nep-cba New Economics Papers
on Central Banking
Issue of 2008‒05‒31
forty-two papers chosen by
Alexander Mihailov
University of Reading

  1. Central Bank communication and monetary policy - a survey of theory and evidence. By Alan S. Blinder; Michael Ehrmann; Marcel Fratzscher; Jakob De Haan; David-Jan Jansen
  2. Insiders versus Outsiders in Monetary Policy-Making By Besley, Timothy; Meads, Neil; Surico, Paolo
  3. Robust monetary rules under unstructured and structured model uncertainty. By Paul Levine; Joseph Pearlman
  4. Monetary Aggregates and Liquidity in a Neo-Wicksellian Framework By Canzoneri, Matthew B; Cumby, Robert; Diba, Behzad; López-Salido, J David
  5. Monetary and Fiscal Policy Coordination when Bonds Provide Transactions Services By Canzoneri, Matthew B; Cumby, Robert; Diba, Behzad; López-Salido, J David
  6. DSGE-Modelling - when agents are imperfectly informed. By Paul De Grauwe
  7. Can Central Banks Go Broke? By Buiter, Willem H
  8. The behaviour of the MPC: Gradualism, inaction and individual voting patterns By Groth, Charlotta; Wheeler, Tracy
  9. Inflation, Monetary Policy and Stock Market Conditions By Michael D. Bordo; Michael J. Dueker; David C. Wheelock
  10. Money and the Natural Rate of Interest: Structural Estimates for the United States and the Euro Area By Andrés, Javier; López-Salido, J David; Nelson, Edward
  11. Credit and the natural rate of interest. By Fiorella De Fiore; Oreste Tristani
  12. Systemic Sudden Stops: The Relevance Of Balance-Sheet Effects And Financial Integration By Guillermo A. Calvo; Alejandro Izquierdo; Luis-Fernando Mejía
  13. Time-Varying Yield Curve Dynamics and Monetary Policy By Mumtaz, Haroon; Surico, Paolo
  14. Estimation of De Facto Exchange Rate Regimes: Synthesis of the Techniques for Inferring Flexibility and Basket Weights By Jeffrey A. Frankel; Shang-Jin Wei
  15. Outside Versus Inside Bonds By Aleksander Berentsen; Christopher Waller
  16. Can the Facts of UK Inflation Persistence be Explained by Nominal Rigidity? By Meenagh, David; Minford, Patrick; Nowell, Eric; Sofat, Prakriti; Srinivasan, Naveen
  17. Fiscal consolidation in the euro area - long-run benefits and short-run costs. By Günter Coenen; Matthias Mohr; Roland Straub
  18. M3 Money Demand and Excess Liquidity in the Euro Area By Christian Dreger; Jürgen Wolters
  19. Globalisation, domestic inflation and global output gaps - evidence from the euro area. By Alessandro Calza
  20. In Search of a Theory of Debt Management By Albert Marcet; Elisa Faraglia; Andrew Scott
  21. Oil and the Macroeconomy: A Structural VAR Analysis with Sign Restrictions By Lippi, Francesco; Nobili, Andrea
  22. Optimal Monetary Policy under Staggered Loan Contracts By Yuki Teranishi
  23. Expected Inflation, Expected Stock Returns, and Money Illusion: What can we learn from Survey Expectations? By Maik Schmeling; Andreas Schrimpf
  24. Sticky wages. Evidence from quarterly microeconomic data. By Michele Ca’ Zorzi; Micha? Rubaszek
  25. Identification of New Keynesian Phillips Curves from a global perspective. By Stéphane Dées; M. Hashem Pesaran; L. Vanessa Smith; Ron P. Smith
  26. Sticky wages. Evidence from quarterly microeconomic data. By Thomas Heckel; Hervé Le Bihan; Jérémi Montornès
  27. Persistence in Law-Of-One-Price Deviations: Evidence from Micro-Data By Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
  28. Understanding International Price Differences Using Barcode Data By Christian Broda; David E. Weinstein
  29. House prices and the stance of monetary policy. By Marek Jaroci?ski; Frank Smets
  30. Testing the Taylor Model Predictability for Exchange Rates in Latin America By Moura, Marcelo
  31. The Maastricht Convergence Criteria and Optimal Monetary Policy for the EMU Accession Countries. By Anna Lipinska
  32. Supply-side effects of monetary policy and the central bank’s objective function By Araújo, Eurilton
  33. Has trade with China affected UK inflation? By Wheeler, Tracy
  34. The usefulness of infra-annual government cash budgetary data for fiscal forecasting in the euro area. By Luca Onorante; Diego J. Pedregal; Javier J. Pérez; Sara Signorini
  35. General to specific modelling of exchange rate volatility : a forecast evaluation By Luc Bauwens; Genaro Sucarrat
  36. A New Keynesian Model for Analysing Monetary Policy in Mainland China By Li-gang Liu; Wenlang Zhang
  37. Do External Political Pressures Affect the Renminbi Exchange Rate? By Li-gang Liu; Laurent Pauwels; Jun-yu Chan
  38. Exchange Rate Pass-Through to Domestic Inflation in Hong Kong By Li-gang Liu; Andrew Tsang
  39. Is the Hong Kong Dollar Real Exchange Rate Misaligned? By Frank Leung; Philip Ng
  40. Assessing the Credibility of The Convertibility Zone of The Hong Kong Dollar By Laurence Fung; Ip-wing Yu
  41. Market Expectation of Appreciation of the Renminbi By Cho-Hoi Hui; Chi-Fai Lo; Tsz-Kin Chung
  42. Price-Setting Policy Determinants: Micro-Evidence from Brazil By Moura, Marcelo; Rossi, José

  1. By: Alan S. Blinder (Princeton University - Department of Economics, Princeton, NJ 08544-1021, USA.); Michael Ehrmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Jakob De Haan (University of Groningen - Department of Economics, Postbus 72, 9700 AB Groningen, NL.); David-Jan Jansen (De Nederlandsche Bank - Economics and Research Division, P.O. Box 98, 1000 AB Amsterdam, NL.)
