nep-cba New Economics Papers
on Central Banking
Issue of 2008‒05‒24
23 papers chosen by
Alexander Mihailov
University of Reading

  1. Controllability under rational expectations. By Hughes Hallett Andrew; Di Bartolomeo Giovanni; Acocella Nicola
  2. Improving Forecasts of Inflation using the Term Structure of Interest Rates By Alonso Gomez; John M Maheu; Alex Maynard
  3. Heterogeneous Expectations, Adaptive Learning,and Forward-Looking Monetary Policy By Martin Fukac
  4. Learning about the Interdependence between the Macroeconomy and the Stock Market By Fabio Milani
  5. Currency Crises and Monetary Policy in an Economy with Credit Constraints: The No Interest Parity Case By U. Michael Bergman; Shakill Hassan
  6. "A Regime Switching Analysis of Exchange Rate Pass-through" By Kólver Hernández; Asli Leblebicioglu
  7. Analyzing Economic Policy Using High Order Perturbations By Michael Ben-Gad
  8. Crude Oil Prices and the Euro-Dollar Exchange Rate: A Forecasting Exercise By Jesus Crespo Cuaresma; Andreas Breitenfellner
  9. Combining Multivariate Density Forecasts Using Predictive Criteria By Hugo Gerard; Kristoffer Nimark
  10. Nowcasting, Business Cycle Dating and the Interpretation of New Information when Real Time Data are Available By Kevin Lee; Nilss Olekalns; Kalvinder Shields
  11. Risk and uncertainty in central bank signals By Sheila Dow; Matthias Klaes; Alberto Montagnoli
  12. Representations of knowledge in monetary policy processes: a discursive perspective By Dana Gabor
  13. A macro stress testing model with feedback effects By Mizuho Kida
  14. Central bank reaction to public deficit and sound public finance: the case of the European Monetary Union By Canale, R.R.
  15. Is volatility good for growth? Evidence from the G7. By Andreou Elena; Pelloni Alessandra; Sensier Marianne
  16. Why do growth rates differ? Evidence from cross-country data on private sector production By Kilponen , Juha; Viren, Matti
  17. Deep determinants of economic growth – empirical verification with panel data models By Tomasz Brodzicki; Dorota Ciolek
  18. Supplementary Appendix for ‘Non-Bayesian Updating: A Theoretical Framework’ By Larry G. Epstein; Jawwad Noor; Alvaro Sandroni
  19. Infinitesimal Robustness for Diffusions By Davide La Vecchia; Fabio Trojani
  20. A Sectoral Model of the Australian Economy By Jeremy Lawson; Daniel Rees
  21. Changes in the transmission mechanism of monetary policy in New Zealand By Özer Karagedikli; Rishab Sethi; Christie Smith; Aaron Drew
  22. Analysing shock transmission in a data-rich environment: A large BVAR for New Zealand By Chris Bloor; Troy Matheson
  23. Accuracy in forecasting macroeconomic variables in Iceland By Ásgeir Daníelsson

  1. By: Hughes Hallett Andrew; Di Bartolomeo Giovanni; Acocella Nicola
    Abstract: We show that rational expectations do not affect the controllability of an economic system, either in its static or in its dynamic version, even though their introduction in many other circumstances may make it impossible for the policymaker to affect certain variables due to policy invariance, policy neutrality or time inconsistency problems. The controllability conditions stated by Tinbergen and subsequent authors continue to hold under rational expectations; and when they are satisfied rational expectations may even enhance the power to control an economy over time. This is important because it shows that an underlying equilibrium can exist even if our conventional optimisation techniques lead to policy invariance, neutrality or time inconsistency. We provide examples of our results in the context of recent monetary policy debates.
    JEL: C61 C62 E52 E61 E62
    Date: 2008–05
  2. By: Alonso Gomez; John M Maheu; Alex Maynard
    Abstract: Many pricing models imply that nominal interest rates contain information on inflation expectations. This has lead to a large empirical literature that investigates the use of interest rates as predictors of future inflation. Most of these focus on the Fisher hypothesis in which the interest rate maturity matches the inflation horizon. In general forecast improvements have been modest and often fail to improve on autoregressive benchmarks. Rather than use only monthly interest rates that match the maturity of inflation, this paper advocates using the whole term structure of daily interest rates and their lagged values to forecast monthly inflation. Principle component methods are employed to combine information from interest rates across both the term structure and time series dimensions. We find robust forecasting improvements in general as compared to both an augmented Fisher equation and autoregressive benchmarks.
