nep-cba New Economics Papers
on Central Banking
Issue of 2008‒06‒07
43 papers chosen by
Alexander Mihailov
University of Reading

  1. On the need for a new approach to analyzing monetary policy By Andrew Atkeson; Patrick J. Kehoe
  2. When Does Policy Reform Work? The Case of Central Bank Independence By Daron Acemoglu; Simon Johnson; Pablo Querubin; James A. Robinson
  3. Learning, expectations formation and the pitfalls of optimal control monetary policy By Athanasios Orphanides; John C. Williams
  4. The Fed and the ECB: Why such an apparent difference in reactivity? By Grégory Levieuge; Alexis Penot
  5. Talking Less and Moving the Market More: Is this the Recipe for Monetary Policy Effectiveness? Evidence from the ECB and the Fed By Carlo Rosa
  6. Regulation and the neo-Wicksellian approach to monetary policy By John V. Duca; Tao Wu
  7. Core measures of inflation as predictors of total inflation By Theodore M. Crone; N. Neil K. Khettry; Loretta J. Mester; Jason A. Novak
  8. Monetary policy in a channel system By Aleksander Berentsen; Cyril Monnet
  9. Issues in central bank finance and independence By Peter Stella; Åke Lonnberg
  10. Delayed Doves: MPC Voting Behaviour of Externals By Stephen Hansen; Michael F. McMahon
  11. Real Convergence, Price Level Convergence and Inflation Differentials in Europe By Balazs Egert
  12. Fiscal Policy over the Real Business Cycle: A Positive Theory By Marco Battaglini; Stephen Coate
  13. An Anatomy Of Credit Booms: Evidence From Macro Aggregates And Micro Data By Enrique G. Mendoza; Marco E. Terrones
  14. What do we really know about fiscal sustainability in the EU? A panel data diagnostic By Christophe Rault; Antonio Alfonso
  15. EMU and Financial Market Integration By Philip R. Lane
  16. Financial and real integration By Scott L. Baier; Gerald P. Dwyer, Jr.
  17. Does the Financial Market Believe in the Phillips Curve? – Evidence from the G7 countries By Ralf Fendel, Eliza M. Lis and Jan-Christoph Rülke
  18. A Phillips curve interpretation of error-correction models of the wage and price dynamics. By Harck, Søren
  19. Revisions to PCE inflation measures: implications for monetary policy By Dean Croushore
  20. Monopolistic Competition and the Dependent Economy Model By Romain Restout
  21. Cost Pass Through in a Competitive Model of Pricing-to-Market By Auer, Raphael; Chaney, Thomas
  22. How Robust are Estimated Equilibrium Exchange Rates? A Panel BEER Approach By Agnes Benassy-Quere; Sophie Bereau; Valérie Mignon
  23. The Global Effects of U.S. Fiscal Policy By Kimberly Flood
  24. Foreign Debt and Fear of Floating: A Theoretical Exploration By Michael Bleaney; F. Gulcin Ozkan
  25. Overlapping Generations Models of General Equilibrium By John Geanakoplos
  26. Revisiting useful approaches to data-rich macroeconomic forecasting By Jan J. J. Groen; George Kapetanios
  27. Optimal External Debt and Default By Bernardo Guimaraes
  28. The two-period rational inattention model: accelerations and analyses By Kurt F. Lewis
  29. Bayesian Learning in Social Networks By Daron Acemoglu; Munther A. Dahleh; Ilan Lobel; Asuman Ozdaglar
  30. Equilibrium Exchange Rates: a Guidebook for the Euro-Dollar Rate By Agnes Benassy-Quere; Sophie Bereau; Valérie Mignon
  31. Macroeconomic Sources of Foreign Exchange Risk in New EU Members By Tigran Poghosyan; Evzen Kocenda
  32. Divergence in Labor Market Institutions and International Business Cycles By Raquel Fonseca; Lise Patureau
  33. Policy Coordination in an International Payment System By James T. E. Chapman
  34. Specific capital and vintage effects on the dynamics of unemployment and vacancies By Burcu Eyigungor
  35. Vicious and Virtuous Circles - The Political Economy of Unemployment in Interwar UK and USA By Matthews, Kent; Minford, Patrick; Naraidoo, Ruthira
  36. Theoretical support for a new class of demand for real cash balances in explosive hyperinflations. By Alexandre Sokic
  37. Modelling the transaction role of money and the essentiality of money in a hyperinflation context. By Alexandre Sokic
  38. Currency Misalignments and Exchange Rate Regimes in Emerging and Developing Countries By Virginie Coudert; Cecile Couharde
  39. The Impact of Chinese Monetary Policy Shocks on East Asia By Mehrotra, Aaron; Kozluk , Tomasz
  40. Does a Monetary Union protect again foreign shocks? An assessment of Latin American integration using a Bayesian VAR By Jean-Pierre Allégret; Alain Sand-Zantman
  41. Long Run Determinants of Real Exchange Rates in Latin America By Jorge Carrera; Romain Restout
  42. The Polemics and Empirics of the Sustainability of Australia’s Current Account Deficit - Revisited By Neil Dias Karunaratne
  43. Cost of Holding Excess Reserves: The Indian Experience By Abhijit Sen Gupta

  1. By: Andrew Atkeson; Patrick J. Kehoe
    Keywords: Monetary policy
    Date: 2008
  2. By: Daron Acemoglu; Simon Johnson; Pablo Querubin; James A. Robinson
    Abstract: We argue that the question of whether and when policy reform works should be investigated together with the political economy factors responsible for distortionary policies in the first place. These not only determine the initial distortions, but also often shape policy in the post-reform environment. Distortionary policies are more likely to be adopted when politicians are unconstrained and unaccountable to citizens. This reasoning implies that policy reform should have modest effects in societies where the political system already places constraints on politicians. It also implies, however, that in societies with weak political constraints, which are often those adopting the most distortionary policies, policy reforms may be ineffective because the underlying political economy problems are not typically altered by these reforms. Policy reform should therefore have its largest effect in societies with intermediate levels of constraints. In addition, when policy reform is (partly) effective, it may lead to a deterioration in other (unreformed) components of policy in order to satisfy the underlying demands on politicians – a phenomenon we call the seesaw effect. We provide reduced-form evidence consistent with these ideas by looking at the effect of central bank independence on inflation. The evidence is consistent with the notion that central bank reforms have reduced inflation in societies with intermediate constraints and have had no or little effects in countries with the high and low levels of constraints. We also present some evidence suggesting that, consistent with the seesaw effect, in countries where central bank reforms reduce inflation, government expenditure tends to increase.
