nep-cba New Economics Papers
on Central Banking
Issue of 2008‒11‒18
twenty papers chosen by
Alexander Mihailov
University of Reading

  1. How Central Bankers See It: The First Decade of ECB Policy and Beyond By Stephen G. Cecchetti; Kermit L. Schoenholtz
  2. What Lessons have been learnt since the East Asian Crisis in 1997/98? CIBS, Capital Flows, and Exchange Rates By Pircher, Marion
  3. What broke the bubble? By Barnett, William A.
  4. Recession, Depression, and Financial Crisis: Everything Economists Want to Know But Are Afraid to Ask By Graeme Donald Snooks
  5. Productivity, Preferences and UIP deviations in an Open Economy Business Cycle Model By Arnab Bhattacharjee; Jagjit S. Chadha; Qi Sun
  6. Short-Term Forecasts of Euro Area GDP Growth By Elena Angelini; Gonzalo Camba-Mendez; Domenico Giannone; Lucrezia Reichlin; Gerhard Rünstler
  7. Current Account Adjustment and Financial Integration By Pascal Towbin
  8. Opening the Black Box: Structural Factor Models with Large Cross-Sections By Mario Forni; Domenico Giannone; Marco Lippi; Lucrezia Reichlin
  9. The Sub-Prime Crisis and UK Monetary Policy By Christopher Martin; Costas Milas
  10. Fiscal Policy and Monetary Integration in Europe: An Update By Candelon Bertrand; Muysken Joan; Vermeulen Robert
  11. Determinacy of interest rate rules with bond transaction services in a cashless economy  By Marzo, Massimiliano; Zagaglia , Paolo
  12. A continuous-time model of the term structure of interest rates with fiscal-monetary policy interactions By Marzo , Massimiliano; Romagnoli , Silvia; Zagaglia, Paolo
  13. A Measure for Credibility: Tracking US Monetary Developments By Maria Demertzis; Massimiliano Marcellino; Nicola Viegi
  14. RESTAURANT PRICES AND THE MINIMUM WAGE By Fougere, Denis; Gautier, Erwan; Le Bihan, Herve
  15. Optimal Linear Filtering, Smoothing and Trend Extraction for m-period Differences of Processes with a Unit Root By Dimitrios Thomakos
  16. Large Bayesian VARs By Marta Banbura; Domenico Giannone; Lucrezia Reichlin
  17. Structural Breaks in the Real Exchange Rate and Real Interest Rate Relationship By Joseph P. Byrne; Jun Nagayasu
  18. Money Demand Accommodation in the U.S. By Javier Gómez; Antonio Moreno; Fernando Pérez de Gracia
  19. The Macroeconomic Management of Increased Aid: Policy Lessons Date Recent Experience By Aiyar, Shekhar; Berg, Andrew; Hussain, Mumtaz
  20. Monetary Policy Rules for Managing Aid Surges in Africa By Adam, Chris-Datepher S.; Buffie, Edward; O'Connell, Stephen; Pattillo, Catherine

  1. By: Stephen G. Cecchetti; Kermit L. Schoenholtz
    Abstract: In this history of the first decade of ECB policy, we also discuss key challenges for the next decade. Beyond the ECB's track record and an array of published critiques, our analysis relies on unique source material: extensive interviews with current and former ECB leaders and with other policymakers and scholars who viewed the evolution of the ECB from privileged vantage points. We share the assessment of our interviewees that the ECB has enjoyed many more successes than disappointments. These successes reflect both the ECB's design and implementation. Looking forward, we highlight the unique challenges posed by enlargement and, especially, by the euro area's complex arrangements for guarding financial stability. In the latter case, the key issues are coordination in a crisis and harmonization of procedures. As several interviewees suggested, in the absence of a new organizational structure for securing financial stability, the current one will need to function as if it were a single entity.<br><br><i><b><font size="3">Note to readers: The final version of this paper was completed in June 2008. </i></b></font>
    JEL: E42 E58
    Date: 2008–11
  2. By: Pircher, Marion
    Abstract: This paper discusses the movement of capital flows -Date and Date the exchange rate regimes and monetary policies of China, India, Brazil, and South Africa (CIBS). Furthermore, we compare the level of financial stability, and the composition and duration of capital flows of the countries on a policy level according -Date the ? ?third generation? crisis models?; following which the East Asian Crisis of 1997/98 linkages between the corporate and financial sec-Daters, and foreign short-term debt are given further attention. The paper concludes by comparing all four countries and analysing possible risks in CIBS financial systems.