    Keywords: inflation, inflation forecast, Fisher equation, term structure, principal components
    JEL: E31 E37 C53 C32
    Date: 2008–05–16
  3. By: Martin Fukac (Reserve Bank of New Zealand)
    Abstract: In this paper, I examine the role of monetary policy in a heterogeneous expectations environment. I use a New Keynesian business cycle model as the experiment laboratory. I assume that the central bank and private economic agents (households and producing rms) have imperfect and heterogeneous information about the economy, and as a consequence, they disagree in their views on its future development. I facilitate the heterogeneous environment by assuming that all agents learn adaptively. Measured by the central bank's expected loss, the two major findings are: (i) policy that is efcient under homogeneous expectations is not effccient under heterogeneous expectations; (ii) in the short and medium run, policy that is excessively responsive to ination increases ination and output volatility, but in the long run such policy lowers economic volatility.
    JEL: E4 E52
    Date: 2008–05
  4. By: Fabio Milani (Department of Economics, University of California-Irvine)
    Abstract: How strong is the interdependence between the macroeconomy and the stock market? This paper estimates a New Keynesian general equilibrium model, which includes a wealth effect from asset price fluctuations to consumption, to assess the quantitative importance of interactions among the stock market, macroeconomic variables, and monetary policy. The paper relaxes the assumption of rational expectations and assumes that economic agents learn over time and form near-rational expectations from their perceived model of the economy. The stock market, therefore, affects the economy through two channels: through a traditional ``wealth effect" and through its impact on agents' expectations. Monetary policy decisions also affect and are potentially affected by the stock market. The empirical results show that the direct wealth effect is modest, but asset price fluctuations have had important effects on output expectations. Shocks in the stock market can account for a large portion of output fluctuations. The effect on expectations, however, has declined over time.
    Keywords: Stock market; Wealth channel; Monetary policy; Constant-gain learning; Bayesian estimation; Expectations
    JEL: E32 E44 E52 E58
    Date: 2008–05
  5. By: U. Michael Bergman (Department of Economics, University of Copenhagen); Shakill Hassan (University of South Africa)
    Abstract: This paper revisits the currency crises model of Aghion, Bacchetta and Banerjee (2000, 2001, 2004), who show that if there exist nominal price rigidities and private sector credit constraints, and the credit multiplier depends on real interest rates, then the optimal monetary policy response to the threat of a currency crisis is restrictive. We demonstrate that this result is primarily due to the uncovered interest parity assumption. Assuming that the exchange rate is a martingale restores the case for expansionary reaction - even with foreign-currency debt in firms' balance sheets. The effect of lower interest rates on output can help restore the value of the currency due to increased money demand.
    Keywords: currency crises; foreign–currency debt; balance sheets; interest parity; monetary policy
    JEL: E51 F30 O11
    Date: 2008–05
  6. By: Kólver Hernández (Department of Economics,University of Delaware and CIDE); Asli Leblebicioglu (North Carolina State University)
    Abstract: We investigate changes in the pricing policies of exporters, including changes in the exchange rate pass-through elasticity, and changes in the elasticities of variables that affect the firm’s markup. We set up a theoretical model of optimal export pricing in order to illustrate how changes in the pass-through elasticity can emerge together with changes in other elasticities in the pricing policy. Based on our theoretical formulation, we empirically study changes in all the elasticities that define the pricing policy as opposed to focusing only on the exchange rate pass-through. In the empirical model, we assume that in every period exporters get to set prices by following either a “high pass-through” or a “low passthrough” pricing policy. The transition from one policy to the other is governed by a Markov process whose transition probabilities depend on economic fundamentals. We estimate the model using data we have collected on 35 lines of imported cars to the US, from seven exporting countries, for the 1980-2004 period. We find that the “low pass-through” regime is characterized by: a low exchange rate pass-through; a low response to misalignments in the firm’s relative price; a low volatility of technology and preference shocks; and a higher duration than the high pass-through regime. Monetary stability and the market structure are significant factors behind the switching of pricing policies. Ceteris paribus, monetary stability measured as the cross-country inflation differential explains abut 22% of the year-to-year variation in the exchange rate pass-through coefficient; when measured by the volatility of the exchange rate, it explains 37%. Market concentration measured by the Herfindahl index explains about 40%.
