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on Central Banking |
| By: | Blanchard, Olivier J; Cottarelli, Carlo; Spilimbergo, Antonio; Symansky, Steven |
| Abstract: | The current crisis calls for two main sets of policy measures. First, measures to repair the financial system. Second, measures to increase demand and restore confidence. While some of these measures overlap, the focus of this note is on the second set of policies, and more specifically, given the limited room for monetary policy, on fiscal policy. The optimal fiscal package should be timely, large, lasting, diversified, contingent, collective, and sustainable: timely, because the need for action is immediate; large, because the current and expected decrease in private demand is exceptionally large; lasting because the downturn will last for some time; diversified because of the unusual degree of uncertainty associated with any single measure; contingent, because the need to reduce the perceived probability of another “Great Depression” requires a commitment to do more, if needed; collective, since each country that has fiscal space should contribute; and sustainable, so as not to lead to a debt explosion and adverse reactions of financial markets. Looking at the content of the fiscal package, in the current circumstances, spending increases, and targeted tax cuts and transfers, are likely to have the highest multipliers. General tax cuts or subsidies, either for consumers or for firms, are likely to have lower multipliers. |
| Keywords: | financial crisis; fiscal stimulus |
| JEL: | E60 H30 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7130&r=cba |
| By: | Reinhart, Carmen; Felton, Andrew |
| Abstract: | This book is a selection of VoxEU.org columns that deal with the ongoing global financial crisis. VoxEU.org is a portal for research-based policy analysis and commentary written by leading economists. It was launched in June 2007 with the aim of enriching the economic policy debate by making it easier for serious researchers to contribute and to make their contributions more accessible to the public. |
| Keywords: | financial crisis monetary policy bank failures |
| JEL: | F42 E5 F41 E6 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:13604&r=cba |
| By: | Jeanne, Olivier; Ostry, Jonathan D; Zettelmeyer, Jeronimo |
| Abstract: | We present a framework that clarifies the financial role of the IMF, the rationale for conditionality, and the conditions under which IMF-induced moral hazard can arise. In the model, traditional conditionality commits country authorities to undertake crisis resolution efforts, facilitating the return of private capital, and ensuring repayment to the IMF. Nonetheless, moral hazard can arise if there are crisis externalities across countries (contagion) or if country authorities discount crisis costs too much relative to the national social optimum, or both. Moral hazard can be avoided by making IMF lending conditional on crisis prevention efforts - "ex ante" conditionality. |
| JEL: | F02 F32 F33 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7022&r=cba |
| By: | Andrea de Michelis |
| Abstract: | The global financial crisis that emerged in mid 2007 has caused considerable economic disruptions in the United States and elsewhere, and exposed major flaws in the global financial system. After examining the origins of the crisis, this paper recommends specific policy responses to resolve the immediate problems and discusses how to make the US financial system more resilient and stable in the future.<P>Surmonter la crise financière<BR>La crise financière qui a éclaté à la mi-2007 a provoqué des perturbations économiques considérables aux États-Unis et ailleurs, et révélé des failles majeures dans le système financier mondial. Après une analyse des origines de la crise, ce chapitre préconise des réponses spécifiques pour résoudre les problèmes immédiats et étudie les moyens de rendre le système financier des États-Unis plus résilient et plus stable dans l’avenir. |
| Keywords: | United States, États-Unis, surveillance prudentielle, financial regulation, financial crisis, crise financière, deleveraging, housing finance, financement du logement, financial supervision, réglementation des marchés financiers, market stability regulator, securitisation, subprime mortgage, autorité de contrôle pour la stabilité des marchés financiers, crédit hypothécaire à risques, réduction de l’effet de levier, titrisation |
| JEL: | E44 G20 G21 G28 R21 |
| Date: | 2009–02–24 |
| URL: | http://d.repec.org/n?u=RePEc:oec:ecoaaa:669-en&r=cba |
| By: | Reinhart, Carmen; Rogoff, Kenneth |
| Abstract: | The historical frequency of banking crises is quite similar in high- and middle-to-low-income countries, with quantitative and qualitative parallels in both the run-ups and the aftermath. We establish these regularities using a unique dataset spanning from Denmark’s financial panic during the Napoleonic War to the ongoing global financial crisis sparked by subprime mortgage defaults in the United States. Banking crises dramatically weaken fiscal positions in both groups, with government revenues invariably contracting, and fiscal expenditures often expanding sharply. Three years after a financial crisis central government debt increases, on average, by about 86 percent. Thus the fiscal burden of banking crisis extends far beyond the commonly cited cost of the bailouts. Our new dataset includes housing price data for emerging markets; these allow us to show that the real estate price cycles around banking crises are similar in duration and amplitude to those in advanced economies, with the busts averaging four to six years. Corroborating earlier work, we find that systemic banking crises are typically preceded by asset price bubbles, large capital inflows and credit booms, in rich and poor countries alike. |
| Keywords: | bail out; banking; crisis; debt; equity prices; house prices |
| JEL: | E6 F3 N10 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7131&r=cba |
| By: | Caballero, Ricardo; Farhi, Emmanuel; Gourinchas, Pierre-Olivier |
| Abstract: | In this paper we argue that the persistent global imbalances, the subprime crisis, and the volatile oil and asset prices that followed it, are tightly interconnected. They all stem from a global environment where sound and liquid financial assets are in scarce supply. Our story goes as follows: Global asset scarcity led to large capital flows toward the U.S. and to the creation of asset bubbles that eventually crashed. The crash in the real estate market was particularly complex from the point of view of asset shortages since it compromised the whole financial sector, and by so doing, closed many of the alternative saving vehicles. Thus, in its first phase, the crisis exacerbated the shortage of assets in the world economy, which triggered a partial recreation of the bubble in commodities and oil markets in particular. The latter led to an increase in petrodollars seeking financial assets in the U.S. Thus, rather than the typical destabilizing role played by capital outflows during financial crises, petrodollar flows became a source of stability for the U.S. The second phase of the crisis is more conventional and began to emerge toward the end of the summer of 2008. It became apparent then that the financial crisis would permeate the real economy and sharply slow down global growth. This slowdown worked to reverse the tight commodity market conditions required for a bubble to develop, ultimately destroying the commodity bubble. |
| JEL: | E0 F3 F4 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7064&r=cba |
| By: | Claessens, Stijn; Kose, Ayhan; Terrones, Marco E. |
| Abstract: | We provide a comprehensive empirical characterization of the linkages between key macroeconomic and financial variables around business and financial cycles for 21 OECD countries over the period 1960–2007. In particular, we analyze the implications of 122 recessions, 112 (28) credit contraction (crunch) episodes, 114 (28) episodes of house price declines (busts), 234 (58) episodes of equity price declines (busts) and their various overlaps in these countries over the sample period. Our results indicate that interactions between macroeconomic and financial variables can play major roles in determining the severity and duration of recessions. Specifically, we find evidence that recessions associated with credit crunches and house price busts tend to be deeper and longer than other recessions. |
| Keywords: | business cycles; busts; credit crunches; equity prices; house prices; recessions |
| JEL: | E32 E44 E51 F42 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7085&r=cba |
| By: | Joyce, Michael (Bank of England); Lildholdt, Peter; Sorensen, Steffen |
| Abstract: | This paper analyses the nominal and real interest rate term structures in the United Kingdom over the fifteen-year period that the UK monetary authorities have pursued an explicit inflation target, using a four-factor essentially affine term structure model. The model imposes no-arbitrage restrictions across nominal and real yields, enabling us to decompose nominal forward rates into expected real short rates, expected inflation, real term premia and inflation risk premia. We find that inflation risk premia and longer-term inflation expectations fell significantly when the Bank of England was made operationally independent in 1997. The 'conundrum' of unusually low long-term real rates that began in 2004 is mainly attributed by the model to a fall in real term premia, though a significant part of the fall is left unexplained. The relative inability of the model to fit long real forwards during much of this recent period may reflect strong pension fund demand for index-linked bonds. Moreover, the model decompositions suggest that these special factors affecting the index-linked market may also partly account for the contemporaneous rise in longer-horizon inflation breakeven rates. |
| Keywords: | Inflation expectations; inflation risk premia; affine term structure model |
| JEL: | C40 E43 E52 |
| Date: | 2009–02–16 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0360&r=cba |