    Keywords: international financial markets, financial stability, capital flows, exchange rates, China, India, Brazil, South Africa
    Date: 2008
  3. By: Barnett, William A.
    Abstract: This paper is the basis for the Guest Columnist article in the Tuesday, November 11, 2008 issue of the Kansas City Star newspaper's Business Weekly. Because of space limitations, the published newspaper column had to be shortened from the original and unfortunately did not include either of the two supporting figures. This is the unedited source article. The position taken by this opinion editorial is that the declining trend of total reserves during the recent period of financial crisis was counterproductive, and the declining level of the federal funds rate during that period was an inadequate indicator of Federal Reserve policy stance. But the recent startling surge in reserves potentially offsets the problem, although for reasons not motivated by the issues raised by this article. In fact, the reason for the surge is associated with the declining stock of Treasury bonds available to the Federal Reserve for sterilization of the effects of the new lending initiatives on bank reserves.
    Keywords: bubbles; bailouts; monetary policy; reserves; TAFs; sterilization; financial crisis.
    JEL: E32 G18 E52 E44 G28 E61
    Date: 2008–11–11
  4. By: Graeme Donald Snooks
    Abstract: Once again the economic experts are telling us that the current (October 2008) financial “crisis” will lead to a deep recession or depression. The financial press is even claiming that we are headed for “global meltdown”. Heard it all before? The last time was in 1998 when we were told that the financial difficulties in the East would generate the “East Asian meltdown”, which would last for at least a decade and would generate a “global economic crisis”. The economic summit called by President Bush for later in 2008 is reminiscent of the G7 and G22 meetings called to discuss similar issues in 1998. And yet nothing happened. Of course the financial gurus, such as Alan Greenspan were quick to claim the credit, but the truth is that financial crises are supply-side happenings that generate a lot of excitement among the stock market speculators but have little real-world fallout as long as the dynamic strategies being pursued by the world’s leading societies are viable. The stock market crash of 1987 is another case in point: nothing serious happened in the real economy. Depressions only occur when dominant dynamic strategies are finally exhausted and new ones are slow to emerge: as happened in the USA during the 1920s and 1930s. The conventional wisdom among the orthodox economic fraternity, that the Great Depression was the outcome of the 1929 Wall Street crash, is totally incorrect. Economists and their political masters will only understand the relationship between recession, depression, and financial crisis, when they have developed a realist general dynamic theory of human society. Until then, economic policy will be confused, ineffective, and distorting. A general dynamic theory is presented in this paper and used to analyse financial crises and economic downturns. To the degree that the real global economy is in trouble, it is due not to financial mismanagement, but to the misconceived policy of inflation targeting pursued for the past decade or so. Once again, our compulsion to intervene exceeds our capacity to understand the implications of our actions.
    Keywords: financial crisis, depression, dynamic-strategy theory, inflation targeting, economic policy, global meltdown.
    JEL: O40 O50 O43 E31 E32 E42 E50 E60
    Date: 2008–10
  5. By: Arnab Bhattacharjee; Jagjit S. Chadha; Qi Sun
    Abstract: We show that a ‡ex-price two-sector open economy DSGE model can explain the poor degree of international risk sharing and exchange rate disconnect. We use a suite of model evaluation measures and examine the role of (i) traded and non-traded sectors; (ii) financial market incompleteness; (iii) preference shocks; (iv) deviations from UIP condition for the exchange rates; and (v) creditor status in net foreign assets. We find that there is a good case for both traded and non-traded productivity shocks as well as UIP deviations in explaining the puzzles.
    Keywords: Current account dynamics, real exchange rates, incomplete markets, financial frictions.
