nep-cba New Economics Papers
on Central Banking
Issue of 2008‒07‒14
28 papers chosen by
Alexander Mihailov
University of Reading

  1. Determinacy, Learnability, and Plausibility in Monetary Policy Analysis: Additional Results By Bennett T. McCallum
  2. Reconsideration of the P-Bar Model of Gradual Price Adjustment By Bennett T. McCallum
  3. On the Sources of the Great Moderation By Jordi Gali; Luca Gambetti
  4. Random Walk or A Run: Market Microstructure Analysis of the Foreign Exchange Rate Movements based on Conditional Probability By Yuko Hashimoto; Takatoshi Ito; Takaaki Ohnishi; Misako Takayasu; Hideki Takayasu; Tsutomu Watanabe
  5. Global Portfolio Rebalancing Under the Microscope By Harald Hau; Helene Rey
  6. Pitfalls in Measuring Exchange Rate Misalignment: The Yuan and Other Currencies By Yin-Wong Cheung; Menzie D. Chinn; Eiji Fujii
  7. Inflation dynamics with search frictions : a structural econometric analysis By Michael U. Krause; Thomas A. Lubik; David López-Salido
  8. Term premiums and inflation uncertainty: empirical evidence from an international panel dataset By Jonathan H. Wright
  9. Managing Disinflation under Uncertainty By Mewael F. Tesfaselassie; Eric Schaling
  10. Tips from TIPS: the informational content of Treasury Inflation-Protected Security prices By Stefania D'Amico; Don H. Kim; Min Wei
  11. Informality and Macroeconomic Fluctuations By Fiess, Norbert M.; Fugazza, Marco; Maloney, William F.
  12. Are long-run inflation expectations anchored more firmly in the Euro area than in the United States? By Meredith J. Beechey; Benjamin K. Johannsen; Andrew T. Levin
  13. Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia By Kajuth, Florian; Watzka, Sebastian
  14. Monetary Persistence and the Labor Market: A New Perspective By Lechthaler, Wolfgang; Merkl, Christian; Snower, Dennis J.
  15. Optimal monetary and fiscal policies in a search theoretic model of monetary exchange By Pere Gomis-Porqueras; Adrian Peralta-Alva
  16. Asset Prices and Assymetries in the Fed's Interest Rate Rule : a Financial Approach By Romaniuk, Katarzyna; Vranceanu, Radu
  17. Estimating open economy Phillips curves for the euro area with directly measured expectations By Paloviita, Maritta
  18. Real interest rate persistence: evidence and implications By Christopher J. Neely; David E. Rapach
  19. Short and long run causality measures: theory and inference By Jean-Marie Dufour; Abderrahim Taamouti
  20. Getting PPP Right: Identifying Mean-Reverting Real Exchange Rates in Panels By Georgios Chortareas; George Kapetanios
  21. Inflation Target Shocks and Monetary Policy Inertia in the Euro Area By FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
  22. Money in the Inflation Equation: the Euro Area Evidence By Fourçans, André; Vranceanu, Radu
  23. "The Collapse of Monetarism and the Irrelevance of the New Monetary Consensus" By James K. Galbraith
  24. "The Return of Fiscal Policy Can the New Developments in the New Economic Consensus Be Reconciled with the Post-Keynesian View?" By Pavlina R. Tcherneva
  25. The Rise and Fall of the Dollar, or When Did the Dollar Replace Sterling as the Leading International Currency? By Barry Eichengreen; Marc Flandreau
  26. The Implementation of Monetary Policy in Canada By Walter Engert, Toni Gravelle, and Donna Howard
  27. Roles of Fiscal Policy in New Zealand By Felicity C Barker; Robert A Buckle; Robert W St Clair
  28. How Much Intraregional Exchange Rate Variability Could a Currency Union Remove? The Case of ASEAN+3 By Duo Qin; Tao Tan

  1. By: Bennett T. McCallum
    Abstract: In a very broad class of dynamic linear models, if agents possess knowledge of current endogenous variables in a least-squares learning process, determinacy of a rational expectations (RE) equilibrium is sufficient but not necessary for learnability of that equilibrium. Thus, since learnability is an attractive necessary condition for plausibility of any equilibrium, there may exist a single plausible RE solution even in cases of indeterminacy. This paper proposes and outlines a distinct criterion that plausible models should possess, termed "well formulated" (WF), which rules out infinite discontinuities in the implied impulse response functions. The paper explores the relationship between this WF property and learnability, under the information assumption mentioned above, and finds that they often agree but neither strictly implies the other. Extending the P-matrix requirement, implied for specified matrices by the WF property, to one that demands positive dominant-diagonal matrices would guarantee both WF and learnability, but a suitable rationale has not been found. Finally, under a second information assumption, which gives the agents only lagged information on endogenous variables during the learning process, the situation is less favorable in the sense that learnability can be guaranteed only under special assumptions.
