nep-cba New Economics Papers
on Central Banking
Issue of 2008‒03‒08
seventeen papers chosen by
Alexander Mihailov
University of Reading

  1. Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict By Robin Pope; Reinhard Selten; Sebastian Kube; Johannes Kaiser; Jürgen von Hagen
  2. Why Do Politicians Implement Central Bank Independence Reforms? By Daunfeldt, Sven-Olov; Hellström, Jörgen; Landström, Mats
  3. Linear-Quadratic Approximation to Unconditionally Optimal Policy: The Distorted Steady-State By Tatjana Damjanovic; Vladislav Damjanovic; Charles Nolan
  5. International Transmission of Shocks under Financial Frictions: Some Implications for International Business Cycle Comovement By de Blas, Beatriz
  6. Global Macro-Financial Shocks and expected default frequencies in the Euro area. By Olli Castrén; Stéphane Dées; Fadi Zaher
  7. Rediscovering Fiscal Policy Through Minskyan Eyes By Philip Arestis; Elisabetta De Antoni
  8. Designing fiscal rules for commodity exporters By Carlos Garcia; Jorge Restrepo; Evan Tanner
  9. Beggar Thy Neighbour Exchange Rate Regime Misadvice  from Misapplications of Mundell (1961) and the Remedy By Robin Pope
  10. Good News is No News By Dijk, D.J.C. van
  11. Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices By Stefania D'Amico; Don H Kim; Min Wei
  12. The Economic Value of Fundamental and Technical Information in Emerging Currency Markets By Zwart, G. de; Markwat, T.D.; Swinkels, L.; Dijk, D.J.C. van
  13. Monopolistic Competition and the Dependent Economy Model By Romain Restout
  14. Euro Area Enlargement and Euro Adoption Strategies By Zsolt Darvas; György Szapáry
  15. Why do Europeans work part-time? A cross-country Panel Analysis. By Hielke Buddelmeyer; Gilles Mourre; Melanie Ward
  16. Consumer Price Inflation across the Income Distribution in South Africa By Morné Oosthuizen
  17. What drives the current account in commodity exporting countries? The cases of Chile and New Zealand By Juan Pablo Medina; Anella Munro; Claudio Soto

  1. By: Robin Pope; Reinhard Selten; Sebastian Kube; Johannes Kaiser; Jürgen von Hagen
    Abstract: Opinion is divided on whether it is better to have a single world   money or variable exchange rates.  Pope, Selten and von Hagen (2003)   propose that fresh light would be shed via an analysis that allows   for seven complexity impacts on the exchange rate that are   underplayed (where not entirely absent) from current analyses: 1) the   role of official sector, including its central bank; 2) the numerous   official and private sector goals; 3) the disparate degrees of market   power of different sorts of private agents; 4) the documentation that   essentially all shocks to the exchange rate are generated by human   decisions; 5) the non-maximising heuristics that in the complex   economy agents use; 6) heterogenous beliefs.  This paper analyses a   closed form game theoretic solution of version 1 of a model that   combines impacts 1 to 4 with the conventional finance assumption that   all agents maximise their utility.  Impact 1) precludes private   agents being able to destabilise the exchange rate against the   cooperation of the central banks required by the game theoretic   solution.  Impact 4) excludes random events and other exogenous   shocks such as meteors falling from the sky.  The rational maximising   assumption in turn precludes all other sources of shocks and thus any   need for a variable exchange rate to equilibrate after shocks.  We   then modify version 1 of our model substituting for the maximising   assumption impacts 5 to 7, impacts that allow shocks from humans to   be consistently incorporated.  We do so by means of an experimental   investigation which indicates that central bankers less than fully   cooperate, leaving scope for private speculators to support their   preferred currency.  From the viewpoint of the game theoretic   equilibrium, the resultant exchange rate changes render equilibrium   unspecified.  A single world money avoids disruptive exchange rate   changes from less than fully cooperating central banks, exchange rate   changes caused by central bank conflicts and that cannot be   classified as equilibrating.