    JEL: E32 F32 F41
    Date: 2008–11
  6. By: Elena Angelini; Gonzalo Camba-Mendez; Domenico Giannone; Lucrezia Reichlin; Gerhard Rünstler
    Abstract: This paper evaluates models that exploit timely monthly releases to compute early estimates of current quarter GDP (now-casting) in the euro area. We compare traditional methods used at institutions with a new method proposed by Giannone, Reichlin, and Small (2005). The method consists in bridging quarterly GDP with monthly data via a regression on factors extracted from a large panel of monthly series with different publication lags. We show that bridging via factors produces more accurate estimates than traditional bridge equations. We also show that survey data and other ‘soft’ information are valuable for now-casting.
    Keywords: Forecasting, Monetary Policy, Factor Model, Real Time Data, Large data-sets, News
    JEL: E52 C33 C53
    Date: 2008
  7. By: Pascal Towbin (IUHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: The paper investigates whether higher financial integration leads in general to slower current account adjustments. The study estimates theoretically founded trade balance reaction functions for a panel of seventy countries from 1970-2004. The empirical analysis finds that adjustment in integrated economies is slower. Consistent with the presented theory the trade balance of integrated economies is more persistent, responds less strongly to net foreign assets, and is more sensitive to fluctuations in net output. A sufficiently strong response to net foreign assets is also a condition for external sustainability. Under high integration countries appear to stay close to the sustainability limit.
    Keywords: current account adjustment, reaction function, financial integration, capital mobility
    JEL: F32 F36 F41
    Date: 2008–11
  8. By: Mario Forni; Domenico Giannone; Marco Lippi; Lucrezia Reichlin
    Abstract: This paper shows how large-dimensional dynamic factor models are suitable for structural analysis. We argue that all identification schemes employed in SVAR analysis can be easily adapted in dynamic factor models. Moreover, the “problem of fundamentalness”, which is intractable in structural VARs, can be solved, provided that the impulse-response functions are sufficiently heterogeneous. We provide consistent estimators for the impulse-response functions, as well as (n, T) rates of convergence. An exercise with US macroeconomic data shows that our solution of the fundamentalness problem may have important empirical consequences.
    Keywords: Dynamic factor models, structural VARs, identification, fundamentalness
    JEL: E0 C1
    Date: 2008
  9. By: Christopher Martin (Brunel University, Uxbridge, UK); Costas Milas (Keele University, Staffordshire, UK and The Rimini Centre for Economic Analysis, Italy)
    Abstract: The “sub-prime” crisis, which led to major turbulence in global financial markets beginning in mid-2007, has posed major challenges for monetary policymakers. We analyse the impact on monetary policy of the widening differential between policy rates and the 3-month Libor rate, the benchmark for private sector interest rates. We show that the optimal monetary policy rule should include the determinants of this differential, adding an extra layer of complexity to the problems facing policymakers. Our estimates reveal significant effects of risk and liquidity measures, suggesting the widening differential between base rates and Libor was largely driven by a sharp increase in unsecured lending risk. We calculate that the crisis increased libor by up to 60 basis points; in response base rates fell further and quicker than would otherwise have happened as policymakers sought to offset some of the contractionary effects of the sub-prime crisis.
    Keywords: optimal monetary policy; sub-prime crisis
    JEL: C51 C52 E52 E58
    Date: 2008–01
  10. By: Candelon Bertrand; Muysken Joan; Vermeulen Robert (METEOR)
    Abstract: By distinguishing between discretionary and non-discretionary fiscal policy, this paper analyses the stability of fiscal rules for EMU countries before and after the Maastricht Treaty. Using both Instrumental Variables and GMM techniques, it turns out that discretionary fiscal policy has remained procyclical after 1992. This result contradicts the previous findings of Galí and Perotti (2003). It also appears that fiscal rules differ between large and small countries; large countries follow a procyclical discretionary policy. Furthermore, the paper shows that discretionary fiscal policy exhibits different behaviour when facing supply or demand constraints. A procyclical discretionary policy is followed mainly during upswings, when supply constraints are prevalent. Finally, there is no support for the presence of a ‘fatigue effect’ in fiscal discipline.
