nep-cba New Economics Papers
on Central Banking
Issue of 2009‒03‒28
58 papers chosen by
Alexander Mihailov
University of Reading

  1. Monetary and Fiscal Rules in an Emerging Small Open Economy By Nicoletta Batini; Paul Levine; Joseph Pearlman
  2. The International Diversification Puzzle when Goods Prices are Sticky: It's Really about Exchange-Rate Hedging, not Equity Portfolios By Charles Engel; Akito Matsumoto
  3. Optimal sticky prices under rational inattention. By Domenico Giannone; Michele Lenza; Lucrezia Reichlin
  4. Optimal sticky prices under rational inattention. By Bartosz Maćkowiak; Mirko Wiederholt
  5. On the International Dimension of Fiscal Policy By Benigno, Gianluca; De Paoli, Bianca
  6. What’s News in Business Cycles By Schmitt-Grohé, Stephanie; Uribe, Martín
  7. The optimal rate of inflation with trending relative prices By Alexander L. Wolman
  8. The Inflation-Unemployment Trade-off at Low Inflation By Pierpaolo Benigno; Luca Antonio Ricci
  9. The Equity Premium and the Business Cycle: the Role of Demand and Supply Shocks By Smith, Peter N; Sorensen, Steffen; Wickens, Michael R
  10. Financial Stability in Open Economies By Ippei Fujiwara; Yuki Teranishi
  11. Long Run Evidence on Money Growth and Inflation. By Luca Benati
  12. Asset Prices and Current Account Fluctuations in G7 Economies. By Marcel Fratzscher; Roland Straub
  13. Back to square one: identification issues in DSGE models By Canova, Fabio; Sala, Luca
  14. Does Global Liquidity Matter for Monetary Policy in the Euro Area? By Helge Berger; Thomas Harjes
  15. Elasticity optimism By Jean Imbs; Isabelle Méjean
  16. Foreign exchange rate risk in a small open economy By De Paoli, Bianca; Sondergaard, Jens
  17. What lies beneath: what can disaggregated data tell us about the behaviour of prices? By Mumtaz, Haroon; Zabczyk, Pawel; Ellis, Colin
  18. Do house price developments spill over across euro area countries? Evidence from a Global VAR. By Isabel Vansteenkiste; Paul Hiebert
  19. The Volatility Costs of Procyclical Lending Standards:An Assessment Using a DSGE Model By Silvia Sgherri; Bertrand Gruss
  20. The global dimension of inflation - evidence from factor-augmented Phillips curves. By Sandra Eickmeier; Katharina Moll
  21. Can Markets Compute Equilibria? By Hunter K. Monroe
  22. Optimal Prediction Pools. By John Geweke; Gianni Amisano
  23. Unemployment dynamics in the OECD By Michael Elsby; Bart Hobijn; Aysegul Sahin
  24. On Impatience and Policy Effectiveness By Silvia Sgherri; Tamim Bayoumi
  25. Committee decisions: Optimality and Equilibrium By Jean-François Laslier; Jörgen Weibull
  26. An Investigation of Some Macro-Financial Linkages of Securitization By Mangal Goswami; Andreas Jobst; Xin Long
  27. Evaluating Historical CGER Assessments:How Well Have They Predicted Subsequent Exchange Rate Movements? By Abdul Abiad; Prakash Kannan; Jungjin Lee
  28. Assessing long-term fiscal developments - a new approach. By António Afonso; Luca Agnello; Davide Furceri; Ricardo Sousa
  29. Financial (In)stability, Supervision and Liquidity Injections: A Dynamic General Equilibrium Approach By de Walque, Gregory; Pierrard, Olivier; Rouabah, Abdelaziz
  30. Real wages over the business cycle: OECD evidence from the time and frequency domains. By Julián Messina; Chiara Strozzi; Jarkko Turunen
  31. Official Japanese Intervention in the JPY/USD Exchange Rate Market: Is It Effective and Through Which Channel Does It Work? By Rasmus Fatum
  32. Why Do Central Banks Go Weak? By Nada Oulidi; Alain Ize
  33. Determinants of Households' Inflation Expectations By Kozo Ueda
  34. Global roles of currencies. By Christian Thimann
  35. Capital Inflows and the Real Exchange Rate: Can Financial Development Cure the DutchDisease? By Christian Saborowski
  36. New Keynesian versus old Keynesian government spending multipliers By Cogan, John F.; Cwik, Tobias; Taylor, John B; Wieland, Volker
  37. Forecast evaluation of small nested model sets. By Kirstin Hubrich; Kenneth D. West
  38. Norwegian banks in a recession: Procyclical implications of Basel II By Henrik Andersen
  39. Regional Financial Spillovers Across Europe:A Global VAR Analysis By Silvia Sgherri; Alessandro Galesi
  40. Liquidity (risk) concepts - definitions and interactions. By Kleopatra Nikolaou
  41. Opting out of the Great Inflation: German monetary policy after the break down of Bretton Woods. By Andreas Beyer; Vitor Gaspar; Christina Gerberding; Otmar Issing
  42. Dynamics of the term structure of UK interest rates By Bianchi, Francesco; Mumtaz, Haroon; Surico, Paolo
  43. Die Bedeutung monetärer Größen für die deutsche Wachstumsschwäche 1995-2005 By Jonas Dovern; Nils Jannsen; Joachim Scheide
  44. European Financial Market Integration : A Closer Look at Government Bonds in Eurozone Countries By Sebastian Weber
  45. Fiscal policy and default risk in emerging markets By Gabriel Cuadra; Juan M. Sanchez; Horacio Sapriza
  46. Going Multinational under Exchange Rate Uncertainty By Henry Aray; Javier Gardeazabal
  47. Inflation forecasting in the new EU member states. By Olga Arratibel; Christophe Kamps; Nadine Leiner-Killinger
  48. Drivers of Exchange Rate Dynamics in Selected CIS Countries : Evidence from a FAVAR Analysis By Christian Dreger; Jarko Fidrmuc