    JEL: E31 P16
    Date: 2008–05
  3. By: Athanasios Orphanides; John C. Williams
    Abstract: This paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations. We assume that agents have imperfect knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We find that the optimal control policy derived under the assumption of rational expectations can perform poorly when expectations deviate modestly from rational expectations. We then show that the optimal control policy can be made more robust by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to learning provides an incentive to employ a "conservative" central banker. We then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to empirically plausible parameterizations of the learning models and perform about as well or better than optimal control policies.
    Keywords: Rational expectations (Economic theory) ; Econometric models
    Date: 2008
  4. By: Grégory Levieuge (Laboratoire d'Economie d'Orléans (LEO), UMR CNRS 6221); Alexis Penot (GATE, University of Lyon, CNRS, ENS-LSH, Centre Léon Bérard, France,)
    Abstract: Compared with the U.S., the amplitude of the European monetary policy rate cycle is strikingly narrow. Is it an evidence of a less reactive ECB? This observation can certainly reflect the preferences and then the strategy of the ECB. But its greater inertia must also be assessed in the light of the singularity of the European structure and of the shocks hitting it. From this perspective, several contributions assert that the nature, size and persistence of shocks mainly explain the different interest rate setting. Therefore, they rely on the idea that both areas share the same monetary policy rule and, more surprising, the same structure. This paper aims at examining this conclusions with an alternative modelling. The results confirm that the euro area and U.S. monetary policy rules are not fundamentally different. But we reject the differences of nature and amplitude of shocks. What is often interpreted as such is in fact the consequence of how distinctly both economies absorb shocks. So differences in the amplitude of the interest rate cycles in both areas are basically explained by structural dissimilarities.
    Keywords: interest rate, macroeconomic shocks, monetary policy rules, policy activism, structural divergence
    JEL: C51 E52 E58
    Date: 2008
  5. By: Carlo Rosa
    Abstract: This paper examines and compares the communication strategies of the Federal Reserve and the European Central Bank, and their effectiveness. First we do a comparative study exercise. We find that on monetary policy committee meeting days both the ECB and the Fed can move market rates using either monetary policy or news shocks. However, the response of the long-end of the American term structure to the surprise component of Fed's statements is significantly larger than the reaction of European long-term yields to ECB's announcements. This result is intimately related to the higher transparency of U.S. Fed statements compared to ECB announcements rather than to the different institutional mandate of the two central banks. Second, we investigate the cross-effects i.e. the Fed's ability to move European interest rates and the corresponding ECB's capacity to move American rates. We find that the Fed has been more able to move the European interst rates of all maturities than the ECB to move American rates. This finding is tied to the predominance of dollar fixed income assets rather than to an attempt of the ECB to mimic the Fed.
    Keywords: European Central Bank, U.S. Federal Reserve, central bank communication, monetary policy and news shocks, term structure of interest rates
    JEL: E52 E58
    Date: 2008–02
  6. By: John V. Duca; Tao Wu
    Abstract: Laubach and Williams (2003) employ a Kalman filter approach to jointly estimate the neutral real federal funds rate and trend output growth using an IS relationship and an output gap based inflation equation. They find a positive link between these two variables, but also much error surrounding neutral real rate estimates. We modify their approach by including variables for regulations on deposit interest rates and on wages and prices. These variables are statistically significant and notably affect estimates of two policy relevant coefficients: the sensitivity of output to the real interest rate and that of inflation to the output gap.
    Keywords: Monetary policy ; Federal funds rate
    Date: 2008
  7. By: Theodore M. Crone; N. Neil K. Khettry; Loretta J. Mester; Jason A. Novak
    Abstract: Two rationales offered for policymakers' focus on core measures of inflation as a guide to underlying inflation are that core inflation omits food and energy prices, which are thought to be more volatile than other components, and that core inflation is thought to be a better predictor of total inflation over time horizons of import to policymakers. The authors' investigation finds little support for either rationale. They find that food and energy prices are not the most volatile components of inflation and that depending on which inflation measure is used, core inflation is not necessarily the best predictor of total inflation. However, they do find that combining CPI and PCE inflation measures can lead to statistically significant more accurate forecasts of each inflation measure, suggesting that each measure includes independent information that can be exploited to yield better forecasts.
    Keywords: Inflation (Finance)
    Date: 2008
  8. By: Aleksander Berentsen; Cyril Monnet
    Abstract: Channel systems for conducting monetary policy are becoming increasingly popular. Despite its popularity, the consequences of implementing policy with a channel system are not well understood. The authors develop a general equilibrium framework of a channel system and study the optimal policy. A novel aspect of the channel system is that a central bank can "tighten" or "loosen" its policy without changing its policy rate. This policy instrument has so far been overlooked by a large body of the literature on the optimal design of interest-rate rules.
