nep-cba New Economics Papers
on Central Banking
Issue of 2008‒04‒04
23 papers chosen by
Alexander Mihailov
University of Reading

  1. Inflation and Unemployment in the Long Run By Aleksander Berentsen; Guido Menzio; Randall Wright
  2. The Virtues and Vices of Equilibrium and the Future of Financial Economics By J. Doyne Farmer; John Geanakoplos
  3. Social Decision Theory: Choosing within and between Groups By Fabio Maccheroni; Massimo Marinacci; Aldo Rustichini
  4. Measuring Real Value and Inflation By Hillinger, Claude
  5. Anticipated and unanticipated oil price shocks and optimal monetary policy By Wohltmann, Hans-Werner; Winkler, Roland
  6. Predicting the Fed By Kenneth B. Petersen; Vladimir Pozdnyakov
  7. Federal Reserve Policy viewed through a Money Supply Loss By Ibrahim Chowdhury; Andreas Schabert
  8. The choice between state- and time-dependent price rules By Fregert, Klas
  9. The Stress of Having a Single Monetary Policy in Europe By Jan-Egbert Sturm; Timo Wollmershäuser
  10. The Currency Denomination of Trade and Price Discrimination: The Euro after European Union Expansion By Mark David Witte;
  11. Financial markets and the current account – emerging Europe versus emerging Asia By Herrmann, Sabine; Winkler, Adalbert
  12. Comparing the DSGE model with the factor model: an out-of-sample forecasting experiment By Wang, Mu-Chun
  13. Large economies with differential information but without free disposal By Victor Filipe Martins-da-Rocha; Laura Angeloni
  14. Determinants of Risk Taking Behavior: The role of Risk Attitudes, Risk Perceptions and Beliefs By Nosic, Alen; Weber, Martin
  15. How People perceive the Welfare State. A real effort experiment By Ottone, Stefania; Ponzano, Ferruccio
  16. The New Institutionalisms and European Integration By Mark A. Pollack
  17. Social Preferences and Public Economics: Mechanism design when social preferences depend on incentives By Samuel Bowles; Sung Ha Hwang
  18. Optimal Mortgage Refinancing: A Closed Form Solution By Sumit Agarwal; John C Driscoll; David Laibson
  19. A Review of Forecasting Techniques for Large Data Sets By Jana Eklund; George Kapetanios
  20. The theory of implementation : what did we learn? By Luis C. Corchon
  21. Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds By James J Choi; David Laibson; Brigitte C Madrian
  22. Macroeconomic Effects of Ownership Structure in OECD Countries By Gatti, Donatella
  23. IMF Conditionality: Theory and Evidence By Axel Dreher

  1. By: Aleksander Berentsen (Department of Economics, University of Basel); Guido Menzio (Department of Economics, University of Pennsylvania); Randall Wright (Department of Economics, University of Pennsylvania)
    Abstract: We study the long-run relation between money, measured by inflation or interest rates, and unemployment. We first discuss data, documenting a strong positive relation between the variables at low frequencies. We then develop a framework where both money and unemployment are modeled using explicit micro-foundations, integrating and extending recent work in macro and monetary economics, and providing a unified theory to analyze labor and goods markets. We calibrate the model, to ask how monetary factors account quantitatively for low-frequency labor market behavior. The answer depends on two key parameters: the elasticity of money demand, which translates monetary policy to real balances and profits; and the value of leisure, which affects the transmission from profits to entry and employment. For conservative parameterizations, money accounts for some but not that much of trend unemployment — by one measure, about 1/5 of the increase during the stagflation episode of the 70s can be explained by monetary policy alone. For less conservative but still reasonable parameters, money accounts for almost all low-frequency movement in unemployment over the last half century.
    Keywords: inflation, unemployment, search
    JEL: E24 E52
    Date: 2008–03–18
  2. By: J. Doyne Farmer (Sante Fe Institute); John Geanakoplos (Cowles Foundation, Yale University)
    Abstract: The use of equilibrium models in economics springs from the desire for parsimonious models of economic phenomena that take human reasoning into account. This approach has been the cornerstone of modern economic theory. We explain why this is so, extolling the virtues of equilibrium theory; then we present a critique and describe why this approach is inherently limited, and why economics needs to move in new directions if it is to continue to make progress. We stress that this shouldn’t be a question of dogma, but should be resolved empirically. There are situations where equilibrium models provide useful predictions and there are situations where they can never provide useful predictions. There are also many situations where the jury is still out, i.e., where so far they fail to provide a good description of the world, but where proper extensions might change this. Our goal is to convince the skeptics that equilibrium models can be useful, but also to make traditional economists more aware of the limitations of equilibrium models. We sketch some alternative approaches and discuss why they should play an important role in future research in economics.