    JEL: C62 E30 E52
    Date: 2008–07
  2. By: Bennett T. McCallum
    Abstract: This paper compares the P-bar model of price adjustment with the currently dominant Calvo specification. Theoretically, the P-bar model is more attractive as it depends upon adjustment costs for physical quantities rather than nominal prices, while incorporating a one-period information lag. Furthermore, the resulting adjustment relation is more completely free of "money illusion," in terms of dynamic relationships, and therefore satisfies the natural rate hypothesis of Lucas (1972), which is not satisfied by the Calvo model in any of its variants. Along the way, it shows that both the P-bar and Calvo models can be formulated in distinct versions in which current real wages are, or are not, allocative. Quantitatively, for a given calibration of the demand parameters, the implied time series properties of the inflation rate, output gap, and nominal interest rate are determined for various policy parameters, and are compared with quarterly data for the U.S. economy. Neither model dominates but, overall, the comparison seems somewhat more favorable to the P-bar model and certainly does not provide support for the dominant position held by the Calvo model in current monetary policy analysis.
    JEL: E30 E52
    Date: 2008–07
  3. By: Jordi Gali; Luca Gambetti
    Abstract: The remarkable decline in macroeconomic volatility experienced by the U.S. economy since the mid-80s (the so-called Great Moderation) has been accompanied by large changes in the patterns of comovements among output, hours and labor productivity. Those changes are reflected in both conditional and unconditional second moments as well as in the impulse responses to identified shocks. Among other changes, our findings point to (i) an increase in the volatility of hours relative to output, (ii) a shrinking contribution of non-technology shocks to output volatility, and (iii) a change in the cyclical response of labor productivity to those shocks. That evidence suggests a more complex picture than that associated with "good luck" explanations of the Great Moderation.
    JEL: E32
    Date: 2008–07
  4. By: Yuko Hashimoto; Takatoshi Ito; Takaaki Ohnishi; Misako Takayasu; Hideki Takayasu; Tsutomu Watanabe
    Abstract: Using tick-by-tick data of the dollar-yen and euro-dollar exchange rates recorded in the actual transaction platform, a "run" -- continuous increases or decreases in deal prices for the past several ticks -- does have some predictable information on the direction of the next price movement. Deal price movements, that are consistent with order flows, tend to continue a run once it started i.e., conditional probability of deal prices tend to move in the same direction as the last several times in a row is higher than 0.5. However, quote prices do not show such tendency of a run. Hence, a random walk hypothesis is refuted in a simple test of a run using the tick by tick data. In addition, a longer continuous increase of the price tends to be followed by larger reversal. The findings suggest that those market participants who have access to real-time, tick-by-tick transaction data may have an advantage in predicting the exchange rate movement. Findings here also lend support to the momentum trading strategy.
    JEL: F31 F33 G15
    Date: 2008–07
  5. By: Harald Hau; Helene Rey
    Abstract: The dramatic increase in gross stock of foreign assets and liability has revived interest in the portfolio balance theory of international investment. Evidence on the validity of this theory has always been scarce and inconclusive. The current paper derives testable empirical implications from microeconomic foundations, which we confront with a new comprehensive data set on the stock allocations of approximately 6,500 international equity funds domiciled in four different currency areas. The disaggregated data structure allows us to examine whether foreign exchange and equity risk measures trigger the predicted rebalancing behavior at the fund and stock level. The data provide strong support for portfolio rebalancing behavior aimed at reducing both exchange rate and equity risk exposure.