    Keywords: Monetary policy
    Date: 2008
  9. By: Peter Stella; Åke Lonnberg
    Abstract: Conventional economic policy models focus only on selected elements of the central bank balance sheet, in particular monetary liabilities and sometimes foreign reserves. The canonical model of an "independent" central bank assumes that it chooses money (or an interest rate) unconstrained by a need to generate seignorage for itself or the government. Whereas a long line of literature has emphasized the dangers of fiscal dominance influencing the conduct of monetary policy, this paper considers the relatively novel idea that an independent central bank could be constrained in achieving its policy objectives by its own balance sheet situation. If one accepts this potential constraint as a valid concern, the financial strength of the central bank as a stand-alone entity becomes highly relevant for ascertaining monetary policy credibility. We consider several strands of evidence that clearly indicate fiscal backing for central banks cannot be assumed, and hence financial independence is relevant to operational independence. First, we examine 135 central bank laws to illustrate the variety of legal approaches adopted with respect to central bank financial independence. Second, we examine the same data set with regard to central bank recapitalization provisions to show that even in cases where the treasury is nominally responsible for keeping the central bank financially strong, it may do so in purely a cosmetic fashion. Third, we show that, in actual practice, treasuries have frequently not provided central banks with genuine financial support on a timely basis, leaving them excessively reliant on seignorage to finance their operations or forcing them to abandon policy objectives.
    Date: 2008
  10. By: Stephen Hansen; Michael F. McMahon
    Abstract: The use of independent committees for the setting of interest rates, such as the MonetaryPolicy Committee (MPC) at the Bank of England, is quickly becoming the norm in developedeconomies. In this paper we examine the issue of appointing external members (memberswho are outside the staff of the central bank) to these committees. We construct a model ofMPC voting behaviour, and show that members who begin voting for similar interest ratesshould not systematically diverge from each other at any future point. However, econometricresults in fact show that external members initially vote in line with internal members, butafter a year, begin voting for substantially lower interest rates. The robustness of this effect toincluding member fixed effects provides strong evidence that externals behave differentlyfrom internals because of institutional differences between the groups, and not someunobserved heterogeneity. We then examine whether career concerns can explain thesefindings, and conclude that they cannot.
    Keywords: Monetary Policy Committee (MPC), Bank of England, Committee Voting,Signalling
    JEL: E58 D71
    Date: 2008–04
  11. By: Balazs Egert
    Abstract: This paper provides a comprehensive review of the factors that can cause price levels to diverge and which are at the root of different inflation rates in Europe including the EU-27. Among others, we study the structural and cyclical factors influencing market and non-marketbased service, house and goods prices, and we summarise some stylised facts emerging from descriptive statistics. Subsequently, we set out the possible mismatches between price level convergence and inflation rates. Having described in detail the underlying economic factors, we proceed to demonstrate the relative importance of these factors on observed inflation rates first in an accounting framework and then by relying on panel estimations. Our estimation results provide the obituary notice for the Balassa-Samuelson effect. Nevertheless, we show that other factors related to economic convergence may push up inflation rates in transition economies. Cyclical effects and regulated prices are found to be important drivers of inflation rates in an enlarged Europe. House prices matter to some extent in the euro area, whereas the exchange rate plays a prominent (but declining) role in transition economies.
    Keywords: price level, inflation, Balassa-Samuelson, tradables, house prices, regulated prices, Europe, transition
    JEL: C22 E43 E50 E52 G21 O52
    Date: 2007–11–01
  12. By: Marco Battaglini; Stephen Coate
    Abstract: This paper presents a political economy theory of the behavior of fiscal policy over the business cycle. The theory predicts that, in both booms and recessions, fiscal policies are set so that the marginal cost of public funds obeys a submartingale. In the short run, fiscal policy can be pro-cyclical with government debt spiking up upon entering a boom. However, in the long run, fiscal policy is counter-cyclical with debt increasing in recessions and decreasing in booms. Government spending increases in booms and decreases during recessions, while tax rates decrease during booms and increase in recessions. Data on tax rates from the G7 countries supports the submartingale prediction, and the correlations between fiscal policy variables and national income implied by the theory are consistent with much of the existing evidence from the U.S. and other countries.
    JEL: D70 E62 H60
    Date: 2008–05
  13. By: Enrique G. Mendoza; Marco E. Terrones
    Abstract: This paper proposes a methodology for measuring credit booms and uses it to identify credit booms in emerging and industrial economies over the past four decades. In addition, we use event study methods to identify the key empirical regularities of credit booms in macroeconomic aggregates and micro-level data. Macro data show a systematic relationship between credit booms and economic expansions, rising asset prices, real appreciations, widening external deficits and managed exchange rates. Micro data show a strong association between credit booms and firm-level measures of leverage, firm values, and external financing, and bank-level indicators of banking fragility. Credit booms in industrial and emerging economies show three major differences: (1) credit booms and the macro and micro fluctuations associated with them are larger in emerging economies, particularly in the nontradables sector; (2) not all credit booms end in financial crises, but most emerging markets crises were associated with credit booms; and (3) credit booms in emerging economies are often preceded by large capital inflows but not by financial reforms or productivity gains.
