment. A timely increase in aid may also support recovery.
    Keywords: Trade , Exchange rate depreciation , Economic growth ,
    Date: 2008–02–07
  15. By: Luca Benati (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Paolo Surico (Bank of England and University of Bari,Postal address-Monetary Policy Committee Unit, Bank of England, Threadneedle Street, London EC2R 8AH, UK.)
    Abstract: Most analyses of the U.S. Great Moderation have been based on structural VAR methods, and have consistently pointed towards good luck as the main explanation for the greater macroeconomic stability of recent years. Based on an estimated New-Keynesian model in which the only source of change is the move from passive to active monetary policy, we show that VARs may misinterpret good policy for good luck. First, the policy shift is sufficient to generate decreases in the theoretical innovation variances for all series, and decreases in the variances of inflation and the output gap, without any need of sunspot shocks. With sunspots, the estimated model exhibits decreases in both variances and innovation variances for all series. Second, policy counterfactuals based on the theoretical structural VAR representations of the model under the two regimes fail to capture the truth, whereas impulse-response functions to a monetary policy shock exhibit little change across regimes. Since these results are in line with those found in the structural VARbased literature on the Great Moderation, our analysis suggests that existing VAR evidence is compatible with the ‘good policy’ explanation of the Great Moderation. JEL Classification: E38, E52.
    Keywords: Great Moderation; DSGE models; indeterminacy; vector autoregressions.
    Date: 2008–02
  16. By: Joseph P. Daniels (Center for Global and Economic Studies, Marquette University); David D. VanHoose (Hanmaker School of Business, Baylor University)
    Abstract: This paper considers a model of an open economy in which the degree of income-tax progressivity influences the interaction among openness, central bank independence, and the inflation rate. Our model suggests that an increase in the progressivity of the tax system induces a smaller response in real output to a change in the price level. This implies that increased income-tax progressivity reduces the equilibrium inflation rate and that the effect of increased income-tax progressivity on inflation is smaller when the central bank places a higher weight on inflation or when there is greater openness. Examination of cross-country inflation data provides empirical support for these key predictions.
    Keywords: Openness, Tax Progressivity, Inflation
    JEL: F40 F41 F43
    Date: 2007–04
  17. By: Boris Hofmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper assesses the performance of monetary indicators as well as of a large range of economic and financial indicators in predicting euro area HICP inflation out-of-sample over the period first quarter 1999 till third quarter 2006 considering standard bivariate forecasting models, factor models, simple combination forecasts as well as trivariate two-pillar Phillips Curve forecasting models using both ex-post revised and real-time data. The results suggest that the predictive ability of money-based forecasts relative to a simple random walk benchmark model was high at medium-term forecasting horizons in the early years of EMU, but has substantially deteriorated recently. A significantly improved forecasting performance vis-à-vis the random walk can, however, be achieved based on the ECB’s internal M3 series corrected for the effects of portfolio shifts and by combining monetary and economic indicators. JEL Classification: E31, E40, C32.
    Keywords: Euro area, inflation, leading indicators, money.
    Date: 2008–02
  18. By: Franziska Ohnsorge; Nada Choueiri; Rachel van Elkan
    Abstract: This paper explores inflation determinants within the EU and implications for new members' euro adoption plans. Factor analysis partitions observed inflation in EU25 countries into common-origin and country-specific (idiosyncratic) components. Cross-country differences in common-origin inflation within the EU are found to depend on gaps in the initial price level, changes in the nominal effective exchange rate, the quality of institutions, and the economy's flexibility. Idiosyncratic inflation is generally small in magnitude. Nonetheless, the results show that country-specific shocks have systematically pushed down headline inflation, potentially influencing the assessment of compliance with the Maastricht inflation criterion.
    Keywords: Inflation , Euro Area , Globalization , Trade ,
    Date: 2008–01–31
  19. By: Crowley, Patrick (College of Business, Texas A&M University)
    Abstract: Optimal currency area theory suggests that business cycle co-movement is a sufficient condition for monetary union, particularly if there are low levels of labour mobility between potential members of the monetary union. Previous studies of co-movement of business cycle variables found that there was a core of member states in the EU that could be grouped together as having similar business cycle co-movements, but these studies have always used Germany as the country against which to compare. This study updates and extends corresponding previous analyses. More specifically, it correlates the countries against both German and euro area macroeconomic aggregates and uses more recent techniques in cluster analysis, namely model-based clustering.