    Abstract: Over the last two decades, communication has become an increasingly important aspect of monetary policy. These real-world developments have spawned a huge new scholarly literature on central bank communication — mostly empirical, and almost all of it written in this decade. We survey this evergrowing literature. The evidence suggests that communication can be an important and powerful part of the central bank’s toolkit since it has the ability to move financial markets, to enhance the predictability of monetary policy decisions, and potentially to help achieve central banks’ macroeconomic objectives. However, the large variation in communication strategies across central banks suggests that a consensus has yet to emerge on what constitutes an optimal communication strategy. JEL Classification: E52, E58.
    Keywords: communication, central bank, monetary policy.
    Date: 2008–05
  2. By: Besley, Timothy (Monetary Policy Committee Unit, Bank of England); Meads, Neil (Monetary Policy Committee Unit, Bank of England); Surico, Paolo (Monetary Policy Committee Unit, Bank of England)
    Abstract: This paper looks at the voting patterns of internal and external members of the MPC to investigate how far there are differences between insiders and outsiders. We make three contributions. First, we assess the extent to which the Bank of England internally generated forecasts explain the MPC members' voting decisions. This is important as generating forecasts on a quarterly basis is a key part of the process used by the Bank of England. The forecast for inflation is made public in the Inflation Report while the output gap forecast is not. Second, we use a random coefficient method of estimation in which the parameters of the interest rate rule are allowed, but not required, to be different across members. Third, we find evidence of some heterogeneity in the intercept, a measure of experience on the MPC and the interest rate smoothing parameter, but no significant differences in the members' reaction to the forecasts of inflation and the output gap.
    Keywords: Monetary Policy; Voting Patterns
    JEL: D78 E52
    Date: 2007–12
  3. By: Paul Levine (The University of Surrey, Guildford, Surrey GU2 7XH, UK.); Joseph Pearlman (London Metropolitan University - Department of Economics, Finance and InternationalBusiness (EFIB), London EC2M 6SQ, UK.)
    Abstract: This paper compares two contrasting approaches to robust monetary policy design. The first developed by Hansen and Sargent (2003, 2007) assumes unstructured model uncertainty and uses a minimax robustness criterion to design monetary rules. This contrasts with an older literature that structures uncertainty by seeking rules that are robust across competing views of the economy. This paper carries out and compares robust design exercises using both approaches using a standard ‘canonical New Keynesian model’. We pay particular attention to a number of issues: First, we distinguish three possible forms of the implied game between malign nature and the policymaker in the Hansen-Sargent procedure. Second, in both approaches, we examine the consequences for robust rules of the zero lower bound (ZLB) constraint on the nominal interest rate, the monetary instrument. Finally, again for both types of robustness exercise we explore the implications of policy design when the policymaker is obliged to use simple Taylor-type interest rate rules. JEL Classification: E52, E37, E58.
    Keywords: Robustness, structured and unstructured uncertainty, zero lower bound interest rate constraint.
    Date: 2008–05
  4. By: Canzoneri, Matthew B; Cumby, Robert; Diba, Behzad; López-Salido, J David
    Abstract: Woodford (2003) describes a popular class of neo-Wicksellian models in which monetary policy is characterized by an interest-rate rule, and the money market and financial institutions are typically not even modelled. Critics contend that these models are incomplete and unsuitable for monetary-policy evaluation. Our Banks and Bonds model starts with a standard neo-Wicksellian model and then adds banks and a role for bonds in the liquidity management of households and banks. The Banks and Bonds model gives a more complete description of the economy, but the neo-Wicksellian model has the virtue of simplicity. Our purpose here is to see if the neo-Wicksellian model gives a reasonably accurate account of macroeconomic behaviour in the more complete Banks and Bonds model. We do this by comparing the models’ second moments, variance decompositions and impulse response functions. We also study the role of monetary aggregates and velocity in predicting inflation in the two models.
    Keywords: Banks; Monetary Aggregates
    JEL: E51 E52
    Date: 2008–05
  5. By: Canzoneri, Matthew B; Cumby, Robert; Diba, Behzad; López-Salido, J David
    Abstract: It is commonly asserted that monetary and fiscal policy may have to be coordinated if they are to provide a nominal anchor and avoid the pathological outcomes of sunspots or explosive price paths. In this paper, we study a model in which government bonds are an imperfect substitute for money in the transactions technology, providing a new channel for debt dynamics to feed into inflation dynamics. This modification of an otherwise standard NNS model substantially alters the conditions for local determinacy and the requirements for macroeconomic policy coordination: the Taylor Principle is no longer sacrosanct; a weak fiscal response to debt is no longer the panacea for a weak monetary policy; sunspot equilibria may be less relevant than previously thought; and the need for coordination may be less than previously thought. In addition, our model provides a new way of thinking about the structural break that is thought to have occurred around 1980 in monetary policy and in the dynamics of government spending and private consumption.
    Keywords: Bonds; Monetary and Fiscal Policies; Transaction Services
    JEL: E51 E52
    Date: 2008–05
  6. By: Paul De Grauwe (Catholic University of Leuven (KUL) - Department of Economics, B-3000 Leuven, Belgium.)
    Abstract: DSGE-models have become important tools of analysis not only in academia but increasingly in the board rooms of central banks. The success of these models has much to do with the coherence of the intellectual framework it provides. The limitations of these models come from the fact that they make very strong assumptions about the cognitive abilities of agents in understanding the underlying model. In this paper we relax this strong assumption. We develop a stylized DSGE-model in which individuals use simple rules of thumb (heuristics) to forecast the future inflation and output gap. We compare this model with the rational expectations version of the same underlying model. We find that the dynamics predicted by the heuristic model differs from the rational expectations version in some important respects, in particular in their capacity to produce endogenous economic cycles. JEL Classification: E10, E32, D83.