    JEL: E32 E44 E51 F3 G21
    Date: 2008–05
  14. By: Christophe Rault; Antonio Alfonso
    Abstract: We assess the sustainability of public finances in the EU15 over the period 1970-2006 using stationarity and cointegration analysis. Specifically, we use panel unit root tests of the first and second generation allowing in some cases for structural breaks. We also apply modern panel cointegration techniques developed by Pedroni (1999, 2004), generalized by Banerjee and Carrion-i-Silvestre (2006) and Westerlund and Edgerton (2007), to a structural long-run equation between general government expenditures and revenues. While estimations point to fiscal sustainability being an issue in some countries, fiscal policy was sustainable both for the EU15 panel set, and within sub-periods (1970-1991 and 1992-2006)
    Keywords: intertemporal budget constraint, fiscal sustainability, EU, panel unit root, panel cointegration
    JEL: C23 E62 H62 H63
    Date: 2007–10–01
  15. By: Philip R. Lane
    Abstract: The first decade of EMU has taught us much about the power of a single currency to integrate financial markets. In this review, I first discuss the quantitative impact of the euro on cross- border financial holdings before turning to the macroeconomic implications of enhanced financial integration.
    Date: 2008–05–23
  16. By: Scott L. Baier; Gerald P. Dwyer, Jr.
    Abstract: We examine the relationship between real and financial integration. Real integration is measured by productivities of capital and labor from trade data for 1982 to 1997. Financial integration is measured by the black market exchange rate. We find more evidence of convergence to equality for returns to capital than for returns to labor. There is some support for associating the convergence of black market premia with declines in black market premia.
    Date: 2008
  17. By: Ralf Fendel, Eliza M. Lis and Jan-Christoph Rülke
    Abstract: This paper uses monthly survey data for the G7 countries for the time period 1989 - 2007 to explore the link between expectations on nominal wages, prices and unemployment rate as suggested by the traditional and Samuelson-and-Solow-type Phillips curve. Three ma- jor ¯ndings stand out: First, we ¯nd that survey participants trust in the original as well as the Samuelson-and-Solow-type Phillips curve relationship. Second, we ¯nd evidence in favor of nonlinearities in the expected Samuelson-and-Solow-type Phillips curve. Third, when we take into account a kink in the expected Phillips curve indicating that the slope of the Phillips curve di®ers during the business cycle, we ¯nd strong evidence of this feature in the data which con¯rms recent the- oretical discussions in the literature that the Phillips curve is °atter in case of an economic downturn.
    Keywords: Phillips curve, Forecasting, Panel data model
    JEL: C23 E37 E31
    Date: 2008–06–02
  18. By: Harck, Søren (Department of Economics, Aarhus School of Business)
    Abstract: No abstract
    Keywords: No; keywords
    JEL: A10
    Date: 2008–05–01
  19. By: Dean Croushore
    Abstract: This paper examines the characteristics of the revisions to the inflation rate as measured by the personal consumption expenditures price index both including and excluding food and energy prices. These data series play a major role in the Federal Reserve’s analysis of inflation. ; The author examines the magnitude and patterns of revisions to both PCE inflation rates. The first question he poses is: What do data revisions look like? The author runs a variety of tests to see if the data revisions have desirable or exploitable properties. The second question he poses is related to the first: Can we forecast data revisions in real time? The answer is that it is possible to forecast revisions from the initial release to August of the following year. Generally, the initial release of inflation is too low and is likely to be revised up. Policymakers should account for this predictability in setting monetary policy.
    Keywords: Inflation (Finance) ; Monetary policy
    Date: 2008
  20. By: Romain Restout (ECONOMIX (University Paris X) and University of Lyon, Lyon, F-69003, France; CNRS, UMR 5824, GATE, Ecully, F-69130, France; ENS LSH, Lyon, F-69007, France ; Centre Leon Berard, Lyon, F-69003, France)
    Abstract: This paper explores the consequences of introducing a monopolistic competition in an intertemporal two-sector small open economy model which produces traded and non traded goods. It is assumed that the non traded sector is the locus of the imperfectly competition. Our analysis shows that markup depends on the composition of aggregate non traded demand and is therefore endogenously determined in the model. Calibrating the model with OECD parameters, the effects of fiscal and technological shocks are simulated. Our findings are as follows. First, the model is consistent with the observed saving-investment correlations found in the data. Second, unlike the perfectly framework and in accordance with empirical studies, fiscal shocks cause real appreciation of the relative price of non traded goods, which in turn enlarges the responses of current account and investment. Third, the model is consistent with the empirical report that technological shocks result in current account deficits and investment rises. Fourth, the strength of the relative price appreciation following sector productivity differentials, i.e. the Balassa-Samuelson effect, is affected by the monopolistic competition hypothesis. Assume perfect competition when it is not, biases upward estimates of the Balassa-Samuelson effect.
    Keywords: fiscal policy, monopolistic competition, productivity
    JEL: E20 E62 F31 F41
    Date: 2008
  21. By: Auer, Raphael (Swiss National Bank); Chaney, Thomas (Department of Economics University of Chicago)
    Abstract: This paper builds up an extension to the Mussa and Rosen (1978) model of quality pricing under perfect competition. Our model incorporates decreasing returns to scale. First, we predict that exchange rate shocks are imperfectly passed through into prices. Second, prices of low quality goods are more sensitive to exchange rate shocks than prices of high quality goods. Third, in response to an exchange rate appreciation, the composition of exports shifts towards higher quality and more expensive goods. We test those predictions using highly disaggregated price and quantity US import data. We find that the prices of high quality goods, proxied as high unit price goods, are more sensitive to exchange rate movements. Moreover, we find evidence that in response to an exchange rate appreciation, the composition of exports shifts towards high unit price goods.