    Keywords: Exchange Rate Pass-through; Markov Regime Switching; Export Pricing
    JEL: E31 F31 F41
  7. By: Michael Ben-Gad (Department of Economics, City University, London)
    Abstract: In this paper I demonstrate the use of high order general perturbations to analyze policy changes in dynamic economic models. The inclusion of high moments in approximating the behavior of dynamic models is particularly necessary for welfare analysis. I apply the method of general perturbations to the analysis of permanent changes to a flat rate tax on the return to capital in the context of the standard Ramsey optimal growth model. Reliance on simple linearizations or quadratic approximations are adequate for generating impulse responses for the variables of interest or the welfare analysis of small policy changes. However when considering the welfare implications of sizable policy changes, the failure to include higher moments can lead not only to quantitatively serious inaccuracies, but even to spurious welfare reversals.
    Date: 2008–05
  8. By: Jesus Crespo Cuaresma; Andreas Breitenfellner
    Abstract: If oil exporters stabilize the purchasing power of their export revenues in terms of imports, exchange rate developments (and particularly, developments in the US dollar/euro exchange rate) may contain information about oil price changes. This hypothesis depends on three conditions: (a) OPEC has price setting capacity, (b) a high share of OPEC imports comes from the euro area and (c) alternatives to oil invoicing in US dollar are costly. We give evidence that using information on the US dollar/euro exchange rate (and its determinants) improves oil price forecasts significantly. We discuss possible implications that these results might suggest with regard to the stabilization of oil prices or the adjustment of global imbalances.
    Keywords: oil price, exchange rate, forecasting, multivariate time series models.
    JEL: Q43 F31 C53
  9. By: Hugo Gerard (Reserve Bank of Australia); Kristoffer Nimark (Reserve Bank of Australia)
    Abstract: This paper combines multivariate density forecasts of output growth, inflation and interest rates from a suite of models. An out-of-sample weighting scheme based on the predictive likelihood as proposed by Eklund and Karlsson (2007) and Andersson and Karlsson (2007) is used to combine the models. Three classes of models are considered: a Bayesian vector autoregression (BVAR), a factor-augmented vector autoregression (FAVAR) and a medium-scale dynamic stochastic general equilibrium (DSGE) model. Using Australian data over the inflation-targeting period, we find that, at short forecast horizons, the Bayesian VAR model is assigned the most weight, while at intermediate and longer horizons the factor model is preferred. The DSGE model is assigned little weight at all horizons, a result that can be attributed to the DSGE model producing density forecasts that are very wide when compared with the actual distribution of observations. While a density forecast evaluation exercise reveals little formal evidence that the optimally combined densities are superior to those from the best-performing individual model, or a simple equal-weighting scheme, this may be a result of the short sample available.
    Keywords: density forecasts; combining forecasts; predictive criteria
    JEL: C52 C53
    Date: 2008–05
  10. By: Kevin Lee; Nilss Olekalns; Kalvinder Shields
    Abstract: A canonical model is described which reflects the real time informational context of decision-making. Comparisons are drawn with ‘conventional’ models that incorrectly omit market-informed insights on future macroeconomic conditions and inappropriately incorporate information that was not available at the time. It is argued that conventional models are misspecified and misinterpret news. However, neither diagnostic tests applied to the conventional models nor typical impulse response analysis will be able to expose these deficiencies clearly. This is demonstrated through an analysis of quarterly US data 1968q4-2006q1. However, estimated real time models considerably improve out-of- sample forecasting performance, provide more accurate ‘nowcasts’ of the current state of the macroeconomy and provide more timely indicators of the business cycle. The point is illustrated through an analysis of the US recessions of 1990q3—1991q2 and 2001q1— 2001q4.
    Keywords: Structural Modelling; Real Time Data; Nowcasting; Business Cycles
    JEL: E52 E58
    Date: 2008–05
  11. By: Sheila Dow (SCEME, University of Stirling); Matthias Klaes (Keele University); Alberto Montagnoli (Department of Economics, University of Stirling)
    Abstract: This paper considers the signalling aspect of monetary policy. We introduce a heuristic framework for the study of signal uncertainty, and use this to analyses the signal uncertainty implicit in the communications of the Bank of England’s Monetary Policy Committee (MPC). Our findings suggest that frequencies of key terms expressing signal uncertainty in MPC minutes may either reflect the degree of confidence implicit in MPC deliberations, or offer evidence for the presence of an irreducible kind of signal uncertainty that shows up as white noise, casting doubt on the soundness of the various qualitative uncertainty indices found in the literature.
