nep-cba New Economics Papers
on Central Banking
Issue of 2008‒12‒21
24 papers chosen by
Alexander Mihailov
University of Reading

  1. Monetary policies and low-frequency manifestations of the quantity theory By Sargent, Thomas; Surico, Paolo
  2. Did the anchor of inflation expectations in the euro area turn adrift? By Gabriele Galati; Steven Poelhekke; Chen Zhou
  3. Can Structural Small Open Economy Models Account for the Influence of Foreign Disturbances? By Alejandro Justiniano; Bruce Preston
  4. Confidence in Monetary Policy By Yakov Ben-Haim; Maria Demertzis
  5. A Resolution of the Purchasing Power Parity Puzzle: Imperfect Knowledge and Long Swings By Roman Frydman; Michael D. Goldberg; Søren Johansen; Katarina Juselius
  6. Why the Euro Will Rival the Dollar By Menzie Chinn; Jeffrey Frankel
  7. Assessing the impact of the ECB’s monetary policy on the stock markets: A sectoral view By Konstantin Kholodilin; Alberto Montagnoli; Oreste Napolitano; Boriss Siliverstovs
  8. Forecast with judgment and models By Francesca Monti
  9. Optimal Simple Monetary Policy Rules in a Small Open Economy with Exchange Rate Imperfections By Deming Luo; Stephen Ferris
  10. The Great Moderation Flattens Fat Tails: Disappearing Leptokurtosis By WenShwo Fang; Stephen M. Miller; ChunShen Lee
  11. Are Asset Returns Predictable from the National Accounts? By Pierre Lafourcade
  12. Oil Shocks: How Destabilizing are they? By Bhattacharya, Jyotirmoy
  13. The sub-prime crisis, the credit crunch and bank “failure”: An assessment of the UK authorities’ response By Maximilian J. B. Hall
  14. To Dollarize or De-dollarize: Consequences for Monetary Policy By Patricia Alvarez-Plata; Alicia Garcia-Herrero
  15. Dynamic Factor Price Equalization & International Convergence By Joseph Francois; Clinton R. Shiells
  16. Monetary Transmission Mechanism in Central and Eastern Europe: Surveying the Surveyable By Balázs Égert; Ronald MacDonald
  17. Dollarization in Transition Economies: New Evidence from Georgia By Olga Aslanidi
  18. Exchange Market Pressure in Central European Countries from the Eurozone Membership Perspective By Stavarek, Daniel
  19. The Monetary Foundation of the Economic Circuit and the Principle of Effective Demand in Marx, Keynes and Kalecki By Hernando Matallana
  20. Reshaping the International Monetary Architecture and Addressing Global Imbalances: Lessons from the Keynes Plan By Piffaretti, Nadia F.
  21. The monetary effects arising from stochastic resource revenues and the subsidization of financial intermediation in resource rich developing economies By J. Stephen Ferris; Hossein Kavand
  22. A Medium-scale Open Economy Model of Australia By Jarkko Jääskelä; Kristoffer Nimark
  23. 1958-2008, avatars et enjeux de la courbe de Phillips By Le Bihan, Hervé
  24. A Small Open Economy DSGE Model for Pakistan By Bukhari, Syed Adnan Haider Ali Shah; Khan, Safdar Ullah

  1. By: Sargent, Thomas (New York University); Surico, Paolo (Monetary Policy Committee Unit, Bank of England)
    Abstract: To detect the quantity theory of money, we follow Lucas (1980) by looking at scatter plots of filtered time series of inflation and money growth rates and interest rates and money growth rates. Like Whiteman (1984), we relate those scatter plots to sums of two-sided distributed lag coefficients constructed from fixed-coefficient and time-varying VARs for US data from 1900-2005. We interpret outcomes in terms of population values of those sums of coefficients implied by two DSGE models. The DSGE models make the sums of coefficients depend on the monetary policy rule via cross-equation restrictions of a type that Lucas (1972) and Sargent (1971) emphasised in the context of testing the natural unemployment rate hypothesis. When the US data are extended beyond Lucas's 1955-75 period, the scatter plots mutate in ways that we attribute to prevailing monetary policy rules.