    Keywords: Pricing-to-Market; Exchange Rate Pass Through; Local Distribution
    JEL: F11 F31 F41
    Date: 2008–05–15
  22. By: Agnes Benassy-Quere; Sophie Bereau; Valérie Mignon
    Abstract: This paper is concerned with the robustness of equilibrium exchange rate estimations based on the BEER approach for a set of both industrial and emerging countries. The robustness is studied in four directions, successively. First, we investigate the impact of using alternative proxies for relative productivity. Second, we analyze the impact of estimating the equilibrium equation on one single panel covering G20 countries, or separately for G7 and non-G7 countries. Third, we measure the influence of the choice of the numeraire on the derivation of bilateral equilibrium rates. Finally, we study the temporal robustness of the estimations by dropping one or two years from the estimation period. Our main conclusion is that BEER estimations are quite robust to these successive tests, although at one point of time misalignments can differ by several percentage points depending on the methodology. The choice of the productivity proxy is the most sensible one, followed by the country sample. In contrast, the choice of the numeraire and the time sample have a relatively limited impact on estimated misalignments.
    Keywords: Equilibrium exchange rates; BEER; productivity; panel cointegration
    JEL: F31 C23
    Date: 2008–03
  23. By: Kimberly Flood
    Abstract: The author examines the global impact of U.S. fiscal policy using the Bank of Canada's Global Economy Model (Lalonde and Muir 2007). In particular, she examines the global macroeconomic implications of the expiration of major tax cuts in the United States and of expected increases in U.S. entitlement program expenditures. The results of her analysis suggest that the expiration of previously enacted tax cuts in the United States will impose short-run costs on the U.S. economy. However, the rest of the world will benefit from an associated decline in the world real interest rate and from a redistribution of wealth linked to a partial reversal of global current account imbalances as U.S. government debt declines. The author's analysis of the expected increase in U.S. entitlement program expenditures, financed through debt, suggests that entitlement program expenditures will crowd out economic growth in the United States and the rest of the world.
    Keywords: Fiscal policy; International topics; Regional economic developments
    JEL: H0 H2 H3
    Date: 2008
  24. By: Michael Bleaney; F. Gulcin Ozkan
    Abstract: This paper explores the relationship between the denomination of public debt and the choice of exchange rate regime. Unlike indexed domestic debt, foreign debt is subject to valuation effects from real exchange rate shocks. In a standard set-up, where a peg functions only as a nominal anchor, more foreign debt makes pegging less attractive, because it increases the value of a fexible exchange rate as a shock absorber. This result can be reversed if we incorporate the stylized fact that pegs have lower real exchange rate volatility, and if external shocks are sufficiently large relative to domestic shocks.
    Keywords: inflation, output, public debt and exchange rate regimes.
    JEL: F33 H63
    Date: 2008–05
  25. By: John Geanakoplos (Cowles Foundation, Yale University)
    Abstract: The OLG model of Allais and Samuelson retains the methodological assumptions of agent optimization and market clearing from the Arrow-Debreu model, yet its equilibrium set has different properties: Pareto inefficiency, indeterminacy, positive valuation of money, and a golden rule equilibrium in which the rate of interest is equal to population growth (independent of impatience). These properties are shown to derive not from market incompleteness, but from lack of market clearing "at infinity;" they can be eliminated with land or uniform impatience. The OLG model is used to analyze bubbles, social security, demographic effects on stock returns, the foundations of monetary theory, Keynesian vs. real business cycle macromodels, and classical vs. neoclassical disputes.
    Keywords: Demography, Inefficiency, Indeterminacy, Money, Bubbles, Cycles, Rate of interest, Impatience, Land, Infinity, Expectations, Social security, Golden rule
    JEL: D1 D3 D5 D6 D9 E11 E12 E13 E2 E3 E4 E6
    Date: 2008–05
  26. By: Jan J. J. Groen; George Kapetanios
    Abstract: This paper revisits a number of data-rich prediction methods that are widely used in macroeconomic forecasting, such as factor models, Bayesian ridge regression, and forecast combinations, and compares these methods with a lesser known alternative: partial least squares regression. In this method, linear, orthogonal combinations of a large number of predictor variables are constructed such that the linear combinations maximize the covariance between the target variable and each of the common components constructed from the predictor variables. We provide a theorem that shows that when the data comply with a factor structure, principal components and partial least squares regressions provide asymptotically similar results. We also argue that forecast combinations can be interpreted as a restricted form of partial least squares regression. Monte Carlo experiments confirm our theoretical results that principal components and partial least squares regressions are asymptotically similar when the data has a factor structure. These experiments also indicate that when there is no factor structure in the data, partial least square regression outperforms both principal components and Bayesian ridge regressions. Finally, we apply partial least squares, principal components, and Bayesian ridge regressions on a large panel of monthly U.S. macroeconomic and financial data to forecast CPI inflation, core CPI inflation, industrial production, unemployment, and the federal funds rate across different subperiods. The results indicate that partial least squares regression usually has the best out-of-sample performance when compared with the two other data-rich prediction methods. ; These experiments also indicate that when there is no factor structure in the data, partial least square regression outperforms both principal components and Bayesian ridge regressions. Finally, we apply partial least squares, principal components, and Bayesian ridge regressions on a large panel of monthly U.S. macroeconomic and financial data to forecast CPI inflation, core CPI inflation, industrial production, unemployment, and the federal funds rate across different subperiods. The results indicate that partial least squares regression usually has the best out-of-sample performance when compared with the two other data-rich prediction methods.