  49. CHINA'S OFFICIAL RATES AND BOND YIELDS By Fan, Longzhen; Johansson, Anders C.
  50. The Credibility of the Link from the Perspective of Modern Financial Theory By Hans Genberg; Cho-hoi Hui
  51. The Credibility of the Link from the Perspective of Modern Financial Theory By Lillian Cheung; Chi-Sang Tam
  52. How Do Bank Lending Rates and the Supply of Loans React to Shifts in Loan Demand in the U.K.? By Johann Burgstaller; Johann Scharler
  53. Inflation Experiences in Latin America, 2007-2008 By Mark Weisbrot; David Rosnick
  54. Are Capital Controls Effective in the 21st Century? The Recent Experience of Colombia By Herman Kamil; Benedict J. Clements
  55. Australia and New Zealand Exchange Rates: A Quantitative Assessment By Hali J. Edison; Hali J. Edison; Francis Vitek; Francis Vitek
  56. The Effect on the Swedish Real Economy of the Financial Crisis By Österholm, Pär
  57. The Role for Counter-Cyclical Fiscal Policy in Singapore By Leif Lybecker Eskesen
  58. Dedollarization in Liberia-Lessons from Cross-country Experience By Lodewyk Erasmus; Jules Leichter; Jeta Menkulasi

  1. By: Nicoletta Batini; Paul Levine; Joseph Pearlman
    Abstract: We develop a optimal rules-based interpretation of the 'three pillars macroeconomic policy framework': a combination of a freely floating exchange rate, an explicit target for inflation, and a mechanism than ensures a stable government debt-GDP ratio around a specified long run. We show how such monetary-fiscal rules need to be adjusted to accommodate specific features of emerging market economies. The model takes the form of two-blocs, a DSGE emerging small open economy interacting with the rest of the world and features, in particular, financial frictions It is calibrated using Chile and US data. Alongside the optimal Ramsey policy benchmark, we model the three pillars as simple monetary and fiscal rules including and both domestic and CPI inflation targeting interest rate rules alongside a 'Structural Surplus Fiscal Rule' as followed recently in Chile. A comparison with a fixed exchange rate regime is made. We find that domestic inflation targeting is superior to partially or implicitly (through a CPI inflation target) or fully attempting to stabilizing the exchange rate. Financial frictions require fiscal policy to play a bigger role and lead to an increase in the costs associated with simple rules as opposed to the fully optimal policy.
    Keywords: Emerging markets , External shocks , Monetary policy , Interest rate policy , Fiscal policy , Economic models ,
    Date: 2009–02–06
  2. By: Charles Engel; Akito Matsumoto
    Abstract: This paper develops a two-country monetary DSGE model in which households choose a portfolio of home and foreign equities, and a forward position in foreign exchange. Some nominal goods prices are sticky. Trade in these assets achieves the same allocations as trade in a complete set of nominal state-contingent claims in our linearized model. When there is a high degree of price stickiness, we show that not much equity diversification is required to replicate the complete-markets equilibrium when agents are able to hedge foreign exchange risk sufficiently. Moreover, temporarily sticky nominal goods prices can have large effects on equity portfolios even when dividend processes are very persistent.
    Keywords: Private investment , Foreign exchange , Commodity prices , Capital markets , Asset management , Economic models ,
    Date: 2009–01–23
  3. By: Domenico Giannone (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Michele Lenza (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Lucrezia Reichlin (London Business School, Regent's Park, London NW1 4SA, United Kingdom.)
    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. JEL Classification: E32, E33, C5, F2, F43.
    Keywords: Euro area, International Business Cycle, European Monetary Union, European integration.
    Date: 2009–02
  4. By: Bartosz Maćkowiak (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Mirko Wiederholt (Northwestern University, 633 Clark Street, Evanston, IL 60208, USA.)
    Abstract: This paper presents a model in which price setting firms decide what to pay attention to, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in micro data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks. Nominal shocks have strong and persistent real effects. We use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms’ environment. JEL Classification: E3, E5, D8.
    Keywords: rational inattention, sticky prices, real effects of nominal shocks.
    Date: 2009–02
  5. By: Benigno, Gianluca; De Paoli, Bianca
    Abstract: This paper analyses the international dimension of fiscal policy using a small open economy framework in which the government finances its spending by levying distortionary taxation and issuing non-state-contingent debt. The main finding of the paper is that, once the open economy aspect of the policy problem is considered, it is not optimal to smooth taxes following idiosyncratic shocks. Even when prices are flexible and inflation can costlessly act as a shock absorber to restore fiscal equilibrium, the presence of a terms of trade externality lead to movements in the tax rate. Also in contrast with the closed economy, the introduction of sticky prices, can reduce the optimal volatility of taxes.
    Keywords: fiscal policy; optimal policy; small open economy
    JEL: E62 E63 F41
    Date: 2009–03
  6. By: Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: In this paper, we perform a structural Bayesian estimation of the contribution of anticipated shocks to business cycles in the postwar United States. Our theoretical framework is a real-business-cycle model augmented with four real rigidities: investment adjustment costs, variable capacity utilization, habit formation in consumption, and habit formation in leisure. Business cycles are assumed to be driven by permanent and stationary neutral productivity shocks, permanent investment-specific shocks, and government spending shocks. Each of these driving forces is buffeted by four types of structural innovations: unanticipated innovations and innovations anticipated one, two, and three quarters in advance. We find that anticipated shocks account for more than two thirds of predicted aggregate fluctuations.
    Keywords: anticipated shocks; Bayesian estimation; sources of aggregate fluctuations
    JEL: C11 C51 E13 E32
    Date: 2009–03
  7. By: Alexander L. Wolman
    Abstract: The relative prices of different categories of consumption goods have been trending over time. Assuming they are exogenous with respect to monetary policy, these trends imply that monetary policy cannot stabilize the prices of all consumption categories. If prices are sticky, monetary policy then must trade off relative price distortions within different categories of consumption. Optimally, more weight should be placed on stabilizing goods and services prices that are less flexible. Calibrating a simple stickyprice model to U.S. data, we find that slight deflation is optimal, even absent transactions frictions leading to a demand for money. Optimality of deflation derives from the fact that relative prices have been trending up for services, whose nominal prices seem to be less flexible.
    Keywords: Inflation (Finance) ; Prices
    Date: 2009
  8. By: Pierpaolo Benigno; Luca Antonio Ricci
    Abstract: Wage setters take into account the future consequences of their current wage choices in the presence of downward nominal wage rigidities. Several interesting implications arise. First, a closed-form solution for a long-run Phillips curve relates average unemployment to average wage inflation; the curve is virtually vertical for high inflation rates but becomes flatter as inflation declines. Second, macroeconomic volatility shifts the Phillips curve outward, implying that stabilization policies can play an important role in shaping the trade-off. Third, nominal wages tend to be endogenously rigid also upward, at low inflation. Fourth, when inflation decreases, volatility of unemployment increases whereas the volatility of inflation decreases: this implies a long-run trade-off also between the volatility of unemployment and that of wage inflation.
    Keywords: Wage policy , Inflation , Unemployment , Price adjustments , Economic models ,
    Date: 2009–03–11
  9. By: Smith, Peter N; Sorensen, Steffen; Wickens, Michael R
    Abstract: This paper explores the effects of the US business cycle on US stock market returns through an analysis of the equity risk premium. We propose a new methodology based on the SDF approach to asset pricing that allows us to uncover the different effects of aggregate demand and supply shocks. We find that negative shocks are more important that positive shocks, and that supply shocks have a much greater impact than demand shocks.