    Keywords: Economics (Jel: A)
    Date: 2008
  11. By: Marzo, Massimiliano (Università di Bologna); Zagaglia , Paolo (Bank of Finland Research and Stockholm University)
    Abstract: Canzoneri and Diba (2004) show that the Taylor principle is not a panacea for equilibrium determinacy in a model where bonds and money provide liquidity services to households. We consider a cashless New Keynesian model with two types of government bonds. One bond provides transaction services, whereas the other is used only as a store of value. We show that the Taylor principle is still sacrosanct, and that the results of Leeper (1991) are confirmed.
    Keywords: monetary policy; fiscal policy; government bonds; determinacy
    JEL: C68 E52
    Date: 2008–10–16
  12. By: Marzo , Massimiliano (Università di Bologna); Romagnoli , Silvia (Università di Bologna); Zagaglia, Paolo (Bank of Finland Research and Stockholm University)
    Abstract: We study the term structure implications of the fiscal theory of price level determination. We introduce the intertemporal budget constraint of the government in a general equilibrium model in continuous time. Fiscal policy is set according to a simple rule whereby taxes react proportionally to real debt. We show how to solve for the prices of real and nominal zero coupon bonds.
    Keywords: bond pricing; fiscal policy; mathematical methods
    JEL: D90 G12
    Date: 2008–10–17
  13. By: Maria Demertzis; Massimiliano Marcellino; Nicola Viegi
    Abstract: Our objective is to identify a way of checking empirically the extent to which expectations are de-coupled from inflation, how well they might be anchored in the long run, and at what level. This methodology allows us then to identify a measure for the degree of anchorness, and as anchored expectations are associated with credibility, this will serve as a proxy for credibility. We apply this methodology to the US history of inflation since 1963 and examine how well our measure tracks the periods for which credibility is known to be either low or high. Of particular interest to the validity of the measure is the start of the Great Moderation. Following the narrative of a number of well documented incidents in this period, we check how well our measure captures both the evolution of credibility in US monetary policy, as well as reactions to inflation scares.
    Keywords: Great Inflation; Great Moderation; Anchors for Expectations
    JEL: E52 E58
    Date: 2008–11
  14. By: Fougere, Denis; Gautier, Erwan; Le Bihan, Herve
    Abstract: We examine the effect of the minimum wage on restaurant prices. For that purpose, we estimate a price rigidity model by exploiting a unique data set of individual price quotes used to calculate the Consumer Price Index in France. We …find a positive and signifi…cant impact of the minimum wage on prices. We obtain that the effect of the minimum wage on prices is very protracted. The aggregate impact estimated with our model takes more than a year to fully pass through to retail prices.
    Keywords: Price stickiness, minimum wage, inflation, restaurant prices, Demand and Price Analysis, Industrial Organization,
    Date: 2008–10
  15. By: Dimitrios Thomakos
    Abstract: In this paper I consider the problem of optimal linear filtering, smoothing and trend extraction for m-period differences of processes with a unit root. Such processes arise naturally in economics and finance, in the form of rates of change (price inflation, economic growth, financial returns) and finding an appropriate smoother is thus of immediate practical interest. The filter and resulting smoother are based on the methodology of Singular Spectrum Analysis (SSA) and their form and properties are examined in detail. In particular, I find explicit representations for the asymptotic decomposition of the covariance matrix and show that the first two leading eigenvalues of the decomposition account for over 90% of the variability of the process. I examine the structure of the impulse and frequency response functions finding that the optimal filter has a “permanent” and a “transitory component” with the corresponding smoother being the sum of two such components. I also find explicit representations for the extrapolation coefficients that can be used in out-of-sample prediction. The methodology of the paper is illustrated with three short empirical applications using data on U.S. inflation and real GDP growth and data on the Euro/US dollar exchange rate. Finally, the paper contains a new technical result: I derive explicit representations for the filtering weights in the context of SSA for an arbitrary covariance matrix. This result allows one to examine specific effects of smoothing in any situation and has not appeared so far, to the best of my knowledge, in the related literature.
    Keywords: core inflation, business cycles, differences, euro, linear filtering, singular spectrum analysis, smoothing, trading strategies, trend extraction and prediction, unit root.
    Date: 2008
  16. By: Marta Banbura; Domenico Giannone; Lucrezia Reichlin
    Abstract: This paper shows that Vector Autoregression with Bayesian shrinkage is an appropriate tool for large dynamic models. We build on the results by De Mol, Giannone, and Reichlin (2008) and show that, when the degree of shrinkage is set in relation to the cross-sectional dimension, the forecasting performance of small monetary VARs can be improved by adding additional macroeconomic variables and sectoral information. In addition, we show that large VARs with shrinkage produce credible impulse responses and are suitable for structural analysis.