    Keywords: Time-series analysis ; Economic forecasting ; Business cycles ; Econometric models
    Date: 2008
  27. By: Bernardo Guimaraes
    Abstract: This paper analyses whether sovereign default episodes can be seen as contingencies ofoptimal international lending contracts. The model considers a small open economy withcapital accumulation and without commitment to repay debt. Taking first orderapproximations of Bellman equations, I derive analytical expressions for the equilibriumlevel of debt and the optimal debt contract. In this environment, debt relief generated byreasonable fluctuations in productivity is an order of magnitude below that generated byshocks to world interest rates. Debt relief prescribed by the model following the interest ratehikes of 1980-81 accounts for a substantial part of the debt forgiveness obtained by the mainLatin American countries through the Brady agreements.
    Keywords: sovereign debt, default, capital flows, optimal contract, world interest rates
    JEL: F3 F4 G1
    Date: 2008–02
  28. By: Kurt F. Lewis
    Abstract: This paper demonstrates the properties of and a solution method for the more general two-period Rational Inattention model of Sims (2006). It is shown that the corresponding optimization problem is convex and can be solved very quickly. This paper also demonstrates a computational tool well-suited to solving Rational Inattention models and further illustrates a critique raised in Sims (2006) regarding Rational Inattention models whose solutions assume parametric formulations rather than solve for their optimally-derived, non-parametric counterparts.
    Date: 2008
  29. By: Daron Acemoglu; Munther A. Dahleh; Ilan Lobel; Asuman Ozdaglar
    Abstract: We study the perfect Bayesian equilibrium of a model of learning over a general social network. Each individual receives a signal about the underlying state of the world, observes the past actions of a stochastically-generated neighborhood of individuals, and chooses one of two possible actions. The stochastic process generating the neighborhoods defines the network topology (social network). The special case where each individual observes all past actions has been widely studied in the literature. We characterize pure-strategy equilibria for arbitrary stochastic and deterministic social networks and characterize the conditions under which there will be asymptotic learning -- that is, the conditions under which, as the social network becomes large, individuals converge (in probability) to taking the right action. We show that when private beliefs are unbounded (meaning that the implied likelihood ratios are unbounded), there will be asymptotic learning as long as there is some minimal amount of "expansion in observations". Our main theorem shows that when the probability that each individual observes some other individual from the recent past converges to one as the social network becomes large, unbounded private beliefs are sufficient to ensure asymptotic learning. This theorem therefore establishes that, with unbounded private beliefs, there will be asymptotic learning an almost all reasonable social networks. We also show that for most network topologies, when private beliefs are bounded, there will not be asymptotic learning. In addition, in contrast to the special case where all past actions are observed, asymptotic learning is possible even with bounded beliefs in certain stochastic network topologies.
    JEL: C72 D83
    Date: 2008–05
  30. By: Agnes Benassy-Quere; Sophie Bereau; Valérie Mignon
    Abstract: In this paper, we investigate different views of equilibrium exchange rates within a single, stock-flow adjustment framework. We then compare FEER and BEER estimations of equilibrium exchange rates based on the same, econometric model of the net foreign asset position, with special focus on the euro-dollar rate. These estimations suggest that, although more robust to alternative assumptions, the BEER approach may rely on excessive confidence on past behaviors in terms of portfolio allocation. Symmetrically, FEERs may underestimate the plasticity of international capital markets because they focus on the adjustment of the trade balance.
    Keywords: Equilibrium exchange rates; euro-dollar; FEER; BEER; global imbalances
    JEL: F31 C23
    Date: 2008–03
  31. By: Tigran Poghosyan; Evzen Kocenda
    Abstract: We address the issue of foreign exchange risk and its macroeconomic determinants in several new EU members. The joint distribution of excess returns in the foreign exchange market and the observable macroeconomic factors is modeled using the stochastic discount factor (SDF) approach and a multivariate GARCH-in-mean model. We find that in post-transition economies real factors play a small role in determining foreign exchange risk, while nominal and monetary factors have a significant impact. Therefore, to contribute to the further stability of their domestic currencies, the central banks in the new EU member countries should continue stabilization policies aimed at achieving nominal convergence with the core EU members, as nominal factors play a crucial role in explaining the variability of the risk premium.
    Keywords: foreign exchange risk, time-varying risk premium, stochastic discount factor, multivariate GARCH-in-mean, post-transition and emerging markets
    JEL: C22 F31 G15 P59
    Date: 2007–11–01
  32. By: Raquel Fonseca; Lise Patureau
    Abstract: This paper investigates the sources of business cycle comovement within the New Open Economy Macroeconomy framework. It sheds new light on the business cycle comovement issue by examining the role of cross-country divergence in labor market institutions. The authors first document stylized facts supporting that heterogeneous labor market institutions are associated with lower cross-country GDP correlations among OECD countries. They then investigate this fact within a two-country dynamic general equilibrium model with frictions on the good and labor markets. On the good-market side, they model monopolistic competition and nominal price rigidity. Labor market frictions are introduced through a matching function ˆ la Mortensen and Pissarides (1999). Their conclusions disclose that heterogenous labor market institutions amplify the crosscountry GDP differential in response to aggregate shocks. In quantitative terms, they contribute to reduce cross-country output correlation, when the model is subject to real and/or monetary shocks. Their overall results show that taking into account labor market heterogeneity improves their understanding of the quantity puzzle.
    Keywords: International business cycle, labor market institutions, wage bargaining
    JEL: E24 E32 F41
    Date: 2008–04
  33. By: James T. E. Chapman
    Abstract: Given the increasing interdependence of both financial systems and attendant payment and settlement systems a vital question is what form should optimal policy take when there are two connected payment systems with separate regulators. In this paper I show that two central banks operating in a non-cooperative way will not have an incentive to achieve the optimal allocation of goods. I further show that this non-cooperative outcome will be supported by a zero intraday interest rate and constant fixed exchange rate. This is in contrast to recent research; which has shown that domestically a zero intraday interest rate will achieve a social optimum and that the central bank has an incentive to achieve it.