    Keywords: business cycles; demand and supply shocks; equity premium; stock returns
    JEL: C32 C51 E44 G12
    Date: 2009–03
  10. By: Ippei Fujiwara (Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: ippei.fujiwara; Yuki Teranishi (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: yuuki.teranishi
    Abstract: This paper investigates the implications for monetary policy of financial markets that are internationally integrated but have intrinsic frictions. When there is no other distortion than financial market imperfections in the form of staggered international loan contracts, financial stability, which here constitutes eliminating the inefficient fluctuations of loan premiums, is the optimal monetary policy in open economies, regardless of whether policy coordination is possible. Yet, the optimality of inward-looking monetary policy requires an extra condition, in addition to those included in previous studies on the optimal monetary policy in open economies. To make allocations between cooperative and noncooperative monetary policy coincide, the exchange rate risk must be perfectly covered by the banks. Otherwise, each central bank has an additional incentive to control the nominal exchange rate to favor firms in her own country by reducing the exchange rate risk.
    Keywords: optimal monetary policy, policy coordination, global banking, international staggered loan contracts
    JEL: E50 F41
    Date: 2009–03
  11. By: Luca Benati (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Over the last two centuries, the cross-spectral coherence between either narrow or broad money growth and inflation at the frequency ω=0 has exhibited little variation–being, most of the time, close to one–in the U.S., the U.K., and several other countries, thus implying that the fraction of inflation’s long-run variation explained by long-run money growth has been very high and relatively stable. The cross-spectral gain at ω=0, on the other hand, has exhibited significant changes, being for long periods of time smaller than one. The unitary gain associated with the quantity theory of money appeared in correspondence with the inflationary outbursts associated with World War I and the Great Inflation–but not World War II–whereas following the disinflation of the early 1980s the gain dropped below one for all the countries and all the monetary aggregates I consider, with one single exception. I propose an interpretation for this pattern of variation based on the combination of systematic velocity shocks and infrequent inflationary outbursts. Based on estimated DSGE models, I show that velocity shocks cause, ceteris paribus, comparatively much larger decreases in the gain between money growth and inflation at ω=0 than in the coherence, thus implying that monetary regimes characterised by low and stable inflation exhibit a low gain, but a still comparatively high coherence. Infrequent inflationary outbursts, on the other hand, boost both the gain and coherence towards one, thus temporarily revealing the one-for-one correlation between money growth and inflation associated with the quantity theory of money, which would otherwise remain hidden in the data. JEL Classification: E30, E32.
    Keywords: Quantity theory of money, inflation, frequency domain, cross-spectral analysis, band-pass filtering, DSGE models, Bayesian estimation, trend inflation.
    Date: 2009–03
  12. By: Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Roland Straub (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: The paper analyses the effect of equity price shocks on current account positions for the G7 industrialized countries in 1974-2007. It uses a Bayesian VAR with sign restrictions for the identification of asset price shocks and to test empirically for their effect on current accounts. Such shocks are found to exert a sizeable effect, with a 10 percent equity price increase for instance in the United States relative to the rest of the world worsening the US trade balance by 0.9 percentage points after 16 quarters. However, the response of the trade balance to equity price shocks varies substantially across countries. The evidence suggests that the channels accounting for this hetero-geneity function both through wealth effects on private consumption and to some extent through the real exchange rate of countries. JEL Classification: E2, F32, F40, G1.
    Keywords: asset prices, current account, identification, Bayesian VAR, financial markets, industrialized economies.
    Date: 2009–02
  13. By: Canova, Fabio; Sala, Luca
    Abstract: We investigate identification issues in DSGE models and their consequences for parameter estimation and model evaluation when the objective function measures the distance between estimated and model-based impulse responses. Observational equivalence, partial and weak identification problems are widespread and typically produced by an ill-behaved mapping between the structural parameters and the coefficients of the solution. Different objective functions affect identification and small samples interact with parameters identification. Diagnostics to detect identification deficiencies are provided and applied to a widely used model.
    Keywords: DSGE models; Identification; Impulse Responses; small samples.
    JEL: C10 C52 E32 E50
    Date: 2009–03
  14. By: Helge Berger; Thomas Harjes
    Abstract: Global excess liquidity is sometimes believed to limit sovereign monetary policy even in large economies, including the euro area. There is much discussion about what constitutes global excess liquidity and our approach adjusts liquidity for longer-term interest rate and output effects. We find that especially excess liquidity in the U.S. leads developments in euro area liquidity. U.S. excess liquidity also enters consistently positive as a determinant of euro area inflation. There is some evidence that this result may be related to a weakening of the effectiveness of monetary policy in the euro area during times of excessive U.S. liquidity.
    Keywords: Excess liquidity , Europe , Euro Area , United States , Japan , Monetary policy , Interest rates , Inflation ,
    Date: 2009–01–28
  15. By: Jean Imbs (HEC, Lausanne - Department of Economics, Center for Economic Research - CEPR, Swiss Finance Institut - Swiss Finance Institut); Isabelle Méjean (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)
    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: Trade Elasticities, Aggregation, Calibration, Global Imbalances, International Transmission, International Portfolio, Monetary Policy.
    Date: 2009–02
  16. By: De Paoli, Bianca (Bank of England); Sondergaard, Jens (Bank of England)
    Abstract: Resolving the forward premium puzzle requires a volatile foreign exchange rate risk premium that covaries negatively with the expected depreciation rate. Earlier work has shown how models featuring consumption habits can generate such premia when either trade costs or 'deep habits' are assumed. We show that as long as consumption habits are slow-moving and shocks are highly persistent, a standard small open endowment economy - without any additional features - can address the puzzle. Moreover endogenising the labour supply decision in the small open economy can improve the model's ability to match risk premia observations so long as it makes business cycles less synchronised.
    Date: 2009–03–20
  17. By: Mumtaz, Haroon (Bank of England); Zabczyk, Pawel (Bank of England); Ellis, Colin (Daiwa Securities SMBC Europe Ltd)
    Abstract: This paper uses a factor-augmented vector autoregression technique to examine the role that macroeconomic and sector-specific factors play in UK price fluctuations at the aggregate and disaggregated levels. Macroeconomic factors are less important for disaggregated prices than aggregate ones. There also appears to be significant aggregation bias - the persistence of aggregate inflation series is much higher than the underlying persistence across the range of disaggregated price series. Our results suggest that monetary policy affects relative prices in the short to medium term, and that the degree of competition within industries plays a role in determining pricing behaviour.
    Keywords: Inflation persistence; disaggregation; principal components
    JEL: C30 D40 E31 E52
    Date: 2009–03–20
  18. By: Isabel Vansteenkiste (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Paul Hiebert (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: This paper empirically assesses the prospects for house price spillovers in the euro area, where co-movement in house prices across countries may be particularly relevant given a general trend with monetary union toward increasing linkages in trade, financial markets, and general economic conditions. The application involves a Global VAR for three housing demand variables (real house prices, real per capita disposable income, and the real interest rate) on the basis of quarterly data for 10 euro area countries (Belgium, Germany, Ireland, Spain, France, Italy, the Netherlands, Austria, Portugal and Finland) over the period 1989-2007. The results suggest limited house price spillovers in the euro area, with evidence of some overshooting in the first 1-3 years after the shock, followed by a long run aggregate euro area impact of country-specific changes in real house prices related in part to the country's economic weight. This contrasts with the impacts of a shock to domestic long-term interest rates, with the latter causing a permanent shift in house prices after around 3 years. Underlying this aggregate development are rather heterogeneous house price spillovers at the country level, with a strong importance for economic weight in the euro area in governing their general magnitude, while geographic proximity appears to also play a role. JEL Classification: R21, R31, C32.