    Keywords: MPC, signal uncertainty, central bank uncertainty, word frequencies, uncertainty index, seasonality
    JEL: E52 E58 E12 D81
    Date: 2008–05
  12. By: Dana Gabor (SCEME, University of Stirling)
    Abstract: Exploring knowledge in monetary policy process stands to benefit by departing from conceptualizing knowledge as an objective depiction of reality, a neutral language of science underpinning technocratic policy-making. This paper proposes a postpositivist perspective, approaching knowledge production as a process of struggle over truth claims which structures policy action by establishing boundaries for policy choices. To contextualize the mechanisms of knowledge generation, it explores the adoption by the National Bank of Romania of a new policy framework, Inflation Targeting, in August 2005. This allows a mapping of the knowledge agenda, the knowing subjects allowed to participate in policy talk and avenues for contesting truth claims.
    Keywords: discourse analysis, MPC, monetary policy
    JEL: B41 Z1
    Date: 2007–11
  13. By: Mizuho Kida (Reserve Bank of New Zealand)
    Abstract: Stress testing is a tool to analyse the resilience of a financial system under extreme shocks. In contrast to single-bank stress testing models, macro stress testing models attempt to analyse risk for the system as a whole by taking into account feedback – i.e. the transmission of risks – within the system or between the financial system and the real economy. This paper develops a simple model of macro stress testing, incorporating two types of feedback: one between credit and interest rate risks and another between the banking system and the real economy. The model is tested using hypothetical banking sector data. The results from the exercise highlight the importance of incorporating feedback effects for the assessment of total risks to the system, and of recognising more than one type of feedback effect in a model for a robust assessment of risks to financial stability.
    JEL: G21 G32
    Date: 2008–05
  14. By: Canale, R.R.
    Abstract: The paper aims to shed light on the relation between monetary and fiscal policy in EMU, focusing on the interest rates and deficit dynamics. We present a theoretical model in which monetary and fiscal policy independently interact in a closed economic system through their own instrument, namely, the rate of interest for the central bank and deficit spending for governments. We demonstrate that the possibility of the two policy authorities producing not conflicting results depends on the idea each has of the workings of the economic system and on the influence each variable has on inflation and equilibrium income. Furthermore the inflationary opinion of the ECB about deficit spending leads to the result that public finance becomes surely unsound, unless governments stop using expansionary instruments. We provocatively conclude that the limits set by the Maastricht Treaty are a necessary solution to avoid unsound public finance.
    Keywords: Monetary policy; Fiscal Policy; Policy coordination; EMU
    JEL: E62 E58 E52 E63 E61
    Date: 2008–05–10
  15. By: Andreou Elena; Pelloni Alessandra; Sensier Marianne
    Abstract: We provide empirical support for a DSGE model with nominal wage stickiness where growth is driven by learning-by-doing and money shocks and their variance are allowed to impact on long-run output growth. In our theoretical model the variance of monetary shocks has a negative effect on growth, while output volatility is good for growth as a positive relationship exists. Utilising a bivariate GARCH-M model we test the empirical conditional mean and variance relationships of nominal money and production growth rates in the G7 countries. We corroborate the theoretical model predictions with evidence from Bonferroni multiple tests across the G7.
    JEL: C32 E32 O42
    Date: 2008–04
  16. By: Kilponen , Juha (Bank of Finland Research); Viren, Matti (Bank of Finland Research)
    Abstract: We estimate a standard production function with a new cross-country data set on business sector production, wages and R&D investment for a selection of 14 OECD countries including the United States. The data sample covers the years 1960–2004. The data suggest that growth differences can largely be explained by capital deepening and an ability to produce new technology in the form of new patents. The importance of patents is magnified by the openness of the economy. We find some evidence of increasing elasticity of substitution over time, all though the results are sensitive to assumptions on the nature of technological progress.
    Keywords: growth; R&D; production function; patents
    JEL: E10 O40 O43
    Date: 2008–05–19
  17. By: Tomasz Brodzicki (Faculty of Economics, University of Gdansk); Dorota Ciolek (Faculty of Management, Department of Econometrics, University of Gdansk)
    Abstract: We verify the impact of the so-called deep determinants on the level of economic real GDP per capita for an unbalanced panel of 207 economies within the period 1996-2004 using the Hausman-Taylor method of estimation. Institutional variables are detected to be endogenous. The results confirmed the assumed impact of deep determinants on the observed disparities in economic development. In most cases the basic specification of the model suggested by the empirical literature (log of openness, rule of law, distance from equator) is statistically significant and the impact of the variables has the anticipated direction. Several other specifications are tested and they perform pretty well. As the distance from equator has been detected not to be statistically insignificant in several specifications (for Asia and Europe) a combination of exogenous geographical variables enters the model with positive results. The basic specification of the model fits well the context of Africa and South America. It however performs badly for Asia. The quality of institutions is of prime importance for southern hemisphere economies as well as for former (currently economies in transition) and current socialist economies. The permanent improvement in the quality of institutions is the key determinant of success of economic transformation – underperformance in this area leads to smaller gains in terms of GDP per capita levels attained.
