nep-cba New Economics Papers
on Central Banking
Issue of 2008‒06‒27
38 papers chosen by
Alexander Mihailov
University of Reading

  1. Optimal Monetary Policy in an Operational Medium-Sized DSGE Model By Malin Adolfson; Stefan Laseen; Jesper Linde; Lars E.O. Svensson
  2. On the Welfare Cost of Inflation and the Recent Behavior of Money Demand By Peter N. Ireland
  3. Short-run Exchange-Rate Dynamics: Theory and Evidence By John A Carlson; Christian M. Dahl; Carol L. Osler
  4. Exchange Rate Regimes and Capital Mobility: How Much of the Swoboda Thesis Survives? By Barry Eichengreen
  5. Interest Rate Forecasts: A Pathology By Wen Bin Lim; Charles Goodhart
  6. International Bank Portfolios: Short- and Long-Run Responses to the Business Cycle By Sven Blank; Claudia M. Buch
  7. Real-Time Price Discovery in Global Stock, Bond and Foreign Exchange Markets By Torben G. Andersen; Tim Bollerslev; Francis X. Diebold; Clara Vega
  8. Arbitrage in the Foreign Exchange Market: Turning on the Microscope By Akram, Qaisar Farooq; Rime, Dagfinn; Sarno, Lucio
  9. Fiscal, Monetary, and Financial Interactions in Dynamic General Equilibrium By Strulik, Holger
  10. Monetary and Fiscal Policy Interaction: What is the Role of the Transaction Cost of the Tax System in Stabilisation Policies? By Panagiotis Chronis; Aspassia Strantzalou
  11. Inflation Risk Premia and Survey Evidence on Macroeconomic Uncertainty By Paul Söderlind
  12. Deconstructing Shocks and Persistence in OECD Real Exchange Rates By Syed A. Basher; Josep Lluis Carrión-i-Silvestre
  13. Ensuring the Validity of the Micro Foundation in DSGE Models By Martin Møller Andreasen
  14. Real Exchange Rate Dynamics under Staggered Loan Contracts By Ippei Fujiwara; Yuki Teranishi
  15. Do Peso Problems Explain the Returns to the Carry Trade? By Burnside, A Craig; Eichenbaum, Martin; Kleshchelski, Isaac; Rebelo, Sérgio
  16. Market Microstructure Approach to the Exchange Rate Determination Puzzle By Thabo Mokoena; Rangan Gupta; Renee Van Eyden
  17. The Measurement of Globalisation using International Imput-Outpout Tables By Koen De Backer; Norihiko Yamano
  18. Banking Globalization, Monetary Transmission, and the Lending Channel By Nicola Cetorelli; Linda S. Goldberg
  19. Monetary policy, asset prices and model uncertainty. By Meixing DAI; Eleftherios SPYROMITROS
  20. "Habit Formation and the Present-Value Model of the Current Account: Yet Another Suspect" By Takashi Kano
  21. Exact rational expectations, cointegration, and reduced rank regression By Søren Johansen; Anders Rygh Swensen
  22. Resuscitating the credit cycle By Patrick A. Pintus; Yi Wen
  23. Capital Market Imperfections and the Theory of Optimum Currency Areas By Pierre-Richard Agenor; Joshua Aizenman
  24. Testing for conditional heteroscedasticity in the components of inflation By Carmen Broto; Esther Ruiz
  25. Non-linear DSGE Models, The Central Difference Kalman Filter, and The Mean Shifted Particle Filter By Martin Møller Andreasen
  26. Long memory modelling of inflation with stochastic variance and structural breaks By Charles S. Bos; Siem Jan Koopman; Marius Ooms
  27. Time-Varying Effects of Oil Supply Shocks on the US Economy By C. BAUMEISTER; G. PEERSMAN
  28. Testing hypotheses in an I(2) model with applications to the persistent long swings in the Dmk/$ rate By Søren Johansen; Katarina Juselius; Roman Frydberg; Michael Goldberg
  29. Does Government Spending Optimally Crowd in Private Consumption? By Michal Horvath
  30. The external finance premium and the macroeconomy: US post-WWII evidence By Ferre De Graeve
  31. Globalisation, domestic inflation and the global output gaps: evidence from the Euro era By Alessandro Calza
  32. Implementing monetary policy in the 2000s: operating procedures in Asia and beyond By Corrinne Ho
  33. Globalization Effect on both Inflation and Domestic Monetary Policy By Adamcik, Santiago
  34. Testing a Model of the UK by the Method of Indirect Inference By Meenagh, David; Minford, Patrick; Theodoridis, Konstantinos
  35. European Economic Growth, 1950-2005: An Overview By Crafts, Nicholas; Toniolo, Gianni
  36. Bounded Decision Making: From Description to Improvement By Dolly Chugh; Katherine Lyford Milkman; Max H. Bazerman
  37. Inflation dynamics in a small open-economy model under inflation targeting: some evidence from Chile By Marco Del Negro; Frank Schorfheide
  38. Searching for the Natural Rate of Unemployment in a Large Relative Price Shocks' Economy: the Brazilian Case By Tito Nícias Teixeira da Silva Filho

  1. By: Malin Adolfson; Stefan Laseen; Jesper Linde; Lars E.O. Svensson
    Abstract: We show how to construct optimal policy projections in Ramses, the Riksbank's open-economy medium-sized DSGE model for forecasting and policy analysis. Bayesian estimation of the parameters of the model indicates that they are relatively invariant to alternative policy assumptions and supports that the model may be regarded as structural in a stable low inflation environment. Past policy of the Riksbank until 2007:3 (the end of the sample used) is better explained as following a simple instrument rule than as optimal policy under commitment. We show and discuss the differences between policy projections for the estimated instrument rule and for optimal policy under commitment, under alternative definitions of the output gap, different initial values of the Lagrange multipliers representing policy in a timeless perspective, and different weights in the central-bank loss function.