    Keywords: DSGE-model, imperfect information, heuristics, animal spirits.
    Date: 2008–05
  7. By: Buiter, Willem H
    Abstract: Central banks can go broke and have done so, although mainly in developing countries. The conventional balance sheet of the central bank is uninformative about the financial resources it has at its disposal and about its ability to act as an effective lender of last resort and market marker of last resort. As long as central banks don’t have significant foreign exchange-denominated liabilities or index-linked liabilities, it will always be possible for the central bank to ensure its solvency though monetary issuance (seigniorage). However, the scale of the recourse to seigniorage required to safeguard central bank solvency may undermine price stability. In addition, there are limits to the amount of real resources the central bank can appropriate by increasing the issuance of nominal base money. For both these reasons, it may be desirable for the Treasury to recapitalise the central bank should the central bank suffer a major capital loss as a result of its lender of last resort and market maker of last resort activities. The fiscal authorities of the Euro Area should as a matter of urgency agree on a formula for dividing the fiscal burden of recapitalising the European Central Bank/Eurosystem, should the need arise.
    Keywords: central bank insolvency; lender of last resort; market maker of last resort; recapitalising central banks
    JEL: E31 E41 E44 E52 E58 E63 F31 F41
    Date: 2008–05
  8. By: Groth, Charlotta (Monetary Policy Committee Unit, Bank of England); Wheeler, Tracy (Monetary Policy Committee Unit, Bank of England)
    Abstract: We evaluate the degree of gradualism and inaction in UK monetary policy over the Monetary Policy Committee (MPC) period (1997-2007) at the quarterly and the monthly frequency. After accounting for misspecification in standard Taylor rules, we find little evidence for gradualism. A measure of optimal policy is calculated. Comparing this with actual policy suggests that there is less inaction in monetary policy decisions than previous work suggested for the period prior to the formation of the MPC. In an analysis of the MPC's monthly voting decisions, we find that the activity rate, defined as the probability that the MPC vote to change interest rates in a given month, has fallen over time. This reflects the increased stability of inflation and output growth, rather than changes in the degree of gradualism and/or inaction. There is some evidence for inaction at the monthly frequency however, demonstrated by the fact that the MPC is more active in the forecast month than in the non-forecast month. The MPC also tends to wait longer before reversing the direction of interest rate changes than continuing them. This difference appears not to be driven by gradualism, and so provides further evidence for inaction at the monthly frequency. A panel data analysis suggests that the MPC as a whole is equally active as its individual members, so inaction appears not to be driven by the use of a committee to set monetary policy. There is no evidence that activity rates fall with the length of time that a member has served on the committee, suggesting that learning about the transmission mechanism has no impact on the tendency for gradualism and inaction.
    Keywords: Monetary Policy; Taylor Rules; Voting Patterns
    JEL: D78 E43 E52
    Date: 2008–01
  9. By: Michael D. Bordo; Michael J. Dueker; David C. Wheelock
    Abstract: This paper examines the association between inflation, monetary policy and U.S. stock market conditions during the second half of the 20th century. We estimate a latent variable VAR to examine how macroeconomic and policy shocks affect the condition of the stock market. Further, we examine the contribution of various shocks to market conditions during particular episodes and find evidence that inflation and interest rate shocks had particularly strong impacts on market conditions in the postwar era. Disinflation shocks promoted market booms and inflation shocks contributed to busts. We conclude that central banks can contribute to financial market stability by minimizing unanticipated changes in inflation.
    JEL: E31 E52 G12 N12 N22
    Date: 2008–05
  10. By: Andrés, Javier; López-Salido, J David; Nelson, Edward
    Abstract: We examine the role of money in three environments: the New Keynesian model with separable utility and static money demand; a nonseparable utility variant with habit formation; and a version with adjustment costs for holding real balances. The last two variants imply forward-looking behaviour of real money balances, with forecasts of future interest rates entering current portfolio decisions. We conduct a structural econometric analysis of the U.S. and euro area economies. FIML estimates confirm the forward-looking character of money demand. A consequence is that real money balances are valuable in anticipating future variations in the natural interest rate.
    Keywords: money; natural rate; New Keynesian models
    JEL: E51 E52
    Date: 2008–05
  11. By: Fiorella De Fiore (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Oreste Tristani (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We analyze the of the natural rate of interest in an economy where nominal debt contracts generate a spread between loan rates and the policy interest rate. In our model, monetary policy has real effects in the flexible-price equilibrium, because it affects the credit spread. Relying on a definition suitable for this environment, we demonstrate that: (i) the natural rate is independent of monetary policy and (ii) it delivers price stability, if used as the intercept of a monetary policy rule. The second result hold exactly if real balances are remunerated at a constand spread below policy interest rates, approximately otherwise. We also highlight, however, that the natural rate is not robust to model uncertainty. The natural rate reacts differently to aggregate shocks - not only quantitatively but also qualitatively - depending on the underlying model assumptions (e.g. whether or not financial markets are frictionless). JEL Classification: E40, E50, G10.
    Keywords: Monetary policy, natural rate of interest, credit frictions.