    Keywords: House price, Global VAR (GVAR), International linkages.
    Date: 2009–03
  19. By: Silvia Sgherri; Bertrand Gruss
    Abstract: The ongoing financial turmoil has triggered a lively debate on ways of containing systemic risk and lessening the likelihood of 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: Business cycles , Borrowing , External shocks , Spillovers , Credit ceilings , Capital markets , Asset prices , Financial risk , Economic models ,
    Date: 2009–03–11
  20. By: Sandra Eickmeier (Deutsche Bundesbank, Economic Research Center, Wilhelm-Epstein-Straße 14, 60431 Frankfurt am Main, Germany.); Katharina Moll (Goethe-Universität Frankfurt am Main, D-60054 Frankfurt am Main, Germany.)
    Abstract: We examine the global dimension of inflation in 24 OECD countries between 1980 and 2007 in a traditional Phillips curve framework. We decompose output gaps and changes in unit labor costs into common (or global) and idiosyncratic components using a factor analysis and introduce these components separately in the regression. Unlike previous studies, we allow global forces to affect inflation through (the common part of) domestic demand and supply conditions. Our most important result is that the common component of changes in unit labor costs has a notable impact of inflation. We also find evidence that movements in import price inflation affect CPI inflation while the impact of movements in the common component of the output gap is unclear. A counterfactual experiment illustrates that the common component of unit labor cost changes and non-commodity import price inflation have held down overall inflation in many countries in recent years whereas commodity import price inflation has only raised the short-run volatility of inflation. In analogy to the Phillips curves, we estimate monetary policy rules with common and idiosyncratic components of inflation and the output gap included separately. Central banks have indeed reacted to the global components. JEL Classification: E31, F41, C33, C50.
    Keywords: Inflation, globalization, Phillips curves, factor models, monetary policy rules.
    Date: 2009–02
  21. By: Hunter K. Monroe
    Abstract: Recent turmoil in financial and commodities markets has renewed questions regarding how well markets discover equilibrium prices, particularly when those markets are highly complex. A relatively new critique questions whether markets can realistically find equilibrium prices if computers cannot. For instance, in a simple exchange economy with Leontief preferences, the time required to compute equilibrium prices using the fastest known techniques is an exponential function of the number of goods. Furthermore, no efficient technique for this problem exists if a famous mathematical conjecture is correct. The conjecture states loosely that there are some problems for which finding an answer (i.e., an equilibrium price vector) is hard even though it is easy to check an answer (i.e., that a given price vector is an equilibrium). This paper provides a brief overview of computational complexity accessible to economists, and points out that the existence of computational problems with no best solution algorithm is relevant to this conjecture.
    Keywords: Capital markets , Commodity markets , Prices , Economic models ,
    Date: 2009–02–10
  22. By: John Geweke (Departments of Statistics and Economics, University of Iowa, Iowa City, IA, USA.); Gianni Amisano (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: A prediction model is any statement of a probability distribution for an outcome not yet observed. This study considers the properties of weighted linear combinations of n prediction models, or linear pools, evaluated using the conventional log predictive scoring rule. The log score is a concave function of the weights and, in general, an optimal linear combination will include several models with positive weights despite the fact that exactly one model has limiting posterior probability one. The paper derives several interesting formal results: for example, a prediction model with positive weight in a pool may have zero weight if some other models are deleted from that pool. The results are illustrated using S&P 500 returns with prediction models from the ARCH, stochastic volatility and Markov mixture families. In this example models that are clearly inferior by the usual scoring criteria have positive weights in optimal linear pools, and these pools substantially outperform their best components. JEL Classification: C11, C53.
    Keywords: forecasting, GARCH, log scoring, Markov mixture, model combination, S&P 500 returns, stochastic volatility.
    Date: 2009–03
  23. By: Michael Elsby; Bart Hobijn; Aysegul Sahin
    Abstract: We provide a set of comparable estimates for the rates of inflow to and outflow from unemployment for 14 OECD economies using publicly available data. We then devise a method to decompose changes in unemployment into contributions accounted for by changes in inflow and outflow rates for cases where unemployment deviates from its flow steady state, as it does in many countries. Our decomposition reveals that fluctuations in both inflow and outflow rates contribute substantially to unemployment variation within countries. For Anglo-Saxon economies we find approximately a 20:80 inflow/outflow split to unemployment variation, while for Continental European and Nordic countries, we observe much closer to a 50:50 split. Using the estimated flow rates we compute gross worker flows into and out of unemployment. In all economies we observe that increases in inflows lead increases in unemployment, whereas outflows lag a ramp up in unemployment.
    Keywords: Unemployment
    Date: 2009
  24. By: Silvia Sgherri; Tamim Bayoumi
    Abstract: An increasing body of evidence suggests that the behavior of the economy has changed in many fundamental ways over the last decades. In particular, greater financial deregulation, larger wealth accumulation, and better policies might have helped lower uncertainty about future income and lengthen private sectors' planning horizon. In an overlapping-generations model, in which individuals discount the future more rapidly than implied by the market rate of interest, we find indeed evidence of a falling degree of impatience, providing empirical support for this hypothesis. The degree of persistence of "windfall" shocks to disposable income also appears to have varied over time. Shifts of this kind are shown to have a key impact on the average marginal propensity to consume and on the size of policy multipliers.
    Keywords: Fiscal policy , Income distribution , Private sector , Interest rates , Monetary policy , Consumption , Economic models ,
    Date: 2009–01–28
  25. By: Jean-François Laslier (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X); Jörgen Weibull (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X, SSE - Department of Economics - Stockholm School of Economics)
    Abstract: We consider a group or committee that faces a binary decision under uncertainty. Each member holds some private information. Members agree which decision should be taken in each state of nature, had this been known, but they may attach different values to the two types of mistake that may occur. Most voting rules have a plethora of uninformative equilibria, and informative voting may be incompatible with equilibrium. We analyze an anonymous randomized majority rule that has a unique equilibrium. This equilibrium is strict, votes are informative, and the equilibrium implements the optimal decision with probability one in the limit as the committee size goes to infinity. We show that this also holds for the usual majority rule under certain perturbations of the behavioral assumptions: (i) a slight preference for voting according to one's conviction, and (ii) transparency and a slight preference for esteem. We also show that a slight probability for voting mistakes strengthens the incentive for informative voting.
    Keywords: Voting, Condorcet, committee, judgement aggregation.