    JEL: E52 E58 F41
    Date: 2008–06
  2. By: Peter N. Ireland
    Abstract: Post-1980 U.S. data trace out a stable long-run money demand relationship of Cagan's semi-log form between the M1-income ratio and the nominal interest rate, with an interest semi-elasticity below 2. Integrating under this money demand curve yields estimates of the welfare costs of modest departures from Friedman's zero nominal interest rate rule for the optimum quantity of money that are quite small. The results suggest that the Federal Reserve's current policy, which generates low but still positive rates of inflation, provides an adequate approximation in welfare terms to the alternative of moving all the way to the Friedman rule.
    JEL: E31 E41 E52
    Date: 2008–06
  3. By: John A Carlson; Christian M. Dahl; Carol L. Osler (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: Recent research has revealed a wealth of information about the microeconomics of currency markets and thus the determination of exchange rates at short horizons. This information is valuable to us as scientists since, like evidence of macroeconomic regularities, it can provide critical guidance for designing exchange-rate models. This paper presents an optimizing model of short-run exchange-rate dynamics consistent with both the micro evidence and the macro evidence, the first such model of which we are aware. With respect to microeconomics, the model is consistent with the institutional structure of currency markets, it accurately reflects the constraints and objectives faced by the major participants, and it fits key stylized facts concerning returns and order flow. With respect to macroeconomics, the model is consistent with most of the major puzzles that have emerged under floating rates.
    Keywords: Exchange-rate dynamics, currency market microstructure
    JEL: F31 G12 G15
    Date: 2008–01–07
  4. By: Barry Eichengreen
    Abstract: Alexander Swoboda is one of the originators of the bipolar view that capital mobility creates pressure for countries to abandon intermediate exchange rate arrangements in favor of greater flexibility and harder pegs. This paper takes another look at the evidence for this hypothesis using two popular de facto classifications of exchange rate regimes. That evidence supports the bipolar view for the advanced countries, the sample for which it was originally developed, but not obviously for emerging markets and other developing countries. One interpretation of the contrast is that there is a tendency to move away from intermediate regimes in the course of economic and financial development, implying that emerging markets and other developing countries will eventually abandon intermediate regimes as well. Another interpretation is that the advanced countries have been faster to abandon soft pegs because they have been faster to develop attractive alternatives, notably Europe's monetary union. In this view, other countries are unlikely to abandon soft pegs because of the absence of the distinctive political conditions that have made the European alternative feasible. A final interpretation is that the advanced countries have been able to abandon soft peg because of their success in substituting inflation targeting for exchange rate targeting as the anchor for monetary policy. The paper presents some evidence for this view, which suggests the feasibility of further movement by emerging markets and developing countries in the direct of greater exchange rate flexibility.
    JEL: F31
    Date: 2008–06
  5. By: Wen Bin Lim; Charles Goodhart
    Abstract: This is the first of three prospective papers examining how well forecasters can predict the future time path of short-term interest rates. Most prior work has been done using US data; in this exercise we use forecasts made for New Zealand (NZ) by the Reserve Bank of New Zealand (RBNZ), and those derived from money market yield curves in the UK. In this first exercise we broadly replicate recent US findings for NZ and UK, to show that such forecasts in NZ and UK have been excellent for the immediate forthcoming quarter, reasonable for the next quarter and useless thereafter. Moreover, when ex post errors are assessed depending on whether interest rates have been upwards, or downwards, trending, they are shown to have been biased and, apparently, inefficient. In the second paper we shall examine whether (NZ and UK) forecasts for inflation exhibit the same syndromes, and whether errors in inflation forecasts can help to explain errors in interest rate forecasts. In the third paper we shall set out an hypothesis to explain those findings, and examine whether the apparent ex post forecast inefficiencies may still be consistent with ex ante forecastefficiency. Even if the forecasts may be ex ante efficient, their negligible ex post forecasting ability suggests that, beyond a six months’ horizon from the forecast date, they would be better replaced by a simple ‘no-change thereafter’ assumption.