    Keywords: business cycles; co-movement; optimal currency areas; model-based cluster analysis
    JEL: F15 F31
    Date: 2008–02–27
  20. By: Yusuke Kamishiro; Roberto Serrano
    Abstract: We study core convergence in interim quasilinear economies with asymmetric information, concentrating on core notions in which information is transmitted endogenously within coalitions and the incentive constraints are relevant. Specifically, we shall focus on the credible core and randomized mediated core concepts. We consider independent replicas of the basic economy: independent copies of the economy in which each individual’s utility only depends on the information of the individuals who belong to the same copy. We provide an example in which core convergence does not obtain for the Dutta-Vohra credible core and for Myerson’s randomized mediated core. On the other hand, we establish a positive convergence result for a refinement of Myerson’s core for which information disseminates across coalitions within a given random blocking mechanism. Under some conditions, this core converges to the set of incentive compatible ex-post Walrasian allocations.
    Keywords: Core Convergence; Information Transmission; Coalitional Voting; Mechanisms; Mediation; Rational Expectations Equilibrium
    Date: 2008
  21. By: John Pippenger (University of California, Santa Barbara)
    Abstract: As support for traditional asset models of the foreign exchange market fades, there is growing interest in more general models that include flows from international trade and international investment. One advantage of flow models is that they fit naturally into the recent literature on microstructure, particularly the work on order flow. My objective here is to use intervention data to help discriminate between traditional asset models of the foreign exchange market and more general flow models. The evidence supports a flow approach.
    Keywords: exchange rates, foreign exchange markets, intervention,
    Date: 2007–11–07
  22. By: Liew , Venus Khim-Sen; Baharumshah, Ahmad Zubaidi; Habibullah, Muzafar Shah; Midi, Habshah
    Abstract: Using nonlinear testing procedures relevant to the recent literature, this study provides evidence of nonlinear adjustment of nominal exchange rate towards monetary fundamentals in the context of ASEAN-5 countries. While it supports earlier findings supportive of monetary exchange rate model in this region using the linear testing procedures, this study provides insightful information in explaining why persistent misalignments between nominal exchange rate and monetary fundamentals are often observed in the sample data.
    Keywords: monetary model; exchange rate; nonlinear; unit root test; linearity test; STAR model
    JEL: C32 F31
    Date: 2008
  23. By: Robert D. J. Anderson
    Abstract: Central banks have become increasingly aware of the importance of consumer inflation expectations in meeting monetary policy objectives. US consumer year-ahead inflation expectations data is available as measured by the Michigan 'Survey of Consumer Attitudes and Behavior'. Using the detailed demographic information recorded as part of the interview process to accommodate forecast heterogeneity, results suggest the accuracy of forecasts is linked to the demographic characteristics of the respondent. This survey also contains a short-rotating panel dimension, with most respondents being reinterviewed six months after the initial interview. Uniquely, this paper uses these matched interviews to examine whether consumers learn about inflation, improving the accuracy of their forecast from initial to reinterview. Results suggest, having corrected for attrition bias, that being reinterviewed stimulates agents to learn and improve forecast accuracy, the level of improvement being dependent on the demographic characteristic of the interviewee.
    Date: 2008
  24. By: David Hofman; Ruben Atoyan; Dimitri Tzanninis; Mauro Mecagni
    Abstract: This paper examines the duration of capital account crises. We develop a new index to identify both the start and the end of these crises. Applying the index to a sample of 18 crisis episodes, we derive stylized facts on crisis duration and review the economic and financial circumstances that prevailed at the dusk of crises, a relatively unexplored area. We use the econometric technique of duration analysis to gauge the relative importance of various factors affecting the probability of exiting a crisis. We find that initial and external conditions are key determinants. But fiscal and monetary policies can also help shorten crisis duration.
    Keywords: Financial crisis , Capital account ,
    Date: 2007–11–08
  25. By: Domenico Giannone (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Michele Lenza (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper shows that general equilibrium effects can partly rationalize the high correlation between saving and investment rates observed in OECD countries. We find that once controlling for general equilibrium effects the saving-retention coefficient remains high in the 70’s but decreases considerably since the 80’s, consistently with the increased capital mobility in OECD countries. JEL Classification: C23, F32, F41.
    Keywords: Saving-Investment Correlation, Capital Mobility, International Comovement, Dynamic Factor Model.