    JEL: F3 F32 G11 G15
    Date: 2008–07
  6. By: Yin-Wong Cheung; Menzie D. Chinn; Eiji Fujii
    Abstract: We evaluate whether the Renminbi (RMB) is misaligned, relying upon conventional statistical methods of inference. A framework built around the relationship between relative price and relative output levels is used. We find that, once sampling uncertainty and serial correlation are accounted for, there is little statistical evidence that the RMB is undervalued, even though the point estimates usually indicate economically significant misalignment. The result is robust to various choices of country samples and sample periods, as well as to the inclusion of control variables. We then update the results using the latest vintage of the data to demonstrate how fragile the results are. We find that whatever misalignment we detected in our previous work disappears in this data set.
    JEL: F31 F41
    Date: 2008–07
  7. By: Michael U. Krause; Thomas A. Lubik; David López-Salido
    Abstract: The New Keynesian Phillips curve explains inflation dynamics as being driven by current and expected future real marginal costs. In competitive labor markets, the labor share can serve as a proxy for the latter. In this paper, we study the role of real marginal cost components implied by search frictions in the labor market. We construct a measure of real marginal costs by using newly available labor market data on worker finding rates. Over the business cycle, the measure is highly correlated with the labor share. Estimates of the Phillips curve using GMM reveal that the marginal cost measure remains significant, and that inflation dynamics are mainly driven by the forward-looking component. Bayesian estimation of the full new Keynesian model with search frictions helps us disentangle which shocks are driving the economy to generate the observed unit labor cost dynamics. We find that mark-up shocks are the dominant force in labor market fluctuations.
    Keywords: Inflation (Finance)
    Date: 2008
  8. By: Jonathan H. Wright
    Abstract: This paper provides cross-country empirical evidence on term premia, inflation uncertainty, and their relationship. It has three components. First, I construct a panel of zero-coupon nominal government bond yields spanning ten countries and eighteen years. From these, I construct forward rates and decompose these into expected future short-term interest rates and term premiums, using both statistical methods (an affine term structure model) and using surveys. Second, I construct alternative measures of time-varying inflation uncertainty for these countries, using actual inflation data and survey expectations. I discuss some possible determinants of inflation uncertainty. Finally, I use panel data methods to investigate the relationship between term premium estimates and inflation uncertainty measures, and find a strong positive relationship. The economic determinants of term premia remain mysterious; but this evidence points to uncertainty about intermediate- to long-run inflation rates being a substantial part of the explanation for why yield curves slope up.
    Date: 2008
  9. By: Mewael F. Tesfaselassie; Eric Schaling
    Abstract: In this paper we analyze disinflation policy when a central bank has imperfect information about private sector inflation expectations but learns about them from economic outcomes, which are in part the result of the disinflation policy. The form of uncertainty is manifested as uncertainty about the effect of past disinflation policy on current output gap. Thus current as well as past policy actions matter for output gap determination. We derive the optimal policy under learning (DOP) and compare it two limiting cases---certainty equivalence policy (CEP) and cautionary policy (CP). It turns out that under the DOP inflation stay between the levels implied by the CEP and the CP. A novel result is that this holds irrespective of the initial level of inflation. Moreover, while at high levels of inherited inflation the DOP moves closer to the CEP, at low levels of inherited inflation the DOP resembles the CP
    Keywords: Learning, Inflation Expectations, Disinflation Policy, Separation Principle, Kalman Filter, Optimal Control
    JEL: C53 E42 E52 F33
    Date: 2008–06
  10. By: Stefania D'Amico; Don H. Kim; Min Wei
    Abstract: We examine the informational content of TIPS yields from the viewpoint of a general 3-factor no-arbitrage term structure model of inflation and interest rates. Our empirical results indicate that TIPS yields contained a "liquidity premium" that was until recently quite large (~ 1%). Key features of this premium are difficult to account for in a rational pricing framework, suggesting that TIPS may not have been priced efficiently in its early years. Besides the liquidity premium, a time-varying inflation risk premium complicates the interpretation of the TIPS breakeven inflation rate (the difference between the nominal and TIPS yields). Nonetheless, high-frequency variation in the TIPS breakeven rates is similar to the variation in inflation expectations implied by the model, lending support to the view that TIPS breakeven inflation rates are a useful proxy for inflation expectations.
