nep-cba New Economics Papers
on Central Banking
Issue of 2009‒03‒14
37 papers chosen by
Alexander Mihailov
University of Reading

  1. Transparency under Flexible Inflation Targeting: Experiences and Challenges By Svensson, Lars E O
  2. New Keynesian versus Old Keynesian Government Spending Multipliers By John F. Cogan; Tobias Cwik; John B. Taylor; Volker Wieland
  3. On the Paradox of Prudential Regulations in the Globalized Economy: International Reserves and the Crisis a Reassessment By Joshua Aizenman
  4. On the dynamics of inflation persistence around the world By Antonio E. Noriega; Manuel Ramos Francia
  5. Do Asymmetric Central Bank Preferences Help Explain Observed Inflation Outcomes? By Matthew Doyle; Barry Falk
  6. Reset Price Inflation and the Impact of Monetary Policy Shocks By Mark Bils; Peter J. Klenow; Benjamin A. Malin
  7. A Likelihood Analysis of Models with Information Frictions By Leonardo Melosi
  8. On the role of money growth targeting under inflation targeting regime By Dai, Meixing
  9. Monetary policy transparency and inflation persistence in a small open economy By Dai, Meixing; Sidiropoulos, Moïse; Spyromitros, Eleftherios
  10. Fiscal Policy in a Monetary Union in the Presence of Uncertainty about the Central Bank Preferences By Dai, Meixing; Sidiropoulos, Moise
  11. Public debt and currency crisis: how central bank opacity can make things bad? By Dai, Meixing
  12. Global Slack and Domestic Inflation Rates: A Structural Investigation for G-7 Countries By Fabio Milani
  13. Quantifying the Effect of Financial Conditions in the Euro Area, Japan, United Kingdom and United States By Stéphanie Guichard; David Haugh; David Turner
  14. Transparency and Numeric Rules in the Budgeting Process: Theory and Evidence By Amoroso Nicolás
  15. Assessing Long-Term Fiscal Developments: a New Approach By António Afonso; Luca Agnello; Davide Furceri; Ricardo M. Sousa
  16. Inflation Targets in a Monetary Union with Endogenous Entry By Stéphane Auray; Aurélien Eyquem; Jean-Christophe Poutineau
  17. A Note on the Dynamics of Persistence in US Inflation By Noriega Antonio E.; Ramos Francia Manuel
  18. Real exchange rates and real interest rate differentials: a present value interpretation By Mathias Hoffmann; Ronald MacDonald
  19. Why did we fail to predict GDP during the last cycle? A breakdown of forecast errors for Austria. By Martin Schneider; Christian Ragacs
  20. Expected Monetary Policy and the Dynamics of Bank Lending Rates By Claudia Kwapil; Johann Scharler
  21. Money, Infation and Interest Rate: Does the Link Change when the Policy Instrument Changes? By Castillo, Paul; Montoro, Carlos; Tuesta, Vicente
  22. The Revenge of Purchasing Power Parity on Carry Trades during Crises By Marie Brière; Bastien Drut
  23. Bayesian Analysis of DSGE Models with Regime Switching By Eo, Yunjong
  24. Money, Credit and Default By Sandra Lizarazo; Jose Maria Da-Rocha
  25. One Money, One Market: A Revised Benchmark By Theo Eicher; Christian Henn
  26. Common and Spatial Drivers in Regional Business Cycles By Artis, Michael J; Dreger, Christian; Kholodilin, Konstantin
  27. Heterogeneous Expectations and Exchange Rate Dynamics By Carl Chiarella; Xue-Zhong He; Min Zheng
  28. The Misfortune of Non-financial Firms in a Financial Crisis: Disentangling Finance and Demand Shocks By Tong, Hui; Wei, Shang-Jin
  29. A New Evidence for Exchange Rate Pass-through: Disaggregated Trade Data from Local Ports By Yushi Yoshida
  30. The Universal Shape of Economic Recession and Recovery after a Shock By Challet, Damien; Solomon, Sorin; Yaari, Gur
  31. Two Orthogonal Continents: Testing a Two-country DSGE Model of the US and EU Using Indirect Inference By Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick; Wickens, Michael
  32. The monetary policy rules in EU-15: before and after the euro By Borek Vasicek
  33. The Spanish economy in EMU: The first ten years By Ángel Estrada; Juan Francisco Jimeno; José Luis Malo de Molina
  34. Experts´ Macroeconomics Expectations: An Evaluation of Mexican Short-Run Forecasts. By Carlos Capistrán; Gabriel López-Moctezuma
  35. Out of reach? Convergence to an inflation target in the Central Bank of Iceland’s macroeconomic model By Baldursson, Fridrik M.; Hall, Axel
  36. Do Latin American Central Bankers Behave Non-Linearly?: The experiences of Brazil, Chile, Colombia and Mexico By Luiz de Mello; Diego Moccero; Matteo Mogliani
  37. Pro cyclicité de la politique budgétaire et surveillance multilatérale dans les unions monétaires africaines By Sylviane GUILLAUMONT JEANNENEY; Sampawende Jules TAPSOBA

  1. By: Svensson, Lars E O
    Abstract: I report some personal views and reflections on transparency experiences and transparency challenges following my first year and a half as Deputy Governor at Sveriges Riksbank regarding (1) flexible inflation targeting, (2) the role of transparency in inflation targeting and committee decisions on instrument-rate paths, (3) the management of interest-rate expectations, and (4) the publishing of attributed minutes. I also mention some future developments and improvements in transparency and flexible inflation targeting that I believe would be desirable.