    Date: 2008–06
  6. By: Sven Blank; Claudia M. Buch
    Abstract: International bank portfolios constitute a large component of international country portfolios. Yet, their response to macroeconomic conditions and their impact on the international transmission of business cycles developments remains largely unexplored. We use a novel dataset on banks’ international portfolios to answer three questions. First, what are the long-run determinants of banks’ international portfolios? Second, how do banks’ international portfolios adjust to short-run macroeconomic developments? Third, does the speed of adjustment change with the degree of financial integration? We provide evidence of significant long-run cointegration relationships between cross-border assets and liabilities of banks and key macroeconomic variables. Both, the long-run determinants of banks’ international portfolios as well as the short-run dynamics show a significant degree of heterogeneity across countries and, to some extent, over time. Gravitytype variables help explaining differences in the speed of adjustment to new equilibria.
    Keywords: international bank portfolios, macroeconomic developments, transmission channels
    JEL: F32 F42 F34
    Date: 2007–03
  7. By: Torben G. Andersen; Tim Bollerslev; Francis X. Diebold; Clara Vega (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: Using a unique high-frequency futures dataset, we characterize the response of U.S., German and British stock, bond and foreign exchange markets to real-time U.S. macroeconomic news. We find that news produces conditional mean jumps, hence high-frequency stock, bond and exchange rate dynamics are linked to fundamentals. Equity markets, moreover, react differently to news depending on the stage of the business cycle, which explains the low correlation between stock and bond returns when averaged over the cycle. Hence our results qualify earlier work suggesting that bond markets react most strongly to macroeconomic news, in particular, when conditioning on the state of the economy, the equity and foreign exchange markets appear equally responsive. Finally, we also document important contemporaneous links across all markets and countries, even after controlling for the effects of macroeconomic news.
    Keywords: Asset Pricing, Macroeconomic News Announcements, Financial Market Linkages, Market Microstructure, High-Frequency Data, Survey Data, Asset Return Volatility, Forecasting
    JEL: F3 F4 G1 C5
    Date: 2007–08–16
  8. By: Akram, Qaisar Farooq; Rime, Dagfinn; Sarno, Lucio
    Abstract: This paper provides real-time evidence on the frequency, size, duration and economic significance of arbitrage opportunities in the foreign exchange market. We investigate deviations from the covered interest rate parity (CIP) condition using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency. The analysis unveils that: i) short-lived violations of CIP arise; ii) the size of CIP violations can be economically significant; iii) their duration is, on average, high enough to allow agents to exploit them, but low enough to explain why such opportunities have gone undetected in much previous research using data at lower frequency.
    Keywords: arbitrage; covered interest rate parity; exchange rates; foreign exchange microstructure
    JEL: F31 F41 G14 G15
    Date: 2008–06
  9. By: Strulik, Holger
    Abstract: This paper proposes a model that links households and firms, as usual, by markets for factors and goods and, additionally, by a banking sector that channels households' funds to firms and eliminates idiosyncratic risk. In equilibrium, agency costs and tax benefits of corporate debt are equalizing each other, which renders an institutionally based explanation of financial structure. Adjustment of corporate finance adds to the ordinary savings channel of fiscal and monetary policy. Taking real and financial interactions into account, the model predicts a somewhat lower impact of fiscal policy on macroeconomic aggregates as commonly assessed and a much stronger impact of monetary policy. This amplification is caused by the banking sector's translation of borrowing rates into lending rates and vice versa.
    Keywords: Fiscal Policy, Monetary Policy, Corporate Finance, Agency Costs, Banking, Economic Growth, Business Cycles.
    JEL: E44 E52 E62 O16
    Date: 2008–06
  10. By: Panagiotis Chronis (Bank of Greece); Aspassia Strantzalou (Ministry of Employment and Social Protection, Greece)
    Abstract: In the theory of monetary and fiscal policy interaction, the assumption of Ricardian households isolates the determinants of fiscal policy instrument from the price stabilization policies carried out by the central bank. One of the main implications of the above mentioned Ricardian assumption is that the fiscal policy does not have any distortionary effect for the economy, i.e. it does not affect the behaviour of the households, supporting that way the fiscal policy’s neutrality. The argument for this view comes if one assumes that fiscal policy has a distortionary effect on the behaviour of the agents. We relax the above non distortionary assumption by assuming that the imposition of the taxes is consistent with a transaction cost of the tax system that underlies the state - tax payer interaction. In this way we develop a channel through which the stability of prices carried out by the independent central bank is, within optimality, also a function of the fiscal policy determinants (the transaction cost, the tax rates and the debt level). The analysis is carried out in a framework of a monetary union, with two different countries. Within this framework, the effectiveness of a numerical fiscal rule is also examined.