    Date: 2008
  11. By: Fiess, Norbert M. (University of Glasgow); Fugazza, Marco (UNCTAD); Maloney, William F. (World Bank)
    Abstract: This paper examines the adjustment of developing country labor markets to macroeconomic shocks. It models as having two sectors: a formal salaried (tradable) sector that may or may not be affected by union or legislation induced wage rigidities, and an informal (nontradable) self-employment sector facing liquidity constraints to entry. This is embedded in a standard small economy macro model that permits the derivation of patterns of comovement among relative salaried/self-employed incomes, salaried/self-employed sector sizes and the real exchange rate with respect to different types of shocks in contexts with and without wage rigidities. The paper then explores time series data from Argentina, Brazil, Colombia and Mexico to test for cointegrating relationships corresponding to the patterns predicted by theory. We confirm episodes of expansion of informal self-employment consistent with the traditional segmentation views. However, we also identify episodes consistent with the sectoral expansion being driven by relative demand or productivity shocks to the nontradables sector that lead to “procyclical” behavior of the informal self-employed sector.
    Keywords: informality, labor market dynamics, self-employment, real exchange rates
    JEL: F41 J21 J24 J31 O17
    Date: 2008–05
  12. By: Meredith J. Beechey; Benjamin K. Johannsen; Andrew T. Levin
    Abstract: This paper compares the recent evolution of long-run inflation expectations in the euro area and the United States, using evidence from financial markets and surveys of professional forecasters. Survey data indicate that long-run inflation expectations are reasonably well-anchored in both economies, but also reveal substantially greater dispersion across forecasters' long-horizon projections of U.S. inflation. Daily data on inflation swaps and nominal-indexed bond spreads--which gauge compensation for expected inflation and inflation risk--also suggest that long-run inflation expectations are more firmly anchored in the euro area than in the United States. In particular, surprises in macroeconomic data releases have significant effects on U.S. forward inflation compensation, even at long horizons, whereas macroeconomic news only influences euro area inflation compensation at short horizons.
    Date: 2008
  13. By: Kajuth, Florian; Watzka, Sebastian
    Abstract: We provide a critical assessment of the method used by the Cleveland Fed to correct expected inflation derived from index-linked bonds for liquidity and inflation risk premia and show how their method can be adapted to account for time-varying inflation risk premia. Furthermore, we show how sensitive the Cleveland Fed approach is to different measures of the liquidity premium. In addition we propose an alternative approach to decompose the bias in inflation expectations derived from index-linked bonds using a state-space estimation. Our results show that once one accounts for time-varying liquidity and inflation risk premia current 10-year U.S. inflation expectations are lower than estimated by the Cleveland Fed.
    Keywords: Inflation expectations; liquidity risk premium; inflation risk premium; treasury inflation-protected securities (TIPS); state-space model
    JEL: E31 E52 G12
    Date: 2008–07–10
  14. By: Lechthaler, Wolfgang (Kiel Institute for the World Economy); Merkl, Christian (Kiel Institute for the World Economy); Snower, Dennis J. (Kiel Institute for the World Economy)
    Abstract: It is common knowledge that the standard New Keynesian model is not able to generate a persistent response in output to temporary monetary shocks. We show that this shortcoming can be remedied in a simple and intuitively appealing way through the introduction of labor turnover costs (such as hiring and firing costs). Assuming that it is costly to hire and fire workers implies that the employment rate is slow to converge to its steady state value after a monetary shock. The after-effects of a shock continue to exert an effect on the labor market even long after the shock is over. The sluggishness of the labor market translates to the product market and thus the output effects of the monetary shock become more persistent. Under reasonable calibrations our model generates hump-shaped output responses. In addition, it is able to replicate the Beveridge curve relationship and a negative correlation between job creation and job destruction.