    Date: 2008–04
  12. By: Guillermo A. Calvo; Alejandro Izquierdo; Luis-Fernando Mejía
    Abstract: Using a sample of 110 developed and developing countries for the period 1990-2004 we analyze the empirical characteristics of systemic sudden stops (3S) in capital flows --understood as large and largely unexpected capital account contractions that occur in periods of systemic turmoil -- and the relevance of balance sheet effects in the likelihood of their materialization. We conjecture that large real exchange rate (RER) fluctuations come hand in hand with 3S. A small supply of tradable goods relative to their domestic absorption -- a proxy for potential changes in the real exchange rate -- and large foreign-exchange denominated debts towards the domestic banking system, denoted Domestic Liability Dollarization, DLD, are claimed to be key determinants of the probability of 3S, conforming a balance-sheet effect that impacts on the probability of 3S in non-linear fashion. Regarding financial integration, the larger is the latter, the larger is likely to be the probability of Sudden Stop; however, beyond a critical point the relationship gets a sign reversion.
    JEL: F31 F32 F34 F41
    Date: 2008–05
  13. By: Mumtaz, Haroon (Monetary Assessment and Strategy, Bank of England); Surico, Paolo (Monetary Policy Committee Unit, Bank of England)
    Abstract: The dynamics of the US economy are modelled using a time-varying structural vector autoregression that incorporates information from the yield curve. We find important changes in the dynamics of macroeconomic variables such as inflation and the federal funds rate. In addition our results suggest a change in the relationship between the yield curve and macroeconomic variables. The monetary policy shocks of the early 1980s explain a large portion of the persistence of inflation and the level of the yield curve. Shocks to the level of the yield curve account for the persistence of the federal funds rate. We use our time-varying model provides to revisit the evidence on the expectations hypothesis.
    Keywords: Nelson-Siegel; time variation; inflation expectations; credibility building; evidence on expectations hypothesis
    JEL: C15 E44 E52
    Date: 2008–03
  14. By: Jeffrey A. Frankel; Shang-Jin Wei
    Abstract: The paper offers a new approach to estimate de facto exchange rate regimes, a synthesis of two techniques. One is a technique that the authors have used in the past to estimate implicit de facto weights when the hypothesis is a basket peg with little flexibility. The second is a technique used by others to estimate the de facto degree of exchange rate flexibility when the hypothesis is an anchor to the dollar or some other single major currency, but with a possibly-substantial degree of flexibility around that anchor. Since many currencies today follow variants of Band-Basket-Crawl, it is important to have available a technique that can cover both dimensions, inferring weights and inferring flexibility. We try out the technique on twenty-some currencies, over the period 1980-2007. Most are currencies that have officially used baskets as anchors for at least part of this sample period. But a few are known floaters or known simple peggers. In general the synthesis technique seems to work as it should.
    JEL: F31 F41
    Date: 2008–05
  15. By: Aleksander Berentsen; Christopher Waller
    Abstract: When agents are liquidity constrained, two options exist — borrow or sell assets. We compare the welfare properties of these options in two economies: in one, agents can borrow (issue inside bonds) and in the other they can sell government bonds (outside bonds). All transactions are voluntary, implying no taxation or forced redemption of private debt. We show that any allocation in the economy with inside bonds can be replicated in the economy with outside bonds and that the converse is not true. Moreover, under best policies, the allocation with outside bonds strictly Pareto dominates the allocation with inside bonds.
    Keywords: Liquidity, Financial markets, Monetary policy, Search
    JEL: E4 E5
    Date: 2008–05
  16. By: Meenagh, David; Minford, Patrick; Nowell, Eric; Sofat, Prakriti; Srinivasan, Naveen
    Abstract: It has been widely argued that inflation persistence since WWII has been widespread and durable and that it can only be accounted for by models with a high degree of nominal rigidity. We examine UK post-war data where after confirming previous studies’ findings of varying persistence due to changing monetary regimes, we find that models with little nominal rigidity are best equipped to explain it.
    Keywords: Inflation Persistence; Monetary Regime Shifts; New Classical; New Keynesian; Nominal Rigidity
    JEL: E31 E37
    Date: 2008–05
  17. By: Günter Coenen (Directorate General Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Matthias Mohr (Directorate General Economics, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Roland Straub (Directorate General International and European Relations, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: In this paper, we examine the macroeconomic effects of alternative fiscal consolidation policies in the New Area-Wide Model (NAWM), a two-country open-economy model of the euro area developed at the European Central Bank (cf. Coenen et al., 2007). We model fiscal consolidation as a permanent reduction in the targeted government debt-to-output ratio and analyse both expenditure and revenue-based policies that are implemented by means of simple fiscal feedback rules. We find that fiscal consolidation has positive long-run effects on key macroeconomic aggregates such as output and consumption, notably when the resulting improvement in the budgetary position is used to lower distortionary taxes. At the same time, fiscal consolidation gives rise to noticeable short-run adjustment costs in contrast to what the literature on expansionary fiscal consolidations suggests. Moreover, depending on the fiscal instrument used, fiscal consolidation may have pronounced distributional effects. JEL Classification: E32, E62.
    Keywords: DSGE modelling, limited asset-market participation, fiscal policy, fiscal consolidation, euro area.
    Date: 2008–05
  18. By: Christian Dreger; Jürgen Wolters
    Abstract: Money growth in the euro area has exceeded its target since 2001. Likewise, recent empirical studies did not find evidence in favour of a stable long run money demand function. The equation appears to be increasingly unstable if more recent data are used. If the link between money balances and the macroeconomy is fragile, the rationale of monetary aggregates in the ECB strategy has to be doubted. In contrast to the bulk of the literature, we are able to identify a stable long run money demand relationship for M3 with reasonable long run behaviour. This finding is robust for different (ML and S2S) estimation methods. To obtain the result, the short run homogeneity restriction between money and prices is relaxed. In addition, a rise in the income elasticity after 2001 is taken into account. The break might be linked to the introduction of euro coins and banknotes. The monetary overhang and the real money gap do not indicate significant inflation pressures. The corresponding error correction model survives a battery of specification tests.