    Keywords: Quantity theory; policy regimes; time-varying VAR
    JEL: E40 E42 E51 E52 N10
    Date: 2008–12–08
  2. By: Gabriele Galati; Steven Poelhekke; Chen Zhou
    Abstract: Survey evidence indicates that inflation expectations increased after HICP inflation rose markedly in the course of 2007 and the first half of 2008, underpinning a general view that inflation expectations may have become unanchored from the ECB's target. However, until now there has been no formal test of whether this has in fact been the case. We fill this gap by testing the reaction of financial market-based measures of long-term expectations inflation expectations to news about inflation and other macroeconomic variables in the main euro area economies. If long-term inflation expectations are anchored, they should not react to the arrival of news. We find evidence that long-term inflation expectations have started to drift away from the ECB's anchor in the course of 2007. 
    Keywords: ECB; euro-area inflation and inflation compensation; anchors for expectations; news announcements. 
    JEL: E44 E52 E58
    Date: 2008–12
  3. By: Alejandro Justiniano; Bruce Preston
    Abstract: This paper demonstrates that an estimated, structural, small open economy model of the Canadian economy cannot account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The benchmark model assumes uncorrelated shocks across countries and implies that U.S. shocks account for less than 3 percent of the variability observed in several Canadian series, at all forecast horizons. Accordingly, model-implied cross-correlation functions between Canada and U.S. are essentially zero. Both findings are at odds with the data. A specification that assumes correlated cross-country shocks partially resolves this discrepancy, but still falls well short of matching reduced-form evidence.
    JEL: F41
    Date: 2008–12
  4. By: Yakov Ben-Haim; Maria Demertzis
    Abstract: In situations of relative calm and certainty, policy makers have confidence in the mechanisms at work and feel capable of attaining precise and ambitious results. As the environment becomes less and less certain, policy makers are confronted with the fact that there is a trade-off between the quality of a certain outcome and the confidence (robustness) with which it can be attained. Added to that, in the presence of Knightian uncertainty, confidence itself can no longer be represented in probabilistic terms (because probabilities are unknown). We adopt the technique of Info-Gap Robust Satisficing to first define confidence under Knightian uncertainty, and second quantify the trade-off between quality and robustness explicitly.We apply this to a standard monetary policy example and provide Central Banks with a framework to rank policies in a way that will allow them to pick the one that either maximizes confidence given an acceptable level of performance, or alternatively, optimizes performance for a given level of confidence. 
    Keywords: Knightian Uncertainty; Satisficing; Bounded Rationality; Minmax
    JEL: D81 E52 E58
    Date: 2008–12
  5. By: Roman Frydman (New York University); Michael D. Goldberg (University of New Hampshire); Søren Johansen (Department of Economics, University of Copenhagen); Katarina Juselius (Department of Economics, University of Copenhagen)
    Abstract: Asset prices undergo long swings that revolve around benchmark levels. In currency markets, fluctuations involve real exchange rates that are highly persistent and that move in near-parallel fashion with nominal rates. The inability to explain these two regularities with one model has been called the "Purchasing Power Parity puzzle". In this paper, we trace the puzzle to exchange rate modelers' use of the "Rational Expectations Hypothesis". We show that once imperfect knowledge is recognized, a monetary model is able to account for the puzzle, as well as other salient features of the data, including the long-swings behavior of exchange rates.
    Keywords: PPP puzzle; long swings; imperfect knowledge; rational expectations hypothesis
    JEL: F31 F41 G15
    Date: 2008–12
  6. By: Menzie Chinn (Wisconsin University); Jeffrey Frankel (Harvard University)
    Abstract: Evro je izrastao u kredibilnog potencijalnog konkurenta dolaru kao vodećoj međunarodnoj valuti, baš kao što je dolar pretekao britansku funtu pre 70 godina. Ovaj rad koristi ekonometrijski ocenjene determinante udela najvažnijih valuta u deviznim rezervama svetskih banaka širom sveta. Značajni faktori su: veličina zemlje, stopa prinosa, i likvidnost relevantnog domaćeg finansijskog centra (merena obrtom na deviznom tržištu). Postoji prelomni trenutak, ali promene se osećaju tek znatno kasnije (ocena pondera na prošlogodišnji valutni udeo je otprilike 0.9). Van uzorka, naš model je precizno predvideo smanjenje jaza između dolara i evra u periodu od 1999. do 2007. godine. Rad ažurira ove kalkulacije u pogledu budućih scenarija. Isključujemo scenario po kom se Velika Britanija priključuje evrozoni. Međutim, uzimamo u obzir da je London ipak postao de facto finansijski centar evra, više nego Frankfurt. Takođe uzimamo za pretpostavku da dolar nastavlja depresijaciju po trend stopi koju je u proseku pokazao u poslednjih 20 godina.