| By: | Den Haan, Wouter; Rendahl, Pontus |
| Abstract: | We construct a method to solve models with heterogeneous agents and aggregate uncertainty that is simpler than existing algorithms; the aggregate law of motion is obtained neither by simulation nor by parameterization of the cross-sectional distribution, but by explicitly aggregating the individual policy rule. This establishes a link between the individual policy rule and the set of necessary aggregate state variables. In particular, the cross-sectional average of each basis function in the individual policy rule is a state variable. That is, if the individual capital stock, k, (or k²) enters the policy function then the mean of k (or the mean of k²) is a state variable. The laws of motions for these aggregate state variables are obtained by explicit aggregation of separate individual policy functions for the different elements. |
| Keywords: | numerical solutions; projection methods |
| JEL: | C63 D52 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6963&r=cba |
| By: | Franklin Allen; Elena Carletti; Douglas Gale |
| Abstract: | We develop a simple model of the interbank market where banks trade a long term, safe asset. We show that when there is a lack of opportunities for banks to hedge aggregate and idiosyncratic liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. The model shows also that market freezes, where banks stop trading with each other, can be a feature of the constrained efficient allocation if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand. |
| Keywords: | interbank market, liquidity, central bank intervention, open market operations |
| JEL: | G18 G21 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/09&r=cba |
| By: | Loranth, Gyongyi; Morrison, Alan |
| Abstract: | We examine the interdependency between loan officer compensation contracts and commercial bank internal reporting systems (IRSs). The optimal incentive contract for bank loan officers may require the bank headquarters to commit not to act on certain types of information. The headquarters can achieve this by running a basic reporting system that restricts information flow within the bank. We show that origination fees for loan officers emerge naturally as part of the optimal contract in our set-up. We examine the likely effect of the new Basel Accord upon IRS choice, loan officer compensation, and bank investment strategies. We argue that the new Accord reduces the value of commitment, and hence that it may reduce the number of marginal projects financed by banks. |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7155&r=cba |
| By: | Chinn, Menzie David; Wei, Shang-Jin |
| Abstract: | The assertion that a flexible exchange rate regime would facilitate current account adjustment is often repeated in policy circles. In this paper, we compile a data set encompassing data for over 170 countries over the 1971-2005 period, and examine whether the rate of current account reversion depends upon the de facto degree of exchange rate fixity, as measured by two popular indices. We find that there is no strong, robust, or monotonic relationship between exchange rate regime flexibility and the rate of current account reversion, even after accounting for the degree of economic development, the degree of trade and capital account openness. We also find that the endogenous selection of exchange rate regimes does not explain the observed lack of correlation. |
| Keywords: | current account imbalances; fixed exchange rate; floating exchange rate; real exchange rate |
| JEL: | F3 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7076&r=cba |
| By: | Polito, Vito; Wickens, Michael R |
| Abstract: | In this paper we propose a new way to formulate optimal policy based on a quadratic intertemporal welfare function where the dynamic constraint is based on a VAR model of the economy which we call the PVAR method. We argue that the VAR under control should not be derived simply by replacing the VAR equation for the policy instruments by an optimal control rule because this alters the stochastic structure of the VAR. Instead, one should first transform the VAR in order to condition the non-policy variables on the policy instruments, then use the resulting sub-system as the dynamic constraint, and finally construct the VAR under control by combining this sub-system with the resulting optimal policy rule. In this way the original stochastic structure of the VAR is retained. In comparing the two approaches we explain the theoretical advantages of the PVAR over the standard method and we illustrate the methods by examining the formulation of optimal monetary policy for the US. We suggest that since the whole process is easily automated, the PVAR method may provide a useful benchmark for use in real time against which to compare other, probably far more labour intensive, policy choices. |
| Keywords: | monetary policy; optimal control; VAR models |
| JEL: | C2 C6 E5 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6957&r=cba |
| By: | Fernández-Villaverde, Jesús |
| Abstract: | In this paper, I review the literature on the formulation and estimation of dynamic stochastic general equilibrium (DSGE) models with a special emphasis on Bayesian methods. First, I discuss the evolution of DSGE models over the last couple of decades. Second, I explain why the profession has decided to estimate these models using Bayesian methods. Third, I briefly introduce some of the techniques required to compute and estimate these models. Fourth, I illustrate the techniques under consideration by estimating a benchmark DSGE model with real and nominal rigidities. I conclude by offering some pointers for future research. |
| Keywords: | Bayesian Methods; DSGE Models; Likelihood Estimation |
| JEL: | C11 C13 E30 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7157&r=cba |
| By: | Consolo, Agostino; Favero, Carlo A; Paccagnini, Alessina |
| Abstract: | Dynamic Stochastic General Equilibrium (DSGE) models are now considered attractive by the profession not only from the theoretical perspective but also from an empirical standpoint. As a consequence of this development, methods for diagnosing the fit of these models are being proposed and implemented. In this article we illustrate how the concept of statistical identification, that was introduced and used by Spanos(1990) to criticize traditional evaluation methods of Cowles Commission models, could be relevant for DSGE models. We conclude that the recently proposed model evaluation method, based on the DSGE-VAR(ë), might not satisfy the condition for statistical identification. However, our application also shows that the adoption of a FAVAR as a statistically identified benchmark leaves unaltered the support of the data for the DSGE model and that a DSGE-FAVAR can be an optimal forecasting model. |
| Keywords: | Bayesian analysis; Dynamic stochastic general equilibrium model; Factor-Augmented Vector Autoregression; Model evaluation |
| JEL: | C11 C52 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7176&r=cba |
| By: | Alan S. Blinder (Princeton University); Jeremy B. Rudd (Federal Reserve Board) |
| Abstract: | U.S. inflation data exhibit two notable spikes into the double-digit range in 1973-1974 and again in 1978-1980. The well-known “supply-shock” explanation attributes both spikes to large food and energy shocks plus, in the case of 1973-1974, the removal of price controls. Yet critics of this explanation have (a) attributed the surges in inflation to monetary policy and (b) pointed to the far smaller impacts of more recent oil shocks as evidence against the supply-shock explanation. This paper reexamines the impacts of the supply shocks of the 1970s in the light of the new data, new events, new theories, and new econometric studies that have accumulated over the past quarter century. We find that the classic supply-shock explanation holds up very well; in particular, neither data revisions nor updated econometric estimates substantially change the evaluations of the 1972-1983 period that were made 25 years (or more) ago. We also rebut several variants of the claim that monetary policy, rather than supply shocks, was really to blame for the inflation spikes. Finally, we examine several changes in the economy that may explain why the impacts of oil shocks are so much smaller now than they were in the 1970s. |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:pri:cepsud:1097&r=cba |
| By: | Keiichi Morimoto (Graduate School of Economics, Osaka University) |
| Abstract: | This paper analyzes the relationship between the optimal weight on output gap in the central bankfs loss function and the degree of inertia in a hybrid version of New Keynesian model with a pure discretionary inflation targeting. I present the policy recommendations as to the weight on output gap in the presence of endogenous persistence in inflation dynamics. Especially, I show that under endogenous persistence of inflation dynamics, even in discretionary monetary policy regime, a Rogofffs (1985) conservative central banker does not necessarily improve social welfare. |
| Keywords: | hybrid New Keynesian model; inflation targeting; policy weight |
| JEL: | E52 E58 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:0905&r=cba |
| By: | Keiichi Morimoto (Graduate School of Economics, Osaka University) |
| Abstract: | In this paper, I show that accountability for inflation target will improve social welfare when the central bank makes transparency-opaqueness choices endogenously. The key elements are uncertainty of the firmsf informational quality, the opacity bias of constrained discretionay monetary policy under noisy information, and the role of harmful noisy public information. Based on the qualitative and quantitative result, I present a policy recommendation as to policy announcements and inflation targeting regime. |
| Keywords: | asymmetric information, economic transparency, inflation targeting |
| JEL: | D82 E52 E58 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:0906&r=cba |
| By: | Tille, Cédric; van Wincoop, Eric |