    Keywords: economic growth, economic development, institutions, geography, openness, panel data models, Hausman-Taylor estimator
    Date: 2008–05
  18. By: Larry G. Epstein (Department of Economics, Boston University); Jawwad Noor (Department of Economics, Boston University); Alvaro Sandroni (Department of Economics, University of Pennsylvania)
    Abstract: This appendix applies the model in ”Non-Bayesian Updating: A Theoretical Frame-Work” to address the question: What do non-Bayesian updaters learn?
    Keywords: Non-Bayesian Learning
    JEL: C70 C12 D81
    Date: 2008–01–18
  19. By: Davide La Vecchia; Fabio Trojani
    Abstract: We develop infinitesimally robust statistical procedures for general diffusion processes. We first prove existence and uniqueness of the times series influence function of conditionally unbiased M–estimators for ergodic and stationary dffusions, under weak conditions on the (martingale) estimating function used. We then characterize the robustness of M–estimators for diffusions and derive a class of conditionally unbiased optimal robust estimators. To compute these estimators, we propose a general algorithm, which exploits approximation methods for dffusions in the computation of the robust estimating function. Monte Carlo simulation shows a good performance of our robust estimators and an application to the robust estimation of the exchange rate dynamics within a target zone illustrates the methodology in a real–data application.
    Keywords: Dffusion processes, Eigenexpansion, Influence Function, Infinitesimal Generator, M–Estimators, Saddle– point Approximation.
    JEL: C13 C22 C32
    Date: 2008–04
  20. By: Jeremy Lawson (Reserve Bank of Australia); Daniel Rees (Reserve Bank of Australia)
    Abstract: We use a structural vector autoregression (SVAR) to examine the effect of unanticipated changes in monetary policy on the expenditure and production components of GDP over the period from 1983 to 2007. We find that dwelling investment and machinery & equipment investment are the most interest-sensitive expenditure components of activity, and that construction and retail trade are the most interest-sensitive production components of activity. We subject our model to a range of sensitivity checks and find that our results are robust to omitted variables, alternative identification schemes and the time period over which our model is estimated.
    Keywords: Australian economy; sectoral macroeconomic model; monetary policy
    JEL: E32 E52
    Date: 2008–04
  21. By: Özer Karagedikli; Rishab Sethi; Christie Smith; Aaron Drew (Reserve Bank of New Zealand)
    Abstract: Over the last few years, monetary policy in New Zealand has focused on reducing strong demand and inationary pressures. It has been commented that this task has been frustrated by a weakening of the monetary policy transmission mechanism in New Zealand. In this paper we draw upon a range of empirical models to assess whether monetary policy has lost its potency over the recent cycle, and to identify changes in the mechanism more broadly. Our main conclusion is that the overall impact of monetary policy has not obviously weakened, and in some respects has strengthened, over the past decade.
    JEL: C32 E32 E58
    Date: 2008–02
  22. By: Chris Bloor; Troy Matheson (Reserve Bank of New Zealand)
    Abstract: We analyse a large Bayesian Vector Autoregression (BVAR) containing almost one hundred New Zealand macroeconomic time series. Methods for allowing multiple blocks of equations with block-specific Bayesian priors are described, and forecasting results show that our model compares favourably to a range of other time series models. Examining the impulse responses to a monetary policy shock and to two less conventional shocks – net migration and the climate – we highlight the usefulness of the large BVAR in analysing shock transmission.
    JEL: C11 C13 C33 C53
    Date: 2008–05
  23. By: Ásgeir Daníelsson
    Abstract: This paper discusses accuracy in forecasting of macroeconomic time series in Iceland. Until recently only the National Economic Institute (NEI) did macroeconomic forecasting in Iceland. Extensive analysis of forecasting can therefore only be done for the forecasts made by this institution during 1974-2002. The paper analysis macroeconomic forecasts published by the Central Bank of Iceland (CBI). It also analysis the accuracy of the first realeases of data from Statistics Iceland as “forecasts” of final (or the most recent) data during recent years. Forecasts made by international institutions like OECD and IMF are not included. The paper finds that errors in forecasting of GDP and private consumption have declined and that the performance of the forecasting for these variables has improved on some measures. But the volatility in the series has also decreased so when the forecast errors are compared to measures of the shocks that hit the economy the forecasting of changes in GDP do not seem to have improved. For some of the main components of GDP like export, imports and investments, the forecast errors have not decreased.
    Date: 2008–05

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