    Keywords: Inflation targeting; interest rate path; transparency
    JEL: E42 E43 E52 E58
    Date: 2009–03
  2. By: John F. Cogan; Tobias Cwik; John B. Taylor; Volker Wieland
    Abstract: Renewed interest in fiscal policy has increased the use of quantitative models to evaluate policy. Because of modelling uncertainty, it is essential that policy evaluations be robust to alternative assumptions. We find that models currently being used in practice to evaluate fiscal policy stimulus proposals are not robust. Government spending multipliers in an alternative empirically-estimated and widely-cited new Keynesian model are much smaller than in these old Keynesian models; the estimated stimulus is extremely small just when needed most, and GDP and employment effects are only one-sixth as large, with private sector employment impacts likely to be even smaller.
    JEL: C52 E62
    Date: 2009–03
  3. By: Joshua Aizenman
    Abstract: This paper discusses two pertinent issues dealing with the global liquidity crisis -- global prudential regulation reform, and reassessment of using international reserves in the crisis. We point out the paradox of prudential regulations -- while the identity of economic actors that benefited directly from crises avoidance is unknown, the cost and the burden of regulations are transparent. Hence, crises that had been avoided are imperceptible and are underrepresented in the public discourse, and the demand for prudential regulations declines during prolonged good times, thereby increasing the ultimate cost of eventual crises. While the seeds of the present crisis were mostly home grown, international flows of capital magnified its costs. Global financial integration produces the by-product of "regulatory arbitrage" -- capital tends to flow to under regulated countries, frequently resulting in excessive risk taking, in anticipation of future bailout. A coordinated globalized prudential regulation, by increasing the cost of prudential deregulation, may mitigate the temptation to under-regulate during prolonged good-times, thus adding a side benefit. We also analyze the different approaches to the use of reserves during the crisis and what this means for the global financial system. The deleveraging triggered by the crisis implies that countries that hoarded reserves have been reaping the benefits. The crisis illustrates the importance of the self insurance provided by reserves, as well as the usefulness of policies that channel a share of the windfall gains associated with improvements in the terms-of-trade to reserves and sovereign wealth funds. The reluctance of many developing countries to draw down on their reserve holdings raises the possibility that they may now suffer less from the "fear of floating" than from a "fear of losing international reserves", which may signal deterioration in the credit worthiness of a country.
    JEL: F15 F36
    Date: 2009–03
  4. By: Antonio E. Noriega; Manuel Ramos Francia
    Abstract: We study the dynamics of inflation persistence in 45 countries for the period 1960-2008. We use a nonparametric unit root test robust to nonlinearities, error distributions, structural breaks and outliers, many of them typical features of inflation data, and a test for multiple changes in persistence, which decomposes the sample information between adjacent I(0) and I(1) periods. We find that (1) With very few exceptions, inflation around the world rejects a unit root, (2) for several countries there is evidence of significant changes in persistence, (3) bursts and drops in the level of inflation and in inflation persistence tend to coincide, (4) these drops occurred during “the Great Moderation” and during the adoption of inflation targeting. We conclude that inflation is characterized by either a stationary behaviour throughout the sample, or by switches of the type I(0)-I(1)-I(0). For all countries in our sample, any indication of nonstationarity seems to be temporary.
    Keywords: Inflation, Multiple persistence change, Stationarity, Unit root tests, Unknown direction of change, Monetary policy
    JEL: C12 C22 E31 E52 E58
    Date: 2009–02
  5. By: Matthew Doyle (Department of Economics, University of Waterloo); Barry Falk (Department of Economics, James Madison University)
    Abstract: When the central banker’s loss function is asymmetric, changes in the volatility of inflation and/or unemployment affect equilibrium inflation. This suggests that changing macroeconomic volatilities may be an important driving force behind trends in observed inflation. Previous evidence, which has offered support for this idea, suffers from a spurious regression problem. Once this problem is controlled for, the evidence suggests that the volatility of unemployment does not help explain inflation outcomes. There is some evidence of a relationship between inflation and its volatility, but overall the data does not support the view that changing economic volatility, as filtered through asymmetric central bank preferences, is an important driver of inflation trends.
    Keywords: Inflation, Monetary Policy, Asymmetric Loss Function.
    JEL: E50 E61
    Date: 2009–02
  6. By: Mark Bils; Peter J. Klenow; Benjamin A. Malin
    Abstract: A standard state-dependent pricing model generates little monetary non-neutrality. Two ways of generating more meaningful real effects are time-dependent pricing and strategic complementarities. These mechanisms have telltale implications for the persistence and volatility of "reset price inflation." Reset price inflation is the rate of change of all desired prices (including for goods that have not changed price in the current period). Using the micro data underpinning the CPI, we construct an empirical measure of reset price inflation. We find that time-dependent models imply unrealistically high persistence and stability of reset price inflation. This discrepancy is exacerbated by adding strategic complementarities, even under state-dependent pricing. A state-dependent model with no strategic complementarities aligns most closely with the data.