| Abstract: | We develop a new theory of international capital flows based on dispersed information across individual investors. There is extensive evidence of information heterogeneity within and across countries, which has proven critical to understanding asset price behavior. We introduce information dispersion into an open economy dynamic general equilibrium portfolio choice model, and emphasize two implications for capital flows that are specific to the presence of dispersed information. First, gross and net capital flows become partially disconnected from publicly observed fundamentals. Second, capital flows (particularly gross flows) contain information about future fundamentals, even after controlling for current fundamentals. We find that these implications are quantitatively significant and consistent with data for industrialized countries. |
| Keywords: | information dispersion; international capital flows |
| JEL: | F32 F36 F41 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6989&r=cba |
| By: | Demertzis, Maria; Marcellino, Massimiliano; Viegi, Nicola |
| 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: | anchors for expectations; credibility; Great Inflation; Great Moderation |
| JEL: | E52 E58 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7036&r=cba |
| By: | Kozo Ueda (Institute for Monetary and Economic Studies, Deputy Director and Bank of Japan (Email: kouzou.ueda boj.or.jp)) |
| Abstract: | We construct a simple model in which a central bank communicates with money market traders. We demonstrate that there exist multiple equilibria. In one equilibrium, traders truthfully reveal their own information, and by learning this, the central bank can make better forecasts. Another equilibrium is a gdog-chasing-its-tailh equilibrium in Blinder (1998). Traders mimic the central bankfs forecast, so the central bank simply observes its own forecast from traders. The latter equilibrium is socially worse in that inflation variability becomes larger. We also demonstrate that too high transparency of central banks is bad because it yields the gdog-chasing-its-tailh equilibrium, and that central banks should conduct continuous monitoring or emphasize that their forecasts are conditional because doing so eliminates the gdog- chasing-its-tailh equilibrium. |
| Keywords: | Transparency, disclosure, coordination |
| JEL: | C72 D83 E52 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:ime:imedps:09-e-05&r=cba |
| By: | Julián Messina; Chiara Strozzi; Jarkko Turunen |
| Abstract: | We study differences in the adjustment of aggregate real wages in the manufacturing sector over the business cycle across OECD countries, combining results from different data and dynamic methods. Summary measures of cyclicality show genuine cross-country heterogeneity even after controlling for the impact of data and methods. We find that more open economies and countries with stronger unions tend to have less pro-cyclical (or more counter-cyclical) wages. We also find a positive correlation between the cyclicality of real wages and employment, suggesting that policy complementarities may influence the adjustment of both quantities and prices in the labour market. |
| Keywords: | Real Wages, Business Cycle, Dynamic Correlation, Labour Market Institutions |
| JEL: | E32 J30 C10 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:mod:recent:028&r=cba |
| By: | Jordà, Òscar; Marcellino, Massimiliano |
| Abstract: | A path forecast refers to the sequence of forecasts 1 to H periods into the future. A summary of the range of possible paths the predicted variable may follow for a given confidence level requires construction of simultaneous confidence regions that adjust for any covariance between the elements of the path forecast. This paper shows how to construct such regions with the joint predictive density and Scheffé's (1953) S-method. In addition, the joint predictive density can be used to construct simple statistics to evaluate the local internal consistency of a forecasting exercise of a system of variables. Monte Carlo simulations demonstrate that these simultaneous confidence regions provide approximately correct coverage in situations where traditional error bands, based on the collection of marginal predictive densities for each horizon, are vastly off mark. The paper showcases these methods with an application to the most recent monetary episode of interest rate hikes in the U.S. macroeconomy. |
| Keywords: | error bands.; path forecast; simultaneous confidence region |
| JEL: | C32 C52 C53 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7009&r=cba |
| By: | Acocella, Nicola; Di Bartolomeo, Giovanni; Hughes Hallett, Andrew |
| Abstract: | Rational expectations are often used as a strong argument against policy activism, as they may undermine or neutralize the policymaker’s actions. Although this sometimes happens, rational expectations do not always imply policy invariance or ineffectiveness. In fact, in certain circumstances rational expectations can enhance our power to control an economy over time. In those cases, policy announcements, properly communicated, can be used to extend the impact of conventional policy instruments. In this paper we present a general forward-looking policy framework and use it to provide a formal justification for attempting to anchor expectations, and as a possible justification for publishing interest rate forecasts or tax rate projections. This approach allows us to test when policymakers can and cannot expect to be able to manage expectations. |
| Keywords: | controllability; fiscal policy; monetary policy; policy neutrality; Rational expectations |
| JEL: | C61 C62 E52 E61 E62 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7078&r=cba |
| By: | Andersen, Torben M |
| Abstract: | Approaching demographic shifts are raising concerns about fiscal sustainability in most OECD countries. A widespread view based on the tax-smoothing idea is that a prior consolidation of public finances is required to cope with the predicted trend deterioration in the primary budget balance. Both positive aspects in assessing the order of magnitude of sustainability problems and normative aspects of formulating policy strategies are addressed. It is argued that the smoothing argument cannot unconditionally be applied to the demographic problem. It is important to distinguish between increases in the dependency ratio driven by changes in fertility and longevity. For the former the smoothing argument may be appropriate, but not for the latter. In the case of longevity, a trade-off between consolidation and increasing retirement ages becomes relevant, and there are strong arguments why the latter should be pursued by e.g. linking retirement ages to longevity. |
| Keywords: | fertility; fiscal sustainability; longevity; Tax smoothing |
| JEL: | E60 H50 J11 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7044&r=cba |
| By: | Spivak, Avia; Sussman, Nathan |
| Abstract: | Financial globalization has seen the emergence of a new monetary standard based on inflation targeting. At the same time the most financially advanced economies moved away from exchange rate targeting which also characterized the previous era of globalization - the era of the Classical Gold Standard. Does the new financial environment of free capital flows constrain the independence of central banks to conduct monetary policy? We argue, and show empirically, that credible inflation targeting allows central banks to conduct an independent monetary policy as manifested in their ability to deviate from the world (Fed) interest rate. This new regime, with exchange rate flexibility, generates sufficient short term volatility that prevents short term arbitrage against central banks that deviate from the Fed rate. In contrast, during the Gold Standard only limited deviation was possible within the 'gold points'. On the other hand, the credibility of inflation targeting regime is as good as gold in anchoring inflation expectations for the long run as manifested in strong co-movement and similar levels of long term borrowing rates- just as was the case during the gold standard. We conclude that inflation targeting allows more flexibility than the Gold Standard to conduct monetary policy in the short run and has similar benefits for long term stability. We suggest that it is the new golden rule. |
| Keywords: | Credibility; Exchange rate variability; Gold standard; Inflation targeting |
| JEL: | E31 E4 E42 E43 E44 E58 F3 F33 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7001&r=cba |
| By: | Francois, Joseph; Shiells, Clinton R. |
| 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. Outside the steady-state, the relative price of labor intensive goods/services also trends with the evolution of the capital stock. |
| Keywords: | Cross country income convergence; Neoclassical Models of Trade; Open economy growth |
| JEL: | F11 F41 F43 O47 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7065&r=cba |
| By: | Heathcote, Jonathan; Perri, Fabrizio |
| Abstract: | In simple one-good international macro models, the presence of non-diversifiable labor income risk means that country portfolios should be heavily biased toward foreign assets. The fact that the opposite pattern of diversification is observed empirically constitutes the international diversification puzzle. We embed a portfolio choice decision in a frictionless two-country, two-good version of the stochastic growth model. In this environment, which is a workhorse for international business cycle research, we fully characterize equilibrium country portfolios. These are biased towards domestic assets, as in the data. Home bias arises because endogenous international relative price fluctuations make domestic assets a good hedge against non-diversifiable labor income risk. We then use our theory to link openness to trade to the level of diversification, and find that it offers a quantitatively compelling account for the patterns of international diversification observed across developed economies in recent years. |
| Keywords: | Country portfolios; Home bias; International business cycles |
| JEL: | F36 F41 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6982&r=cba |