    Keywords: Cointegration analysis, error correction, excess liquidity, money demand, monetary policy
    JEL: C22 C52 E41
    Date: 2008
  19. By: Alessandro Calza (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper tests whether the proposition that globalisation has led to greater sensitivity of domestic inflation to the global output gap (the “global output gap hypothesis”) holds for the euro area. The empirical analysis uses quarterly data over the period 1979-2003. Measures of the global output gap using two different weighting schemes (based on PPPs and trade data) are considered. We find little evidence that global capacity constraints have either explanatory or predictive power for domestic consumer price inflation in the euro area. Based on these findings, the prescription that central banks should specifically react to developments in global output gaps does not seem to be justified for the euro area. JEL Classification: E3, F4.
    Keywords: Globalisation, inflation, global output gap.
    Date: 2008–04
  20. By: Albert Marcet; Elisa Faraglia; Andrew Scott
    Abstract: A growing literature integrates theories of debt management into models of optimal fiscal policy. One promising theory argues that the composition of government debt should be chosen so that fluctuations in the market value of debt offset changes in expected future deficits. This complete market approach to debt management is valid even when the government only issues non-contingent bonds. A number of authors conclude from this approach that governments should issue long term debt and invest in short term assets. We argue that the conclusions of this approach are too fragile to serve as a basis for policy recommendations. This is because bonds at different maturities have highly correlated returns, causing the determination of the optimal portfolio to be ill-conditioned. To make this point concrete we examine the implications of this approach to debt management in various models, both analytically and using numerical methods calibrated to the US economy. We find the complete market approach recommends asset positions which are huge multiples of GDP. Introducing persistent shocks or capital accumulation only worsens this problem. Increasing the volatility of interest rates through habits partly reduces the size of these simulations we find no presumption that governments should issue long term debt ? policy recommendations can be easily reversed through small perturbations in the specification of shocks or small variations in the maturity of bonds issued. We further extend the literature by removing the assumption that governments every period costlessly repurchase all outstanding debt. This exacerbates the size of the required positions, worsens their volatility and in some cases produces instability in debt holdings. We conclude that it is very difficult to insulate fiscal policy from shocks by using the complete markets approach to debt management. Given the limited variability of the yield curve using maturities is a poor way to substitute for state contingent debt. The result is the positions recommended by this approach conflict with a number of features that we believe are important in making bond markets incomplete e.g allowing for transaction costs, liquidity effects, etc.. Until these features are all fully incorporated we remain in search of a theory of debt management capable of providing robust policy insights.
    Keywords: Complete Markets, Debt Management, Government Debt, Maturity Structure, Yield Curve
    JEL: E43 E62
    Date: 2008–05–07
  21. By: Lippi, Francesco; Nobili, Andrea
    Abstract: We consider an economy where the oil price, industrial production, and other macroeconomic variables fluctuate in response to a variety of fundamental shocks. We estimate the effects of different structural shocks using robust sign restrictions suggested by theory using US data for the 1973-2007 period. The estimates show that identifying the shock underlying the oil price change is important to predict the sign and the magnitude of its correlates with the US production. The results offer a natural explanation for the smaller correlation between oil prices and US production in the recent years compared to the seventies.
    Keywords: Business cycle; Oil prices; Sign Restrictions; Structural VAR
    JEL: C32 E3 F4
    Date: 2008–05
  22. By: Yuki Teranishi (Institute for Monetary and Economic Studies, Bank of Japan (E-mail: yuuki.teranishi
    Abstract: The first aim of the paper is to investigate a new source of economic stickiness, staggered nominal loan interest rate contracts between a private bank and a firm under the monopolistic competition. We introduce this staggered loan contract mechanism with micro-foundation based on agent's optimized behaviors into a standard New Keynesian model in a tractable way. Simulation results show that staggered loan contracts play an important role in determining both the amplitude and the persistence of economic fluctuations. The second aim of the paper is to analyze optimal monetary policy in this environment with staggered loan contracts. To this end, we derive an approximated microfounded-welfare function in the model. Unlike the loss functions derived in other New Keynesian models, this model's welfare function includes a term that measures the first order difference in loan interest rates, which requires reduction of the magnitude of policy interest rate changes in the welfare itself. We derive the optimal monetary policy rule when the central bank can commit to its policy in the timeless perspective. One implication of the optimal policy rule is that the central bank has the incentive to smooth the policy interest rate. This empirically realistic conclusion can be seen in our simulation results.
    Keywords: Staggered Loan Interest Rate Contract, Optimal Monetary Policy, Economic Fluctuation
    JEL: E32 E44 E52 G21
    Date: 2008–05
  23. By: Maik Schmeling; Andreas Schrimpf
    Abstract: We show empirically that survey-based measures of expected inflation are significant and strong predictors of future aggregate stock returns in several industrialized countries both in-sample and out-of-sample. By empirically discriminating between competing sources of this return predictability by virtue of a comprehensive set of expectations data, we find that money illusion seems to be the driving force behind our results. Another popular hypothesis - inflation as a proxy for aggregate risk aversion - is not supported by the data.
    Keywords: Inflation expectations, Money Illusion, Proxy hypothesis, Stock returns
    JEL: G10 G12 E44
    Date: 2008–05
  24. By: Michele Ca’ Zorzi (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Micha? Rubaszek (National Bank of Poland, ul. ?wi?tokrzyska 11/21, 00-919 Warsaw, Poland and Warsaw School of Economics, al. Niepodleg?osci 162, 02-554 Warsaw, Poland.)