    Keywords: Equilibrium, Rational expectations, Efficiency, Arbitrage, Bounded rationality, Power laws, Disequilibrium, Zero intelligence, Market ecology, Agent based modeling
    JEL: A10 A12 B0 B40 B50 C69 C9 D5 D1 G1 G10 G11 G12 G13 G14
    Date: 2008–03
  3. By: Fabio Maccheroni; Massimo Marinacci; Aldo Rustichini
    Abstract: We introduce a theoretical framework in which to study interdependent preferences, where the outcome of others affects the preferences of the decision maker. The dependence may take place in two conceptually different ways, depending on how the decision maker evaluates what the others have. In the first he values his outcome and that of others on the basis of his own utility. In the second, he ranks outcomes according to a social value function. These two different views of the interdependence have separate axiomatic foundations. We then characterize preferences according to the relative importance assigned to social gains and losses, or in other words to pride and envy. Finally, we study a two period economy in which agents have our social preferences. We show how envy leads to conformism in consumption behavior and pride to diversity.
    Keywords: Social preferences, social economics.
    JEL: D81 E21
    Date: 2008
  4. By: Hillinger, Claude
    Abstract: The most important economic measures are monetary. They have many different names, are derived in different theories and employ different formulas; yet, they all attempt to do basically the same thing : to separate a change in nominal value into a ‘real part’ due to the changes in quantities and an inflation due to the changes in prices. Examples are: real national product and its components, the GNP deflator, the CPI, various measures related to consumer surplus, as well as the large number of formulas for price and quantity indexes that have been proposed. The theories that have been developed to derive these measures are largely unsatisfactory. The axiomatic theory of indexes does not make clear which economic problem a particular formula can be used to solve. The economic theories are for the most part based on unrealistic assumptions. For example, the theory of the CPI is usually developed for a single consumer with homothetic preferences and then applied to a large aggregate of diverse consumers with non-homothetic preferences. In this paper I develop a unitary theory that can be used in all situations in which monetary measures have been used. The theory implies a unique optimal measure which turns out to be the Törnqvist index. I review, and partly re-interpret the derivations of this index in the literature and provide several new derivations. The paper also covers several related topics, particularly the presently unsatisfactory determination of the components of real GDP.
    Keywords: Consumer price index, consumer surplus, money metric, price and quantity indexes, welfare measurement
    JEL: C43 C82 D61
    Date: 2008
  5. By: Wohltmann, Hans-Werner; Winkler, Roland
    Abstract: This paper studies the welfare effects of severalmonetary policy rules in the presence of anticipated and unanticipated oil price shocks. Our analysis is based on a stylized New Keynesian model of a small open economy. Our main findings are the following: i) Standard interest rate rules amplify the welfare loss compared to neutral monetary policies. ii) The optimal policy under commitment, by contrast, dampens the welfare loss. iii) Optimized simple rules can replicate the outcome under the optimal unrestricted rule if they are history-dependent, contain the exchange rate and, in the anticipated case, forward-looking elements. iv) Anticipated oil shocks lead to a higher welfare loss than unanticipated shocks.
    Keywords: Anticipated Shocks, Oil Price Shocks, Open Economy, Optimal Monetary Policy, Simple Policy Rules
    JEL: E32 E52 F41
    Date: 2008
  6. By: Kenneth B. Petersen (Laffer Associates and University of Connecticut); Vladimir Pozdnyakov (University of Connecticut)
    Abstract: Predicting the federal funds rate and beating the federal funds futures market: mission impossible? Not so. We employ a Markov transition process and show that this model outperforms the federal funds futures market in predicting the target federal funds rate. Thus, by using purely historical data we are able to better explain future monetary policy than a forward looking measure like the federal funds futures rate. The fact that the federal funds futures market can be beaten by a statistical model, suggests that the federal funds futures market lacks eciency. The mar- ket allocates too much weight to current Federal Reserve communication and other real-time macro events, and allocates too little weight to past monetary policy behavior.
    Keywords: Monetary policy, Federal funds futures market, Markov modeling
    JEL: E44 E47 E52 E58 G13
    Date: 2008–03
  7. By: Ibrahim Chowdhury (Swiss National Bank); Andreas Schabert (University of Dortmund, University of Amsterdam)
    Abstract: Federal Reserve nonborrowed reserve supply systematically responded to changes in inflation and in the output gap over the period 1969-2000. While the feedback from output gap is always negative, the response of money supply to changes in inflation varies considerably across time. Nonborrowed reserves decreased with inflation in the post-1979 period and increased in the pre-1979 period. Applying a standard macro-model, the estimated reaction functions are shown to ensure equilibrium determinacy. Viewed through the money supply lens, Federal Reserve policy substantially changed over time, but has never allowed for endogenous fluctuations, which contrasts conclusions drawn from federal funds rate analyses.