| By: | Gregory de Walque (National Bank of Belgium, Research Department; University of Namur); Olivier Pierrard (Central Bank of Luxembourg; Catholic University of Louvain); Henri Sneessens (Catholic University of Louvain); Raf Wouters (National Bank of Belgium, Research Department; University of Louvain) |
| Abstract: | We consider a model with frictional unemployment and staggered wage bargaining where hours worked are negotiated for each period. The workers' bargaining power in the working time negotiations affects both unemployment volatility and inflation persistence. The closer to zero this parameter, (i) the more firms tend to adjust on the intensive margin, reducing employment volatility, (ii) the lower the effective workers' bargaining power for wages and (iii) the more important the hourly wage in determining the marginal cost. This set-up produces realistic labour market figures together with inflation persistence. Distinguishing the probability to bargain the wage rate for existing and new jobs, we show that the intensive margin helps reduce the new entrants' wage rigidity required to match observed unemployment volatility. |
| Keywords: | DSGE, Search and Matching, Nominal Wage Rigidity, Monetary Policy |
| JEL: | E31 E32 E52 J64 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbb:reswpp:200902-19&r=cba |
| By: | Bertrand Gruss; Silvia Sgherri |
| Abstract: | The ongoing financial turmoil has triggered a lively debate on ways of containing systemic risk and lessening the likelihood of future boom-and-bust episodes in credit markets. Particularly, it has been argued that banking regulation might attenuate procyclicality in lending standards by affecting the behavior of banks capital buffers. This paper uses a two-country DSGE model with financial frictions to illustrate how procyclicality in borrowing limits reinforces the ”overreaction” of asset prices to shocks described by Aiyagari and Gertler (1999), and to quantify the stabilization gains from policies aimed at smoothing cyclical swings in credit conditions. Results suggest that, in financially constrained economies, the ensuing volatility reduction in equity prices, investment, and external imbalances would be sizable. In the presence of cross-border spillovers, gains would be even higher. |
| Keywords: | Credit Cycles; Collateral Constraints; DSGE Models |
| JEL: | E32 F42 F36 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/07&r=cba |
| By: | Milesi-Ferretti, Gian Maria |
| Abstract: | In mid-2008, the real effective exchange rate of the dollar was close to its minimum level for the past 4 decades. At the same time, however, the U.S. trade and current account deficits remain large and, absent a significant correction in coming years, would contribute to a further accumulation of U.S. external liabilities. The paper discusses the tension between these two aspects of the dollar assessment, and what factors can help reconcile them. It focuses in particular on the terms of trade, adjustment lags, and measurement issues related to both the real effective exchange rate and the current account balance. |
| Keywords: | current account; real exchange rate; terms of trade |
| JEL: | F31 F32 F41 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7046&r=cba |
| By: | Marzo, Massimiliano (Università di Bologna); Zagaglia, Paolo (Dept. of Economics, Stockholm University) |
| Abstract: | This note reconsiders the impact of the reform of the operational framework of the European Central Bank that took place in March 2004. We estimate a bivariate GARCH model with the overnight rate and 1-year swap rate, where identifying restrictions are imposed on the conditional variance. Differently from previous studies, we use a measure of structural correlation to show that the 1-year swap segment has decoupled from the overnight rate as the two rates do not co-vary any longer. |
| Keywords: | Money Market; Multivariate GARCH; Structural Identification |
| JEL: | C22 E58 |
| Date: | 2009–02–15 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sunrpe:2009_0008&r=cba |
| By: | Adolfson, Malin; Laséen, Stefan; Lindé, Jesper; Svensson, Lars E O |
| Abstract: | This paper studies the transmission of shocks and the trade-offs between stabilizing CPI inflation and alternative measures of the output gap in Ramses, the Riksbank's empirical dynamic stochastic general equilibrium (DSGE) model of a small open economy. The main results are, first, that the transmission of shocks depends substantially on the conduct of monetary policy, and second, that the trade-off between stabilizing CPI inflation and the output gap strongly depends on which concept of potential output in the output gap between output and potential output is used in the loss function. If potential output is defined as a smooth trend this trade-off is much more pronounced compared to the case when potential output is defined as the output level that would prevail if prices and wages were flexible. |
| Keywords: | impulse responses; instrument rules; open-economy DSGE models; Optimal monetary policy; output gap; potential output |
| JEL: | E52 E58 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7070&r=cba |
| By: | Horii, Ryo; Ono, Yoshiyasu |
| Abstract: | This paper presents a simple model in which the learning behavior of agents generates fluctuations in money demand and possibly causes a prolonged depression. We consider a stochastic Money-in-Utility model, where agents receive utility from holding money only when a liquidity shock (e.g., a bank run) occurs. Households update the subjective probability of the shock based on the observation and change their money demand accordingly. In this setting, we first derive a stationary cycles under perfect price adjustment, which is characterized by periods of gradual inflation and sudden sporadic falls of the price level. When the nominal stickiness is introduced, the liquidity shock is followed by a period of low output. We show that the adverse effects of the shocks are largest when they occur in succession in an economy which has enjoyed a long period of stability. |
| Keywords: | Bayesian Learning; Money Demand; Hamilton-Jacobi-Bellman Equations; Markov Modulated Poisson Processes; Partial Delay Differential Equations |
| JEL: | E32 D83 E41 |
| Date: | 2009–02–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:13485&r=cba |
| By: | Jean-Marie Dufour; Lynda Khalaf; Maral Kichian |
| Abstract: | Using identification-robust methods, the authors estimate and evaluate for Canada and the United States various classes of inflation equations based on generalized structural Calvo-type models. The models allow for different forms of frictions and vary in their assumptions regarding the type of price indexation adopted by firms. Point and confidence-set parameter estimates are obtained based on the inversion of identification-robust test statistics. Focus is maintained on the structural aspect of the model with formal imposition of the restrictions that map the theoretical model into the econometric one. The results show that there is some statistical merit to using indexation-based Calvo-type models for inflation. However, some identification difficulties are also uncovered with considerable uncertainty associated with estimated parameter values. In particular, we find that implausibly-high frequency of price re-optimization values cannot be ruled out from our identification-robust confidence sets. |
| Keywords: | Inflation and prices; Econometric and statistical methods |
| JEL: | C13 C52 E31 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:09-7&r=cba |
| By: | Hafedh Bouakez; Emanuela Cardia; Francisco J. Ruge-Murcia |
| Abstract: | In this paper, we study the macroeconomic implications of sectoral heterogeneity and, in particular, heterogeneity in price setting, through the lens of a highly disaggregated multi-sector model. The model incorporates several realistic features and is estimated using a mix of aggregate and sectoral U.S. data. The frequencies of price changes implied by our estimates are remarkably consistent with those reported in micro-based studies, especially for non-sale prices. The model is used to study (i) the contribution of sectoral characteristics to the observed cross sectional heterogeneity in sectoral output and inflation responses to a monetary policy shock, (ii) the implications of sectoral price rigidity for aggregate output and inflation dynamics and for cost pass-through, and (iii) the role of sectoral shocks in explaining secotral prices and quantities. |
| Keywords: | Multi-sector models, price stickiness, simulated method of moments, sectoral shocks, monetary policy |
| JEL: | E3 E4 E5 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:0906&r=cba |
| By: | von Hagen, Jürgen; Zhou, Jizhong |
| Abstract: | We present an analysis of the determinants of de jure and de facto exchange rate regimes based on a panel probit model with simultaneous equations. The model is estimated using simulation-based maximum likelihood methods. The empirical results suggest a triangular structure of the model such that the choice of de facto regimes depends on the choice of de jure regimes but not vice versa. This gives rise to a novel interpretation of regime discrepancies. |
| Keywords: | de facto exchange rate regimes; developing countries; simultaneous equations |
| JEL: | C35 F33 F41 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7006&r=cba |
| By: | Mishra, Prachi; Spilimbergo, Antonio |
| Abstract: | We analyze how the pass-through from exchange rate to domestic wages depends on the degree of integration between domestic and foreign labor markets. Using data from 66 countries over the period 1981–2005, we find that the elasticity of domestic wages to real exchange rate is 0.1 after a year for countries with high barriers to external labor mobility, but about 0.4 in countries with low barriers to mobility. The results are robust to the inclusion of various controls, different measures of exchange rates, and concepts of labor market integration. These findings call for including labor mobility in macro models of external adjustment. |
| Keywords: | Exchange rates; Labor market integration; Migration |
| JEL: | F16 F22 J31 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7167&r=cba |