    Date: 2008–02
  26. By: Stephanie Medina Cas; Rui Ota
    Abstract: Using a new fiscal dataset for small states, this paper analyzes the link between country size, government size, debt, and economic performance. It finds that on average small states have larger governments and higher public debt. Although there are intrinsic factors that explain why governments are bigger in small states, those with smaller governments and lower public debt tend to grow faster and are less vulnerable. Large fiscal adjustments, primarily through expenditure restraint, can underpin growth, although sometimes other elements can also impact. Since better governance is associated with lower debt, fiscal adjustment should be supported by governance improvements.
    Keywords: Governance , Fiscal policy , Public debt , Exchange rate regimes , Transparency ,
    Date: 2008–02–08
  27. By: Martin Cihák; Sofia Bauducco; Ales Bulir
    Abstract: This paper contributes to the analysis of monetary policy in the face of financial instability. In particular, we extend the standard new Keynesian dynamic stochastic general equilibrium (DSGE) model with sticky prices to include a financial system. Our simulations suggest that if financial instability affects output and inflation with a lag and if the central bank has privileged information about credit risk, monetary policy that responds instantly to increased credit risk can trade off more output and inflation instability today for a faster return to the trend than a policy that follows the simple Taylor rule with only the contemporaneous output gap and inflation.
    Keywords: Monetary policy , Inflation , Credit risk , Financial stability ,
    Date: 2008–01–30
  28. By: María J. Nieto (Banco de España); Garry J. Schinasi (International Monetary Fund)
    Abstract: European finance is becoming increasingly cross-border, while the European architecture for safeguarding financial stability —including decision-making processes for providing financial-stability public goods— have remained decentralized with some explicit mechanisms for coordination across countries. Policy makers are aware of the limitations of the existing institutional setting, but opinions on how to proceed, including on burden sharing, are lining up along national and regional political lines with less attention paid to European needs. This paper applies the ‘economics of alliances’ to examine these European policy challenges. The paper establishes benchmarks for assessing the ability of Europe’s existing institutional architecture to efficiently allocate resources to safeguard the EU financial system against systemic threats to stability, such as the insolvency of a pan European bank.
    Keywords: Safeguarding EU financial stability, crisis resolution, burden sharing
    JEL: C7 F3 G15 G20 G38 H41
    Date: 2008–02
  29. By: António Afonso (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Miguel St. Aubyn (ISEG/TULisbon, Technical University of Lisbon, Department of Economics, UECE, Research Unit on Complexity and Economics, R. Miguel Lupi 20, 1249-078 Lisbon, Portugal.)
    Abstract: Using annual data from 14 European Union countries, plus Canada, Japan and the United States, we evaluate the macroeconomic effects of public and private investment through VAR analysis. From impulse response functions, we are able to assess the extent of crowding-in or crowding-out of both components of investment. We also compute the associated macroeconomic rates of return of public and private investment for each country. The results point mostly to the existence of positive effects of public investment and private investment on output. On the other hand, the crowding-in effects of public investment on private investment vary across countries, while the crowding-in effect of private investment on public investment is more generalised. JEL Classification: C32, E22, E62.
    Keywords: Fiscal policy, public investment, private investment, impulse response, vector autoregression, European Union.
    Date: 2008–02
  30. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Martin Seneca (University of Aarhus and Danmarks Nationalbank)
    Abstract: In this paper we study the transmission mechanisms of productivity shocks in a model with rule-of-thumb consumers. In the literature, this financial friction has been studied only with reference to fiscal shocks. We show that the presence of rule-of-thumb consumers is also very helpful in accounting for recent empirical evidence on productivity shocks. Rule-of-thumb agents, together with nominal and real rigidities, play an important role in reproducing the negative response of hours and the delayed responses of output and consumption after a productivity shock.
    Keywords: rule-of-thumb consumers, productivity shocks, nominal rigidities, real rigidities.
    JEL: E32
    Date: 2007–11–14
  31. By: Andolfatto, David
    Abstract: The business of money creation is conceptually distinct from that of intermediation. Yet, these two activities are frequently---but not always---combined together in the form of a banking system. We develop a simple model to examine the question: When is banking essential? There is a role for money due to a lack of record-keeping and a role for intermediation due to the existence of private information: both money and intermediation are essential. When monitoring costs associated with intermediation are sufficiently low, the two activities can be separated from one another. However, when monitoring costs are sufficiently high, a banking system that combines these two activities is essential.