    Date: 2008–09
  26. By: Mangal Goswami; Andreas Jobst; Xin Long
    Abstract: Policy-makers have attributed the scale of the credit crisis and its profound impact on money markets (as well as financial sector stability) to the fast rise of securitization and the way it has arguably complicated both the conduct of monetary policy and the effect of interest rate transmission to the real economy. In our study, we examine whether financial innovation, specifically through securitization, has altered the nature of some macro-financial linkages, often with considerable policy implications. We find that securitization activity in the United States (mature market) and South Africa (emerging market) has indeed dampened the interest rate elasticity of real output via the balance sheet channel (while decreasing the interest rate pass-through from policy rates to market rates). That being said, current reservations about securitization do not invalidate the fact that securitization activity helps cushion the immediate impact of interest rate shocks to loan origination, which might be particularly effective in EM countries where poorly developed capital markets provide few alternatives to bank lending.
    Keywords: Monetary policy , United States , South Africa , Securities markets , Money markets , Capital markets , Market interest rates , Emerging markets , Economic models , Cross country analysis ,
    Date: 2009–02–10
  27. By: Abdul Abiad; Prakash Kannan; Jungjin Lee
    Abstract: The IMF's Consultative Group on Exchange Rate issues (CGER) has been conducting exchange rate assessments as part of the surveillance process since 1997. This paper evaluates CGER assessments from 1997 to 2006, by comparing these to subsequent movements in real effective exchange rates (REER). We find that CGER's estimated misalignments have predictive power over future REER movements, especially over longer horizons and after changes in fundamentals are accounted for. But while CGER misalignments frequently predict the direction of currency movements correctly, misalignments have tended to be persistent, resulting in systematic errors-overprediction for undervalued currencies and underprediction for overvalued currencies.
    Keywords: Exchange rate assessments , Developed countries , Emerging markets , Exchange rate policy surveillance , Real effective exchange rates , Current account balances , Economic models , Cross country analysis ,
    Date: 2009–03–10
  28. By: António Afonso (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Luca Agnello (University of Palermo, Department of Economics, Viale delle Scienze, 90128 Palermo, Sicily, Italy.); Davide Furceri (OECD, 2, rue André Pascal, F-75775 Paris Cedex 16, France.); Ricardo Sousa (Economic Policies Research Unit (NIPE), University of Minho, Department of Economics, Campus of Gualtar, 4710-057 - Braga, Portugal.)
    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. JEL Classification: E62, H50.
    Keywords: Fiscal Deterioration, Fiscal Sustainability.
    Date: 2009–03
  29. By: de Walque, Gregory; Pierrard, Olivier; Rouabah, Abdelaziz
    Abstract: We develop a dynamic stochastic general equilibrium model with an heterogeneous banking sector. We introduce endogenous default probabilities for both firms and banks, and allow for bank regulation and liquidity injection into the interbank market. Our aim is to understand the interactions between the banking sector and the rest of the economy, as well as the importance of supervisory and monetary authorities to restore financial stability. The model is calibrated against real US data and used for simulations. We show that Basel regulation reduces the steady state but improves the resilience of the economy to shocks, and that moving from Basel I to Basel II is procyclical. We also show that liquidity injections relieve financial instability but have ambiguous effects on output fluctuations.
    Keywords: banking sector; central bank; default risk; DSGE; supervision
    JEL: E13 E20 G21 G28
    Date: 2009–03
  30. By: Julián Messina (University of Girona, Plaça Sant Domènec, 3, E-17071 Girona, Spain.); Chiara Strozzi (Università degli Studi di Modena e Reggio Emilia,Via Università 4, I - 41100 Modena, Italy.); Jarkko Turunen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    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. JEL Classification: E32, J30, C10.
    Keywords: real wages, business cycle, dynamic correlation, labour market institutions.
    Date: 2009–02
  31. By: Rasmus Fatum (University of Alberta (4-30H Business Building, University of Alberta, Edmonton AB, T6G 2R6 Canada. Telephone: 1-780-492- 3951, fax: 1-780-492-3325, email:
    Abstract: This paper investigates whether official Japanese intervention in the JPY/USD exchange rate over the January 1999 to March 2004 time period is effective. By integrating the official intervention data with a comprehensive set of newswire reports capturing days on which there is a rumor or speculation of intervention, the paper also attempts to shed some light on through which of the two channels, the signaling channel in a broad sense or the portfolio balance channel, effective Japanese intervention works. The results suggest that Japanese intervention is effective during the first 5 years of the sample and ineffective during the last 3 months of the sample, thereby providing an ex-post rationale for why Japan intervened as well as for why the interventions stopped. Moreover, the results suggest that when Japanese intervention is effective, it works through a portfolio-balance channel. The results do not rule out that effective intervention also works through signaling.
    Keywords: Exchange Rates, Foreign Exchange Market Intervention, Channels of Transmission
    JEL: E52 F31 G14
    Date: 2009–03
  32. By: Nada Oulidi; Alain Ize
    Abstract: Determinants of central banks' profitability are studied using a statistical analysis of their balance sheets, country characteristics, and the macroeconomic and institutional environments in which they operate. Central banks at both tails of the distribution of profits generally operate in poorer countries with more troubled macroeconomic and institutional environments. For these central banks, profitability is strongly influenced by fiscal dominance and, to a lesser extent, by how actively central banks used their balance sheet for monetary policy purposes.
    Keywords: Central banks , Profits , Fiscal analysis , Cross country analysis , Fiscal management , Economic models , Bank soundness ,
    Date: 2009–01–23
  33. By: Kozo Ueda (Institute for Monetary and Economic Studies, Deputy Director and Economist, Bank of Japan (Email: kouzou.ueda
    Abstract: In this paper, we investigate the determinants of households' inflation expectations in Japan and the United States. We estimate a vector autoregression model in which the four endogenous variables are inflation expectations, inflation, the short-term nominal interest rate and the output gap, with energy prices and (fresh) food prices being exogenous. Short-term nonrecursive restrictions are imposed taking account of simultaneous codependence between realized inflation and expected inflation. We find, first, that responding not only to changes in energy prices and food prices but also to monetary policy shocks, inflation expectations adjust more quickly than does realized inflation. This explains why Japanese and US data indicate that inflation expectations lead realized inflation. Second, the effects of changes in energy prices and food prices on inflation and inflation expectations are large in the short run in Japan, while in the United States, they are not only large but also long lasting. Third, shocks to expectations occasionally fluctuate greatly, and can have self-fulfilling effects on realized inflation. The self-fulfilling property is more apparent in the United States than in Japan.