| By: | Artis, Michael J; Okubo, Toshihiro |
| Abstract: | The paper uses long-run GDP data for developed countries drawn from Maddison (2003) to generate deviation cycles for the period from 1870 to 2001. The cyclical deviates are examined for their bilateral cross-correlation values in three separate periods, those of the first globalization wave (1870 to 1914), the period of the “bloc economy” (1915 to 1959) and for the period of the second globalization (1960-2001). Cluster analysis is applied and the McNemar test is used to test for the relative coherence of alternative groupings of countries in the three periods. The bloc economy period emerges as one that features some well-defined sub-global clusters, where the second globalization period does not, the first globalization period lying between the two in this respect. The second globalization period shows a generally higher level of cross correlations and a lower variance than the other two periods. The features uncovered suggest that the second globalization period is indeed one that comprises a more inclusive world economy than ever before. |
| Keywords: | bloc economy; business cycle; cluster analysis; globalization; McNemar Test |
| JEL: | E32 F0 F15 F41 N10 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7041&r=cba |
| By: | Beck, Günter; Wieland, Volker |
| Abstract: | Research with Keynesian-style models has emphasized the importance of the output gap for policies aimed at controlling inflation while declaring monetary aggregates largely irrelevant. Critics, however, have argued that these models need to be modified to account for observed money growth and inflation trends, and that monetary trends may serve as a useful cross-check for monetary policy. We identify an important source of monetary trends in form of persistent central bank misperceptions regarding potential output. Simulations with historical output gap estimates indicate that such misperceptions may induce persistent errors in monetary policy and sustained trends in money growth and inflation. If interest rate prescriptions derived from Keynesian-style models are augmented with a cross-check against money-based estimates of trend inflation, inflation control is improved substantially. |
| Keywords: | monetary policy under uncertainty; money; output gap uncertainty; quantity theory; Taylor rules |
| JEL: | E32 E41 E43 E52 E58 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6947&r=cba |
| By: | Mackowiak, Bartosz Adam; Smets, Frank |
| Abstract: | We review the recent literature that studies new, detailed micro data on prices. We discuss implications of the new micro data for macro models. We argue that the new micro data are helpful for macro models, but not decisive. There is no simple mapping from the frequency of price changes in micro data to impulse responses of prices and quantities to shocks. We discuss ideas that promise to deliver macro models matching the impulse responses seen in macro data while being broadly in line with micro data. |
| Keywords: | micro price data; models of price setting; real effects of nominal shocks; sticky prices |
| JEL: | E3 E5 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6961&r=cba |
| By: | Papaioannou, Elias |
| Abstract: | This paper uses a large panel of financial flow data from banks to assess how institutions affect international lending. First, employing a time varying composite institutional quality index in a fixed-effects framework, the paper shows that institutional improvements are followed by significant increases in international finance. Second, cross-sectional models also show a strong effect of initial levels of institutional quality on future bank lending. Third, instrumental variable estimates further show that the historically predetermined component of institutional development is also a significant correlate of international bank inflows. The results thus suggest that institutional underdeveloped can explain a significant part of Lucas (1990) paradox of why doesn’t capital flow from rich to poor countries. The analysis also does a first-step towards understanding which exactly institutional features affect international banking. |
| Keywords: | banks; capital flows; institutions; international finance; law and finance; politics |
| JEL: | F21 F34 G21 K00 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7010&r=cba |
| By: | Monacelli, Tommaso; Perotti, Roberto |
| Abstract: | We document that an increase in government purchases generates a rise in consumption, the real and the product wage, and a fall in the markup. This evidence is robust across alternative empirical methodologies used to identify innovations in government spending (structural VAR vs. narrative approach). Simultaneously accounting for these facts is a formidable challenge for a neoclassical model, which relies on the wealth effect on labor supply as the main channel of transmission of unproductive government spending shocks. The goal of this paper is to explore further the role of the wealth effect in the transmission of government spending shocks. To this end, we build an otherwise standard business cycle model with price rigidity, in which preferences can be consistent with an arbitrarily small wealth effect on labor supply, and highlight that such effect is linked to the degree of complementarity between consumption and hours. The model is able to match our empirical evidence on the effects of government spending shocks remarkably well. This happens when the preferences are such that the positive wealth effect on labor supply is small and therefore the negative wealth effect on consumption is, somewhat counterintuitively, large. |
| Keywords: | Government spending; markup; private consumption; wealth effect |
| JEL: | D91 E21 E62 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7099&r=cba |
| By: | Acharya, Viral V |
| Abstract: | Systemic risk is modeled as the endogenously chosen correlation of returns on assets held by banks. The limited liability of banks and the presence of a negative externality of one bank’s failure on the health of other banks give rise to a systemic risk-shifting incentive where all banks undertake correlated investments, thereby increasing economy-wide aggregate risk. Regulatory mechanisms such as bank closure policy and capital adequacy requirements that are commonly based only on a bank’s own risk fail to mitigate aggregate risk-shifting incentives, and can, in fact, accentuate systemic risk. Prudential regulation is shown to operate at a collective level, regulating each bank as a function of both its joint (correlated) risk with other banks as well as its individual (bank-specific) risk. |
| Keywords: | Bank regulation; Capital adequacy; Crisis; Risk-shifting; Systemic risk |
| JEL: | D62 E58 G21 G28 G38 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7164&r=cba |
| By: | Bikbov, Ruslan; Chernov, Mikhail |
| Abstract: | This paper proposes to investigate whether US monetary policy changed over time by evaluating evidence from the entire yield curve. A regime-switching no-arbitrage term structure model relies on inflation, output and the short interest rate as factors. In a departure from the finance literature, the model is complemented with identifying assumptions that allow the private sector (inflation and output dynamics) to be separated from monetary policy (short interest rate). The model posits regime changes in the volatility of exogenous output and inflation shocks, in the monetary policy rule, and in the volatility of monetary shocks. The monetary policy regimes cannot be identified correctly if the yield curve is ignored during estimation. Counterfactual analysis uses the disentangled regimes in policy and shocks to understand their importance for the great moderation. The low-volatility regime of exogenous shocks during the last two decades plays an important role, while monetary policy contributes by trading off asymmetric responses of output and inflation under different regimes. |
| Keywords: | great moderation; monetary policy; regime switches; structural VAR; term structure model |
| JEL: | C52 E43 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7096&r=cba |
| By: | Forni, Mario; Gambetti, Luca |
| Abstract: | We use the structural factor model proposed by Forni, Giannone, Lippi and Reichlin (2007) to study the effects of monetary policy. The advantage with respect to the traditional vector autoregression model is that we can exploit information from a large data set, made up of 112 US monthly macroeconomic series. Monetary policy shocks are identified using a standard recursive scheme, in which the impact effects on both industrial production and prices are zero. Such a scheme, when applied to a VAR including a suitable selection of our variables, produces puzzling results. Our main findings are the following. (i) The maximal effect on bilateral real exchange rates is observed on impact, so that the “delayed overshooting” or “forward discount” puzzle disappears. (ii) After a contractionary shock prices fall at all horizons, so that the price puzzle is not there. (iii) Monetary policy has a sizable effect on both real and nominal variables. Such results suggest that the structural factor model is a promising tool for applied macroeconomics. |
| Keywords: | Delayed Overshooting Puzzle; Monetary Policy; Price Puzzle; Structural Factor Model |
| JEL: | C32 E32 E52 F31 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7098&r=cba |
| By: | Mario Forni; Luca Gambetti |
| Abstract: | We use the structural factor model proposed by Forni, Giannone, Lippi and Reichlin (2007) to study the effects of monetary policy. The advantage with respect to the traditional vector autoregression model is that we can exploit information from a large data set, made up of 112 US monthly macroeconomic series. Monetary policy shocks are identified using a standard recursive scheme, in which the impact effects on both industrial production and prices are zero. Such a scheme, when applied to a VAR including a suitable selection of our variables, produces puzzling results. Our main findings are the following. (i) The maximal effect on bilateral real exchange rates is observed on impact, so that the “delayed overshooting” or “forward discount” puzzle disappears. (ii) After a contractionary shock prices fall at all horizons, so that the price puzzle is not there. (iii) Monetary policy has a sizable effect on both real and nominal variables. Such results suggest that the structural factor model is a promising tool for applied macroeconomics. |