    Keywords: Monetary and fiscal policy interactions; Transaction cost of the tax system; Probability of re-election; Stability and growth pact
    JEL: E52 E58 E62 E63 H60
    Date: 2008–05
  11. By: Paul Söderlind
    Abstract: Nominal and real U.S. interest rates (1997-2007) are combined with inflation expectations from the Survey of Professional Forecasters to calculate time series of "inflation risk premia." It is shown that survey data on inflation and output growth uncertainty, as well as a proxy for liquidity premia can explain a large amount of the variation in these risk premia.
    Keywords: break-even inflation; liquidity premium, Survey of Professional Forecasters
    JEL: E27 E47
    Date: 2008–06
  12. By: Syed A. Basher (Department of Economic Policies, Qatar Central Bank, Doha, Qatar.); Josep Lluis Carrión-i-Silvestre (AQR-IREA, University of Barcelona.)
    Abstract: This paper analyzes the persistence of shocks that affect the real exchange rates for a panel of seventeen OECD developed countries during the post-Bretton Woods era. The adoption of a panel data framework allows us to distinguish two different sources of shocks, i.e. the idiosyncratic and the common shocks, each of which may have di¤erent persistence patterns on the real exchange rates. We first investigate the stochastic properties of the panel data set using panel stationarity tests that simultaneously consider both the presence of cross-section dependence and multiple structural breaks that have not received much attention in previous persistence analyses. Empirical results indicate that real exchange rates are non-stationary when the analysis does not account for structural breaks, although this conclusion is reversed when they are modeled. Consequently, misspecification errors due to the non-consideration of structural breaks leads to upward biased shocks' persistence measures. The persistence measures for the idiosyncratic and common shocks have been estimated in this paper always turn out to be less than one year.
    Date: 2008–06
  13. By: Martin Møller Andreasen (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: The presence of i) stochastic trends, ii) deterministic trends, and/or iii) stochastic volatil- ity in DSGE models may imply that the agents' objective functions attain infinite values. We say that such models do not have a valid micro foundation. The paper derives sufficient condi- tions which ensure that the objective functions of the households and the firms are finite even when various trends and stochastic volatility are included in a standard DSGE model. Based on these conditions we test the validity of the micro foundation in six DSGE models from the literature. The models of Justiniano & Primiceri (American Economic Review, forth- coming) and Fernández-Villaverde & Rubio-Ramírez (Review of Economic Studies, 2007) do not satisfy these sufficient conditions, or any other known set of conditions ensuring finite values for the objective functions. Thus, the validity of the micro foundation in these models remains to be established.
    Keywords: Deterministic trends, DSGE models, Error distributions, Moment generating functions, Stochastic trends, Stochastic volatility, Unit-roots
    JEL: E10 E30
    Date: 2008–05–26
  14. By: Ippei Fujiwara (Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: ippei.fujiwara; Yuki Teranishi (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: yuuki.teranishi
    Abstract: In this paper, we investigate the relationship between real exchange rate dynamics and financial market imperfections. For this purpose, we first construct a New Open Economy Macroeconomics (NOEM) model that incorporates international staggered loan contracts as a simple form of the financial market imperfections. Recent empirical studies show that such staggered loan contracts are prevalent in the US, UK, and Japan and direct shocks to the bank lending interest rate (risk premium shocks) are major drivers of business cycle dynamics. Simulation results only with such a financial market friction and a risk premium shock can generate persistent, volatile, and realistic hump-shaped responses of real exchange rates, which have been thought very difficult to reproduce in standard NOEM models. This implies that these financial market developments can possibly be a major source of real exchange rate fluctuations.
    Keywords: Financial Market Imperfections, Real Exchange Rates, Staggered Loan Contracts
    JEL: F31 E41
    Date: 2008–06
  15. By: Burnside, A Craig; Eichenbaum, Martin; Kleshchelski, Isaac; Rebelo, Sérgio
    Abstract: Currencies that are at a forward premium tend to depreciate. This `forward-premium puzzle' is an egregious deviation from uncovered interest parity. We document the properties of the carry trade, a currency speculation strategy that exploits this anomaly. This strategy consists of borrowing low-interest-rate currencies and lending high-interest-rate currencies. We first show that the carry trade yields a high Sharpe ratio that is not a compensation for risk. We then consider a hedged version of the carry trade, which protects the investor against large, adverse currency movements. This strategy, implemented with currency options, yields average payoffs that are statistically indistinguishable from the average payoffs to the standard carry trade. We argue that this finding implies that the peso problem cannot be a major determinant of the payoff to the carry trade.