    JEL: E31 E32 E52
    Date: 2009–03
  7. By: Leonardo Melosi (Department of Economics, University of Pennsylvania)
    Abstract: This paper develops a dynamic stochastic general equilibrium model where firms are imperfectly informed. We estimate the model through likelihood-based methods and find that it can explain the highly persistent real effects of monetary disturbances that are documented by a benchmark VAR. The model of imperfect information nests a model of rational inattention where firms optimally choose the variances of signal noise, subject to an information-processing constraint. We present an econometric procedure to evaluate the predictions of this rational inattention model. Implementing this procedure delivers insights on how to improve the fit of rational inattention models.
    Keywords: Imperfect common knowledge; rational inattention; Bayesian econometrics; real effects of nominal shocks; VAR identification
    JEL: E3 E5 C32 D8
    Date: 2009–02–27
  8. By: Dai, Meixing
    Abstract: The mainstream inflation-targeting literature makes the strong assumption that the central bank can exactly target the interest rate which affects investment and consumption decisions and hence the money supply plays no role in the monetary policy strategy. This assumption is equivalent to admitting the perfect credibility of inflation target announced by the central bank, the perfect functioning of money and financial markets and that the central bank is willing to inject as much liquidity as the economic agents demand. Neither of these assumptions corresponds to the reality. In effect, the inflation expectations can not be easily anchored by the cheap talk of central bankers. On the other hand, the central bank may have many difficulties to target, in a context of financial instability, the interest rates which affect the real and financial decisions of private agents. We suggest that under inflation-targeting regime, money and credit markets vehicle the inflation expectations that can be anchored with a well-specified feedback money growth rule. The latter, in contrast to the Friedman’s k percent money growth rule, can help managing the inflation expectations in a manner to guarantee the dynamic stability of the economy. Furthermore, the model can be easily used to discuss the implications of the zero interest rate policy and the quantitative easing policy.
    Keywords: Interest rate rule; imperfect money and credit markets; inflation targeting; monetary targeting; inflation expectations; Friedman’s k percent money growth rule; feedback money growth rule; macroeconomic stability; zero interest rate policy; quantitative easing policy.
    JEL: E43 E51 E58 E52 E44
    Date: 2009–02–20
  9. By: Dai, Meixing; Sidiropoulos, Moïse; Spyromitros, Eleftherios
    Abstract: Using a New Keynesian small open economy model, we examine the effects of central bank transparency on inflation persistence. We have found that more opacity could reinforce the effect of persistent shocks on the level and variability of endogenous variables if the difference between the interest elasticity of domestic goods demand and the degree of trade openness is sufficient large or sufficiently low, judging on structural parameters characterising the economy, the central bank preference and its initial degree of opacity. Our result implies that, under perfect capital mobility, a high degree of domestic financial development is a good reason for increasing the transparency.
    Keywords: Central bank’s transparency; open economy; inflation persistence; real exchange rate persistence.
    JEL: E58 E52 F41
    Date: 2008–12
  10. By: Dai, Meixing; Sidiropoulos, Moise
    Abstract: In this paper, we examine the link between political transparency of a common central bank (CCB) and decentralized supply-side fiscal policies in a monetary union. We find that the opacity of a conservative CCB has a restrictive effect on national fiscal policies since each government internalizes the influence of its actions on the common monetary policy and thus reinforces the disciplinary effect of institutional constraints such as the Stability and Growth Pact on national fiscal authorities. However, more opacity could imply higher inflation and unemployment when the union is large enough and induce higher inflation and output-gap variability. An enlargement of the union incites national governments to increase tax rate, and weakens the disciplinary effects of opacity on member countries if fiscal policymaking is relatively decentralized and the CCB quite conservative. It induces an increase in the level of inflation and unemployment, and could increase inflation and output-gap variability.
    Keywords: central bank transparency; supply-side fiscal policy; monetary union.
    JEL: E58 E52 E50 E63
    Date: 2008–06
  11. By: Dai, Meixing
    Abstract: This paper examines how the transparency in monetary policy decision can impact the likelihood of currency crisis in a simple open economy model with public debt. In the presence of opacity, it is found that if the debt is high, the government will devaluate and vice versa, and the self-fulfilling multiple equilibria solution disappears. Furthermore, the opacity reduces the threshold of public debt above which the government is considered as totally lacking the credibility in its pre-commitment to maintain fixed the exchange rate.
    Keywords: central bank transparency; public debt; currency crisis; speculative attack.
    JEL: F37 O23 E58 E52 F31
    Date: 2008–12
  12. By: Fabio Milani (Department of Economics, University of California-Irvine)
    Abstract: Recent papers have argued that one implication of globalization is that domestic inflation rates may have now become more a function of ``global", rather than domestic, economic conditions, as postulated by closed-economy Phillips curves. This paper aims to assess the empirical importance of global output in determining domestic inflation rates by estimating a structural model for a sample of G-7 economies. The model can capture the potential effects of global output fluctuations on both the aggregate supply and the aggregate demand relations in the economy and it is estimated using full-information Bayesian methods. The empirical results reveal a significant effect of global output on aggregate demand in most countries. Through this channel, global economic conditions can indirectly affect inflation. The results, instead, do not seem to provide evidence in favor of altering domestic Phillips curves to include global slack as an additional driving variable for inflation.