    Keywords: Money; Record-keeping; Private Information; Delegated Monitoring
    JEL: E42
    Date: 2008–02–24
  32. By: Francis Y. Kumah
    Abstract: This paper characterizes exchange market pressure as a nonlinear Markov-switching phenomenon, and examines its dynamics in response to money growth and inflation over three regimes. The empirical results identify episodes of exchange market pressure in the Kyrgyz Republic and confirm the statistical superiority of the nonlinear regime-switching model over a linear VAR version in understanding exchange market pressure. The nonlinear empirical approach adequately characterizes the data generation process and yields results that are consistent with theoretical predictions, particularly the dampening effect of monetary contraction on depreciation pressure. During periods of appreciation pressure, however, the reverse policy option-monetary expansion-may not be efficient, particularly where PPP rather than UIP drives exchange rates. In addition, monetary expansion in such cases defeats the primary objective of monetary policy-price stability-and may exacerbate the instability.
    Keywords: Working Paper , Exchange rate regimes , Monetary policy , Price stabilization , Kyrgyz Republic , Economic models ,
    Date: 2007–10–24
  33. By: Magnus Andersson (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Antonello D’Agostino (Central Bank and Financial Services Authority of Ireland, Economic Analysis and Research Department, PO Box 559, Dame Street, Dublin 2, Ireland.)
    Abstract: This paper evaluates how well sectoral stock prices forecast future economic activity compared to traditional predictors such as the term spread, dividend yield, exchange rates and money growth. The study is applied to euro area financial asset prices and real economic growth, covering the period 1973 to 2006. The paper finds that the term spread is the best predictor of future growth in the period leading up to the introduction of Monetary Union. After 1999, however, sectoral stock prices in general provide more accurate forecasts than traditional asset price measures across all forecast horizons. JEL Classification: C52, C53.
    Keywords: Forecasting Models, Asset Prices.
    Date: 2008–02
  34. By: Cheng-Zhong Qin (University of California, Santa Barbara); Xiaojuan Hu (University of California, Santa Barbara)
    Abstract: Traders' expected utilities in fully revealing rational expectations equilibrium (REE) are shown to decrease as the number of informed traders is increased for an asset market model with diverse information as in Grossman (1976). It follows that no trader has any incentive to acquire information even if no other traders do. Consequently, when information acquisition is endogenous, there exists unique overall equilibrium with no trader acquiring information that has the fully revealing REE as an integral part, so that prices would fully reveal private information were it to be acquired by traders. This result provides a strengthening of the fundamental conflict between the efficiency with which markets spread information through the prices and the incentive to acquire information. Both the existence and the no information acquisition feature of the overall equilibrium do not depend on whether traders are endowed with the risky asset or not.
    Keywords: asymmetric information, Grossman Paradox, Hirshleifer Effect, rational expectations equilibrium,
    Date: 2006–05–20
  35. By: Stavarek, Daniel
    Abstract: In this paper, we examine the exchange rate volatility in selected new EU Member States (Czech Republic, Hungary, Poland, Slovakia) and candidate countries (Croatia, Romania, Turkey) using TARCH model and daily data from the period May 2004 – December 2006. Besides the volatility estimation, the paper analyzes the asymmetric effects. The results suggest that some symptoms of asymmetry were found in all exchange rates except for CZK/EUR. However, the most distinct effects are evident in Slovakia and Turkey where the appreciation of the national currency and the appreciation-side deviation from the target exchange rate contribute significantly to the increase in the exchange rate volatility.
    Keywords: asymmetry; European Union; exchange rate volatility; TARCH models
    JEL: G15 F31
    Date: 2007
  36. By: Daniel Leigh; Etibar Jafarov
    Abstract: This paper considers long-term fiscal policy options in Norway, the world's fifth largest oil exporter, in light of the substantial expected increase in pension outlays. It compares the current fiscal rule, which targets a (central government structural) non-oil deficit equal to 4 percent of Government Pension Fund assets, with three alternatives that save a larger share of oil revenue and accumulate more assets to pay for aging costs. It also analyzes the macroeconomic consequences of accumulating more assets, finding that the additional income generated from more assets allows lower tax rates, with positive effects on long-term output.