    Keywords: central bank; cooperation; conflict; exchange rate; experiment; market power; heuristics; heterogenous beliefs; personality; interpersonal dynamics; friendship; complex; destabilising speculators, irrational central bankers
    JEL: F31 F33 B40 B59 C79 C90 C91 C92
    Date: 2007–12
  2. By: Daunfeldt, Sven-Olov (The Swedish Retail Institute (HUI)); Hellström, Jörgen (Department of Economics); Landström, Mats (Department of Economics)
    Abstract: It is something of a puzzle that politicians around the world have chosen to give up power to independent central banks, thereby reducing their possibilities to fine-tune the economy. In this paper the determinants of central bank independence (CBI) reforms are studied using a new data set on the possible event of such reforms in 119 countries. According to the data, as much as 81 countries had implemented CBI-reforms during the study period. The results indicate, moreover, that policymakers are more likely to delegate power to independent central banks when the foreign debt is relatively high. In non-OECD countries, the likelihood of a CBI-reform also seems to increase when policymakers face a high probability of getting replaced.
    Keywords: Central bank independence; political economy
    JEL: E42 E58 E61 P16
    Date: 2008–02–29
  3. By: Tatjana Damjanovic; Vladislav Damjanovic; Charles Nolan
    Abstract: This paper establishes that one can generally obtain a purely quadratic approximation to the unconditional expectation of social welfare when the steady-state is distorted. A specific example is provided employing a canonical New Keynesian model. Unlike in the non-distorted steady state case, the approximate loss function is not defined simply over terms in inflation and output. Furthermore, optimal steady state inflation and the nominal interest rate are positive.
    Keywords: Unconditional expectations, Optimal monetary policy.
    JEL: E20 E32 F32 F41
    Date: 2008–02
  4. By: Andrew Hughes Hallet; Jan Libich; Petr Stehlik
    Abstract: The paper considers a simple model in which monetary and fi?scal policies are formally independent, but still interdependent - through their spillovers onto the macroeconomic targets to which they are not primarilly assigned. It shows that the average equilibrium levels of inflation, deficit, debt, and output depend on the two policies' (i) potency (elas- ticity of output with respect to the policy instruments); (ii) ambition (the level of their output target); and (iii) conservatism (inflation vs output volatility aversion). However, it is the relative degrees of these characteristics that matter, rather than the absolute degrees for each policy. Therefore, and as expected, coordination of monetary and ?fiscal policy is found to be superior to non-cooperative Nash behaviour for both policymakers. Interestingly though, it is coordination in terms of the policies' ambition, rather than conservatism, that is essential. That is a new result. Furthermore, ambition-coordination can be welfare improving even if the policymakers' objectives are idiosyncratic, and/or even their coordinated output targets differ from the socially optimal one.
    JEL: E61 E63
    Date: 2008–03
  5. By: de Blas, Beatriz (Departamento de Análisis Económico (Teoría e Historia Económica). Universidad Autónoma de Madrid.)
    Abstract: This paper analyzes the international transmission of shocks in economies with financial frictions. In a two-country flexible price monetary model with distribution costs in the imported good I study the transmission of shocks to productivity, money supply, government spending and to entrepreneurs' net worth. Financial frictions amplify the effects of shocks both at the domestic and at the international level. In the model, international business cycle comovement, measured as cross-country output correlations, is increasing in the degree of openness and distribution costs, and as in previous literature, decreasing in the degree of financial frictions. Finally, fiscal shocks play an important role in international business cycle comovement in the presence of financial frictions. First, because the crowding out effect is stronger on private consumption and weaker on investment if there are financial frictions, and second, because fiscal shocks may reduce the cross-country correlation of output.
    Keywords: international business cycles; distribution costs; financial frictions; flexible prices
    JEL: E32 E44 F41 F42
    Date: 2008–02
  6. By: Olli Castrén (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Stéphane Dées (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Fadi Zaher (Financial Services Authority, 25 The North Colonnade, Canary Wharf, London E14 5HS, United Kingdom.)
    Abstract: Modelling the link between the global macro-financial factors and firms’ default probabilities constitutes an elementary part of financial sector stress-testing frameworks. Using the Global Vector Autoregressive (GVAR) model and constructing a linking satellite equation for the firm-level Expected Default Frequencies (EDFs), we show how to analyse the euro area corporate sector probability of default under a wide range of domestic and foreign macroeconomic shocks. The results show that, at the euro area aggregate level, the median EDFs react most to shocks to the GDP, exchange rate, oil prices and equity prices. There are some intuitive variations to these results when sector-level EDFs are considered. Overall, the Satellite-GVAR model appears to be a useful tool for analysing plausible global macrofinancial shock scenarios designed for financial sector stress-testing purposes. JEL Classification: C33, F47, G32, G33.