    Keywords: Globalization; Global Slack; Inflation Dynamics; Phillips Curve; Bayesian Estimation
    JEL: E31 E50 E52 E58 F41
    Date: 2009–02
  13. By: Stéphanie Guichard; David Haugh; David Turner
    Abstract: This paper constructs a broad measure of financial conditions for the United States, Japan, the Euro Area and the United Kingdom, by extending monetary condition indices which are traditionally used to gauge the impact of monetary policy on the economy. In addition to changes in the exchange rate and short and long interest rates, the change in credit availability, corporate bond spreads and household wealth are taken into account to gauge the evolution of financial conditions. Since the onset of the financial crisis, financial conditions have tightened by an unprecedented degree in the four countries/regions and this is evaluated to exert a major drag on activity.<P>Quantifier l’impact des conditions financières dans la Zone Euro, le Japon, le Royaume-Uni et les États-Unis<BR>Ce document propose une mesure des conditions financières au sens large pour les États-Unis, le Japon, la Zone Euro et le Royaume-Uni, en étendant les indices des conditions monétaires traditionnellement employés pour mesurer l’impact de la politique monétaire sur l’économie. En plus des variations du taux de change et des taux d’intérêt à court et long terme, l’évolution de la disponibilité du crédit, des primes de risques sur les obligations des sociétés et de la richesse des ménages sont prises en considération pour apprécier l’évolution des conditions financières. Depuis le début de la crise financière, le resserrement des conditions financières a attient un degré sans précédent dans les quatre pays/régions et ceci devrait peser fortement sur l’activité.
    Keywords: wealth effects, effet de richesse, financial conditions index, interest rate spreads, credit crunch, credit channel, macro-financial linkages, indice des conditions financières, écarts de taux d’intérêt, contraction du crédit, canal du crédit, relations macro-financières, monetary conditions index, indice des conditions monétaires
    JEL: E32 E44 E47 E51
    Date: 2009–03–09
  14. By: Amoroso Nicolás
    Abstract: In this paper I develop a simple dynamic agency model postulating that, among budgetary institutions, transparency of the budgeting process is the main driving force in explaining differences in fiscal outcomes and that budgetary numeric rules can be an active long-run constraint only if the budgeting process is transparent enough. The model does not only account for long-run differences where countries with better budgetary institutions will have more disciplined fiscal outcomes, but can rationalize situations where countries with relatively better budgetary institutions can have what would appear to be less disciplined fiscal outcomes in the short-run. Empirical tests corroborate some but not all of the model´s predictions.
    Keywords: Budgetary Institutions, Fiscal Outcomes, Transparency.
    JEL: H61 D70 E60
    Date: 2008–08
  15. By: António Afonso (European Central Bank and ISEG/TULisbon); Luca Agnello (University of Palermo); Davide Furceri (OECD and University of Palermo); Ricardo M. Sousa (Universidade do Minho - NIPE)
    Abstract: We use a new approach to assess long-term fiscal developments. By analyzing the time-varying behaviour of the two components of government spending and revenue – responsiveness and persistence – we are able to infer about the sources of fiscal behaviour. Drawing on quarterly data we estimate recursively these components within a system of government revenue and spending equations using a Three-Stage Least Square method. In this way we track fiscal developments, i.e. possible fiscal deteriorations and/or improvements for eight European Union countries plus the US. Results suggest that positions have not significantly changed for Finland, France, Germany, Spain, the United Kingdom and the US, whilst they have improved for Belgium, Italy, and the Netherlands.
    Keywords: Fiscal Deterioration, Fiscal Sustainability.
    JEL: E62 H50
    Date: 2009
  16. By: Stéphane Auray (Université Lille 3 (GREMARS), Université de Sherbrooke (GREDI) and CIRPÉE); Aurélien Eyquem (GATE, UMR 5824, Université de Lyon and Ecole Normale Supérieure Lettres et Sciences Humaines, France); Jean-Christophe Poutineau (CREM (UMR 6211) Universite de Rennes 1 and Ecole Normale Superieure de Cachan, France.)
    Abstract: This paper shows that in a monetary union the interest rate rule of the Central Bank should react to the in°ation rate of the Harmonized Index of Consumption Price (HICP) rather than to the inflation rate of the Welfare-Based Consumption Price (WBCP). In a two{country general equilibrium model of the EMU with endogenous entry, we compare both monetary policy regimes and find that targeting the HICP inflation rate reduces the volatility of the Producer Price Index (PPI) in°ation rate and the volatility of the nominal .
    Keywords: monetary union, interest rate rule, harmonized index of consumption price
    JEL: E51 E58 F36 F41
    Date: 2009
  17. By: Noriega Antonio E.; Ramos Francia Manuel
    Abstract: Empirical research on the degree and stability of inflation persistence in the US has produced mixed results: some suggest high and unchanged persistence during the last few decades, while others argue in favor of a decline in persistence since the early 1980s. We show that post-WWII US inflation (monthly and quarterly) became highly persistent during the´Great Inflation´ period, and then switched back to a low persistence process during 1984, and has remained stationary until the present day.