    Keywords: Devizno tržište, Evro, Dolar, Rezervna valuta
    JEL: E32 R10
    Date: 2008–07
  7. By: Konstantin Kholodilin (DIW Berlin, Germany); Alberto Montagnoli (University of Stirling, Stirling, UK); Oreste Napolitano (Parthenope University of Naples, Napoli, Italy); Boriss Siliverstovs (KOF Swiss Economic Institute, ETH Zurich, Switzerland)
    Abstract: This paper analyzes the response of the European stock markets to the monetary policy shocks by the European Central Bank using the heteroskedasticity based approach of Rigobon (2003). We find that monetary policy tightening has a heterogeneous impact on the Euro Area sectors on the day the monetary policy is publicly announced. Furthermore, we provide statistical evidence against the use of the popular event study approach when assessing the impact of monetary policy shocks on the stock market as the maintained assumptions can be rejected for the aggregate stock market and for most of the sectoral stock market indexes.
    Keywords: Monetary policy, Stock markets, ECB
    JEL: E44 E47 E52
    Date: 2008–12
  8. By: Francesca Monti (ECARES, Université Libre de Bruxelles)
    Abstract: This paper proposes a simple and model-consistent method for combining forecasts generated by structural micro-founded models and judgmental forecasts. The method also enables the judgmental forecasts to be interpreted through the lens of the model. We illustrate the proposed methodology with a real-time forecasting exercise, using a simple neo-Keynesian dynamic stochastic general equilibrium model and prediction from the Survey of Professional Forecasters
    Keywords: forecasting, judgment, structural models, Kalman Filter, real time
    JEL: C32 C53
    Date: 2008–12
  9. By: Deming Luo (Department of Economics, Carleton University); Stephen Ferris (Department of Economics, Carleton University)
    Abstract: The paper addresses whether or not the exchange rate or some other dimension of the external side of the economy should form an integral part of the monetary rule for a small open economy (SOE) in which the central bank faces data deficiencies. Under a number of information scenarios, the model’s simulations suggest that some reflection of the external environment facing the SOE—either the real exchange rate gap and/or the law of one price gap—is needed to improve monetary policy performance. When the money rule includes both interest rate smoothing and the real exchange rate (or law of one price gap), the relative welfare gain from their inclusion increases as the monetary authorities loses access to more current and reliable information.
    Keywords: New Keynesian small open economy model, exchange rate pass through, optimal simple money rules, stochastic general equilibrium model.
    Date: 2008–08–01
  10. By: WenShwo Fang (Feng Chia University); Stephen M. Miller (University of Nevada, Las Vegas, and University of Connecticut); ChunShen Lee (Feng Chia University)
    Abstract: Recently, Fagiolo et al. (2008) find fat tails of economic growth rates after adjusting outliers, autocorrelation and heteroskedasticity. This paper employs US quarterly real output growth, showing that this finding of fat tails may reflect the Great Moderation. That is, leptokurtosis disappears after GARCH adjustment once we incorporate the break in the variance equation.
    Keywords: Real GDP growth, the Great Moderation, leptokurtosis, GARCH models
    JEL: C32 E32 O40
    Date: 2008–12
  11. By: Pierre Lafourcade
    Abstract: Rational expectations and the logic of budget constraints imply that the predictability of asset returns hinges on the stability and persistence of households' ratio of saving to asset wealth, not of consumption to total wealth. This misalignment undermines the rationale for Lettau and Ludvigson's estimated cay, a stationary but unduly loose approximation to the true but non-mean-reverting cay. Definitional considerations on saving, assets and returns suggest rehabilitating money in the households'  flow of funds identity. Accounting for money balances in cay restores stationarity, but at the cost of drastically lower persistence and predictive potential. 