    Keywords: Payment, clearing, and settlement systems; Exchange rate regimes
    JEL: E58 E42 F31 F33
    Date: 2008
  34. By: Burcu Eyigungor
    Abstract: In a reasonably calibrated Mortensen and Pissarides matching model, shocks to average labor productivity can account for only a small portion of the fluctuations in unemployment and vacancies (Shimer (2005a)). In this paper, the author argues that if vintage specific shocks rather than aggregate productivity shocks are the driving force of fluctuations, the model does a better job of accounting for the data. She adds heterogeneity in jobs (matches) with respect to the time the job is created in the form of different embodied technology levels. The author also introduces specific capital that, once adapted for a match, has less value in another match. In the quantitative analysis, she shows that shocks to different vintages of entrants are able to account for fluctuations in unemployment and vacancies and that, in this environment, specific capital is important to decreasing the volatility of the destruction rate of existing matches.
    Keywords: Unemployment
    Date: 2008
  35. By: Matthews, Kent; Minford, Patrick; Naraidoo, Ruthira
    Abstract: This paper develops a political economy model of multiple unemployment equilibria to provide a theory of an endogenous natural rate of unemployment. This model is applied to the UK and the US interwar period which is remembered as the decade of mass unemployment. The theory here sees the natural rate and the associated path of unemployment as a reaction to shocks (mainly demand in nature) and the institutional structure of the economy. The channel through which these two forces feed on each other is a political economy process whereby voters with limited information on the natural rate react to shocks by demanding more or less social protection. The reduced form results obtained confirm a pattern of unemployment behaviour in which unemployment moves between high and low equilibria in response to shocks.
    Keywords: "vicious" and "virtuous" circles; bootstrapping; Equilibrium unemployment; forecasting; Political economy
    JEL: E24 E27 P16
    Date: 2008–05
  36. By: Alexandre Sokic
    Abstract: This paper aims at providing some new theoretical support for money demand functions in monetary hyperinflation analysis given the well known failure of Cagan based inflationary finance models to produce explosive hyperinflation. An analytical approach is used to characterize the agents’ preferences which are compatible with monetary hyperinflation. In the context of a MIUF model, we show that the possibility of explosive hyperinflation paths depends on a sufficient level of money essentiality in the sense of Scheinkman (1980) which is conveyed by the agents’ preferences. This result emerges without any ad-hoc assumption implying the inclusion of some friction in the adjustment of some nominal variable. It suggests that monetary hyperinflation analysis under perfect foresight requires abandoning the Cagan money demand and adopting a demand for money respecting money essentiality. Theoretical support is brought to inelastic functional forms of money demand and specifically to the double-log schedule.
    Keywords: money demand, monetary hyperinflation, inflation tax, money essentiality.
    JEL: E31 E41
    Date: 2008
  37. By: Alexandre Sokic
    Abstract: This paper uses an analytical approach and the precise definition of money essentiality given by Scheinkman (1980) with the aim to establish a formal theoretical link between the possibility of hyperinflationary paths and the concept of money essentiality. In this respect the paper contributes to the understanding of the well known failure of Cagan based inflationary finance models to produce explosive hyperinflation. We consider two standard optimizing monetary models representing alternative ways of modelling the transaction role of money. The paper considers a money-in-the-utility-function model and a cash-in-advance model where representative agent’s preferences are represented by general utility functions. We show that modelling monetary hyperinflation with perfect foresight is closely linked to the concept of money essentiality as defined by Scheinkman (1980). The possibility of explosive monetary hyperinflation in a perfect foresight inflationary finance model always relies on a sufficient level of money essentiality. The main contribution of this paper is to show that, whether in a cash-in-advance or in a money-in-the-utility-function framework, this sufficient level of money essentiality does not depend on the specific way, cash-in-advance or moneyin- the-utility-function, of modelling the role of money as a medium of exchange.
    Keywords: monetary hyperinflation, inflation tax, money essentiality.
    JEL: E31 E41
    Date: 2008
  38. By: Virginie Coudert; Cecile Couharde
    Abstract: Pegged exchange rates are often pointed out as more prone to risk of overvaluation, because their real exchange rates have a tendency to appreciate. We check this assumption empirically over a large sample of emerging and developing countries, by using two databases for de facto classifications by Levy-Yeyati and Sturzenegger (2003) and by Reinhart and Rogoff (2004). We assess currency misalignments by estimating real equilibrium exchange rates taking into account a Balassa effect and the impact of net foreign assets. Pegged currencies are shown to be more overvalued than floating ones.
    Keywords: Exchange rate regimes; emerging and developing countries; misalignments
    JEL: F31 F33
    Date: 2008–04
  39. By: Mehrotra, Aaron (BOFIT); Kozluk , Tomasz (BOFIT)
    Abstract: We study the effects of Chinese monetary policy shocks on China’s major trading partners in East Asia by estimating structural vector autoregressive (SVAR) models for six economies in the region. We find that a monetary expansion in Mainland China leads to an increase in real GDP (temporary) and the price level (permanent) in a number of economies in our sample, most notably in Hong Kong and the Philippines. The impact could result from intertemporal substitution present in a general equilibrium framework which allows for positive domestic impacts of foreign monetary expansions. Our results emphasize the growing importance of China for its neighboring economies and the significance of Chinese shocks for the design of monetary policy in Asian economies.