    Keywords: monetary persistence, labor market, hiring and firing costs
    JEL: E24 E32 E52 J23
    Date: 2008–05
  15. By: Pere Gomis-Porqueras; Adrian Peralta-Alva
    Abstract: In this paper we study optimal monetary and fiscal policies, and the welfare costs of inflation, within the Lagos and Wright (2005) framework. Monetary equilibria may be inefficient without fiscal policy tools due to bargaining frictions. We show that subsidies in decentralized markets can be implemented to alleviate underproduction, while money is still essential. Deviations from the Friedman rule may be large, and having fiscal and monetary policies in place results in considerable welfare gains. When fiscal policies are held constant, the welfare costs of increasing inflation may be as high as 8% of lifetime consumption. When lump sum monetary transfers are not available, a positive production subsidy may be inflationary and welfare reducing. However, sales taxes in the decentralized market and production taxes in the centralized market may increase welfare. The optimality of the Friedman rule in this case depends crucially on the bargaining power of the buyer, and equilibria are not first best.
    Keywords: Monetary policy ; Fiscal policy
    Date: 2008
  16. By: Romaniuk, Katarzyna (University of Paris 1 Panthéon-Sorbonne, PRISM); Vranceanu, Radu (ESSEC Business School)
    Abstract: Financial Newspapers have for long suggested that the Fed tends to provide additional Liquidity when the Stock Market thumbs. We provide a theoretical Explanation for this Behaviour that builds on the Methodology developed by Romaniuk (2008) for a central Banker with two main Goals, Output and Price stability. In this Paper, the Policymaker behaves as a Portfolio Manager who aims at stabilizing Output, Goods Prices, as well as Asset Prices. An optimal, Time-varying Interest Rate Rule is obtained as the Merton's (1971) continuous Time Solution to the Portfolio Manager's Problem. In a second Step, we infer the optimal Interest Rate Rule of a central Bank that can react differently to positive and negative Variations in the Stock Market.
    Keywords: Optimal Interest Rate Rule; Portfolio Choice; Fed; Asset Prices; Options Theory
    JEL: C61 E58 G11
    Date: 2008–03
  17. By: Paloviita, Maritta (Bank of Finland Research)
    Abstract: This paper examines euro area inflation dynamics by estimating open economy New Keynesian Phillips curves based on the assumption that all imports are intermediate goods. Instead of imposing rational expectations a priori, Consensus Economics survey data and OECD inflation forecasts are used to proxy inflation expectations. The results suggest that, compared with a closed economy New Keynesian Phillips curve, euro area inflation dynamics are better captured by the open economy specification. Moreover, in the open economy context, and even if we allow for persistence in expectations, the hybrid specification of the New Keynesian Phillips curve is needed in order to capture the euro area inflation process properly. We also provide some evidence that in recent years of low and stable inflation, euro area inflation dynamics have become more forward-looking and the link between inflation and domestic demand has weakened (ie the euro area Phillips curve has flattened). On the other hand, in low-inflation euro area countries the inflation process seems to have been more forward-looking already since the early 1980s.
    Keywords: New Keynesian Phillips curve; open economy; expectations; euro area
    JEL: C52 E31 F41
    Date: 2008–06–25
  18. By: Christopher J. Neely; David E. Rapach
    Abstract: The real interest rate plays a central role in many important financial and macroeconomic models, including the consumption-based asset pricing model, neoclassical growth model, and models of the monetary transmission mechanism. We selectively survey the empirical literature that examines the time-series properties of real interest rates. A key stylized fact is that postwar real interest rates exhibit substantial persistence, shown by extended periods of time where the real interest rate is substantially above or below the sample mean. The finding of persistence in real interest rates is pervasive, appearing in a variety of guises in the literature. We discuss the implications of persistence for theoretical models, illustrate existing findings with updated data, and highlight areas for future research.