    Keywords: Working Paper , Fiscal policy , Norway , Oil revenues , Pensions ,
    Date: 2007–10–24
  37. By: Knut Are Aastveit (University of Oslo and Norges Bank (Central Bank of Norway)); Tørres G. Trovik (Norges Bank (Central Bank of Norway))
    Abstract: This paper finds that asset prices on Oslo Stock Exchange is the single most important block of data to improve estimates of current quarter GDP in Norway. Other important blocks of data are labor market data and industrial production indicators. We use an approximate dynamic factor model that is able to handle new information as it is released, thus the marginal impact on mean square nowcasting error can be studied for a large number of variables. We use a panel of 148 non-synchronous variables covering a broad spectrum of the Norwegian economy. The strong impact from financial data is due to an ability of the market clearing process to impart information about the real activity in Norway in a timely manner.
    Keywords: Forecasting, financial markets, economic growth, small open economy
    JEL: E37 E50 G14
    Date: 2008–01–11
  38. By: Nuno Cassola (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The theory of liquidity management under uncertainty predicts that, under certain conditions, commercial banks will accumulate minimum reserve requirements linearly over the reserve maintenance period. This prediction is empirically tested using daily data (from March 2004 until February 2007) on the current accounts and minimum reserve requirements of a panel of 79 commercial banks from the euro area. The linear accumulation hypothesis is not rejected by the data with the exception of small banks which build-up excess reserves. The empirical analysis suggest that idio-syncratic liquidity uncertainty is much higher than aggregate liquidity uncertainty. Nevertheless, on the penultimate day in the reserve maintenance period, the inverse demand schedule of the representative bank is relatively flat around the middle of the interest rate corridor set by the standing facilities. This suggests that liquidity effects on the overnight inter-bank rate should be very muted on this day. Our calibration exercise suggests that the probability of an individual bank's daily overdraft in the euro area is very low (less than 1.0%). This is confirmed by the analysis of the daily recourses to the marginal lending facility by the panel banks. JEL Classification: C23, E4, E5, G2.
    Keywords: Monetary policy implementation, Reserve requirements, Rate corridor, Liquidity management, Panel data.
    Date: 2008–02
  39. By: María Santana-Gallego (Universidad de La Laguna); Francisco J. Ledesma-Rodríguez (Universidad de La Laguna); Jorge V. Pérez-Rodríguez (Universidad de Las Palmas de Gran Canaria)
    Abstract: The main objective of this paper is to analyze the effect of the exchange rate arrangements on international tourism. The ambiguity of literature about the effect of exchange rate volatility contrasts with the magnitude of the impact of a common currency on trade. On the basis of a gravity equation we estimate a moderate effect of a currency union on tourism of almost 12%. Furthermore, we estimate a gravity equation for international trade, obtaining that the common currency effect on trade is reduced when tourism is introduced as a regressor. This suggests that tourism flows may contribute to explain the excessive magnitude of the estimated effect of a common currency on trade in this literature. Finally, we analyze the impact of several de facto exchange rate arrangements on tourism, finding that less flexible exchange rates promotes tourism flows.
    Keywords: Tourism, Exchange Rate Regime, Common Currency
    JEL: G15
    Date: 2007–12
  40. By: Vladimir Klyuev; Ondra Kamenik; Heesun Kiem; Douglas Laxton
    Abstract: One of the pioneers of inflation targeting (IT), the Bank of Canada is now considering a possibility of switching to price-level-path targeting (PLPT), where past deviations of inflation from the target would have to be offset in the future, bringing the price level back to a predetermined path. This paper draws attention to the fact that the price level in Canada has strayed little from the path implied by the two percent inflation target since its introduction in December 1994, and has tended to revert to that path after temporary deviations. Econometric analysis using Bayesian estimation suggests that a low probability can be assigned to explaining this behavior by sheer luck manifesting itself in mutually offsetting shocks. Much more plausible is the assumption that inflation expectations and interest rates are determined in a way that is consistent with an element of PLPT. This suggests that the difference between IT as it is actually practiced (or perceived) and PLPT may be less stark than what pure theoretical constructs posit, and that the transition to a fullfledged PLPT regime will likely be considerably easier than what was previously thought. The paper also shows that inflation expectations are a major driver of actual inflation in Canada, which makes it easier to keep inflation close to the target without large output costs.