| Keywords: | Delayed Overshooting Puzzle, Monetary Policy, Price Puzzle, Structural Factor Model, Structural VAR. |
| JEL: | C32 E32 E52 F31 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:mod:recent:026&r=cba |
| By: | Viktors Ajevskis; Kristine Vitola |
| Abstract: | This paper develops a convergence model of the term structure of interest rates in the context of entering the EMU. Compared with the other models developed so far in this field, our model specification ensures convergence of the domestic short-term interest rates to the euro area ones. We achieve this convergence by stating that the spread between the domestic and euro short-term interest rates follows the Brownian bridge process. We also develop an econometric counterpart of the theoretical model. To address the problem of nonstationarity and nonlinearity of the model, the extended Kalman filter for coefficient estimation is applied. |
| Keywords: | term structure of interest rates, the Brownian bridge, the EMU, nonlinear Kalman filter |
| JEL: | E43 F36 G12 G15 |
| Date: | 2009–02–09 |
| URL: | http://d.repec.org/n?u=RePEc:ltv:wpaper:200901&r=cba |
| By: | Guimarães, Bernardo; Sheedy, Kevin D. |
| Abstract: | A striking fact about prices is the prevalence of "sales": large temporary price cuts followed by a return exactly to the former price. This paper builds a macroeconomic model with a rationale for sales based on firms facing consumers with different price sensitivities. Even if firms can vary sales without cost, monetary policy has large real effects owing to sales being strategic substitutes: a firm's incentive to have a sale is decreasing in the number of other firms having sales. Thus the flexibility of prices at the micro level due to sales does not translate into flexibility at the macro level. |
| Keywords: | monetary policy; nominal rigidities; sales |
| JEL: | E3 E5 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6940&r=cba |
| By: | Carriero, Andrea; Kapetanios, George; Marcellino, Massimiliano |
| Abstract: | Models based on economic theory have serious problems at forecasting exchange rates better than simple univariate driftless random walk models, especially at short horizons. Multivariate time series models suffer from the same problem. In this paper, we propose to forecast exchange rates with a large Bayesian VAR (BVAR), using a panel of 33 exchange rates vis-a-vis the US Dollar. Since exchange rates tend to co-move, the use of a large set of them can contain useful information for forecasting. In addition, we adopt a driftless random walk prior, so that cross-dynamics matter for forecasting only if there is strong evidence of them in the data. We produce forecasts for all the 33 exchange rates in the panel, and show that our model produces systematically better forecasts than a random walk for most of the countries, and at any forecast horizon, including at 1-step ahead. |
| Keywords: | Bayesian VAR; Exchange Rates; Forecasting |
| JEL: | C11 C53 F31 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7008&r=cba |
| By: | Chih-nan Chen (Research Analyst, Center for Multicultural Mental Health Research, Harvard University (cchen@chareresearch.org)); Tsutomu Watanabe (Institute of Economic Research and Research Center for Price Dynamics, Hitotsubashi University (E-mail: tsutomu.w@srv.cc.hit-u.ac.jp)); Tomoyoshi Yabu (Assistant Graduate School of Systems and Information Engineering, University of Tsukuba, and Institute for Monetary and Economic Studies, Bank of Japan (E-mail: tyabu@sk.tsukuba.ac.jp)) |
| Abstract: | The monetary authorities react even to intraday changes in the exchange rate; however, in most cases, intervention data is available only at a daily frequency. This temporal aggregation makes it difficult to identify the effects of interventions on the exchange rate. We propose a new method based on Markov Chain Monte Carlo simulations to cope with this endogeneity problem: We use "data augmentation" to obtain intraday intervention amounts and then estimate the efficacy of interventions using the augmented data. Applying this method to Japanese data, we find that an intervention of one trillion yen moves the yen/dollar rate by 1.7 percent, which is more than twice as large as the magnitude reported in previous studies applying OLS to daily observations. This shows the quantitative importance of the endogeneity problem due to temporal aggregation. |
| Keywords: | Foreign exchange intervention, Intraday data, Markov-chain Monte Carlo method, Endogeneity problem, Temporal aggregation |
| JEL: | C11 C22 F31 F37 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:ime:imedps:09-e-06&r=cba |
| By: | Ravn, Morten O.; Schmitt-Grohé, Stephanie; Uribe, Martín; Uusküla, Lenno |
| Abstract: | This paper introduces deep habits into a sticky-price sticky-wage economy and asks whether the countercyclical markup movements induced by deep habits is helpful for accounting for the dynamic effects of monetary policy shocks. We find that this is the case: When allowing for deep habits, the model can account very precisely for the persistent impact of monetary policy shocks on aggregate consumption and for the impact on inflation that other models have hard a time explaining. In particular, the model can account both for the price puzzle and for inflation persistence. We also show that the deep habits mechanism and nominal rigidities are complementary: The deep habits model can account for the dynamic effects of monetary policy shock at low to moderate levels of nominal rigidities. We show that the results are stable over time and are not caused by monetary policy changes. |
| Keywords: | countercyclical markup; deep habits; inflation persistence; monetayr policy shocks; price puzzle |
| JEL: | E21 E31 E32 E52 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7128&r=cba |
| By: | Jose Angelo Divino (Catholic University of Brasilia) |
| Abstract: | IPC One Pager 51 argued that inflation targeting has only slim prospects of success. This One Pager presents the findings of a recent empirical study of the impact of inflation targeting in a cross section of developing and emerging countries. The reasons usually given to justify adoption of this policy regime are transparency and credibility in monetary policy, the reduction of uncertainty, and implementation of the institutional and economic reforms required by the new regime. For developing and emerging countries, however, the economic benefits of inflation targeting are not yet well documented. (...) |
| Keywords: | What Impact Does Inflation Targeting Have on Unemployment? |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:ipc:opager:74&r=cba |
| By: | Vladimir Kuzin; Massimiliano Marcellino; Christian Schumacher |
| Abstract: | This paper discusses pooling versus model selection for now- and forecasting in the presence of model uncertainty with large, unbalanced datasets. Empirically, unbalanced data is pervasive in economics and typically due to di¤erent sampling frequencies and publication delays. Two model classes suited in this context are factor models based on large datasets and mixed-data sampling (MIDAS) regressions with few predictors. The specification of these models requires several choices related to, amongst others, the factor estimation method and the number of factors, lag length and indicator selection. Thus, there are many sources of mis-specification when selecting a particular model, and an alternative could be pooling over a large set of models with di¤erent specifications. We evaluate the relative performance of pooling and model selection for now- and forecasting quarterly German GDP, a key macroeconomic indicator for the largest country in the euro area, with a large set of about one hundred monthly indicators. Our empirical findings provide strong support for pooling over many speci.cations rather than selecting a specific model. |
| Keywords: | nowcasting, forecast combination, forecast pooling, model selection, mixed-frequency data, factor models, MIDAS |
| JEL: | E37 C53 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/13&r=cba |
| By: | Imbs, Jean; Mejean, Isabelle |
| Abstract: | Estimates of the elasticity of substitution between domestic and foreign varieties are small in macroeconomic data, and substantially larger in disaggregated studies. This may be an artifact of heterogeneity. We use disaggregated multilateral trade data to structurally identify elasticities of substitution in US goods. We spell out a partial equilibrium model to aggregate them adequately at the country level. We compare aggregate elasticities that impose equality across sectors, to estimates allowing for heterogeneity. The former are similar in value to conventional macroeconomic estimates; but they are more than twice larger -up to 7- with heterogeneity. The parameter is central to calibrated models in most of international economics. We discuss the difference our corrected estimate makes in various areas of international economics, including the dynamics of external balances, the international transmission of shocks, international portfolio choice and optimal monetary policy. |
| Keywords: | Aggregation; Calibration; Global Imbalances; International Portfolio; International Transmission; Monetary Policy; Trade Elasticities |
| JEL: | F21 F32 F41 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7177&r=cba |
| By: | Giannone, Domenico; Lenza, Michele; Reichlin, Lucrezia |