    Keywords: Bayesian VAR, Forecasting, Monetary VAR, large cross-sections
    JEL: C11 C13 C33 C53
    Date: 2008
  17. By: Joseph P. Byrne; Jun Nagayasu
    Abstract: In this paper we empirically examine the relationship between the real exchange rate and real interest rate differentials using recent econometric methods robust to potential structural breaks. Generally, our study provides evidence of this relationship in the long-run context. More specifically, we first focus on the UK-US relationship, and interestingly find limited evidence of this long-run relationship using traditional methods. But when an approach robust to endogenously determined structural breaks is employed, we find evidence that the real interest rate differential is an important determinant of the real exchange rate. Secondly, in order to investigate the relevance of structural shifts in a more global context, we carry out multiple country analysis. While providing evidence of this long-run relationship, European data suggest that the presence of structural breaks is not very common across countries and is indeed country-specific.
    Keywords: Real exchange rate; real interest rate differential; nonstationarity; endogenously determined structural breaks; trace tests
    JEL: F31
    Date: 2008–10
  18. By: Javier Gómez (IESE Business School, University of Navarra); Antonio Moreno (Universidad de Navarra); Fernando Pérez de Gracia (Universidad de Navarra)
    Abstract: In this paper we account for the U.S. Fed's response to money demand shocks by allowing for less-than-complete accommodation in the estimation of its money supply policy rule. We estimate a significantly lower degree of money accommodation in the 1979-1982 period than before and after. We identify the path of money demand and money supply shocks and show their effects on the money market, output and inflation. Both money demand and money supply shocks have been considerably less destabilizing since 1984. We also find that monetary policy was significantly pro-cyclical in the 70s. Additionally, the price puzzle disappears for two of the three subperiods considered in the study.
    Keywords: Money demand shocks, money demand accommodation, monetary policy procedures, macroeconomic dynamics
    JEL: E32 E41 E52 E58
    Date: 2008–10–11
  19. By: Aiyar, Shekhar; Berg, Andrew; Hussain, Mumtaz
    Abstract: This paper investigates the macroeconomic challenges created by a surge in aid inflows. It develops an analytical framework for examining possible policy responses -Date increased aid, in terms of absorption and spending of aid?where the central bank controls absorption through monetary policy and the sale of foreign exchange and the fiscal authority controls spending. Different combinations of absorption and spending lead -Date different macroeconomic consequences. Evidence Date five countries that recently experienced an aid surge (Ethiopia, Ghana, Tanzania, Mozambique and Uganda) shows no support for aid-related real exchange rate appreciation in these countries, but indicates that the fear of Dutch disease played an important part in the policy reaction -Date aid surges. Fiscal and monetary authorities should coordinate their responses -Date an aid surge, because an uncoordinated response?typically when fiscal authority wants -Date spend aid while the central bank wants -Date avoid exchange rate appreciation?can have serious negative macroeconomic consequences.
    Keywords: aid, exchange rate, aid absorption, policy
    Date: 2008
  20. By: Adam, Chris-Datepher S.; Buffie, Edward; O'Connell, Stephen; Pattillo, Catherine
    Abstract: We examine the properties of alternative monetary policy rules in response -Date large aid surges in low-income countries characterized by incomplete capital market integration and currency substitution. Using a dynamic s-Datechastic general equilibrium model, we show that simple monetary rules that stabilize the path of expected future seigniorage for a given aid flow have attractive properties relative -Date a range of conventional alternatives, including those involving heavy reliance on bond sterilization or a commitment -Date a pure exchange rate float. These simple rules, which are shown -Date be robust across a range of fiscal responses -Date aid inflows, appear -Date be consistent with actual responses -Date recent aid surges in a range of post-stabilization countries in Sub-Saharan Africa.
    Keywords: monetary policy, currency substitution, aid, Africa, DSGE models
    Date: 2008

This nep-cba issue is ©2008 by Alexander Mihailov. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.