    Abstract: In this paper we present a novel approach to the empirical validation of the intertemporal approach to the current account. We develop a calibrated model highlighting the role of consumption smoothing and capital accumulation in the economic convergence process. After solving the model, we derive the theoretical values for the euro area countries’ current account, testing to what extent they match reality. The model explains most of the dispersion in the current account and saving ratio, though cannot equally well capture differences in the investment ratios. The conclusion that we draw is that consumption smoothing, based on expectations of economic convergence, is driving the current account of the euro area countries over medium-term horizons. Capital accumulation appears to play a less pronounced role. JEL Classification: D91, F36, F41.
    Keywords: General equilibrium models, intertemporal optimisation, current account, euro area.
    Date: 2008–05
  25. By: Stéphane Dées (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); M. Hashem Pesaran (Cambridge University and USC; The Old Schools, Trinity Lane, Cambridge CB2 1TN, United Kingdom.); L. Vanessa Smith (Centre for Financial Analysis and Policy (CFAP), Judge Business School, University of Cambridge, Trumpington Street, Cambridge CB2 1AG, UK.); Ron P. Smith (Birkbeck, University of London, Malet Street, Bloomsbury, London WC1E 7HX, UK.)
    Abstract: New Keynesian Phillips Curves (NKPC) have been extensively used in the analysis of monetary policy, but yet there are a number of issues of concern about how they are estimated and then related to the underlying macroeconomic theory. The first is whether such equations are identified. To check identification requires specifying the process for the forcing variables (typically the output gap) and solving the model for inflation in terms of the observables. In practice, the equation is estimated by GMM, relying on statistical criteria to choose instruments. This may result in failure of identification or weak instruments. Secondly, the NKPC is usually derived as a part of a DSGE model, solved by log-linearising around a steady state and the variables are then measured in terms of deviations from the steady state. In practice the steady states, e.g. for output, are usually estimated by some statistical procedure such as the Hodrick-Prescott (HP) filter that might not be appropriate. Thirdly, there are arguments that other variables, e.g. interest rates, foreign inflation and foreign output gaps should enter the Phillips curve. This paper examines these three issues and argues that all three benefit from a global perspective. The global perspective provides additional instruments to alleviate the weak instrument problem, yields a theoretically consistent measure of the steady state and provides a natural route for foreign inflation or output gap to enter the NKPC. JEL Classification: C32, E17, F37, F42.
    Keywords: Global VAR (GVAR), identification, New Keynesian Phillips Curve, Trend-Cycle decomposition.
    Date: 2008–04
  26. By: Thomas Heckel (BNP Paribas Asset Management, 5 avenue Kleber, 75016 Paris, France.); Hervé Le Bihan (Banque de France, Direction de la Recherche, DGEI-DIR-Rec.n 41-1391, 31 rue Croix-des-petits-champs, 75049 Paris Cedex 01, France.); Jérémi Montornès (Banque de France, Direction de la Recherche, 31 rue Croix-des-petits-champs, 75049 Paris Cedex 01, France.)
    Abstract: This paper documents nominal wage stickiness using an original quarterly firm-level dataset. We use the ACEMO survey, which reports the base wage for up to 12 employee categories in French .rms over the period 1998 to 2005, and obtain the following main results. First, the quarterly frequency of wage change is around 35 percent. Second, there is some downward rigidity in the base wage. Third, wage changes are mainly synchronized within firms but to a large extent staggered across firms. Fourth, standard Calvo or Taylor schemes fail to match micro wage adjustment patterns, but fixed duration 'Taylor-like'wage contracts are observed for a minority of firms. Based on a two-thresholds sample selection model, we perform an econometric analysis of wage changes. Our results suggest that the timing of wage adjustments is not state-dependent, and are consistent with existence of predetermined of wage changes. They also suggest that both backward- and forward-looking behavior is relevant in wage setting. JEL Classification: E24, J3.
    Keywords: Wage stickiness, wage predetermination.
    Date: 2008–05
  27. By: Mario J. Crucini (Department of Economics, Vanderbilt University); Mototsugu Shintani (Department of Economics, Vanderbilt University); Takayuki Tsuruga (Faculty of Economics, Kansai University)
    Abstract: We study the dynamics of good-by-good real exchange rates using a micro-panel of 270 goods prices drawn from major cities in 63 countries and 258 goods prices drawn from 13 major U.S. cities. We find the half-life of deviations from the Law-of-One-Price for the average good is about 1 year. The average half-life is very similar across the OECD, the LCD and within the U.S., suggesting little in the way of nominal exchange rate regime influences. The average non-traded good has a half-life of 1.9 years compared to 1.2 years for traded-goods, for the OECD, with modest differences elsewhere. Aggregating the micro-data increases persistence in the OECD by 6 months to 1.5 years, well below levels obtained using aggregate CPI data. We attribute these differences to conceptual and methodological factors and argue in favor of increased use of micro-price data in applied theory.
    Keywords: Real exchange rates, purchasing power parity, law of one price, dynamic panel
    JEL: E31 F31 D40
    Date: 2008–05
  28. By: Christian Broda; David E. Weinstein
    Abstract: The empirical literature in international finance has produced three key results about international price deviations: borders give rise to flagrant violations of the law of one price, distance matters enormously for understanding these deviations, and most papers find that convergence rates back to purchasing power parity are inconsistent with the evidence of micro studies on nominal price stickiness. The data underlying these results are mostly comprised of price indexes and price surveys of goods that may not be identical internationally. In this paper, we revisit these three stylized facts using massive amounts of US and Canadian data that share a common barcode classification. We find that none of these three main stylized facts survive. We use our barcode level data to replicate prior work and explain what assumptions caused researchers to find different results from those we find in this paper. Overall, our work is supportive of simple pricing models where the degree of market segmentation across the border is similar to that within borders.