    Keywords: monetary policy shocks; Asian production chain; SVAR; East Asia; China
    JEL: E52 F42
    Date: 2008–06–03
  40. By: Jean-Pierre Allégret (GATE, University of Lyon, CNRS, ENS-LSH, Centre Léon Bérard, France); Alain Sand-Zantman (GATE, University of Lyon, CNRS, ENS-LSH, Centre Léon Bérard, France)
    Abstract: This paper analyses the monetary consequences of the Latin-American trade integration process. We consider a sample of five countries –Argentina, Brazil, Chile, Mexico and Uruguay- spanning the period 1991-2007. The main question raised pertains to the feasibility of a monetary union between L.A. economies. To this end, we study whether this set of countries is characterized by business cycle synchronization with the occurrence of common shocks, a strong similarity in the adjustment process and the convergence of policy responses. We focus especially our attention on two points. First, we try to determine to what extent international disturbances influence the domestic business cycles through trade and/or financial channels. Second, we analyze the impact of the adoption of different exchange rate regimes on the countries’ responses to shocks. All these features are the main issues in the literature relative to regional integration and OCA process.
    Keywords: bayesian VAR, business cycles, Latin American countries, optimum currency area
    JEL: C32 E32 F42
    Date: 2008
  41. By: Jorge Carrera (Banco Central de la Republica Argentina, Buenos Aires and Universidad Nacional de La Plata); Romain Restout (GATE, University of Lyon, CNRS, ENS-LSH, Centre Léon Bérard, France)
    Abstract: This paper investigates the long run behavior of real exchange rates in nineteen countries of Latin America over the period 1970 - 2006. Our data does not support the Purchasing Power Parity (PPP) hypothesis, implying that real shocks tend to have permanent effects on Latin America’s real exchange rates. By exploiting the advantage of non stationary panel econometrics, we are able to determinate factors that drive real exchanges rate in the long run : the Balassa-Samuelson effect, government spending, the terms of trade, the openness degree, foreign capital flows and the de facto nominal exchange regime. The latter effect has policy implications since we find that a fixed regime tends to appreciate the real exchange rate. This finding shows the non neutrality of exchange rate regime regarding its effects on real exchange rates. We also run estimations for country subgroups (South America versus Caribbean and Central America). Regional results highlight that several real exchange rates determinants are specific to one geographic zone. Finally, we compute equilibrium real exchange rate estimations. Two main results are derived from the investigation of misalignments, [i ] eight real exchange rates are quite close to their equilibrium level in 2006, and [ii ] our model shows that a part of currencies crises that arose in Latin America was preceded by a real exchange rate overvaluation.
    Keywords: equilibrium real exchange rate, panel cointegration, panel unit roots
    JEL: C23 F31
    Date: 2008
  42. By: Neil Dias Karunaratne (School of Economics, The University of Queensland)
    Abstract: In this paper the polemics and empirics on the sustainability of Australia’s high current account deficits and foreign debt that prevailed during the period 1959q3-2007q1 is revisited. The paper contends that the forces of globalization brought about a policy regime shift culminating in the floating of the Australian dollar in 1983q4. However, the policymakers failed to abandon the static old paradigm, the Keynesian-Mundell-Fleming model, which had been rendered obsolete by the policy regime shift. The policymakers continued to distill their activist policies to reduce the high current account deficits from an outmoded paradigm. The proponents of the rival new paradigm argued that the current account imbalances were the residual outcome of rational optimizing decisions of private sector agents and therefore the use of activist policies to target the reduction of the current account deficits as proposed by the adherents of the old paradigm were misconceived. The ensuing clash between the proponents of rival paradigms fuelled the policy polemics during almost a decade after the paradigm shift that occurred at the same time as the floating of the exchange rate. The activist policies failed to halt the rise in the current account deficits and foreign debt and the predicted dire economic consequences from the failure to rein in the current account deficit never materialized. Today, the current deficits and the foreign debt are at record high levels by historical standards, but they do not seem to grab the attention of the policymakers or make media headlines as in the past. The empirical results offer qualified support for prevalence of consumption smoothing during both the pre and post-float periods. The finding in favour of consumption-smoothing during the pre-float era is at odds with the findings of other studies. There appears to be evidence supporting the hypothesis that a regime-shift due to globalization and it occurred at the same time as the float and was reflected in an increase in consumption-tilting. Post-float and during the entire study period Australia, appears to have satisfied the intertemporal budget constraint and remained solvent. Furthermore, both over the whole sample period and post float period Australia appears to have engaged in effective consumption-smoothing notwithstanding the polemics and some empirics to the contrary. The solvency and consumption smoothing dynamics observed for Australia during the study period supports the new paradigm’s non-activist policy stance towards high current account deficits. However, it should be noted that this passive policy stance that is intertemporally optimal for achieving current account sustainability in Australia may not be applicable in other countries with high current account deficits because they may idiosyncratic features that differ widely from those prevalent in Australia.
    Date: 2008
  43. By: Abhijit Sen Gupta (Indian Council for Research on International Economic Rela; Indian Council for Research on International Economic Rela)
    Abstract: Most of the existing literature has used single reserve adequacy measures to evaluate the volume of excess reserves. In this paper, we employ empirical methods to generate a comprehensive reserve adequacy measure, incorporating the various objectives of holding reserves, and compare the actual reserve accumulation experience of various emerging markets with the prediction of our empirical model. Using this comprehensive reserve adequacy measure, we calculate the cost of holding excess reserves for India by looking at three different alternative uses of resources. We find that India is foregoing as much as 2 of its GDP by accumulating reserves instead of employing resources in alternative uses.
    Keywords: Reserve Holdings, Reserve Management
    JEL: F37 F47 C33
    Date: 2008–03

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