    Keywords: Interest rates
    Date: 2008
  19. By: Jean-Marie Dufour; Abderrahim Taamouti
    Abstract: The concept of causality introduced by Wiener (1956) and Granger (1969) is defined in terms of predictability one period ahead. This concept can be generalized by considering causality at a given horizon h, and causality up to any given horizon h [Dufour and Renault (1998)]. This generalization is motivated by the fact that, in the presence of an auxiliary variable vector Z, it is possible that a variable Y does not cause variable X at horizon 1, but causes it at horizon h > 1. In this case, there is an indirect causality transmitted by Z. Another related problem consists in measuring the importance of causality between two variables. Existing causality measures have been defined only for the horizon 1 and fail to capture indirect causal effects. This paper proposes a generalization of such measures for any horizon h. We propose nonparametric and parametric measures of unidirectional and instantaneous causality at any horizon h. Parametric measures are defined in the context of autoregressive processes of unknown order and expressed in terms of impulse response coefficients. On noting that causality measures typically involve complex functions of model parameters in VAR and VARMA models, we propose a simple method to evaluate these measures which is based on the simulation of a large sample from the process of interest. We also describe asymptotically valid nonparametric confidence intervals, using a bootstrap technique. Finally, the proposed measures are applied to study causality relations at different horizons between macroeconomic, monetary and financial variables in the U.S. These results show that there is a strong effect of nonborrowed reserves on federal funds rate one month ahead, the effect of real gross domestic product on federal funds rate is economically important for the first three months, the effect of federal funds rate on gross domestic product deflator is economically weak one month ahead, and finally federal fundsrate causes the real gross domestic product until 16 months.
    Keywords: Time series, Granger causality, Indirect causality, Multiple horizon causality, Causality measure, Predictability, Autoregressive model, Vector autoregression, VAR, Bootstrap, Monte Carlo, Macroeconomics, Money, Interest rates, Output, Inflation
    JEL: C1 C12 C15 C32 C51 C53 E3 E4 E52
    Date: 2008–07
  20. By: Georgios Chortareas (University of Athens); George Kapetanios (Queen Mary, University of London)
    Abstract: Recent advances in testing for the validity of Purchasing Power Parity (PPP) focus on the time series properties of real exchange rates in panel frameworks. One weakness of such tests, however, is that they fail to inform the researcher as to which cross-section units are stationary. As a consequence, a reservation for PPP analyses based on such tests is that a small number of real exchange rates in a given panel may drive the results. In this paper we examine the PPP hypothesis focusing on the stationarity of the real exchange rates in up to 25 OECD countries. We introduce a methodology that when applied to a set of established panel-unit-root tests, allows the identification of the real exchange rates that are stationary. We apply procedures that account for cross-sectional dependence. Our results reveal evidence of mean-reversion that is significantly stronger as compared to that obtained by the existing literature, strengthening the case for PPP. Moreover, our approach can be used to provide half-lives estimates for the mean-reverting real exchange rates. We find that the half-lives are shorter than the literature consensus and therefore that the PPP puzzle is less pronounced than initially thought.
    Keywords: PPP, Panel unit root tests, Real exchange rates, Half-lives, PPP puzzle
    JEL: C12 C15 C23 F31
    Date: 2008–07
  21. By: FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
    Date: 2008–06
  22. By: Fourçans, André (ESSEC Business School); Vranceanu, Radu (ESSEC Business School)
    Abstract: The ECB is the only major central bank that still emphasizes the role of money in monetary policy management. In this paper, we bring some support to this approach. Taking into account Euro area data from the period between 1999 and 2007, we demonstrate that a steady 10 per cent increase in M3 may result in an inflation rate of approximately 2½ percentage points. A negative output gap would have a short term offsetting effect, and vice versa.
    Keywords: ECB; Inflation; Monetary Policy; Money
    JEL: E31 E51 E58
    Date: 2008–05
  23. By: James K. Galbraith
    Abstract: What in monetarism, and what in the "new monetary consensus," led to a correct or even remotely relevant anticipation of the extraordinary financial crisis that broke over the housing sector, the banking system, and the world economy in August 2007 and that has continued to preoccupy central bankers ever since? Absolutely nothing, says Senior Scholar James K. Galbraith. In this new Policy Note, Galbraith reevaluates monetary policy in light of the collateral damages inflicted by the subprime mortgage crisis. He provides a critique of monetarism--what Milton Friedman famously defined as the proposition that "inflation is everywhere and always a monetary phenomenon"--and of the "new monetary consensus" on which Federal Reserve Chairman Ben Bernanke's ostensible doctrine of inflation targeting rests. Given the current economic crisis, Galbraith says, the Fed would do well to embrace the intellectual victory of John Maynard Keynes, John Kenneth Galbraith, and Hyman P. Minsky--and act accordingly.