    Keywords: Credit risk, Global VAR, corporate default probability, macro stress testing.
    Date: 2008–02
  7. By: Philip Arestis; Elisabetta De Antoni
    Abstract: Recent developments in macroeconomic policy, both in terms of theory and practice, have elevated monetary policy while fiscal policy has been downgraded. The latter is rarely mentioned in policy discussion, apart from arguing to place limits on budget deficits and fiscal variables. This paper presents the opposite view of Hyman P. Minsky. Rejecting the orthodox assumptions of unbounded individual and collective rationality, Minsky places uncertainty and financial instability at the centre of his analysis. The limits of individual and collective rationality feed each other, generating deviation-amplifying mechanisms that make the economy unstable. The last one thus assumes a cyclical behaviour that drives it from the torrid summers of speculative booms to the gloomy winters of financial crises, debt deflations and deep depressions. Even if Minsky is generally considered as one of the main interpreters of Keynes, according to this work his economics is very different from Keynes’s one in terms both of business cycles and of growth. In comparison with the Keynesian tradition, according to Minsky fiscal policy is even more important and effective. Government intervention is not only necessary to reach and maintain full employment; it is also indispensable to contain capitalism’s instability and to avoid the disaster. The effect of fiscal policy is not only to underpin and stabilize aggregate demand, income and employment. It has also the task to protect the robustness of the financial system by stabilizing profits and by issuing government bonds. The opening up of the economy may increase its fragility, making fiscal policy even more important. The unprecedented growth of the domestic and international financial transactions, as well as the recent financial turmoil, confirm the validity of Minsky’s insights and make his views on fiscal policy even more noteworthy and fruitful.
    Keywords: Minsky, bounded rationality, business cycles, financial instability, fiscal policy.
    JEL: E12 E32 E42 E62
    Date: 2007
  8. By: Carlos Garcia (ILADES-Georgetown University, Universidad Alberto Hurtado); Jorge Restrepo (Banco Central de Chile); Evan Tanner (IMF Institute, International Monetary Fund, Washington D.C.-USA)
    Abstract: We compare welfare levels under two alternative fiscal rules: a procyclical balanced budget policy and an acyclical structural surplus (government accumulates assets). We use a dynamic, stochastic, general equilibrium model. The acylical rule benefits households that do not enjoy access to capital markets. It provides a financial cushion that they themselves cannot provide, while also boosting their mean consumption. By contrast, households that enjoy full access to capital markets suffer under this rule. Effectively, the government usurps their previous role in smoothing consumption and accumulating assets. However, a policy in between these extremes may be preferred by all.
    Keywords: welfare, small open economy, fiscal rules, rule of thumb consumers, government spending.
    JEL: E32 E61 E62 E63 F41
    Date: 2007–12
  9. By: Robin Pope
    Abstract: Economists invoke Mundell (1961) in arguing for the general policy of   a flexible exchange rate regime as a means of restoring equilibria   after shocks. But there is a discrepancy between the intent of the   general policy and attempts at its implementation as identified by   specific changes in exchange rates.  When we assemble the set of   specific changes called for by distinct economists operating as   advocates for individual countries, these are uniformly in the form   of beggar-thy-neighbour advice – ie travesties of objectively   identifying disequilibria and a menace to international cooperation   and peace.  This paper traces the unintended travesties to problems   of complexity and uncertainty, problems that implicitly are assumed   absent in Mundell (1961) rendering the situation so simple that   equilibria are transparent.  The problems remained essentially   unaddressed when economists extended Mundell (1961) via expected   utility theory since this theory also ignores the impossibility of   maximising and the complexities of central bankers, private firms and   others in doing the evaluation stage in reaching decisions.  The   problems can be overcome by modelling within SKAT, the Stages of   Knowledge Ahead Theory.  This paper points to experimental evidence   in support of the view that under all sorts of disequilibrating   shocks, currency unions outperform flexible currencies by eliminating   the inefficiencies generated by exchange rate uncertainty.