    JEL: F1 F15 F31
    Date: 2008–05
  29. By: Marek Jaroci?ski (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Frank Smets (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper estimates a Bayesian VAR for the US economy which includes a housing sector and addresses the following questions. Can developments in the housing sector be explained on the basis of developments in real and nominal GDP and interest rates? What are the effects of housing demand shocks on the economy? How does monetary policy affect the housing market? What are the implications of house price developments for the stance of monetary policy? Regarding the latter question, we implement a version of a Monetary Conditions Index (MCI) due to Céspedes et al. (2006). JEL Classification: E3-E4.
    Keywords: House prices, monetary conditions index, Bayesian VAR, monetary policy shock, conditional forecast.
    Date: 2008–04
  30. By: Moura, Marcelo
    Date: 2008–10
  31. By: Anna Lipinska (Bank of England, Monetary Analysis, International Economic Analysis Division, Threadneedle Street, London EC2R 8AH, UK.)
    Abstract: The EMU accession countries are obliged to fulfill the Maastricht convergence criteria prior to entering the EMU. This paper uses a DSGE model of a two-sector small open economy, to address the following question: How do the Maastricht convergence criteria modify optimal monetary policy in an economy facing domestic and external shocks? First, we derive the micro founded loss function that represents the objective function of the optimal monetary policy not constrained to satisfy the criteria. We find that the optimal monetary policy should not only target inflation rates in the domestic sectors and aggregate output fluctuations but also domestic and international terms of trade. Second, we show how the loss function changes when the monetary policy is constrained to satisfy the Maastricht criteria. The loss function of such a constrained policy is characterized by additional elements penalizing fluctuations of the CPI inflation rate, the nominal interest rate and the nominal exchange rate around the new targets which are potentially different from the steady state of the unconstrained optimal monetary policy. Under the chosen parameterization, the unconstrained optimal monetary policy violates two criteria: concerning the CPI in.ation rate and the nominal interest rate. The constrained optimal policy results in targeting the CPI inflation rate and the nominal interest rate that are 0.7% lower (in annual terms)than the CPI inflation rate and the nominal interest rate in the countries taken as a reference. The welfare costs associated with these constraints need to be offset against credibility gains and other benefits related to the compliance with the Maastricht criteria that are not modelled. JEL Classification: F41, E52, E58, E61.
    Keywords: Optimal monetary policy, Maastricht convergence criteria, EMU accession countries.
    Date: 2008–05
  32. By: Araújo, Eurilton
    Date: 2008–10
  33. By: Wheeler, Tracy (Monetary Policy Committee Unit, Bank of England)
    Abstract: This paper investigates empirically whether the level or growth of cheap imports from China has had an impact on UK inflation. We use two methods; the first calculates UK weighted world export price inflation as the sum of the effect of the inflation level in the UK's trading partners and the effect of substituting imports from more expensive countries with imports from countries with lower price levels. The second estimates these two effects on UK inflation using panel regressions. The results from the first method suggest that the substitution of imports from more expensive countries with imports from China reduced UK weighted world export price inflation by an average of -0.75 percentage points per annum from 2000 to 2004. Similarly, the panel regressions suggest that over the 1997-2005 period this substitution had a small but significant downward impact on UK CPI inflation. However, the same regressions also suggest that higher inflation in imports from China than in imports from other countries has put upward pressure on some components of UK CPI inflation. As this upward 'inflation effect' is likely to have outweighed the downward 'substitution effect' the regressions suggest that the overall effect of Chinese imports on UK CPI inflation from 1997-2005 was positive.
    Keywords: Inflation; China; Imports
    JEL: E31 F15
    Date: 2008–02
  34. By: Luca Onorante (DG Economics, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Diego J. Pedregal (ETSI Industriales, Edificio Politécnico, Universidad de Castilla-la-Mancha, campus universitario s/n, 13071 Ciudad Real, Spain.); Javier J. Pérez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Sara Signorini (Global Economics & FI/FX Research, HVB Milan, Via Tommaso Grossi 10, 20121 Milan, Italy.)
    Abstract: Short-term fiscal indicators based on public accounts data are often used by European policy makers. They represent one of the main sources of publicly available intra-annual fiscal information. Nevertheless, these indicators have received limited attention from the academic literature analysing fiscal forecasting in Europe. Some recent literature suggests the validity of public accounts data to forecast government deficits in the euro area. We extend this literature on two fronts: (i) we shift the focus from indicators of government deficits to look at indicators for government total revenue and total expenditure; (ii) we use a mixed-frequency state-space model to integrate readily available monthly/quarterly cash-based fiscal data with annual general government series (National Accounts). By doing so, we are able to maintain the focus on forecasting and monitoring annual outcomes, while making use of infra-annual fiscal information, available within the current year. The paper makes a case for the use of monthly cash indicators for multilateral fiscal surveillance at the European level. JEL Classification: C53, E6, H6.
    Keywords: Leading indicators, Fiscal forecasting and monitoring, Euro area.
    Date: 2008–05
  35. By: Luc Bauwens; Genaro Sucarrat
    Abstract: The general-to-specific (GETS) methodology is widely employed in the modelling of economic series, but less so in financial volatility modelling due to computational complexity when many explanatory variables are involved. This study proposes a simple way of avoiding this problem when the conditional mean can appropriately be restricted to zero, and undertakes an out-of-sample forecast evaluation of the methodology applied to the modelling of weekly exchange rate volatility. Our findings suggest that GETS specifications perform comparatively well in both ex post and ex ante forecasting as long as sufficient care is taken with respect to functional form and with respect to how the conditioning information is used. Also, our forecast comparison provides an example of a discrete time explanatory model being more accurate than realised volatility ex post in 1 step forecasting.