    Date: 2008–05
  24. By: Pavlina R. Tcherneva
    Abstract: The monetarist counterrevolution and the stagflation period of the 1970s were among the theoretical and practical developments that led to the rejection of fiscal policy as a useful tool for macroeconomic stabilization and full employment determination. Recent mainstream contributions, however, have begun to reassess fiscal policy and have called for its restitution in certain cases. The goal of this paper is to delimit the role of and place for fiscal policy in the New Economic Consensus (NEC) and to compare it to that of Post-Keynesian theory, the latter arguably the most faithful approach to the original Keynesian message. The paper proposes that, while a consensus may exist on many macroeconomic issues within the mainstream, fiscal policy is not one of them. The designation of fiscal policy within the NEC is explored and contrasted with the Post-Keynesian calls for fiscal policy via Abba Lerner's "functional finance" approach. The paper distinguishes between two approaches to functional finance--one that aims to boost aggregate demand and close the GDP gap, and one that secures full employment via direct job creation. It is argued that the mainstream has severed the Keynesian link between fiscal policy and full employment--a link that the Post-Keynesian approach promises to restore.
    Date: 2008–07
  25. By: Barry Eichengreen; Marc Flandreau
    Abstract: We present new evidence on the currency composition of foreign exchange reserves in the 1920s and 1930s. Contrary to the presumption that the pound sterling continued to dominate the U.S. dollar in central bank reserves until after World War II, we show that the dollar first overtook sterling in the mid-1920s. This suggests that the network effects thought to lend inertia to international currency status and to create incumbency advantages for the dominant international currency do not apply in the reserve currency domain. Our new evidence is similarly incompatible with the notion that there is only room in the market for one dominant reserve currency at a point in time. Our findings have important implications for our understanding of interwar monetary history but also for the prospects of the dollar and the euro as reserve currencies.
    JEL: F0 F33 N1 N2
    Date: 2008–07
  26. By: Walter Engert, Toni Gravelle, and Donna Howard
    Abstract: The authors present a detailed discussion of the Bank of Canada's framework for the implementation of monetary policy. As background, they provide a brief overview of the financial system in Canada, including a discussion of the financial services industry and the money market. Key features of the large-value payments system, which is integral to the implementation of monetary policy, are also explained. The authors then discuss in some detail the operating framework for the implementation of monetary policy. An assessment of the effectiveness of the Bank of Canada's framework is also provided, including an analysis of monetary policy implementation in the period of financial market stress beginning in August 2007.
    Keywords: Financial institutions; Financial markets; Monetary policy implementation; Payment, clearing, and settlement systems
    JEL: E52 E58 G21
    Date: 2008
  27. By: Felicity C Barker; Robert A Buckle; Robert W St Clair (The Treasury)
    Abstract: Economic growth is one of the objectives of the current government. Fiscal policy, encompassing government expenditure and taxation decisions, can significantly impact on economic growth. This paper proposes a framework which views fiscal policy through three lenses and applies this approach to consider how fiscal policy affects economic growth. The three lenses are: fiscal sustainability, fiscal structure and fiscal stabilisation. The paper reviews international literature pertaining to these three lenses and discusses the extent to which these lenses are incorporated into New Zealand’s current fiscal framework. Contemporary New Zealand fiscal challenges are discussed and, in light of these challenges, the paper concludes with consideration of areas to investigate which may yield improvements to the New Zealand fiscal framework.
    Keywords: Fiscal policy, sustainability, stability, structure, taxation, government spending, economic growth
    JEL: E6 E61 E62 E63
    Date: 2008–06
  28. By: Duo Qin (Queen Mary, University of London); Tao Tan (Tianjin University of Finance and Economics)
    Abstract: A multilateral currency union removes the intraregional exchange rates but not the union rate variability with the rest of the world. The intraregional exchange rate variability is thus latent. A two-step procedure is developed to measure the variability. The measured variables are used to model inflation and intraregional trade growth of individual union members. The resulting models form the base for counterfactual simulations of the union impact. Application to ASEAN+3 shows that the intraregional variability consists of mainly short-run shocks, which have significantly affected the inflation and trade growth of major ASEAN+3 members, and that a union would reduce inflation and promote intraregional trade on the whole but the benefits facing each member vary and may not be significant enough to warrant a vote for the union.
    Keywords: Currency union, Latent variables, Dynamic factor model, Simulation
    JEL: F02 F40 O19 O53
    Date: 2008–07

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