    Keywords: optimal currency area; exchange rate regime; certainty effects;   policy; beggar-thy-neighbour; SKAT the Stages of Knowledge Ahead Theory; complexity; equilibrium; small world; shocks; expenditure-switching shocks; supply-side shocks; demand shocks; experiment, safety, international competitiveness.
    JEL: D80 F31
    Date: 2007–11
  10. By: Dijk, D.J.C. van (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: News plays a crucial role in determining prices in financial markets. In an efficient market, current prices fully and correctly reflect all available information, such that only truly new information leads to price adjustment. This lecture shows that using high-frequency data makes it possible to accurately measure the reaction of stock prices on the New York stock exchange to new information related to the Federal funds target rate. An unexpected change in the target rate of 25 basis points leads to a return of slightly more than one percent within five minutes after the news announcement. Furthermore, the effects of positive and negative news on stock prices are fundamentally different. In case of positive news the stock market reaction depends upon the magnitude of the unexpected decrease of the interest rate; in case of negative news, stock prices only respond to the fact that an unexpected rate increase occurs.
    Keywords: Federal funds target rate;monetary announcements;interest rate surprises;high-frequency data;stock return predictability;large data sets;factor analysis;model instability;structural breaks
    Date: 2007–11–15
  11. By: Stefania D'Amico; Don H Kim; Min Wei
    Abstract: We examine the informational content of TIPS yields from the viewpoint of a general 3-factor no-arbitrage term structure model of inflation and interest rates. Our empirical results indicate that TIPS yields contained a "liquidity premium" that was until recently quite large (~1%). Key features of this premium are difficult to account for in a rational pricing framework, suggesting that TIPS may not have been priced efficiently in its early years. Besides the liquidity premium, a time-varying inflation risk premium complicates the interpretation of the TIPS breakeven inflation rate (the difference between the nominal and TIPS yields). Nonetheless, high-frequency variation in the TIPS breakeven rates is similar to the variation in inflation expectations implied by the model, lending support to the view that TIPS breakeven inflation rates are a useful proxy for inflation expectations.
    Keywords: term structure model, inflation expectation, inflation risk premium, SPF, Treasury Inflation-Protected Securities (TIPS)
    Date: 2008–02
  12. By: Zwart, G. de; Markwat, T.D.; Swinkels, L.; Dijk, D.J.C. van (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: We measure the economic value of information derived from macroeconomic variables and from technical trading rules for emerging markets currency investments. Using a sample of 23 emerging markets with a floating exchange rate regime over the period 1995-2007, we document that both types of information can be exploited to implement profitable trading strategies. In line with evidence from surveys of foreign exchange professionals concerning the use of fundamental and technical analysis, we find that combining the two types of information improves the risk-adjusted performance of the investment strategies.
    Keywords: emerging markets;foreign exchange rates;structural exchange rate models;technical trading;heterogeneous agents
    Date: 2007–12–21
  13. By: Romain Restout (GATE - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - Ecole Normale Supérieure Lettres et Sciences Humaines)
    Abstract: This paper explores the consequences of introducing a monopolistic competition in an intertemporal two-sector small open economy model which produces traded and non traded goods. It is assumed that the non traded sector is the locus of the imperfectly competition. Our analysis shows that markup depends on the composition of aggregate non traded demand and is therefore endogenously determined in the model. Calibrating the model with OECD parameters, the effects of fiscal and technological shocks are simulated. Our findings are as follows. First, the model is consistent with the observed saving-investment correlations found in the data. Second, unlike the perfectly framework and in accordance with empirical studies, fiscal shocks cause real appreciation of the relative price of non traded goods, which in turn enlarges the responses of current account and investment. Third, the model is consistent with the empirical report that technological shocks result in current account deficits and investment rises. Fourth, the strength of the relative price appreciation following sector productivity differentials, i.e. the Balassa-Samuelson effect, is affected by the monopolistic competition hypothesis. Assume perfect competition when it is not, biases upward estimates of the Balassa-Samuelson effect.