    Keywords: carry trade; exchange rates; Uncovered interest parity
    JEL: F31
    Date: 2008–06
  16. By: Thabo Mokoena (South African Reserve Bank, Pretoria); Rangan Gupta (Department of Economics, University of Pretoria); Renee Van Eyden (Department of Economics, University of Pretoria)
    Abstract: The market microstructure approach has been applied to the three major puzzles of exchange rate economics: the forward bias puzzle, the excess volatility puzzle, and the exchange rate determination puzzle. It claims that the imbalances between ‘buyer-initiated and seller-initiated trades’ in foreign exchange markets are indicative of the transmission link between exchange rates and fundamental determinants of exchange rates. In the context of the exchange rate determination puzzle, this paper discusses the market microstructure approach from the stand point of hybrid models that integrate order flow, fundamentals and non-fundamental variables to establish the determinants of the rand-dollar exchange rate. Among the non-fundamentals considered is the Economist commodity price index, the relevance of which is based on Chen and Rogoff (2002). Another non-fundamental variable included is a proxy for country risk—the differential between the Global Emerging Market Bond Index and the South African long-term bond. The paper relies on the autoregressive distributed lag (ARDL) model of Persaran, Shin and Smith (2001) and as explained in Persaran and Persaran (1997). The ARDL approach to cointegration does not require pre-testing for the integration properties of the individual series used in the empirical analysis. Instead, it relies on a bounds testing procedure. In this setting, inference is based on an F-test on the significance of lagged levels of variables in the error correction form. The results, based on the Schwarz Bayesian Criterion for choosing a model’s lag length, show that the there is a long-run relationship between the rand-dollar real exchange rate, nonfundamentals, the fundamentals and the proxy for order flow, which is the dollar-denominated daily net turnover on the South African markets.
    Keywords: Market Microstructure, Real Exchange Rates, ARDL
    JEL: C32
    Date: 2008–06
  17. By: Koen De Backer; Norihiko Yamano
    Abstract: One of the distinctive characteristics of the current globalisation process is the emergence of global value chains. Within global value chains and international production networks, not only are final goods traded internationally, but intermediate goods (parts and components) and, in recent years, services also increasingly are. This trend significantly alters the economic relations between countries and increasingly casts doubt on empirical indicators such as trade and FDI that are traditionally used to measure globalisation. Input-output tables may provide much finer detail in describing current globalisation as they offer information on the use of goods instead of the rather arbitrary classification schemes that divide goods into intermediate and other categories. Moreover, input-output tables also incorporate information on the use of services, enabling measurement of the increasing offshoring of service activities in today's business activities. Based on the OECD Input-Output Database, which includes harmonised tables for 38 countries (of which 10 emerging non-OECD economies), this paper brings together empirical evidence on the growing importance of global value chains and the increasing interdependence between countries. Input-output indicators are presented for individual countries and individual industries, aiming to demonstrate the changing characteristics of current globalisation.
    Date: 2007–12–31
  18. By: Nicola Cetorelli; Linda S. Goldberg
    Abstract: The globalization of banking in the United States is influencing the monetary transmission mechanism both domestically and in foreign markets. Using quarterly information from all U.S. banks filing call reports between 1980 and 2005, we find evidence for the lending channel for monetary policy in large banks, but only those banks that are domestically-oriented and without international operations. We show that the large globally-oriented banks rely on internal capital markets with their foreign affiliates to help smooth domestic liquidity shocks. We also show that the existence of such internal capital markets contributes to an international propagation of domestic liquidity shocks to lending by affiliated banks abroad. While these results imply a substantially more active lending channel than documented in the seminal work of Kashyap and Stein (2000), the lending channel within the United States is declining in strength as banking becomes more globalized.
    JEL: E5 F3 G20 G3
    Date: 2008–06
  19. By: Meixing DAI; Eleftherios SPYROMITROS
    Abstract: Using a macroeconomic model with asset prices, we analyze how optimal monetary policy, and macroeconomic dynamics and performance are affected by the central bank’s desire to be robust against model misspecifications. Considering the worst-case model, we show that an increase in the central bank’s preference for robustness requires a more aggressive reaction of the optimal nominal interest rate with respect to expected inflation and inflation shocks. According to the value of structural parameters, the economic equilibrium can be stable or saddle-point stable. In both cases, the speed of dynamic convergence is smaller under robust control compared to a benchmark case without it. Finally, an increase in the preference for robustness reinforces the reaction of current and expected future inflation, asset prices and output-gap to inflation shocks. However, the preference for robustness has no effect on the reaction of asset prices to the shocks affecting goods demand and financial markets.
    Keywords: Monetary policy, asset prices, model uncertainty, macro-financial stability.
    JEL: E44 E52 E58
    Date: 2008
  20. By: Takashi Kano (University of Tokyo)
    Abstract: A recent paper claims that habit formation in consumption plays an important role in current account fluctuations in selected developed countries, extending the present-value model of the current account (PVM) with consumption habits. In this paper, however, I show that the habit-forming PVM is observationally equivalent to the PVM augmented with persistent transitory consumption, which is induced by world real interest rate shocks. Based on a small open-economy real business cycle (SOE-RBC) model endowed with consumption habits as well as persistent world real interest rate shocks, this paper resolves the inherent identification problem of the habit-forming PVM by Bayesian methods to seek effects of habit formation on current account fluctuations in typical small open economies, Canada and the United Kingdom. Results reveal no clear evidence that habit formation plays a crucial role in current account fluctuations.