    JEL: E01 E21 E41
    Date: 2008–12
  12. By: Bhattacharya, Jyotirmoy
    Abstract: This note examines Prabhat Patnaik's argument that the contemporary international financial system crucially requires the stability of oil prices in terms of the dollar. By comparing the macroeconomic impact of recent oil shocks to those of the 1970s, it argues that sharp changes in the dollar price of oil need not necessarily lead to instability.
    Keywords: oil price; inflation; recession; dollar
    JEL: E31 E52
    Date: 2008
  13. By: Maximilian J. B. Hall (Dept of Economics, Loughborough University)
    Abstract: On 8 October 2008 the UK Government announced a far-reaching plan to restore financial stability, protect depositors and re-invigorate the flow of credit to businesses and individuals in the UK. The £400 billion bailout plan embraced three elements: a massive expansion in emergency liquidity support from the Bank of England; recapitalisation of UK banks and building societies using taxpayers' money; and the provision of a Government guarantee of new short- and medium-term debt issuance made by UK-incorporated banks and building societies. This action proved necessary in the wake of continuing and substantial weaknesses in many banks' share prices despite the temporary ban on short-selling imposed by the Financial Services Authority. It followed two revisions to domestic deposit protection arrangements, and the adoption of a piecemeal approach to failure resolution which saw the eventual nationalisation of Northern Rock in February 2008, the nationalisation of Bradford and Bingley in September 2008 and the brokering of takeover rescues of Alliance and Leicester and HBOS by Banco Santander and Lloyds TSB respectively in July and September 2008, and of the Cheshire and Derbyshire Building Societies by the Nationwide Building Society in September 2008. This metamorphosis in approach to failure resolution by the UK authorities in response to the sub-prime crisis and the credit crunch – nationalisation by default to (part) nationalisation as the preferred course of action - is duly analysed in this article, as well as their proposals for banking reforms which still have to be agreed by Parliament.
    Keywords: UK banks; banking regulation and supervision; failure resolution; central banking; deposit protection.
    JEL: E53 E58 G21 G28
    Date: 2008–11
  14. By: Patricia Alvarez-Plata; Alicia Garcia-Herrero
    Date: 2008
  15. By: Joseph Francois; Clinton R. Shiells (International Monetary Fund & Joint Vienna Institute)
    Abstract: We offer a duality-based methodology for incorporating multi-sector effects of international trade into open economy macroeconomic models, developing the concepts of the dynamic factor price equalization set and the integrated intertemporal equilibrium. Under this approach, the aggregate production function depends on output prices and factor endowment stocks. It preserves all of the structure of a standard GDP function from the trade theory literature. In a two-country version of the model considered below, we examine the properties of the dynamic factor price equalization set. If the global economy is initially outside of this set, the equations of motion will pull the economy back into this set. Inside the dynamic FPE set, factor prices are equalized internationally, and with identical tastes and technology, the economy can be regarded as a fully integrated world equilibrium in a dynamic sense (the integrated intertemporal equilibrium). In this equilibrium, all of the standard properties of a closed economy one-sector neoclassical growth model hold, ruling out cycles and chaos, and allowing us to characterize the evolution of international inequality and the persistence of productivity and endowment shocks. Working from the integrated intertemporal equilibrium, we identify properties of persistence linked to inequality and real economic shocks. Cross-country differences in per capita incomes and wealth, and the factor content of trading patterns, may persist over time and even into the new steady state. This provides yet another reason why we might observe lack of income convergence internationally. In addition, real shocks in one country may be transmitted to the other country through factor markets and product prices, and may have persistent effects into the steady-state as well. The model can also generate an endogenous Balassa-Samuelson effect.