    Keywords: Exchange rate volatility, General to specific, Forecasting
    JEL: C53 F31
    Date: 2008–04
  36. By: Li-gang Liu (Research Department, Hong Kong Monetary Authority); Wenlang Zhang (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper adopts a three-equation New Keynesian model to evaluate the appropriateness of China's monetary policy framework. Our simulation results show that a hybrid rule that relies on both interest rate and quantity of money to conduct monetary policy appears to be more suitable than its alternatives at the current stage of economic and financial market development. Our simulation results also show that a sharp appreciation of the renminbi exchange rate would be disruptive to the inflation and output processes of the economy, despite its effectiveness in curbing inflation.
    Keywords: Monetary Policy Rule, New Keynesian Model, China
    JEL: E42 E52
    Date: 2007–11
  37. By: Li-gang Liu (Research Department, Hong Kong Monetary Authority); Laurent Pauwels (Research Department, Hong Kong Monetary Authority); Jun-yu Chan (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper investigates whether external political pressures calling for faster renminbi (RMB) appreciation have any statistically significant effect on both the daily returns and the conditional volatility of the RMB central parity rate. We construct various external pressure indicators according to the sources of foreign political pressures pertaining to the RMB exchange rate, with a special emphasis on the pressures originated in the United States. After controlling for the underlying domestic factors, we find that neither the overall foreign pressure indicator nor the US-specific pressure indicator has any significant influence on RMB¡¦s daily returns. However, there is strong evidence to suggest that external pressures, and especially those from US sources, have a statistically significant impact on the conditional volatility of the RMB exchange rate. In other words, even though external pressures do not seem to have systematic influence on the speed of the RMB appreciation, they do seem to influence the uncertainty in the daily changes of the RMB exchange rate.
    Keywords: Renminbi exchange rate, Conditional volatility, Event studies, Macroeconomic news or surprises
    JEL: F31 G10
    Date: 2008–05
  38. By: Li-gang Liu (Research Department, Hong Kong Monetary Authority); Andrew Tsang (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper estimates pass-through of exchange rate changes to domestic inflation in Hong Kong in a two-step approach. We first estimate exchange rate pass-through to import prices and then from import price to domestic inflation using a Phillips-Curve model. We find that Hong Kong¡¦s exchange rate pass-through to import prices is relatively high compared to the OECD average, although Hong Kong also witnessed a decline of pass-through after 1991. With respect to exchange rate pass-through to domestic prices, we find that a 10% depreciation of the US dollar against all currencies except for the Hong Kong dollar would lead domestic prices to increase by 0.82 and 1.61 percent in the short run and medium run, respectively. These results are also broadly consistent with those obtained from a calibration exercise that estimates exchange rate pass-through to domestic prices via channels of the tradable and non-tradable goods.
    Keywords: Exchange rate pass-through, Phillips Curve, Hong Kong
    JEL: F3 F4
    Date: 2008–03
  39. By: Frank Leung (Research Department, Hong Kong Monetary Authority); Philip Ng (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper estimates the equilibrium path of the Hong Kong dollar real effective exchange rate (REER) and compares it with the actual path of the Hong Kong dollar REER to assess the extent of real exchange rate misalignment. Empirical results from various approaches of exchange rate assessment adopted in this study generally suggest that there was no obvious evidence of exchange rate misalignment for the Hong Kong dollar in 2006. This is consistent with the observation that there were no obvious signs of macroeconomic imbalances in the Hong Kong economy.
    Keywords: Real effective exchange rate, Hong Kong dollar
    JEL: F32 F41
    Date: 2007–12
  40. By: Laurence Fung (Research Department, Hong Kong Monetary Authority); Ip-wing Yu (Research Department, Hong Kong Monetary Authority)
    Abstract: The features under the two-sided Convertibility Zone of the Hong Kong dollar resemble in many ways the target zone exchange rate regime in the literature. Following Tronzano et al. (2000), this paper utilises a Bayesian extension of the Svensson (1991) test, which takes into account the exchange rate movement and the differential between domestic and foreign interest rates, to assess the credibility of the Convertibility Zone since it was introduced in May 2005. The empirical evidence suggests that the Hong Kong Monetary Authority has been successful in building a high degree of credibility in maintaining the Convertibility Zone.
    Keywords: Bayesian Analysis, Credibility, Convertibility Zone, Markov Chain Monte Carlo
    JEL: C11 C15 C22 F31
    Date: 2007–12
  41. By: Cho-Hoi Hui (Research Department, Hong Kong Monetary Authority); Chi-Fai Lo (Institute of Theoretical Physics and Department of Physics, The Chinese University of Hong Kong); Tsz-Kin Chung (Department of Physics, The Chinese University of Hong Kong)
    Abstract: This paper proposes a path-dependent approach for estimating maximum appreciations of the renminbi expected by the market based on first-passage-time distributions. Using market data of the renminbi spot exchange rates, non-deliverable forward rates and currency option prices from 21 July 2005 (the reform of the exchange rate regime) to 28 February 2008 for model parameters, the maximum appreciations of the renminbi estimated under the proposed approach show that the market expected another large movement of the exchange rate during the 14 months after the reform. Subsequently, the few occasions of appreciations beyond the expected maximums coincided with trade-related issues and speculation that greater momentum of appreciation would be allowed by the authorities. The PBoC¡¦s measures were however largely incorporated into the derivatives¡¦ prices. The proposed approach can be used to gauge the range of appreciations of the renminbi anticipated in the market and to identify any exchange rate movements beyond market expectations.
    Keywords: renminbi exchange rate, first-passage-time distributions, currency options
    JEL: F31 G13
    Date: 2008–04
  42. By: Moura, Marcelo; Rossi, José
    Date: 2008–10

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