    Keywords: Inflation, Multiple change in persistence, Stationarity, Great inflation.
    JEL: C12 C22 E31 E52
    Date: 2008–08
  18. By: Mathias Hoffmann; Ronald MacDonald
    Abstract: Although the real exchange rate - real interest rate (RERI) relationship is central to most open economy macroeconomic models, empirical support for the relationship is generally found to be rather weak. In this paper we re-investigate the RERI relationship using bilateral U.S. real exchange rate data spanning the period 1978 to 2007. Instead of testing one particular model, we build on Campbell and Shiller (1987) to propose a metric of the economic significance of the relationship. Our empirical results provide robust evidence that the RERI link is economically significant and that the real interest rate differential is a reasonable approximation of the expected rate of depreciation over longer horizons.
    Keywords: Real Exchange Rates, Real Interest Rates, Present Value Model.
    JEL: E43 F31 F41
    Date: 2009–02
  19. By: Martin Schneider (Oesterreichische Nationalbank, Economic Analysis Division, P.O. Box 61, A-1010 Vienna,); Christian Ragacs (Oesterreichische Nationalbank, Economic Analysis Division, P.O. Box 61, A-1010 Vienna,)
    Abstract: This paper proposes an informal taxonomy to break down forecast errors of institutional forecasts. This breakdown is demonstrated for the forecasts of the Oesterreichische Nationalbank (OeNB) for Austrian GDP. The main result is that the largest part of the forecast errors can be explained by erroneous projections of the international environment. Data revisions also substantially contribute to the forecasting error for the forecast of the current year. Domestic exogenous variables play a minor role only. The inclusion of judgement improves the forecasting performance.
    Keywords: Forecast error taxonomy; Breakdown; Austria; Judgement; Technical forecast.
    Date: 2009–02–11
  20. By: Claudia Kwapil (Oesterreichische Nationalbank, Economic Analysis Division, Otto-Wagner-Platz 3,POB 61, A-1011 Vienna, Austria); Johann Scharler (Department of Economics, University of Linz, Altenbergerstrasse 69, A-4040 Linz, Austria,)
    Abstract: In this paper we explore empirically to what extent expected monetary policy matters for the dynamics of bank lending rates in the U.S., the U.K. and Germany. We find that banks have increasingly behaved in a forward-looking fashion by taking expected changes in monetary policy rates into account when setting lending rates. We document that along with the shifts in monetary policy regimes towards inflation targeting, expected monetary policy has become more important as a determinant of bank lending rates. Overall, our results provide support for the hypothesis that monetary policy has become more effective by successfully influencing private sector expectations.
    Keywords: Monetary Policy, Expectations, Interest Rate Pass-Trough
    JEL: E52 E58
    Date: 2009–01–30
  21. By: Castillo, Paul (Banco Central de Reserva del Perú); Montoro, Carlos (Banco Central de Reserva del Perú); Tuesta, Vicente (Deutsche Bank)
    Abstract: The goal of this paper is to explain a recent regularity observed in economies in which central banks have moved from using a money aggregate as the instrument for the conduction of monetary policy towards a short-term interest rate (for example Peru in 2002). In particular, in those economies we observe that, after the change in the policy instrument, there is a decrease in the macroeconomic volatility accompanied by a reduction in the average level of both inflation and interest rates vis-à-vis an increase in the average level of money aggregates (an increase in the money demand). In order to explain the previous stylized fact, a second order solution of a general equilibrium model for a small open economy is evaluated. By analyzing the second order solution we relax the assumption of certainty equivalence which permits consider the role of uncertainty (risk) in the equilibrium solution of the economy. The previous solution takes into account the reduction of macroeconomic uncertainty (risk) as a consequence of changing the instrument (from money aggregates to interest rate rules), helping to explain the stylized fact. Our findings show that the use of the interest rate as the instrument for the conduction of monetary policy induces a reduction of macroeconomic risks. In turn, the previous reduction has driven a decrease in the average level of interest rates and inflation which is consistent with the increase in the demand for money observed in Peru in the 2000s. Hence, the recent increase in the growth rate of money aggregates should not be linked, whatsoever, to higher inflation rates.
    Keywords: Small Open Economy Model, Incomplete Markets, Second Order Solution
    JEL: E52 E42 E12 C63
    Date: 2009–01
  22. By: Marie Brière (Centre Emile Bernheim, Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussel and Credit Agricole Asset Management SGR, Paris.); Bastien Drut (Centre Emile Bernheim, Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussel, Credit Agricole Asset Management SGR and University of Paris Ouest, Paris.)
    Abstract: Empirical evidence shows that fundamental models have produced disappointing results over the past 20 years while carry trade strategies have performed superbly. But the real picture is much more complex. In fact, the track records of both strategies have varied considerably. This article shows that they have actually alternated between periods of profitability and underperformance. It also shows that when carry trade strategies perform well, fundamental strategies do poorly, and vice versa. Crises appear to play a significant role in the alternation of investment styles on currency markets. In contrast to carry trades, fundamental strategies perform remarkably well in crises. A portfolio that rotates between these two types of strategies, based on a risk aversion indicator such as implied equity volatility, would substantially outperform a pure carry trade strategy.