    Date: 2008–06
  21. By: Søren Johansen; Anders Rygh Swensen (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: We interpret the linear relations from exact rational expectations models as restrictions on the parameters of the statistical model called the cointegrated vector autoregressive model for non-stationary variables. We then show how reduced rank regression, Anderson (1951), plays an important role in the calculation of maximum likelihood estimation of the restricted parameters.
    Keywords: Exact rational expectations, Cointegrated VAR model, Reduced rank regression
    JEL: C32
    Date: 2007–12–04
  22. By: Patrick A. Pintus; Yi Wen
    Abstract: This paper resuscitates the credit-cycle theory of Kiyotaki and Moore (1997) in a two-agent RBC model with conventional preferences and standard neoclassical technologies. It is shown that small transitory shocks to credit demand (or supply) can generate large, highly persistent, dampened cycles in aggregate output. Key to our results is the interaction between credit constraints and habit formation. Credit constraints based on collateralized assets mainly amplify the impact of shocks while habit formation in consumption demand mainly propagates it. Hump-shaped boom-bust cycles do not arise in the model under standard parameter values if either one of the two elements is missing.
    Keywords: Credit
    Date: 2008
  23. By: Pierre-Richard Agenor; Joshua Aizenman
    Abstract: This paper studies how capital market imperfections affect the welfare effects of forming a currency union. The analysis considers a bank-only world where intermediaries compete in Cournot fashion and monitoring and state verification are costly. The first part determines the credit market equilibrium and the optimal number of banks, prior to joining the union. The second part discusses the benefits from joining a currency union. A competition effect is identified and related to the added monitoring costs that banks may incur when operating outside their home country, through an argument akin to the Brander-Krugman "reciprocal dumping" model of bilateral trade. Whether joining a union raises welfare of the home country is shown to depend on the relative strength of "investment creation" and "intermediation diversion" effects.
    JEL: F12 F15 F2 F36
    Date: 2008–06
  24. By: Carmen Broto (Banco de España); Esther Ruiz (Universidad Carlos III de Madrid)
    Abstract: In this paper we propose a model for monthly inflation with stochastic trend, seasonal and transitory components with QGARCH disturbances. This model distinguishes whether the long-run or short-run components are heteroscedastic. Furthermore, the uncertainty associated with these components may increase with the level of inflation as postulated by Friedman. We propose to use the differences between the autocorrelations of squares and the squared autocorrelations of the auxiliary residuals to identify heteroscedastic components. We show that conditional heteroscedasticity truly present in the data can be rejected when looking at the correlations of standardized residuals while the autocorrelations of auxiliary residuals have more power to detect conditional heteroscedasticity. Furthermore, the proposed statistics can help to decide which component is heteroscedastic. Their finite sample performance is compared with that of a Lagrange Multiplier test by means of Monte Carlo experiments. Finally, we use auxiliary residuals to detect conditional heteroscedasticity in monthly inflation series of eight OECD countries.
    Keywords: Leverage effect, QGARCH, seasonality, structural time series models, unobserved component
    JEL: C22 C52 E31
    Date: 2008–06
  25. By: Martin Møller Andreasen (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: This paper shows how non-linear DSGE models with potential non-normal shocks can be estimated by Quasi-Maximum Likelihood based on the Central Difference Kalman Filter (CDKF). The advantage of this estimator is that evaluating the quasi log-likelihood function only takes a fraction of a second. The second contribution of this paper is to derive a new particle filter which we term the Mean Shifted Particle Filter (MSPFb). We show that the MSPFb outperforms the standard Particle Filter by delivering more precise state estimates, and in general the MSPFb has lower Monte Carlo variation in the reported log-likelihood function.
    Keywords: Multivariate Stirling interpolation, Particle filtering, Non-linear DSGE models, Non-normal shocks, Quasi-maximum likelihood
    JEL: C13 C15 E10 E32
    Date: 2008–06–20
  26. By: Charles S. Bos; Siem Jan Koopman; Marius Ooms (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: We investigate changes in the time series characteristics of postwar U.S. inflation. In a model-based analysis the conditional mean of inflation is specified by a long memory autoregressive fractionally integrated moving average process and the conditional variance is modelled by a stochastic volatility process. We develop a Monte Carlo maximum likelihood method to obtain efficient estimates of the parameters using a monthly dataset of core inflation for which we consider different subsamples of varying size. Based on the new modelling framework and the associated estimation technique, we find remarkable changes in the variance, in the order of integration, in the short memory characteristics and in the volatility of volatility.