    Keywords: expected inflation, structured vector autoregression, monetary policy
    JEL: C32 E31 E52
    Date: 2009–03
  34. By: Christian Thimann (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: This paper presents a new concept - the global roles of currencies. The concept combines the domestic and international (cross-border) use of currencies and therefore captures the overall importance of different currencies in a globalised economy. The measure of a currency’s global role is based on the size and stage of development of the underlying economy, as well as the size and stage of development of its financial markets and the scope of financial instruments available in this currency. The paper applies the concept to 22 currencies of advanced and emerging economies. The results confirm the well-known ranking for the leading currencies – in particular the US dollar and the euro – but give considerably greater weight to currencies of emerging economies than the results obtained from the international debt market, which has so far been used as the basis for measuring the international role of currencies in capital markets. The paper also discusses this established measure in detail, arguing that in view of financial globalisation, an indicator based on currency shares in the international debt market alone represents a decreasing share of international financial market activity, as this market excludes government debt, other domestic debt and equities, which are increasingly of interest to international investors. The paper also presents an empirical application of the new global concept to examine cross-border portfolio holdings in debt and equity markets across advanced and emerging economies. It finds that the global role indicator is positively correlated with such holdings and, especially for emerging economies, fares better than the established international debt market indicator. The findings suggest a positive relationship between domestic financial development and international financial integration. JEL Classification: F31, F33, F37, G15, E58.
    Keywords: International currencies, international finance, global capital markets.
    Date: 2009–03
  35. By: Christian Saborowski
    Abstract: This paper argues that, in improving the efficient allocation of resources, financial sector development could dampen the appreciation effect of capital inflows. Using dynamic panel data techniques, the paper finds that the exchange rate appreciation effect of FDI inflows is indeed attenuated when financial and capital markets are larger and more active. The main implication of these results is that one of the main dangers associated with large capital inflows in emerging markets-the destabilization of macroeconomic management due to a sizeable appreciation of the real exchange rate-can be mitigated partly by developing a deep financial sector.
    Keywords: Capital inflows , Real effective exchange rates , Capital markets , Emerging markets , Financial sector , Economic models , Cross country analysis , Statistical annexes ,
    Date: 2009–01–29
  36. By: Cogan, John F.; Cwik, Tobias; Taylor, John B; Wieland, Volker
    Abstract: Renewed interest in fiscal policy has increased the use of quantitative models to evaluate policy. Because of modeling 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.
    Keywords: Fiscal Policy; Government Spending; Keynesian models; model uncertainty; Multiplier
    JEL: C52 E62
    Date: 2009–03
  37. By: Kirstin Hubrich (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Kenneth D. West (University of Wisconsin, Madison, Department of Economics,  1180 Observatory Drive,  Madison, WI 53706, USA.)
    Abstract: We propose two new procedures for comparing the mean squared prediction error (MSPE) of a benchmark model to the MSPEs of a small set of alternative models that nest the benchmark. Our procedures compare the benchmark to all the alternative models simultaneously rather than sequentially, and do not require reestimation of models as part of a bootstrap procedure. Both procedures adjust MSPE differences in accordance with Clark and West (2007); one procedure then examines the maximum t-statistic, the other computes a chi-squared statistic. Our simulations examine the proposed procedures and two existing procedures that do not adjust the MSPE differences: a chi-squared statistic, and White’s (2000) reality check. In these simulations, the two statistics that adjust MSPE differences have most accurate size, and the procedure that looks at the maximum t-statistic has best power. We illustrate, our procedures by comparing forecasts of different models for U.S. inflation. JEL Classification: C32, C53, E37.
    Keywords: Out-of-sample, prediction, testing, multiple model comparisons, inflation forecasting.
    Date: 2009–03
  38. By: Henrik Andersen (Norges Bank (Central Bank of Norway))
    Abstract: While the new capital adequacy framework, Basel II, aims to make the banks’ capital requirements more sensitive to the underlying risk of the assets, it may also introduce an additional source of procyclicality in the banking sector. A growing share of the literature has assessed the potential cyclicality of Basel II. However, only parts of the banks’ assets have been considered. In addition, the cyclicality of the capital positions is usually left out of the calculations. This paper applies the stress testing framework of Norges Bank to analyse the cyclicality of capital positions and the cyclicality of Basel II capital requirements for the entire bank portfolio of Norwegian banks. We find a substantial increase in the calculated Basel II capital requirements in a recession scenario for the Norwegian economy. We also find a negative co-movement between capital positions and Basel II capital requirements. Hence, our analysis demonstrates that Basel II may introduce an additional source of procyclicality.
    Keywords: Basel II, procyclicality, capital positions
    JEL: E32 G21 G28 G33
    Date: 2009–03–13
  39. By: Silvia Sgherri; Alessandro Galesi
    Abstract: The recent financial crisis raises important issues about the transmission of financial shocks across borders. In this paper, a global vector autoregressive (GVAR) model is constructed to assess the relevance of international spillovers following a historical slowdown in U.S. equity prices. The GVAR model contains 27 country-specific models, including the United States, 17 European advanced economies, and 9 European emerging economies. Each country model is linked to the others by a set of country-specific foreign variables, computed using bilateral bank lending exposures. Results reveal considerable comovements of equity prices across mature financial markets. However, the effects on credit growth are found to be country-specific. Evidence indicates that asset prices are the main channel through which-in the short run-financial shocks are transmitted internationally, while the contribution of other variables-like the cost and quantity of credit-becomes more important over longer horizons.
    Keywords: Spillovers , Europe , Emerging markets , Financial systems , Economic integration , Regional shocks , Capital markets , Cross country analysis , Economic models ,
    Date: 2009–02–06
  40. By: Kleopatra Nikolaou (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We discuss the notion of liquidity and liquidity risk within the financial system. We distinguish between three different liquidity types, central bank liquidity, funding and market liquidity and their relevant risks. In order to understand the workings of financial system liquidity, as well as the role of the central bank, we bring together relevant literature from different areas and review liquidity linkages among these three types in normal and turbulent times. We stress that the root of liquidity risk lies in information asymmetries and the existence of incomplete markets. The role of central bank liquidity can be important in managing a liquidity crisis, yet it is not a panacea. It can act as an immediate but temporary buffer to liquidity shocks, thereby allowing time for supervision and regulation to confront the causes of liquidity risk. JEL Classification: G10, G20.
    Keywords: liquidity, risk, central bank, LLR.
    Date: 2009–02
  41. By: Andreas Beyer (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Vitor Gaspar (Banco de Portugal, Special Adviser, Av. Almirante Reis, 71 – 8°, 1150-012 Lisboa, Portugal.); Christina Gerberding (Deutsche Bundesbank, Monetary Policy and Analysis Division, Wilhelm-Epstein-Strasse 14, D-60431 Frankfurt am Main, Germany.); Otmar Issing (Centre for Financial Studies, Goethe University Frankfurt, Mertonstrasse 17-25, D-60325 Frankfurt am Main, Germany.)
    Abstract: During the turbulent 1970s and 1980s the Bundesbank established an outstanding reputation in the world of central banking. Germany achieved a high degree of domestic stability and provided safe haven for investors in times of turmoil in the international financial system. Eventually the Bundesbank provided the role model for the European Central Bank. Hence, we examine an episode of lasting importance in European monetary history. The purpose of this paper is to highlight how the Bundesbank monetary policy strategy contributed to this success. We analyze the strategy as it was conceived, communicated and refined by the Bundesbank itself. We propose a theoretical framework (following Söderström, 2005) where monetary targeting is interpreted, first and foremost, as a commitment device. In our setting, a monetary target helps anchoring inflation and inflation expectations. We derive an interest rate rule and show empirically that it approximates the way the Bundesbank conducted monetary policy over the period 1975-1998. We compare the Bundesbank's monetary policy rule with those of the FED and of the Bank of England. We find that the Bundesbank's policy reaction function was characterized by strong persistence of policy rates as well as a strong response to deviations of inflation from target and to the activity growth gap. In contrast, the response to the level of the output gap was not significant. In our empirical analysis we use real-time data, as available to policy-makers at the time. JEL Classification: E31, E32, E41, E52, E58.