    Keywords: vix, financial crisis, purchasing power parity, carry trades, exchange rate equilibrium.
    JEL: F31 G15 G11
    Date: 2009–03
  23. By: Eo, Yunjong
    Abstract: I estimate DSGE models with recurring regime changes in monetary policy (inflation target and reaction coefficients), technology (growth rate and volatility), and/or nominal price rigidities. In the models, agents are assumed to know deep parameter values but make probabilistic inference about prevailing and future regimes based on Bayes’ rule. I develop an estimation method that takes these probabilistic inferences into account when relating state variables to observed data. In an application to postwar U.S. data, I find stronger support for regime switching in monetary policy than in technology or nominal rigidities. In addition, a model with regime switching policy that conforms to the long-run Taylor principle given in Davig and Leeper (2007) is preferred to a determinacy-indeterminacy model motivated by Lubik and Schorfheide (2004). These empirical results indicate that, even though a passive policy regime produced more volatility in the economy from the early 1970s to the mid-1980s, the economy can be explained by determinacy over the entire postwar period, implying no role for sunspot shocks in explaining the changes in volatility.
    Keywords: New Keynesian DSGE; Markov-switching; Monetary Policy; Indeterminacy; Long-run Taylor Principle; Bayesian Analysis;
    JEL: C51 C32 E32 C52 E52 C11
    Date: 2008–08
  24. By: Sandra Lizarazo (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM)); Jose Maria Da-Rocha (Facultade de Ciencias Económicas e Empresariais, Universidade de Vigo)
    Abstract: This paper develops a quantitative model of unsecured debt, default, and money demand for heterogenous agents economies. The paper generates a theory of money demand for the case in which money is a dominate asset that is not needed to carry-out transactions. In this environment holding money helps the agents to smooth their consumption during those periods in which they are excluded from credit markets following a default in their debts. In the model the welfare of the individuals is affected by the inflation rate: high inflation rates preclude individuals of using money as an asset that helps them smooth their consumption profile but low inflation rates tend to make softer the punishment for default making it diffcult to sustain high levels of debt at equilibrium. This two opposite effects imply that in equilibrium the inflation rate that maximizes individuals welfare is positive but not too high.
    Keywords: Default, Inflation, Money, Endogenous Borrowing Constraint
    JEL: F34 F36 F42
    Date: 2009
  25. By: Theo Eicher; Christian Henn
    Abstract: The introduction of the euro generated substantial interest in measuring the impact of currency unions (CUs) on trade flows. Rose’s (2000) initial estimates suggested a tripling of trade and created a literature in search of “more reasonable” CU effects. A recent meta-analysis of this literature shows that subsequent papers quantify CU trade impacts at 30–90 percent. However, most recent studies use shorter time series and fewer countries than Rose in his original work. We revisit Rose’s original benchmark, extend the dataset, and address Baldwin’s (2006) critiques of gravity implementation in large panels by simultaneously accounting for multilateral resistance and unobserved bilateral heterogeneity. This produces a robust average CU trade effect of 45 percent. Yet, the trade impacts of individual CUs vary substantially and are generally lower than those of preferential trade agreements (PTAs). Our revised benchmark can be used as a yardstick for future studies to delineate how estimates differ due to new data or differences in econometric specifications.
    Date: 2009–03
  26. By: Artis, Michael J; Dreger, Christian; Kholodilin, Konstantin
    Abstract: We examine real business cycle convergence for 41 euro area regions and 48 US states. Results obtained by a panel model with spatial correlation indicate that the relevance of common business cycle factors is rather stable over the past two decades in the euro area and the US. Ongoing business cycle convergence often detected in cross-country data is not confirmed at the regional level. The degree of synchronization across the euro area is similar to that to be found for the US states. Thus, the lack of convergence does not seem to be an impediment to a common monetary policy.
    Keywords: Business cycle convergence; Spatial correlation; spatial panel model
    JEL: C51 E32 E37
    Date: 2009–03
  27. By: Carl Chiarella (School of Finance and Economics, University of Technology, Sydney); Xue-Zhong He (School of Finance and Economics, University of Technology, Sydney); Min Zheng (School of Finance and Economics, University of Technology, Sydney)
    Abstract: This paper presents a continuous-time model of exchange rates relying not only on macroeconomic factors but also having a market microstructure component. The driving macroeconomic factor is the interest rate differential, while the market microstructure element is described by the expectations of boundedly rational portfolio managers who use a weighted average of the expectations of fundamentalists and chartists. Within this framework, the different roles of the macroeconomic factors and market microstructure elements on the determination of the exchange rate are examined explicitly. We show that this simple model generates very complicated market behaviour, including the existence of multiple steady state equilibria, the deviations of the market exchange rate from the fundamental, and market fluctuations. Numerical simulation of the corresponding stochastic version of the model shows that the model is able to generate typical time series and volatility clustering patterns observed in exchange rate markets.
