nep-cba New Economics Papers
on Central Banking
Issue of 2009‒07‒03
37 papers chosen by
Alexander Mihailov
University of Reading

  1. Inflationary Equilibrium in a Stochastic Economy with Independent Agents By John Geanakoplos; Ioannis Karatzas; Martin Shubik; William D. Sudderth
  2. Credit Cards and Inflation By John Geanakoplos; Pradeep Dubey
  3. Analyzing Macroeconomic Forecastability By Ray C. Fair
  4. Negative Nominal Interest Rates: Three ways to overcome the zero lower bound By Willem H. Buiter
  5. Survey measures of expected inflation and the inflation process By Bharat Trehan
  6. The Rocky Ride of Break-even-inflation rates. By Cette, G.; De Jong, M.
  7. Transmission of the U.S. Subprime Crisis to Emerging Markets: Evidence on the Decoupling-Recoupling Hypothesis By Michael P. Dooley; Michael M. Hutchison
  8. Financial (in)stability, supervision and liquidity injections : a dynamic general equilibrium approach By Gregory, DE WALQUE; Olivier, PIERRARD; Abdelaziz, ROUABAH
  9. The Financial Crisis as an Overshooting Phenomenon By Fritz Breuss
  10. The Multilateral Response to the Global Crisis: Rationale, Modalities, and Feasibility By Eduardo Fernandez-Arias; Andrew Powell; Alessandro Rebucci
  11. Global Savings and Global Investment: The Transmission of Identified Fiscal Shocks By James Feyrer; Jay C. Shambaugh
  12. Understanding inflation dynamics : Where do we stand ? By Maarten Dossche
  13. An Interest Rate Peg Might Be Better than You Think By Andreas Schabert; Markus Hörmann
  14. Foreign Exchange Liberalization: Perceptions, Realities and Way Forward By P Samarasiri
  15. Real Exchange Rates and Time-Varying Trade Costs By David Peel; Ivan Paya; E Pavlidis
  16. The international dimension of productivity and demand shocks in the U.S. economy By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
  17. Survey Data as Coicident or Leading Indicators By Cecilia Frale; Massimiliano Marcellino; Gian Luigi Mazzi; Tommaso Proietti
  18. What Explains Global Exchange Rate Movements During the Financial Crisis? By Marcel Fratzscher
  19. The Impact of U.S. Central Bank Communication on European and Pacific Equity Markets By Bernd Hayo; Ali M. Kutan; Matthias Neuenkirch
  20. Money and Endogenous Growth in a Cash-in-Advance Model with Social Status By Hung-Ju Chen; Jang-Ting Guo
  21. External shocks and international inflation linkages: a Global VAR analysis. By Alessandro Galesi; Marco J. Lombardi
  22. Credit Spread and Monetary Policy By Yuki Teranishi
  23. Global Liquidity and Commodity Prices : A Cointegrated VAR Approach for OECD Countries By Ansgar Belke; Ingo G. Bordon; Torben W. Hendricks
  24. Ramsey Policies in a Small Open Economy with Sticky Prices and Capital By Stéphane Auray; Beatriz de Blas; Aurélien Eyquem
  25. "Business Cycle Implications of Internal Consumption Habit for New Keynesian Models" By Takashi Kano; James M. Nason
  26. Strict and Flexible Inflation Forecast Targets: An Empirical Investigation By Glenn Otto; Graham Voss
  27. One Money and Fifteen Needs Inflation and Output Convergence in the European Monetary Union By Van Poeck A.
  28. Public investment, distortionary taxes and monetary policy transparency By Dai, Meixing; Sidiropoulos, Moïse
  29. Opting out of the great inflation: German monetary policy after the breakdown of Bretton Woods By Beyer, Andreas; Gaspar, Vítor; Gerberding, Christina; Issing, Otmar
  30. Monetary Policy and Housing Sector Dynamics in a Large-Scale Bayesian Vector Autoregressive Model By Rangan Gupta; Marius Jurgilas; Alain Kabundi; Stephen M. Miller
  31. A brief empirical history of U.S. foreign-exchange intervention: 1973-1995 By Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
  32. Fiscal policy challenges in oil-exporting countries – a review of key issues. By Michael Sturm; François Gurtner; Juan Gonzalez Alegre
  33. The role of bank lending in combating the economic crisis By Coman, Florin
  34. Does it pay to have the euro? Italy’s politics and financial markets under the lira and the euro. By Marcel Fratzscher; Livio Stracca
  35. Price adjustments and inflation - evidence from Norwegian consumer price data 1975-2004 By Fredrik Wulfsberg
  36. Monetary policy rules in a small open economy: An application to Mexico By Villagómez, F. Alejandro; Orellana Polo, Javier
  37. Financial Development and Velocity of Money in Bangladesh: A Vector Auto- Regression Analysis By Md. Akhtaruzzaman

  1. By: John Geanakoplos (Cowles Foundation, Yale University); Ioannis Karatzas (Columbia University and INTECH); Martin Shubik (Cowles Foundation, Yale University); William D. Sudderth (University of Minnesota)
    Abstract: We argue that even when macroeconomic variables are constant, underlying microeconomic uncertainty and borrowing constraints generate inflation. We study stochastic economies with fiat money, a central bank, one nondurable commodity, countably many time periods, and a continuum of agents. The aggregate amount of the commodity remains constant, but the endowments of individual agents fluctuate "independently" in a random fashion from period to period. Agents hold money and, prior to bidding in the commodity market each period, can either borrow from or deposit in a central bank at a fixed rate of interest. If the interest rate is strictly positive, then typically there will not exist an equilibrium with a stationary wealth distribution and a fixed price for the commodity. Consequently, we investigate stationary equilibria with inflation, in which aggregate wealth and prices rise deterministically and at the same rate. Such an equilibrium does exist under appropriate bounds on the interest rate set by the central bank and on the amount of borrowing by the agents. If there is no uncertainty, or if the stationary strategies of the agents select actions in the interior of their action sets in equilibrium, then the classical Fisher equation for the rate of inflation continues to hold and the real rate of interest is equal to the common discount rate of the agents. However, with genuine uncertainty in the endowments and with convex marginal utilities, no interior equilibrium can exist. The equilibrium inflation must then be higher than that predicted by the Fisher equation, and the equilibrium real rate of interest underestimates the discount rate of the agents.