    Keywords: fiscal policy ; monopolistic competition ; productivity
    Date: 2008
  14. By: Zsolt Darvas (Department of Mathematical Economics and Economic Analysis, Corvinus University of Budapest and Argenta ZRt.); György Szapáry (Central European University and former Deputy Governor of Magyar Nemzeti Bank)
    Abstract: The paper discusses the risks and challenges faced by the new members on the road to the euro and the strategies for and timing of euro adoption. We investigate the real-nominal convergence nexus from the perspective of euro area entry. We argue that the initial level of economic development as measured by per capita income and the speed of real convergence have a bearing on the strategies to follow and on the timing of entry into euro area. This is because the lower is the per capita income, the larger is the price level gap to close and the greater is the danger of credit booms and overheating. We argue that inflation targeting with floating rates is better suited than hard pegs to manage the price level catching-up process. We suggest a modification in the Maastricht inflation criterion which as currently defined has lost its economic logic.
    Keywords: euro area enlargement, convergence, exchange rate, inflation, Maastricht
    JEL: E31 E52 E60 F30
    Date: 2008–01–28
  15. By: Hielke Buddelmeyer (Melbourne Institute of Applied Economic and Social Research and IZA, Contact address: Melbourne Institute of Applied Economic and Social Research, University of Melbourne, Alan Gilbert Building, 7th fl oor, 161 Barry Street, Carlton 3053 VIC, Australia.); Gilles Mourre (Corresponding author: European Commission, DG Economic and Financial Affairs (ECFIN) and Free University of Brussels (ULB, SBS, CEB), Contact address: BU-1 4/168, European Commission, Rue de la Loi 200, B-1049 Brussels, Belgium.); Melanie Ward (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This empirical paper seeks to determine the relative contribution of the business cycle and structural factors to the development of part-time employment in the EU-15 countries over the 1980s and 1990s, exploiting a panel of EU countries. In the short-run, the business cycle is found to exert a short-term negative effect on part-time employment developments, which is consistent with firms utilising part-time work to adjust their labour force to changing economic conditions. Institutions and other structural factors such as changes in legislation affecting part-time employment are found to be key drivers of the rate of part-time employment, significant in the longer run. Overall, although the role of individual factors differs in the 1980s and 1990s, a contribution analysis considering the most significant factors shows that the main structural and institutional variables generally well explain the development in the part-time employment rate in the EU countries, which is not the case in the United States. JEL Classification: J21, J22, J28, J68.
    Keywords: Part-time employment, working time organisation, the business cycle, labour supply, labour market policies, institutions, regulations.
    Date: 2008–02
  16. By: Morné Oosthuizen (Development Policy Research Unit, University of Cape Town)
    Abstract: Abstract: By monitoring the price changes experienced by some representative household, consumer price indices provide an important measure of changing purchasing power within a given economy. Group price indices offer one method of more accurately reflecting the inflation experiences of specific types of households, such as poor households, elderly households or households with children, for example. This study uses expenditure data from the 2000 Income and Expenditure Survey and price indices from Statistics South Africa to calculate inflation rates for expenditure deciles for the period 1998 to 2006. As a result, price indices and inflation rates calculated on the basis of these weights can not accurately reflect the rates of inflation experienced by what would be viewed as the ‘average’ household.
    Keywords: South Africa: consumer price index, Income distribution (South Africa), purchasing
    JEL: A1
    Date: 2007–11
  17. By: Juan Pablo Medina; Anella Munro; Claudio Soto
    Abstract: This paper uses an open economy DSGE model with a commodity sector and nominal and real rigidities to ask what factors account for current account developments in two small commodity exporting countries. We estimate the model, using Bayesian techniques, on Chilean and on New Zealand data, and investigate the structural factors that explain the behaviour of the two countries' current accounts. We find that foreign financial conditions, investment-specific shocks, and foreign demand account for the bulk of the variation of the current accounts of the two countries. In the case of New Zealand fluctuations in commodity export prices have also been important. Monetary and fiscal policy shocks (deviations from policy rules) are estimated to have relatively small e ects on the current account.We find interesting differences in Chilean and New Zealand responses to some shocks, despite similarities between the two economies and the common structural model employed.
    Keywords: current account, commodity price, small open economy, DSGE model
    Date: 2008–02

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