| Abstract: | This paper shows that the EMU has not affected historical characteristics of member countries’ business cycles and their cross-correlations. Member countries which had similar levels of GDP per-capita in the seventies have also experienced similar business cycles since then and no significant change associated with the EMU can be detected. For the other countries, volatility has been historically higher and this has not changed in the last ten years. We also find that the aggregate euro area per-capita GDP growth since 1999 has been lower than what could have been predicted on the basis of historical experience and US observed developments. The gap between US and euro area GDP per capita level has been 30% on average since 1970 and there is no sign of catching up or of further widening. |
| Keywords: | euro area; European integration; European monetary union; international business cycles |
| JEL: | C5 E32 F2 F43 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7124&r=cba |
| By: | Frale, Cecilia; Marcellino, Massimiliano; Mazzi, Gian Luigi; Proietti, Tommaso |
| Abstract: | A continuous monitoring of the evolution of the economy is fundamental for the decisions of public and private decision makers. This paper proposes a new monthly indicator of the euro area real Gross Domestic Product (GDP), with several original features. First, it considers both the output side (six branches of the NACE classification) and the expenditure side (the main GDP components) and combines the two estimates with optimal weights reflecting their relative precision. Second, the indicator is based on information at both the monthly and quarterly level, modelled with a dynamic factor specification cast in state-space form. Third, since estimation of the multivariate dynamic factor model can be numerically complex, computational efficiency is achieved by implementing univariate filtering and smoothing procedures. Finally, special attention is paid to chain-linking and its implications, via a multistep procedure that exploits the additivity of the volume measures expressed at the prices of the previous year. |
| Keywords: | Chain-linking; Dynamic factor Models; euro area GDP; Kalman filter and smoother; Multivariate State Space Models; Temporal Disaggregation |
| JEL: | C53 E32 E37 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7007&r=cba |
| By: | Meenagh, David; Minford, Patrick; Wickens, Michael R |
| Abstract: | We use the method of indirect inference, using the bootstrap, to test the Smets and Wouters model of the EU against a VAR auxiliary equation describing their data; the test is based on the Wald statistic. We find that their model generates excessive variance compared with the data. But their model passes the Wald test easily if the errors have the properties assumed by SW but scaled down. We compare a New Classical version of the model which also passes the test easily if error properties are chosen using New Classical priors (notably excluding shocks to preferences). Both versions have (different) difficulties fitting the data if the actual error properties are used. |
| Keywords: | Bootstrap; DSGE Model; Indirect inference; Model of EU; VAR model; Wald statistic |
| JEL: | C12 C32 |
| Date: | 2008–06 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6838&r=cba |
| By: | Alho, Kari; Kaitila, Ville; Widgrén, Mika |
| Abstract: | Economic convergence of the new member states (NMS) of the EU towards the old EU countries (EU-15), not only in terms of real income, but also in nominal terms, is of paramount importance for the whole of the EU. We build a dynamic CGE model, starting from the Balassa-Samuelson two-sector framework, but modify and enlarge it with forward-looking investment, consumption, and labour mobility behaviour to address several other issues like welfare and sustainability in terms of foreign indebtedness. At the same time we evaluate the impact of convergence on the EU-15 countries also, by endogenising offshoring and the related FDI flows from them to the NMS. Thereby we identify various effects of relocation and globalisation on the EU-15 enlarging the standard set of effects of globalisation and demonstrate the key role of their dynamic nature in the process of convergence. We find that in a general equilibrium setting fears of large adverse effects of a relocation of EU-15 manufacturing to the NMS are not well founded. In contrast, offshoring appears to be a win-win case for both the EU-15 and the NMS in terms of real income. The convergence of the NMS is fairly rapid, but will involve a persistent rapid inflation rate. |
| Keywords: | Convergence; EU-15; new member states; relocation |
| JEL: | F15 F21 F43 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7000&r=cba |
| By: | Jappelli, Tullio; Pagano, Marco |
| Abstract: | The single most important policy-induced innovation in the international financial system since the collapse of the Bretton-Woods regime is the institution of the European Monetary Union. This paper provides an account of how the process of financial integration has promoted financial development in the euro area. It starts by defining financial integration and how to measure it, analyzes the barriers that can prevent it and the effects of their removal on financial markets, and assesses whether the euro area has actually become more integrated. It then explores to which extent these changes in financial markets have influenced the performance of the euro-area economy, that is, its growth and investment, as well as its ability to adjust to shocks and to allow risk-sharing. The paper concludes analyzing further steps that are required to consolidate financial integration and enhance the future stability of financial markets. |
| Keywords: | EMU; financial market integration |
| JEL: | G20 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7091&r=cba |
| By: | Benk, Szilárd; Gillman, Max; Kejak, Michal |
| Abstract: | The post-1983 moderation coincided with an ahistorical divergence in the money aggregate growth and velocity volatilities away from the downward trending GDP and inflation volatilities. Using an en dogenous growth monetary DSGE model, with micro-based banking production, enables a contrasting characterization of the two great volatility cycles over the historical period of 1919-2004, and enables this puzzle to be addressed more easily. The volatility divergence is explained by the upswing in the credit volatility that kept money supply variability from translating into inflation and GDP volatility. |
| Keywords: | Growth; Inflation; Money and credit shocks; Volatility |
| JEL: | E13 E32 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7150&r=cba |
| By: | Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain |
| Abstract: | This paper investigates the international dimension of productivity and demand shocks to US manufacturing. Identifying shocks with sign restrictions based on standard theory predictions we find that productivity gains in manufacturing - our measure of tradables - have substantial aggregate effects, boosting US consumption and investment, relative to the rest of the world, thus raising real imports; net exports and US net foreign assets correspondingly decrease. We also ascertain substantial repercussions through the international financial adjustment mechanism, via a rise in US shares prices and nontrivial portfolio shifts in gross US foreign assets and liabilities. At the same time these shocks appreciate the US real exchange rate and improve its terms of trade. Shocks to the demand for US manufacturing also lead to real dollar appreciation; however, they appear to have less pronounced aggregate effects, with limited impact on trade and capital accounts. Our findings provide novel evidence on key channels of the international transmission of business cycle impulses, including financial channels, linking aggregate demand, the current account, international relative prices. Namely, asymmetric wealth effects amplify rather than attenuate the consequences of US shocks to tradables on domestic aggregate spending, driving endogenous aggregate demand fluctuations across countries. |
| Keywords: | consumption risk sharing; International transmission mechanism; sign restrictions; structural VAR; US dollar real exchange rate |
| JEL: | F31 F41 F42 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7003&r=cba |
| By: | Corsetti, Giancarlo; Konstantinou, Panagiotis T |
| Abstract: | The joint dynamics of US net output, consumption, and (valuation-adjusted) foreign assets and liabilities, characterized empirically following Lettau and Ludvigson [2004], is shown to be strikingly consistent with current account theory. While US consumption is virtually insulated from transitory shocks, these contribute considerably to the variation in net output and, even more so, in gross foreign positions, arguably smoothing temporary variations in returns. A single permanent shock – naturally interpreted as a productivity shock – raises consumption swiftly while causing net output to adjust only gradually. This leads to persistent, procyclical external deficits but, interestingly, moves gross assets and liabilities in the same direction. |
| Keywords: | Consumption Smoothing; Current Account; International Adjustment Mechanism; Intertemporal Approach to the Current Account; Net Foreign Wealth; Permanent-Transitory Decomposition |
| JEL: | C32 E21 F32 F41 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7134&r=cba |
| By: | Markku Lanne; Helmut Luetkepohl; Katarzyna Maciejowska |
| Abstract: | It is argued that in structural vector autoregressive (SVAR) analysis a Markov regime switching (MS) property can be exploited to identify shocks if the reduced form error covariance matrix varies across regimes. The model setup is formulated and discussed and it is shown how it can be used to test restrictions which are just-identifying in a standard structural vector autoregressive analysis. The approach is illustrated by two SVAR examples which have been reported in the literature and which have features which can be accommodated by the MS structure. |
| Keywords: | Cointegration, Markov regime switching model, vector error correction model, structural vector autoregression, mixed normal distribution |
| JEL: | C32 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/06&r=cba |
| By: | Acharya, Viral V; Gromb, Denis; Yorulmazer, Tanju |