    Keywords: Money supply; reaction functions; nonborrowed reserves; real-time data; equilibrium determinacy
    JEL: E51 E52 E32
    Date: 2008–03–06
  8. By: Fregert, Klas (Department of Economics, Lund University)
    Abstract: Large review costs lead to time-dependent price setting rules. State-dependent rules become more likely when there is an increase in: set-up costs, the variability of the equilibrium price or the efficiency loss associated with being away from equilibrium.
    Keywords: time-dependent price rule; state-dependent price rule
    JEL: E31 E32
    Date: 2008–03–24
  9. By: Jan-Egbert Sturm (KOF Swiss Economic Institute, ETH Zurich Switzerland and CESifo); Timo Wollmershäuser (Ifo Institute for Economic Research, Munich Germany and CESifo)
    Abstract: This paper estimates forward-looking Taylor rules for the euro area. Using the asymmetries in inflation and cyclical output developments across countries, we investigate the adequacy of the single monetary policy for each of the European Monetary Union (EMU) member countries. Notable differences emerge across the countries. Taking a euro area perspective, we also show that it depends upon the underlying country weighting scheme in the monetary decision process of the ECB whether or not there has been a synchronisation of business and inflation cycles among the EMU member countries over the years. Finally, we produce an estimate of the actual policy weights the ECB has implicitly attached to each of the member countries. Developments in small member countries have received more than proportional weights in actual monetary policy decisions of the ECB.
    Keywords: Taylor rule, monetary policy, ECB, stress, business cycle synchronisation
    JEL: C22 E32 E52 E58
    Date: 2008–02
  10. By: Mark David Witte (Department of Economics and Finance, College of Charleston);
    Abstract: If a country’s imports are invoiced in a foreign currency then the import prices paid by consumers, and the importing country’s inflation rate, are vulnerable to exchange rate movements. Using a unique multiple market model I exam a representative firm’s currency denomination decision when selling to different countries. The simulation studies the impact of EU expansion on the currency denomination of trade. Results suggest that when preferences are similar across countries EU expansion decreases the likelihood of price discrimination and could decrease the use of the euro as an invoicing currency in the original EU’s imports.
    Keywords: currency invoicing, exchange rate, inflation, EU expansion, price discrimination
    JEL: F14 F31
  11. By: Herrmann, Sabine; Winkler, Adalbert
    Abstract: Financial globalisation has been associated with divergent current account patterns in emerging market economies. While countries in emerging Asia have been running sizeable current account surpluses, countries in emerging Europe have been facing large current account deficits. In this paper we test for the relevance of financial market characteristics in explaining divergent current account patterns in emerging Europe and emerging Asia based on the assumption that both regions constitute two different convergence clubs with the euro area and the US representing the core, respectively. In line with the theoretical literature, we find that better developed and more integrated financial markets increase emerging markets´ ability to borrow abroad. The degree of financial integration within the convergence clubs as well as the extent of reserve accumulation are found to be the most significant factors to explain divergent current account patterns in emerging Europe and emerging Asia. We conclude that the overall character of integration matters for the pattern of current account developments in catching-up economies.
    Keywords: real convergence, economic integration, saving and investment, current account developments, financial markets, emerging market economies
    JEL: F15 F21 O16 O52 O53
    Date: 2008
  12. By: Wang, Mu-Chun
    Abstract: In this paper, we put DSGE forecasts in competition with factor forecasts. We focus on these two models since they represent nicely the two opposing forecasting philosophies. The DSGE model on the one hand has a strong theoretical economic background; the factor model on the other hand is mainly data-driven. We show that by incooperating large information set using factor analysis can indeed improve the short horizon predictive ability, as claimed by manyresearchers. The micro founded DSGE model can provide reasonable forecasts for inflation, especially with growing forecast horizons. To a certain extent, our results are consistent with the prevailling view that simple time series models should be used in short-horizon forecasting and structural models should be used in long-horizon forecasting. Our paper compareds both state-of-the art data-driven and theory-based modelling in a rigorous manner.
    Keywords: DSGE models, factor models, forecasting, forecastevaluation
    JEL: C2 C3 C53 E37
    Date: 2008
  13. By: Victor Filipe Martins-da-Rocha (Université Paris-Dauphine); Laura Angeloni
    Date: 2008–02
  14. By: Nosic, Alen (Sonderforschungsbereich 504); Weber, Martin (Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre)
    Abstract: Our study analyzes determinants of investors' risk taking behavior. We find that investors' risk taking behavior, i.e. portfolio choices can be predicted using risk attitudes, risk perceptions and belief measures such as optimism and overconfidence. However, the predictive power of these determinants heavily depends on the domain in which it was elicited. More specifically, risk attitudes, risk perceptions and beliefs only allow us to predict investors' risk taking behavior if they are elicited in an investment related context. We think that our results could also benefit practitioners who could incorporate some of the determinants we have used in their investment advisory process.