    Keywords: Time varying parameters, Importance sampling, Monte Carlo simulation, Stochastic Volatility, Fractional Integration
    JEL: C15 C32 C51 E23 E31
    Date: 2007–12–21
    Abstract: Using a Time-Varying Parameters Bayesian Vector Autoregression model, we investigate how the dynamic effects of oil supply shocks on the US economy have changed over time. In contrast to previous studies, we identify oil supply shocks with sign restrictions which are derived from a simple supply and demand model of the global oil market. First, we find a remarkable structural change in the oil market itself, i.e. a typical oil supply shock is characterized by a much smaller impact on world oil production and a greater effect on the real price of crude oil over time. A steepening of the oil demand curve is the only possible explanation for this stylized fact. Accordingly, similar physical disturbances in oil production now have a significantly higher leverage effect on oil prices resulting in a stronger impact on real GDP and consumer prices. Second, we document that the contribution of oil supply shocks to fluctuations in the real price of oil has decreased considerably over time, implying that current oil price fluctuations are more demand driven. Third, oil supply disturbances seem to have played a significant but non-exclusive role in the 1974/75 and early 1990s recessions but were of minor importance in the 1980/81 and millennium slowdowns. Finally, while oil supply shocks explain little of the "Great Inflation", their relative importance for CPI inflation variability has somewhat increased over time.
    Keywords: Oil prices, vector auto regressions, time-varying coefficients
    JEL: E31 E32 Q43
    Date: 2008–04
  28. By: Søren Johansen; Katarina Juselius; Roman Frydberg; Michael Goldberg (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: This paper discusses a number of likelihood ratio tests on long-run relations and common trends in the I(2) model and provide new results on the test of overidentifying restrictions on beta’xt and the asymptotic variance for the stochas- tic trends parameters, alpha 1: How to specify deterministic components in the I(2) model is discussed at some length. Model specification and tests are illustrated with an empirical analysis of long and persistent swings in the foreign exchange market between Germany and USA. The data analyzed consist of nominal exchange rates, relative prices, US in.ation rate, two long-term interest rates and two short-term interest rates over the 1975-1999 period. One important aim of the paper is to demonstrate that by structuring the data with the help of the I(2) model one can achieve a better understanding of the empirical regularities underlying the persistent swings in nominal exchange rates, typical in periods of floating exchange rates.
    Keywords: PPP puzzle, Forward premium puzzle, cointegrated VAR, likelihood inference
    JEL: C32 C52 F41
    Date: 2008–01–15
  29. By: Michal Horvath
    Abstract: We analyze if a rise in private consumption following an exogenous rise in government spending is a feature of the economy under optimal stabilization in a standard New Keynesian setting augmented for the presence of liquidity-constrained agents and non-separable preferences. Our results provide little evidence in support of a crowd-in effect under ‘timelessly optimal’ policy.
    Keywords: Consumption, Government Spending, Optimal Monetary and Fiscal Policy, Non-Separable Preferences, Non-Ricardian Agents.
    JEL: E21 E52 E61 E63
    Date: 2008–05
  30. By: Ferre De Graeve
    Abstract: The central variable of theories of financial frictions--the external finance premium--is unobservable. This paper distils the external finance premium from a DSGE model estimated on U.S. macroeconomic data. Within the DSGE framework, movements in the premium can be given an interpretation in terms of shocks driving business cycles. A key result is that the estimate--based solely on nonfinancial macroeconomic data--picks up over 70 percent of the dynamics of lower grade corporate bond spreads. The paper also identifies a gain in fitting key macroeconomic aggregates by including financial frictions in the model and documents how shock transmission is affected.
    Keywords: Financial markets ; Corporate bonds ; Corporations - Finance
    Date: 2008
  31. By: Alessandro Calza
    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.
    Keywords: Globalization ; Inflation (Finance) ; Monetary policy - Europe ; International trade - Europe
    Date: 2008
  32. By: Corrinne Ho
    Abstract: Just as monetary policy at the strategic level has undergone significant changes over the years, so has its day-to-day implementation. This paper documents the key features of 17 central banks' monetary operating frameworks as of early 2007 and discusses their major developments over the preceding decade. It finds that while some common themes and practices can be identified, there is no unique "best" way to implement monetary policy. Moreover, central banks everywhere - even in industrial economies - have continued to refine their operating frameworks and procedures and to innovate where necessary, responding to changing needs in changing times.