    Keywords: Inflation targeting , Canada , Prices , Interest rates , Price stabilization ,
    Date: 2008–01–31
  41. By: Bassem Kamar; Samy Ben Naceur
    Abstract: Coordinating macroeconomic policies is a pre-requisite to a successful launch of the common currency in the GCC countries. Relying on the Behavioral Equilibrium Exchange Rate approach as a theoretical framework, we apply the Pooled Mean Group methodology to determine the similarity of the impact of a selected set of macroeconomic indicators on the real exchange rate in each country. Our empirical evidence points to a clear coordination of monetary policy, fiscal policy, government consumption, and openness across the member countries. While RER misalignments also show a substantial convergence building over time, differences in the misalignments of the two polar cases remain rather substantial, calling for further coordination and policy harmonization.
    Keywords: Working Paper , Cooperation Council for the Arab States of the Gulf , Monetary unions , Monetary policy , Financial integration , Foreign exchange , Economic policy , Central bank policy ,
    Date: 2007–10–29
  42. By: Jacek Kotlowski (Warsaw School of Economics, National Bank of Poland)
    Abstract: The purpose of the article is to evaluate the forecasting performance of dynamic factor models in forecasting inflation in the Polish economy. The factor models are based on the assumption that the behavior of most macroeconomic variables can be well described by several unobservable factors, which are often interpreted as the driving factors in the economy. Such models are very often successfully used for forecasting. Employing several factors instead of a large number of explanatory variables may increase the number of degrees of freedom with the same information content. In the article we compare forecast accuracy of dynamic factor models with the forecast accuracy of three competitive models: univariate autoregressive model, VAR model and the model with leading indicator from the business survey. We have used 92 monthly time series from the Polish and world economy to conduct the out-of-sample real time forecasts of inflation (consumer price index). The results are encouraging. The dynamic factor model outperforms other models for both 1-step ahead and 3-step ahead forecast. The advantage of factor models is more straightforward for 1-month than for 3-month horizon.
    Keywords: inflation, forecasting, factor models
    JEL: C22 C53 E31 E37
    Date: 2008–02–24
  43. By: Maria Teresa Mota (Faculdade de Economia e Gestão - Universidade Católica Portuguesa (Porto)); Mariana Alves da Cunha (Faculdade de Economia e Gestão - Universidade Católica Portuguesa (Porto)); Carlos Santos (Faculdade de Economia e Gestão - Universidade Católica Portuguesa (Porto))
    Abstract: Using the Bai-Perron test, we look for a shift in the conditional mean of an AR representation of Spanish CPI inflation over the period: 1978-2006. It is clear that Spain, as most OECD economies, experienced an inflation slowdown in the early eithgties, which can be related to some policy measures undertook by the government coming out of the 1982 elections. It is shown, that when the break is accounted for, there are no signs of persistence in Spanish CPI inflation.
    Keywords: inflation persistence; structural breaks; monetary policy
    JEL: E31 E65 C12 C22
    Date: 2008–02
  44. By: Kasai Ndahiriwe (Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: This paper investigates the effectiveness of monetary policy on house prices in South Africa, before and after financial liberalisation, with financial liberalisation being identified with the recommendations of the De Kock Commission (1985). Using both impulse response and variance decomposition analysis performed on SVARs, we find that, irrespective of house sizes, during the period of financial liberalisation, interest rate shocks had relatively stronger effects on house price inflation. However, given that the size of these effects were nearly negligible, the result seems to indicate that house prices are exogenous, and, at least, are not driven by monetary policy shocks.
    Keywords: Financial liberalisation, Impulse Response, Variance Decomposition, Structural Decomposition.
    JEL: C01 C32 E52
    Date: 2008–03
  45. By: Paulo Flavio Nacif Drummond
    Abstract: This paper argues that as part of their fiscal optimization strategies CEMAC countries should be given the opportunity to invest into longer-term assets that generate market-based returns. The BEAC has created a framework of longer-term savings funds but due to low remuneration and other factors usage has remained limited. The paper also argues that regional savings in the form of reserve accumulation must be sufficient to ensure the stability of the common currency. While the current level of common foreign reserves may now be appropriate, maintaining an adequate level calls for a link between country-specific savings decisions and the setting of a regional reserve target. Strengthening and diversifying reserve management will also be desirable, a process the BEAC has embarked upon.