    Keywords: Neoclassical Models of Trade, Economic Growth of Open Economies, Cross- Country Output Convergence
    JEL: F41 O47 F11 F43
    Date: 2008–11
  16. By: Balázs Égert; Ronald MacDonald
    Abstract: This paper surveys recent advances in empirical studies of the monetary transmission mechanism (MTM), with special attention to Central and Eastern Europe (CEE). Our results indicate that the strength of the exchange rate pass-through substantially declined over time mainly due to a fall in inflation rates and to some extent due to the so-called composition effect. The asset price channel is weak and is likely to remain weak because of shallow stock and private bond markets and because of low stock and bond holdings of domestic household. House prices may become an exception with higher levels mortgage lending and with high owner occupancy ratios. While the credit channel could be a powerful channel of monetary transmission - as new funds raised on capital markets are close to zero in CEE - it is actually not, as both commercial banks and non-financial corporations can escape domestic monetary conditions by borrowing from their foreign mother companies. The moderately good news is, however, that those banks and firms are influenced by monetary policy in the euro area because their parent institutions are themselves subjected to the credit channel in the euro area. <P>Canaux de transmission de la politique monétaire dans les PECO: une revue de la littérature <BR>Ce papier vise à synthétiser la littérature empirique portant sur le mécanisme de transmission monétaire, et tout particulièrement dans les pays d’Europe centrale et orientale (PECO). Cette étude montre que l’effet du taux de change sur l’inflation a diminué au cours du temps principalement en raison de la baisse des taux d’inflation, mais aussi dans une certaine mesure suite à un effet dit de composition. Le canal des prix d’actifs est faible et le restera probablement en raison des marchés d’actions et de titres obligataires privés peu développés, mais aussi à cause d’un faible taux de détention d’actifs financiers par les ménages. En revanche, avec l’accroissement du nombre de prêts immobiliers et de ménages propriétaires de leur appartements, les prix immobiliers peuvent jouer un rôle plus important à l’avenir. Même si le canal du crédit devrait être un des canaux de transmission les plus puissants, sachant que le financement externe sur les marchés est quasiment nul dans les PECO, tel n’est pas le cas pour autant. La raison en est que les banques commerciales mais aussi les entreprises peuvent échapper aux conditions monétaires nationales par le biais de financements obtenus auprès de leurs maisons mères implantées à l’étranger. La nouvelle quelque peu encourageante est que les entreprises mères sont elles-mêmes contraintes par la politique monétaire de la zone euro, exportant ainsi les effets du canal du crédit dans les PECO.
    Keywords: monetary transmission mechanism, asset prices, Central Europe, interest rate, credit channel, canal du crédit
    JEL: E31 E51 E58 F31 O11 P20
    Date: 2008–12–01
  17. By: Olga Aslanidi
    Abstract: This paper provides new evidence for dollarization in Georgia during the period from 1996 to 2007 using implications of dynamic money-in-utility-function models. Partial effects of foreign and domestic inflation, exchange rate, and foreign and domestic currency deposits’ interest rates on dollarization are considered. The US dollar is a strong substitute for domestic currency and has a significant share in producing domestic liquidity services. The actual dollarization in Georgia is persistent and larger than partial effects models predict.
    Keywords: Dollarization, Georgia, Money-in-utility-function
    JEL: C51 E41 F31
    Date: 2008–09
  18. By: Stavarek, Daniel
    Abstract: This paper estimates the exchange market pressure (EMP) in four Central European countries (Czech Republic, Hungary, Poland, Slovakia) over the period 1993-2006. Therefore, it is one of very few studies focused on this region and the very first paper applying concurrently model-dependent as well as model-independent approach to the EMP estimation on these countries. The results obtained suggest that the approaches lead to inconsistent findings. They often differ in identification of the principal development trends as well as magnitude and direction of the pressure. The paper provides evidence that a shift in the exchange rate regime towards the quasi-fixed ERM II should not stimulate EMP to grow. However, it is highly probable that some episodes of the excessive EMP will make the fulfillment of the exchange rate stability criterion more difficult in all countries analyzed.
    Keywords: Exchange Market Pressure; Model-dependent Approach; Model-independent Approach; European Union; Euro-candidate Countries
    JEL: C32 E42 F31 F36
    Date: 2008–11–10
  19. By: Hernando Matallana
    Abstract: Marx carried out the first full inquiry on the economics of the all-comprising circulation process of capital, first in Grundrisse in the late 1850s, and later in Capital and Theories of Surplus Value in the 1860s and the 1870s. Two substantial aspects are at the center of Marx’s analysis: (a) the monetary determination of the social process of production and circulation of capital, i.e. the fact that money-capital is a social relation determining the interaction of agents in the monetary production economy alias capitalism; and (b) the notion of the economic circuit as the key economic category for the understanding of the monetary logic of the principle of effective demand. These aspects are also at the center of Keynes’s and Kalecki’s foundation of the theory of the monetary production economy.