    Date: 2007–07–31
  15. By: Ottone, Stefania; Ponzano, Ferruccio
    Abstract: The main activity of a welfare state is to impose taxes in order to collect money to provide services. In this paper we want to test subjects’ perception of these two steps in the lab. In particular, using a real effort experiment as a tool, we aim at measuring both the labour supply and the consensus as the level of taxation and the efficiency of the welfare state vary.
    Date: 2008–03
  16. By: Mark A. Pollack
    Abstract: The European Union is without question the most densely institutionalised international organization in the world, with a welter of intergovernmental and supranational institutions and a rapidly growing body of primary and secondary legislation, the so-called acquis communautaire. Small wonder, then, that the body of literature known under the rubric of the new institutionalism has been applied with increasing frequency and with increasing success to the study of the Union as a polity and to European integration as a process. In fact, however, the new institutionalism in social theory has evolved into plural institutionalisms, with rational-choice, sociological and historical variants, each with a distinctive set of hypotheses and insights about the EU. This chapter examines the new institutionalisms in rational choice and historical analysis and their contributions to EU studies, briefly summarizing the core assumptions of each approach before discussing specific applications to the study of the European Union and the question of EU enlargement, and concluding with an analysis of the strengths and weaknesses of institutional approaches to the study of European integration.
    Date: 2007–03–03
  17. By: Samuel Bowles (Santa Fe Institute, University of Siena and University of Massachusetts); Sung Ha Hwang (University of Massachusetts, Amherst)
    Abstract: Social preferences such as altruism, reciprocity, intrinsic motivation and a desire to uphold ethical norms are essential to good government, often facilitating socially desirable allocations that would be unattainable by incentives that appeal solely to self-interest. But experimental and other evidence indicates that conventional economic incentives and social preferences may be either complements or substitutes, explicit incentives crowding in or crowding out social preferences. We investigate the design of optimal incentives to contribute to a public good under these conditions. We identify cases in which a sophisticated planner cognizant of these non-additive effects would make either more or less use of explicit incentives, by comparison to a naive planner who assumes they are absent. JEL Categories: D52, D64, H21. H41
    Keywords: Social preferences, implementation theory, incentive contracts, incomplete contracts, framing, motivational crowding out, ethical norms, constitutions
    Date: 2008–03
  18. By: Sumit Agarwal; John C Driscoll; David Laibson
    Date: 2008–03–21
  19. By: Jana Eklund (Bank of England); George Kapetanios (Queen Mary, University of London)
    Abstract: This paper provides a review which focuses on forecasting using statistical/econometric methods designed for dealing with large data sets.
    Keywords: Macroeconomic forecasting, Factor models, Forecast combination, Principal components
    JEL: C22 C53 E37 E47
    Date: 2008–03
  20. By: Luis C. Corchon
    Date: 2007–12
  21. By: James J Choi; David Laibson; Brigitte C Madrian
    Date: 2008–03–21
  22. By: Gatti, Donatella (University of Paris 13)
    Abstract: The paper investigates the impact of ownership concentration on GDP growth, for a sample of 18 OECD countries over the period 1980 to 2004. The econometric analysis shows that more concentrated ownership can speed up growth, for countries approaching the technological frontier, provided that labour market regulation is sufficiently tight. In the absence of employment regulation, the logic of financial markets discipline applies and dispersed ownership appears as more favorable for growth. Based on econometric results, impact coefficients are calculated allowing to evaluate the growth points gained/lost following a given change in ownership concentration. This exercise reveals that a reform in the domain of ownership structure can yield sizeable effects in terms of growth. Importantly, these effects are unequally distributed across countries: Anglo-Saxon countries would take more advantage of deregulation (i.e. increased dispersion of ownership in a context of deregulated labour markets) while continental European countries would benefit more from increased concentration of ownership in a context of reinforced labour regulation.
    Keywords: ownership concentration, labour market regulation, growth, developed countries
    JEL: O43 O57 G32 K31
    Date: 2008–03
  23. By: Axel Dreher (KOF Swiss Economic Institute, ETH Zurich)
    Abstract: This article analyzes whether and to what extent reliance on conditionality is appropriate to guarantee the revolving character of Fund resources. The paper presents theoretical arguments in favour of conditionality, and those against the use of conditions. It summarizes the track record of program implementation and discusses the evidence of factors determining implementation. Whether proponents or critics of conditionality can be supported by existing data analysis is also investigated, as is the success of conditionality in terms of outcomes. The final section draws policy implications.
    Keywords: IMF, conditionality, compliance, implementation
    Date: 2008–02

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