    Keywords: Working Paper , Central African Economic and Monetary Community , Oil revenues , Fiscal policy , Reserves adequacy , Reserves accumulation , Savings , Central bank policy ,
    Date: 2007–10–24
  46. By: Macedo, Jorge Braga de; Pereira, Luis Brites; Reis, Afonso Mendonça
    Abstract: This paper explores the credibility of exchange rate arrangements for the five African Portuguese-speaking (PALOP) countries. Our working hypothesis is that credibility necessarily implies low mean exchange market pressure (EMP), low EMP conditional volatility and low-severity EMP crises. In addition, economic fundamentals must account for EMP dynamics. We also seek evidence of a risk-return relationship for mean EMP and of “bad news” (negative shocks) having a greater impact on EMP volatility than “good news” (positive shocks). Using our econometric models, we are able to rank PALOP countries’ conditional volatility in ordinal terms. Our main conclusion is that countries with currency pegs, such as Guinea-Bissau (GB) and Cape Verde (CV), clearly have lower volatility when compared to those with managed floats and are therefore more credible. Moreover, EMP crises episodes under pegs are much less severe. We find that economic fundamentals correctly account for mean EMP in all countries and that the risk-return relationship is much more favourable for investors under currency pegs, as the increase in volatility is lower for the same rate of return. The exception to this finding is Mozambique (MOZ), which apparently has a risk-return profile akin to that enjoyed by countries with pegs. A plausible reason is that MOZ has the only managed float in our sample implementing monetary and exchange rate policy within the confines of an IMF framework, which establishes floors for international reserves and ceilings for the central bank’s net domestic assets. This intuition needs to be tested, however. EMP conditional volatility is generally driven by changes in domestic credit (lowers it) and foreign reserve changes (raises it). The first effect is more pronounced under currency pegs, but also under MOZ’s managed float. “Bad news” increases volatility more that “good news” only in the case of CV’s currency peg, which we take to be another sign of its credibility. A few striking cross-country comparisons also emerge in our analysis. Among countries with managed floats, we find that Angola (ANG) has the most severe EMP crises whilst MOZ has the least severe. São Tomé & Princípe (STP), meanwhile, lies between these two extremes but its EMP crises behaviour is clearly much closer to that of MOZ. STP’s credibility may also be improving since its volatility has declined as of 2002 and its level is now much closer to that of MOZ, whose managed float has lowest volatility of such arrangements.
    Date: 2008
  47. By: Amadou N. R. Sy
    Abstract: The paper reviews trends and developments in the rapidly growing local currency debt markets in the WAEMU. The main findings are that common institutions, such as a regional central bank and securities exchange have led to high cross-border transactions within the union. However, excess liquidity in the regional banking system has led to limited credit differentiation among issuers and a reliance on supply and demand conditions as a key determinant of yields. The paper also discusses a number of policy issues, including debt management, that are likely to emerge as the markets for government securities continue to develop.
    Keywords: West African Economic and Monetary Union , Debt , Bonds , Debt management , Excess liquidity ,
    Date: 2007–11–08
  48. By: Liew , Venus Khim-Sen; Ling, Tai-Hu
    Abstract: This study examines the real interest rate parity (RIP) hypothesis in the case of East Asian economies by taking China as foreign counterpart. Results obtained from panel unit root tests are in line with previous findings that are supportive of the hypothesis. The estimated half-life of the RIP deviations is 3.21 quarters, indicating RIP holds strongly in this region with respect to China. This implies that the choices and effectiveness of the monetary and fiscal policies in the East Asian economies will be very much influenced by the external factors originating from China, in additional to Japan and US as identified in other studies. Furthermore, judging from the another finding of this study that East Asian economies is more integrated with Japan than China, China has yet to further liberalize its financial system before it can overtake Japan as leading financial centre or as anchor country for common currency area in this region.
    Keywords: Real interest rate parity;East Asia; panel unit root test
    JEL: C23 F41 F36
    Date: 2008
  49. By: Mathew Kofi Ocran
    Abstract: The study sought to ascertain the key determinants of inflation in Ghana for the past 40 years. Stylized facts about Ghana’s inflation experience indicate that since the country’s exit from the West African Currency Board soon after independence, inflation management has been ineffective despite two decades of vigorous reforms. Using the Johansen cointegration test and an error correction model, the paper identified inflation inertia, changes in money and changes in Government of Ghana treasury bill rates, as well as changes in the exchange rate, as determinants of inflation in the short run. Of these, inflation inertia is the dominant determinant of inflation in Ghana. It is therefore suggested that to make treasury bill rates more effective as a nominal anchor, inflationary expectations ought to be reduced considerably.
    Date: 2007–08

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