    Keywords: Inflation, Price Stability, Monetary Policy, Monetary Targeting, Policy Rules.
    Date: 2009–03
  42. By: Bianchi, Francesco (Princeton University); Mumtaz, Haroon (Bank of England); Surico, Paolo (Bank of England)
    Abstract: This paper models the evolution of monetary policy, the term structure of interest rates and the UK economy across policy regimes. We model the interaction between the macroeconomy and the term structure using a time-varying VAR model augmented with the factors from the yield curve. Our results suggest that the level, slope and curvature factors display substantial time variation, with the level factor moving closely with measures of inflation expectations. Our estimates indicate a large decline in the volatility of both yield curve and macroeconomic variables around 1992, when the United Kingdom first adopted an inflation-targeting regime. During the inflation-targeting regime, monetary policy shocks have been more muted and inflation expectations have been lower than in the pre-1992 era. The link between the macroeconomy and the yield curve has also changed over time, with fluctuations in the level factor becoming less important for inflation after the Bank of England independence in 1997. Policy rates appear to have responded more systematically to inflation and unemployment in the current regime. We use our time-varying macro-finance model to revisit the evidence on the expectations hypothesis.
    Keywords: Term structure; time-varying VAR; Bayesian estimation
    JEL: E50 E58
    Date: 2009–03–20
  43. By: Jonas Dovern; Nils Jannsen; Joachim Scheide
    Abstract: Between 1995 and 2005, the German economy has experienced a phase of weak economic growth. We analyze whether this weak growth performance can be attributed to the stance of monetary conditions during that period. We show that the real effective exchange rate did have almost no dampening effects on growth. On the contrary, the introduction of the euro and the single monetary policy for the euro area seems to have contributed significantly to the low trend growth rate in Germany between 1999 and 2005
    Keywords: weak growth, monetary conditions, monetary policy, real exchange rate, EMU
    JEL: E32 E52 E58 F31
    Date: 2009–03
  44. By: Sebastian Weber
    Abstract: The European Union made a number of steps not least of them the introduction of a common currency to foster the integration of the European financial markets. A number of papers have tried to gauge the degree of integration for various financial markets looking at the convergence of interest rates. A common finding is that government bond markets are quite well integrated. In this paper stochastic Kernel density estimates are used to take a closer look at the dynamics that drive the process of interest rate convergence. The main finding is that countries with large initial deviations from the mean interest rate do indeed converge. Interestingly the candidates least suspected namely the countries initially with interest rates at the mean level show a pattern of slight divergence.
    Keywords: Financial markets integration, euro area government bonds, stochastic Kernel-density estimates
    JEL: C23 G15
    Date: 2009
  45. By: Gabriel Cuadra; Juan M. Sanchez; Horacio Sapriza
    Abstract: Emerging market economies typically exhibit a procyclical fiscal policy: public expenditures rise (fall) in economic expansions (recessions), whereas tax rates rise (fall) in bad (good) times. Additionally, the business cycle of these economies is characterized by countercyclical default risk. In this paper we develop a quantitative dynamic stochastic small open economy model with incomplete markets, endogenous fiscal policy and sovereign default where public expenditures and tax rates are optimally procyclical. The model also accounts for the dynamics of other key macroeconomic variables in emerging economies.
    Keywords: Business cycles ; Macroeconomics
    Date: 2009
  46. By: Henry Aray (Department of Economic Theory and Economic History, University of Granada.); Javier Gardeazabal (DFAEII - The University of the Basque Country)
    Keywords: Foreign Direct Investment, Oligopoly, Real Option, Dumping.
    JEL: F23 L13
    Date: 2008–12–31
  47. By: Olga Arratibel (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Christophe Kamps (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Nadine Leiner-Killinger (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: To the best of our knowledge, our paper is the first systematic study of the predictive power of monetary aggregates for future inflation for the cross section of New EU Member States. This paper provides stylized facts on monetary versus non-monetary (economic and fiscal) determinants of inflation in these countries as well as formal econometric evidence on the forecast performance of a large set of monetary and non-monetary indicators. The forecast evaluation results suggest that, as has been found for other countries before, it is difficult to find models that significantly outperform a simple benchmark, especially at short forecast horizons. Nevertheless, monetary indicators are found to contain useful information for predicting inflation at longer (3-year) horizons. JEL Classification: C53, E31, E37, E51, E52, E62, P24
    Keywords: Inflation forecasting, leading indicators, monetary policy, information content of money, fiscal policy, New EU Member States
    Date: 2009–02
  48. By: Christian Dreger; Jarko Fidrmuc
    Abstract: We investigate the likely sources of exchange rate dynamics in selected CIS countries (Russia, Kazakhstan, Ukraine, Kyrgyzstan, Azerbaijan, and Moldova) over the past decade (1999-2008). The analysis is based on country VAR models augmented by a regional common factor structure (FAVAR model). The models include nominal exchange rates, the common factor of exchange rates in the CIS countries, and global drivers such as gold, oil and share prices. Global, regional and idiosyncratic shocks are identified in a standard Cholesky fashion. Based on the decomposition of the variance of forecast errors, their relevance for exchange rates is explored. As a quite robust finding, CIS exchange rates have become more vulnerable to global shocks towards the end of the sample.
    Keywords: Exchange rates, CIS countries, financial crisis, FAVAR models
    JEL: F31 C22 G15
    Date: 2009
  49. By: Fan, Longzhen (School of Management, Fudan University); Johansson, Anders C. (China Economic Research Center)
    Abstract: Recent research shows that bond yields are influenced by monetary policy decisions. To learn how this works in an interest rate market that differs significantly from that of the U.S. and Europe, we model Chinese bond yields using the one-year deposit rate as a state variable. We also add the difference between the one-year interest rate and the one-year deposit rate as a factor. The model is developed in an affine framework and closed-form solutions are obtained. It is tested empirically and the results show that the new model characterizes the changing shape of the yield curve well. Incorporating the benchmark rate into the model thus helps us to match Chinese bond yields.