    Keywords: Exchange rate; interest rate differential; heterogeneous expectations
    JEL: F31 F41
    Date: 2009–01–01
  28. By: Tong, Hui; Wei, Shang-Jin
    Abstract: If a non-financial firm does not do well in a financial crisis, it could be due to either a contraction of demand for its output or a contraction of supply of external finance. We propose a framework to assess the relative importance of the two shocks, making use of a measure of a firm's financial constraint based on Whited and Wu (2006) and another measure of sensitivity to a demand shock, and apply it to the 2007-2008 crisis. We find robust evidence suggesting that both channels are at work, but that a finance shock is economically more important in understanding the plight of non-financial firms.
    Keywords: demand shock; financial crisis; liquidity constraint
    JEL: G2 G3
    Date: 2009–03
  29. By: Yushi Yoshida (Faculty of Economics, Kyushu Sangyo University)
    Abstract: For the estimation of exchange rate pass-through (henceforth ERPT), except for few evidences based on firm-level data, even the most disaggregated level of national export data is still biased with aggregation over sub-regions within an exporting country. We investigate to what extent this aggregation within product category is biased by comparing ERPT estimates across local ports. We use monthly exports at the HS 9-digit level from January 1988 to December 2005 for five major Japanese ports. In a panel data regression framework we control for exporting industry and importing country. Statistical tests provide strong evidence that export prices are set at different levels across local ports and that they correspond differently with respect to fluctuations of exchange rates.
    Keywords: Exchange rate pass-through; Firm heterogeneity; Japanese trade; Port-level trade; pricing-to-market
    JEL: F14 F31 F41
    Date: 2008–07
  30. By: Challet, Damien; Solomon, Sorin; Yaari, Gur
    Abstract: We show that a simple and intuitive three-parameter equation fits remarkably well the evolution of the gross domestic product (GDP) in current and constant dollars of many countries during the times of recession and recovery. We then argue that it can be used to detect shocks and discuss its predictive power. Finally, a two-sector theoretical model of recession and recovery illustrates how the severity and length of recession depends on the dynamics of transfer rate between the growing and failing parts of the economy.
    Keywords: Economic growth, transition economies, GDP, modelling, prediction, optimal policy
    JEL: C32 O23 O41
    Date: 2009
  31. By: Le, Vo Phuong Mai (Cardiff Business School); Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Wickens, Michael
    Abstract: We examine a two country model of the EU and the US. Each has a small sector of the labour and product markets in which there is wage/price ridigity, but otherwise enjoys flexible wages and prices with a one quarter information lag. Using a VAR to represent the data, we find the model as a whole rejected. Howerver it is accepted for particular features of the data, such as output and (marginally) inflation behaviour. The model highlights a lack of spillovers between the US and the EU.
    Keywords: Bootstrap; Open economy model; DGSE; VAR; New Keynesian; New Classical; indirect inference; Wald statistic
    JEL: C12 C32 C52 E1
    Date: 2009–03
  32. By: Borek Vasicek (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona)
    Abstract: The objective of this paper is to identify empirically the logic behind short-term interest rates setting of: 1) the monetary authorities of the 15 EU countries before the launch of the European Monetary Union (EMU) and 2) the European Central Bank (ECB) and the central banks of the non-EMU participants since 1999. We find that the Taylor rule, based on the response to inflation and to the output gap, is a reasonable description of the interest rate setting for only a few economies. In addition, the foreign interest rate and the long-term interest rate are often crucial to explain short-term interest rate developments. On the contrary, the impact of other variables often proposed in the literature (exchange rates, monetary growth and asset prices) is negligible. The application of singleequation analysis to Euro area aggregate data to identify the ECB.
    Keywords: monetary policy, Taylor rule, European Monetary Union, panel data
    JEL: E52 E58
    Date: 2008–12
  33. By: Ángel Estrada (Banco de España); Juan Francisco Jimeno (Banco de España); José Luis Malo de Molina (Banco de España)
    Abstract: This paper has been prepared to mark the tenth anniversary of Economic and Monetary Union (EMU). It seeks to give an overview of the Spanish economy’s experience in this new institutional setting. It should be viewed as the result of a joint effort by a sizeable group of researchers from the Banco de España Directorate General Economics, Statistics and Research to rationalise the implications of a structural change on this scale. To do this, the paper firstly defines the starting conditions of the Spanish economy, at the time when there was only a commitment to join the Monetary Union as a founding member; in this connection, it sets out the advantages of belonging to the euro area versus the possibility of having remained outside it. Next, it describes the main transformations made in converting this commitment into reality. Further, it reviews developments in the economic variables that best document the main events of the past decade, focusing both on the factors underpinning the expansion and the headway in convergence, and on the imbalances that triggered the start of the adjustment, and assesses the scope of these imbalances. Finally, it describes the basic features of the process of adjustment towards a new path of sustained economic growth, emphasising the difficulties added by the superimposition of the international financial crisis.
    Keywords: Spanish economy, EMU, international financial crisis
    JEL: E58 E66 F33
    Date: 2009–02
  34. By: Carlos Capistrán; Gabriel López-Moctezuma
    Abstract: This document analyzes inflation, exchange rate, interest rate, and GDP growth forecasts from the monthly Survey of Specialists in Economics from the Private Sector, maintained by Banco de México. The study concentrates on the mean across forecasters for the period from January 1995 to April 2008. The study evaluates the efficiency in the use of information and the relative performance using as benchmarks forecasts from time series models and from other macroeconomic variables. Inflation, interest rate, and GDP expectations seem to incorporate information in a relatively efficient manner. These forecasts appear to be better, in mean squared error terms, than the benchmark forecasts, except for the case of one-yearahead inflation. In addition, exchange rate forecasts do not seem to optimally incorporate available information and do not seem to improve upon forecasts obtained from a random walk model.