    Keywords: monetary policy implementation, operating procedures, policy rate, operating target, reserve requirements, standing facilities, discretionary operations, Asia-Pacific
    Date: 2008–06
  33. By: Adamcik, Santiago
    Abstract: This paper discusses that many of the exaggerated claims that globalization has been an important element in the reduction of the inflation in the recent years do not come true. The globalization has, however, the potential to contribute to the stabilization of economies and this has been crucial element in promoting the growth of economies. The paper, therefore, analyzes four issues on the impact of the globalization upon the mechanisms of monetary transmission and arrives at the following findings. ( 1 ) Globalization did not reduce the sensibility of inflation to the domestic production gaps and in consequence to the effectiveness of the monetary policy,. ( 2 ) Gaps in the product of external economies do not play a more important role than in other times,.( 3 ) Domestic monetary policy maintains still the control on the domestic interest rates and that way pursuing the stabilization of inflation and the product,.( 4 ) Globalization affects, by means of different forms, the mechanisms of monetary transmission
    Keywords: Globalizacion; Inflacion; Politica Monetaria
    JEL: E58 E31 E42 G15 E44
    Date: 2008–02–09
  34. By: Meenagh, David; Minford, Patrick; Theodoridis, Konstantinos
    Abstract: We use the method of indirect inference to test a full open economy model of the UK that has been in forecasting use for three decades. The test establishes, using a Wald statistic, whether the parameters of a time-series representation estimated on the actual data lie within some confidence interval of the model-implied distribution. Various forms of time-series representations that could deal with the UK's various changes of monetary regime are tried; two are retained as adequate. The model is rejected under one but marginally accepted under the other, suggesting that with some modifications it could achieve general acceptability and that the testing method is worth investigating further.
    Keywords: Bootstrap; Indirect inference; Model evaluation; Non-linear Time Series Models; Open economy models; UK models
    JEL: C12 C32
    Date: 2008–06
  35. By: Crafts, Nicholas; Toniolo, Gianni
    Abstract: This paper surveys the extensive literature on European economic growth since 1950. It presents an overview of comparative growth performance together with benchmarked growth accounting estimates. The growth experience is considered in terms of three periods, the Golden Age of 1950-73, the Growth Slowdown of 1973-1995, and the New Economy period since the mid-1990s, both across countries and across regions. The key conclusion is that study of the historical record underlines the importance of incentive structures for growth outcomes while sustaining growth performance over the long run requires the (often difficult) adaptation of institutions and policies as catch up becomes more complete and new technological epochs arrive.
    Keywords: catch-up growth; Golden Age; ICT; slowdown; total factor productivity
    JEL: N14 O47 O52
    Date: 2008–06
  36. By: Dolly Chugh (New York University, Stern School of Business); Katherine Lyford Milkman (Harvard Business School); Max H. Bazerman (Harvard Business School, Negotiation, Organizations & Markets Unit)
    Abstract: The optimal moment to address the question of how to improve human decision making has arrived. In recent research, judgment and decision-making scholars have moved beyond the concept of bounded rationality to recognize a broader set of bounds that affect decision making. We specify a taxonomy that assembles the field's knowledge about these decision-making bounds and organizes efforts toward deepening this knowledge and developing strategies for improvement. Specifically, we group five identified decision-making bounds into three broad categories: bounds on information processing, bounds on the optimal weighting of priorities, and bounds on noticing information. The first category encompasses bounded rationality, the first bound to be discovered and studied extensively. The second category encompasses bounded willpower and bounded self-interest. The third category encompasses two recently identified bounds: bounded ethicality and bounded awareness. By organizing diverse theories into a clear framework, the taxonomy should aid researchers and educators in identifying new strategies for improving decision making.
    Date: 2008–06
  37. By: Marco Del Negro; Frank Schorfheide
    Abstract: This paper estimates a small open-economy dynamic stochastic general equilibrium (DSGE) model, specified along the lines of Galí and Monacelli (2005) and Lubik and Schorfheide (2007), using Chilean data for the full inflation-targeting period of 1999 to 2007. We study the specification of the policy rule followed by the Central Bank of Chile, the dynamic response of inflation to domestic and external shocks, and the change in these dynamics under different policy parameters. We use the DSGE-VAR methodology from our earlier work (2007) to assess the robustness of the conclusion to the presence of model misspecification.
    Keywords: Stochastic analysis ; Time-series analysis ; Econometric models ; Banks and banking, Central ; Monetary policy
    Date: 2008
  38. By: Tito Nícias Teixeira da Silva Filho
    Abstract: This paper contributes to fill the large existing gap in the literature on the Brazilian natural rate of unemployment. It reveals not only that the correlation between inflation and unemployment has changed radically since the stabilisation of the economy but, more surprisingly, that it has become positive in the recent past. In other words, there has apparently been no trade-off between inflation and unemployment. However, this fact is due to – and highlights – the paramount importance of supply shocks in recent inflation dynamics in Brazil. The paper then shows that the exchange rate has been the major source of shocks to inflation, even though it is not enough to explain the magnitude and persistence of those shocks. Part of the answer comes from the large and wide effects produced by privatisation on the price dynamics in Brazil. The evidence presented here suggests that the Brazilian natural rate of unemployment has been constant since 1996. Despite the high degree of uncertainty involved in natural rate estimations, point estimates seem to lie somewhere between the 7.4%–8.5% range. The paper also sheds light on why real interest rates have been so high for extended periods of time in Brazil, a feature that has puzzled many economists. Finally, it calls to attention that one important core inflation measure in Brazil has not been able to capture underlying inflation properly and, therefore, has to be used with caution.
    Date: 2008–05

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