    Date: 2008–11–13
  20. By: Piffaretti, Nadia F.
    Abstract: As we witness profound changes in the global economy, and as it becomes apparent that the so-called “Revived Bretton Woods System” may be nothing more than a temporary non sustainable financing of the US structural internal imbalance, favored by the global role of the dollar, which has increased the overall vulnerability of the global financial architecture, it’s worth revisiting the origins of the Bretton Woods conference, and pointing out the relevance for today’s framework of Keynes’ original 1942 plan for an International Clearing Union. In this note we explore the main characteristics of Keynes’ original plan, by revisiting his original writings between 1940 and 1944, and we outline its relevance to the current debate on the international financial architecture, We’ll argue that reforms of the international financial architecture should include anchoring the international monetary system on a sounder institutional ground.
    Keywords: International Financial Architecture; Bretton Woods Institutions; Keynes Plan; International Currency; Global Imbalances
    JEL: E12 E58 F02 N20 E50 E00 E44 F33
    Date: 2008–12–16
  21. By: J. Stephen Ferris (Department of Economics, Carleton University); Hossein Kavand (Faculty of Economics, University of Tehran, Tehran, Iran)
    Date: 2008–10–01
  22. By: Jarkko Jääskelä (Reserve Bank of Australia); Kristoffer Nimark (Reserve Bank of Australia)
    Abstract: We estimate an open economy dynamic stochastic general equilibrium (DSGE) model of Australia with a number of shocks, frictions and rigidities, matching a large number of observable time series. We find that both foreign and domestic shocks are important drivers of the Australian business cycle. We also find that the initial impact on inflation of an increase in demand for Australian commodities is negative, due to an improvement in the real exchange rate, though there is a persistent positive effect on inflation that dominates at longer horizons.
    Keywords: monetary policy
    JEL: C11 E40 E52
    Date: 2008–12
  23. By: Le Bihan, Hervé
    Abstract: The Phillips curve is fifty years old. Since Phillips (1958)'s original contribution this econometric relationship has undergone many criticisms and evolutions. The Phillips curve yet remains a fundamental tool for inflation forecasting and monetary policy analysis. This paper reviews the various versions of the Phillips curve, using reearch carried out at the Banque de France for illustration purpose, and discusses the main issues associated with this relation.
    Keywords: courbe de Phillips; inflation; salaires
    JEL: E31 B22 J30
    Date: 2008–09
  24. By: Bukhari, Syed Adnan Haider Ali Shah; Khan, Safdar Ullah
    Abstract: This paper estimates a small open economy Dynamic Stochastic General Equilibrium (DSGE) model for Pakistan using Bayesian simulation approach. Model setup is based on new Keynesian framework, characterized by nominal rigidity in prices with habit formation in household’s consumption. The core objective is to study whether an estimated small open economy DSGE model provides a realistic behavior about the structure Pakistan economy with fully articulated description of the monetary policy transmission mechanism vis-à-vis domestic firm’s price setting behavior. To do so, we analyze the impulse responses of key macro variables; domestic inflation, imported inflation, output, consumption, interest rate, exchange rate, term of trade to different structural/exogenous shocks. From several interesting results, few are; (a) high inflation in Pakistan do not hit domestic consumption significantly; (b) Central bank of Pakistan responds to high inflation by increasing the policy rate by 100 to 200 bps; (c) exchange rate appreciates in both the cases of high domestic and imported inflation; (d) tight monetary policy stance helps to curb domestic inflation as well as imported inflation but appreciates exchange rate significantly (f) pass through of exchange rate to domestic inflation is very low; finally parameter value of domestic price stickiness shows that around 24 percent domestic firms do not re-optimize their prices which implies averaged price contract is about two quarters.
    Keywords: New-Keynesian economics; open economy DSGE models; nominal rigidities; monetary policy transmission mechanism; Bayesian Approach
    JEL: F37 E32 E52 F47 E47
    Date: 2008–11–18

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