| Abstract: | We study liquidity transfers between banks through the interbank borrowing and asset sale markets when (i) surplus banks providing liquidity have market power, (ii) there are frictions in the lending market due to moral hazard, and (iii) assets are bank-specific. We show that when the outside options of needy banks are weak, surplus banks may strategically under-provide lending, thereby inducing inefficient sales of bank-specific assets. A central bank can ameliorate this inefficiency by standing ready to lend to needy banks, provided it has greater information about banks (e.g., through supervision) compared to outside markets, or is prepared to extend loss- making loans. The public provision of liquidity to banks, in fact its mere credibility, can thus improve the private allocation of liquidity among banks. This rationale for central banking finds support in historical episodes preceding the modern era of central banking and has implications for recent debates on the supervisory and lender-of-last-resort roles of central banks. |
| Keywords: | Asset specificity; Central bank; Competition; Interbank lending; Lender of last resort; Market power |
| JEL: | D62 E58 G21 G28 G38 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6984&r=cba |
| By: | De Paoli, Bianca (Bank of England); Hoggarth, Glenn (Bank of England); Saporta, Victoria (Bank of England) |
| Abstract: | Avoiding the broader output losses to their economy is likely to be the key reason why governments avoid debt crises. Despite this, there has been little work that seeks to quantify output losses associated with such crises. This paper seeks to fill this gap. We find that debt crisis episodes last for long - on average by about ten years - and are associated with large output losses (of at least 5% per year). Sovereign crises rarely occur in isolation - more often than not they are associated with currency crises or banking crises or both. It is the occurrence of a potent cocktail of 'twin' or 'triple' crises that is strongly associated with output losses rather than sovereign crisis per se. |
| Keywords: | Sovereign debt; output losses; banking crises; currency crises |
| JEL: | F33 F34 |
| Date: | 2009–02–16 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0362&r=cba |
| By: | Flandreau, Marc; Galimard, Christophe; Jobst, Clemens; Nogués Marco, Maria Del Pilar |
| Abstract: | In this article, we study Europe's monetary geography on the eve of the Industrial Revolution. Our unit of analysis is the city and we explore inter-city linkages. Important findings include a considerable degree of integration and multilateralism with monetary centers having already emerged as vehicles for international settlements, before the Industrial Revolution. |
| Keywords: | history; international currency; international monetary system; network analysis |
| JEL: | F33 N23 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7169&r=cba |
| By: | Agustín S. Bénétrix and Philip R. Lane |
| Abstract: | We study the short-run effects of shocks to government spending on Ireland’s output and its real exchange rate. We show that the impact of government spending shocks critically depend on the nature of the fiscal innovation. Our main finding is that there are important differences between shocks to public investment and shocks to government consumption. Moreover, within the latter category, shocks to the wage and non-wage components also have dissimilar effects. |
| Date: | 2009–02–15 |
| URL: | http://d.repec.org/n?u=RePEc:iis:dispap:iiisdp281&r=cba |
| By: | Bernd Hayo (Faculty of Business Administration and Economics, Philipps-University Marburg); Matthias Neuenkirch (Faculty of Business Administration and Economics, Philipps-University Marburg) |
| Abstract: | Using a GARCH model, we study the effects of Canadian and U.S. central bank communication and macroeconomic news on Canadian bond, stock, and foreign exchange market returns and volatility. First, news in both categories and from both countries has an impact on all financial markets. Canadian and U.S. price shocks and monetary policy news are less important than shocks relating to the real economy. Second, Canadian central bank communication is more relevant than its U.S. counterpart, whereas in the case of macro news that originating from the United States dominates. Third, we find evidence that the impact of Canadian news reaches its maximum when the Canadian target rate departs from the Federal Funds target rate (2002–2004). The introduction of fixed announcement dates (FAD) does not cause a noticeable break in the data. Finally, Canadian and U.S. target rate changes lead to higher price volatility, and so does other U.S. news. Other Canadian news, however, lowers price volatility. |
| Keywords: | Bank of Canada, Central Bank Communication, Federal Reserve Bank, Financial Markets, Macroeconomic News, Monetary Policy |
| JEL: | E52 G14 G15 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:mar:magkse:200908&r=cba |
| By: | Felipe Meza (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM)); Antonio Carlos Urrutia (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM)) |
| Abstract: | Between 1988 and 2002, the real exchange rate in Mexico appreciated by 45%. We account for this movement in relative prices using a two sector, dynamic general equilibrium model of a small open economy with tradable an non-tradable goods. The model allows us to identify the effect of the differential in productivity growth across sectors (the Balassa-Samuelson effect) from other types of shocks affecting the allocation of resources (terms of trade, migration remittances and international reserves accumulation). We find that productivity growth in the tradable sector and a decline in the real interest rate faced by Mexico in the international markets account for 70% of the real exchange rate appreciation. Our model is also consistent with the reallocation of capital and labor from tradable to non-tradable sectors. None of our results support a significant role for terms of trade, migration remittances or international reserves accumulation. |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cie:wpaper:0807&r=cba |
| By: | Söderström, Ulf |
| Abstract: | I revisit the potential costs and benefits for Sweden of joining the Economic and Monetary Union (EMU) of the European Union. I first show that the Swedish business cycle since the mid-1990s has been closely correlated with the Euro area economies, suggesting that common shocks have been an important driving force of business cycles in Europe. However, evidence from an estimated model of the Swedish economy instead suggests that country-specific shocks have been important for fluctuations in the Swedish economy since 1993, implying that EMU membership could be costly. The model also indicates that the exchange rate has to a large extent acted to destabilize, rather than stabilize, the Swedish economy, pointing to the costs of independent monetary policy with a flexible exchange rate. Finally, counterfactual simulations of the model suggest that Swedish inflation and GDP growth might have been slightly higher if Sweden had been a member of EMU since the launch in 1999, but also that GDP growth might have been more volatile. The evidence is therefore not conclusive about whether or not participation in the monetary union would be advantageous for Sweden. |
| Keywords: | DSGE model; Monetary union; Open economy; Optimum Currency Area |
| JEL: | E42 E58 F41 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7062&r=cba |
| By: | Aron, Janine; Muellbauer, John |
| Abstract: | South Africa in the 1990s became globally more integrated after years of isolation. Opening the trade and capital accounts gave impetus to a monetary policy regime change to inflation targeting from 2000, after a costly transitional period of monetary mismanagement with low policy transparency. Changes in openness can, however, disrupt the inflation forecasting on which targeting monetary policies depend. This chapter demonstrates how the central bank’s own producer price inflation equation in its core model can be improved by taking account of greater openness, using both innovative time-series openness measures and a more conventional measure. The model has a greatly improved fit and stability over longer samples when also including the real exchange rate and the interest rate differential (making explicit the exchange rate channel of monetary transmission) and asymmetric food price inflation. Moreover, there is a role for the level of the output gap rather than simply a short-run effect, as in the central bank’s model. This helps mitigate the arguments in current South African debate regarding the apparent unconcern of inflation targeting policy for the level of economic activity. |
| Keywords: | inflation dynamics; modelling producer prices; trade openness |
| JEL: | C22 E31 F13 F41 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6992&r=cba |
| By: | Aron, Janine; Muellbauer, John |
| Abstract: | Inflation targeting central banks will be hampered without good models to assist them to be forward-looking. Many current inflation models fail to forecast turning points adequately, because they miss key underlying long-run influences. The world is on the cusp of a dramatic turning point in inflation. If inflation falls rapidly, such models can underestimate the speed at which interest rates should fall, damaging growth. Our forecasting models for the new measure of producer price inflation suggest methodological lessons, and build in conflicting pressures on SA inflation from exchange rate depreciation, terms of trade shocks, collapsing oil, food and other commodity prices, and other shocks. Our US and SA forecasting models for consumer price inflation underline the methodological points, and suggest the usefulness of thinking about sectoral trends. Finally, we apply the sectoral approach to understanding the monetary policy implications of introducing a new CPI measure in SA that uses imputed rents rather than interest rates to capture housing costs. |
| Keywords: | forecasting inflation; homeowner costs in the CPI; PPI inflation; South Africa |
| JEL: | C22 C51 C52 C53 E31 E52 E58 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7183&r=cba |