    Keywords: Predictive ability, Rational expectations, Rolling-forecasts.
    JEL: C22 C53 E17 E37 E47 F37
    Date: 2008–08
  35. By: Baldursson, Fridrik M.; Hall, Axel
    Abstract: Inflation scenarios in forecasts of the Central Bank of Iceland (CBI) appear to converge to the inflation target (2.5%) in 8-9 quarters. We ask whether this is a coincidence or an inherent property of the CBI’s model, QMM. We formulate a sub-model, containing equations for inflation, inflation expectations, wages, exchange rate and the policy interest rate. We find that rapid convergence toward the inflation target is a property of the QMM when a Taylor-rule is included in the model. Underlying is an inflation expectations equation which assumes a high degree of credibility of the CBI. This equation, however, lacks empirical underpinnings. When we replace the QMM expectations equation with an estimated equation, a more realistic picture emerges where the Central Bank has to raise the policy rate considerably higher than in QMM scenarios and it takes much longer to reach the inflation target.
    Keywords: Inflation targeting; inflation forecasts; inflation expectations; macroeconomic models; credibility
    JEL: E27 E58 E52 E44
    Date: 2008–09
  36. By: Luiz de Mello; Diego Moccero; Matteo Mogliani
    Abstract: This papers estimates unrestricted monetary reaction functions for four Latin American countries (Brazil, Chile, Colombia and Mexico) and tests for the presence of non-linear effects in central bank behaviour. The analysis covers the post-1999 inflation-targeting period. We deal with the presence of unit roots in the data by estimating the policy rules in a co-integration setting. We test for linear and non-linear co-integration among the variables of interest. The results suggest that a non-linear specification is not rejected by the data for Brazil, Colombia and Mexico, but it is for Chile. Estimation of smooth-transition models by NLLS and EN-NLLS suggests that the central bank’s response to the inflation gap (i.e. deviations of expected inflation from the target) is invariant across policy regimes in Colombia. It becomes stronger in Mexico as expected inflation deviates from the target. Policy responses appear to weaken in Brazil as the inflation gap widens, a finding that most probably reflects a history of adverse supply shocks and upward adjustments in targets in the early years of inflation targeting. Non-linearity is also found in the central bank’s response to the exchange rate in Brazil and Colombia.<P>Les banques centrales d’Amérique latine se comportent-elles d’une manière non-linéaire? : Les expériences du Brésil, du Chili, de la Colombie et du Mexique<BR>Ce document estime des fonctions de réaction monétaires non-contraintes pour quatre pays d’Amérique latine (Brésil, Chili, Colombie et Mexique) et teste l’existence d’effets non-linéaires dans le comportement des banques centrales. L’analyse couvre la période post-1999 où la politique monétaire se caractérise par le ciblage d’inflation. Nous traitons la question de la présence de racines unitaires dans les données en estimant les règles de politique monétaire dans un cadre de cointégration. Nous testons l’existence d’une cointégration linéaire et non-linéaire de nos variables d’intérêt. Les résultats suggèrent que la spécification non-linéaire ne peut être rejetée pour les données brésiliennes, colombiennes et mexicaines ; elle l’est en revanche dans le cas du Chili. L’estimation de modèles de transition douce par des NLLS et EN-NLLS suggère que la réponse de la banque centrale à la différence entre l’inflation espérée et la cible d’inflation ne change pas selon le régime de politique monétaire au Chili. Elle se durcit au Mexique lorsque l’inflation espérée s’éloigne de la cible. Les réponses semblent s'assouplir au Brésil lorsque la différence entre l’inflation espérée et la cible d’inflation s’accroît ; ce résultat est certainement dû à des chocs d’offre négatifs et à des ajustements à la hausse des cibles dans les premières années de politique monétaire à cible d’inflation. Nous trouvons aussi un effet non-linéaire de la réponse de la Banque centrale au taux de change au Brésil et en Colombie.
    Keywords: cible d'inflation, co-intégration multiple, inflation targeting, reaction function, fonction de réaction, non-linear co-integration, smooth-transition model, modèle de transition douce
    JEL: C22 E52 O54
    Date: 2009–03–06
  37. By: Sylviane GUILLAUMONT JEANNENEY (Centre d'Etudes et de Recherches sur le Développement International); Sampawende Jules TAPSOBA
    Abstract: The devaluation of the CFA Francs in 1994 has highlighted the relevance of fiscal coordination in African monetary unions. After 1994, African monetary unions have adopted a fiscal rule which prescribes a permanent nil or positive budgetary balance. This article studies how this fiscal rule affects the cyclicality of fiscal policies. The results show that compared to other African states, such a fiscal rule creates a pro cyclical bias in public expenditure during recessions. The bias justifies a modification of the rule in order to impose a fiscal surplus during expansions.
    Keywords: Africa., Fiscal policies, Fiscal rules, Pro cyclicality, currency union
    Date: 2009

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