    Keywords: China; deposit rate; bond yields; jump process; affine model
    JEL: E43 E44 E52 E58
    Date: 2009–03–01
  50. By: Hans Genberg (Research Department, Hong Kong Monetary Authority); Cho-hoi Hui (Research Department, Hong Kong Monetary Authority)
    Abstract: Hong Kong¡¯s Linked Exchange Rate system (LERS) has been in operation for 25 years during which time many other fixed exchange rate systems have succumbed to shocks and/or speculative attacks. This fact alone suggests that the LERS is a robust system which enjoys a large measure of credibility in financial markets. This paper intends to investigate whether this is indeed the case, and whether it has been the case throughout its 25-year history. In particular we will use the tools of modern finance to extract information from financial-asset prices about market expectations that are related to the credibility of the LERS. The main focus is on how market participants 'judged' the various changes made to the LERS, such as the 'seven technical measures' introduced in September 1998 and the 'three refinements' made in May 2005. These changes have been characterised as making the system less discretionary over time, and we hypothesise that they have also made it more credible as revealed in the prices of exchange rate-related asset prices. We also investigate the relationship between interest rates and exchange rates in the current system in light of modern models of target-zone exchange rate systems. We will examine whether the intra-marginal intervention in November 2007 changed the dynamic properties of the exchange rate as suggested by such models.
    Keywords: Hong Kong dollar, Linked Exchange Rate system, target zone
    JEL: E42 G14
    Date: 2009–01
  51. By: Lillian Cheung (Research Department, Hong Kong Monetary Authority); Chi-Sang Tam (Research Department, Hong Kong Monetary Authority)
    Abstract: Widespread financial distress typically arises from the unwinding of financial imbalances that build up disguised by benign economic conditions. This paper studies whether credit is a pertinent indicator of future equity price booms, and thus provides a signal for potential financial instability. Our analysis shows that excess credit does increase the probability of an equity price boom ahead. We argue that a policy response worthy of consideration would be a strengthening of the system-wide focus of the prudential framework coupled with monetary policy rules that take into account occasional development of financial imbalances to prevent potentially significant financial strains from developing. To this end, greater co-operation between monetary and prudential authorities is important, not just in managing crises, but also in preventing their emergence.
    Keywords: financial stability; monetary stability; equity price booms and busts; excess credit
    JEL: E51 E52 E58
    Date: 2009–02
  52. By: Johann Burgstaller; Johann Scharler
    Abstract: This paper examines the pass-through from the market interest to the rate charged on bank loans using aggregate data for the U.K. Thereby, we explicitly disentangle credit supply and demand and allow the interest rate charged on loans to depend on the volume of loans. We find that, although banks adjust the lending rate to some extent, they largely accommodate shifts in demand. Overall, our results are consistent with the idea that banks provide insurance against liquidity shocks.
    Keywords: Interest Rate Pass-Through, Relationship Banking
    JEL: E43 G21
    Date: 2009–03
  53. By: Mark Weisbrot; David Rosnick
    Abstract: This paper looks briefly at the recent inflation experiences of ten Latin American countries: Brazil, Mexico, Venezuela, Colombia, Chile, Peru, Ecuador, Guatemala, the Dominican Republic, and Bolivia. The authors construct a core inflation index (excluding food and energy), and look at three-month changes in both headline and core inflation. The paper focuses on the increase in inflation from April 2007 to July 2008, driven by a surge in food and energy prices worldwide. These prices have since dropped considerably. The authors conclude that macroeconomic policy that does not take into account the temporary nature of these price shocks may result in an unnecessary slowing of growth, with reduced output and employment.
    Keywords: Latin America, Inflation
    JEL: E E3 E5 E6 O O54
    Date: 2009–02
  54. By: Herman Kamil; Benedict J. Clements
    Abstract: This paper assesses the effects of capital controls imposed in Colombia in 2007 on capital flows and exchange rate dynamics. The results suggest that the controls were successful in reducing external borrowing, but had no statistically significant impact on the volume of non- FDI flows as a whole. We find no evidence that restrictions to capital mobility moderated the appreciation of Colombia's currency, or increased the degree of independence of monetary policy. We also find that controls have significantly increased the volatility of the exchange rate. Additional research is needed to assess the effects of capital controls on financial stability.
    Keywords: Capital controls , Colombia , Capital flows , Exchange rate appreciation , Exchange rate developments , Emerging markets , Economic models ,
    Date: 2009–02–19
  55. By: Hali J. Edison; Hali J. Edison; Francis Vitek; Francis Vitek
    Abstract: The paper describes three empirical models commonly used to conduct exchange rate assessments and applies them to data for Australia and New Zealand. The baseline results using data and mediumterm projections available as of October 2008, suggest that the Australian and New Zealand dollars were broadly in line with fundamentals, but with a wide variation across models. A battery of sensitivity tests illustrate that altering the underlying assumptions can yield substantially different assessments. The results are particularly sensitive to the choice of assessment horizon, the set of economies included in the sample, medium-term forecasts, and the exchange rate reference period.
    Keywords: Australia , New Zealand , Exchange rate assessments , Real effective exchange rates , Fiscal sustainability , Forecasting models ,
    Date: 2009–01–21
  56. By: Österholm, Pär (National Institute of Economic Research)
    Abstract: This paper investigates the effects of the financial crisis on the Swedish real economy. In order to do this, an index which describes the financial conditions of the Swedish economy is developed. The index indicates that domestic Swedish financial conditions have deteriorated substan-tially during 2008 and are now at the highest level since the crisis of the early 1990’s. A Bayesian VAR model with both US and Swedish variables is used to assess the quantitative effects of the financial crisis on Swedish real GDP growth. Results suggest that the Swedish economy will grow substantially slower in the next couple of years due to the financial crisis.
    Keywords: GDP growth; Bayesian VAR
    JEL: E37 E44
    Date: 2009–02–28
  57. By: Leif Lybecker Eskesen
    Abstract: Singapore's policymakers have often used fiscal policy as a counter-cyclical tool. Empirical results based on a structural autoregression framework suggest that fiscal policy can be used for demand management, although the impact may be somewhat short lived. The short-lived impact could reflect a number of factors, including the absence of credit-constrained economic agents, a high propensity to save among households, monetary focus on price stability, and leakages due to economic openness. Notwithstanding, fiscal policy should still play a key stabilizing role in the current downturn given the downside risks to growth and the vast fiscal space.
    Keywords: Fiscal policy , Singapore , External shocks , Economic stabilization , Price stabilization , Cross country analysis , Economic models ,
    Date: 2009–01–21
  58. By: Lodewyk Erasmus; Jules Leichter; Jeta Menkulasi
    Abstract: Liberia's experience with a dual currency regime, with the U.S. dollar enjoying legal tender status, dates to its founding as a sovereign country in 1847. Following the end of the most recent episode of civil war in late-2003, the new government has expressed interest in strengthening the role of the Liberian dollar. Liberia, however, is heavily dollarized, with the U.S. dollar estimated to account for about 90 percent of money supply. Cross-country experience suggests that dollarization does not preclude monetary policy from achieving its primary objective of price stability, and that successful and lasting dedollarization may be difficult to achieve.
    Keywords: Dollarization , Liberia , Dual exchange rates , U.S. dollar , Liberian dollar , Money supply , Monetary policy , Price stabilization , Cross country analysis ,
    Date: 2009–03–11

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