    Keywords: Inflation, Economic equilibrium and dynamics, Dynamic programming, Consumption
    JEL: D5 D8 E31 E58
    Date: 2009–06
  2. By: John Geanakoplos (Cowles Foundation, Yale University); Pradeep Dubey (SUNY, Stonybrook)
    Abstract: The introduction and widespread use of credit cards increases trading efficiency but, by also increasing the velocity of money, it causes inflation, in the absence of monetary intervention. If the monetary authority attempts to restore pre-credit card price levels by reducing the money supply, it might have to sacrifice the efficiency gains. When there is default on credit cards, there is even more inflation, and less efficiency gains. The monetary authority might then have to accept less than pre-credit card efficiency in order to restore pre-credit card price levels, or else it will have to accept inflation if it is unwilling to cut efficiency below pre-credit card levels. This could be a source of stagflation.
    Keywords: Credit cards, Outside money, Inside money, Central bank, Inflation, Stagflation
    JEL: D50 D51 D53 D61 E40 E50 E51 E52 E58
    Date: 2009–06
  3. By: Ray C. Fair (Cowles Foundation, Yale University)
    Abstract: This paper examines whether recessions and booms are forecastable under the assumption that equity prices, housing prices, import prices, exports, and random shocks are not. Each of the 214 eight-quarter periods within the overall 1954:1--2009:1 period is examined regarding predictions of output growth and inflation. The results for low output growth vary by recession -- there is no common pattern. Of the eight recessions, three are forecast well. For four of the five that are not, the main reason for each is not knowing: 1) the random shocks, 2) import prices and equity prices, 3) exports, and 4) exports and equity prices. For the fifth -- the last one -- all five components are large contributors, including housing prices: a perfect storm.
    Keywords: Macroeconomic forecasting, Recessions, Booms
    JEL: E17
    Date: 2009–06
  4. By: Willem H. Buiter
    Abstract: The paper considers three methods for eliminating the zero lower bound on nominal interest rates and thus for restoring symmetry to domain over which the central bank can vary its policy rate. They are: (1) abolishing currency (which would also be a useful crime-fighting measure); (2) paying negative interest on currency by taxing currency; and (3) decoupling the numéraire from the currency/medium of exchange/means of payment and introducing an exchange rate between the numéraire and the currency which can be set to achieve a forward discount (expected depreciation) of the currency vis-a-vis the numéraire when the nominal interest rate in terms of the numéraire is set at a negative level for monetary policy purposes.
    JEL: E31 E4 E41 E42 E43 E44 E5 E52 E58
    Date: 2009–06
  5. By: Bharat Trehan
    Abstract: This paper uses data from surveys of expected inflation to learn how the expectations formation processes of households and professionals have changed following a change in the inflation process in the early part of this decade. Households do not appear to have recognized the change in the process, and are placing substantially more weight than appears warranted on recent inflation data when forming expectations about inflation over the next year. Professional forecasters do appear to have changed how they predict inflation in recent years, in a way that appears consistent, at first, with the finding that the ‘core’ inflation process has not changed as much as the ‘headline’ inflation process has. But the professionals appear to be placing too much weight on lagged core inflation data, and over recent sample periods professional forecasts of headline CPI inflation are noticeably worse than the alternatives. Some other evidence is consistent with the hypothesis that they are now focusing on the core CPI.
    Keywords: Inflation (Finance)
    Date: 2009
  6. By: Cette, G.; De Jong, M.
    Abstract: The correlation matrix between break-even inflation rate movements and real interest rate movements across several countries shows puzzling features. Correlation is significantly positive for nearly all cross-border pairs whereas it is nil, positive or negative unsystematically within countries. By means of a correlation matrix decomposition, we provide an explanation for this puzzle.
    Keywords: Inflation-linked bonds ; Break-even inflation rates
    JEL: E43 G15
    Date: 2009
  7. By: Michael P. Dooley; Michael M. Hutchison
    Abstract: We find that emerging markets appeared to be somewhat insulated from developments in U.S. financial markets from early 2007 to summer 2008. From that point on, however, emerging markets responded very strongly to the deteriorating situation in the U.S. financial system and real economy. Policy measures taken in emerging markets to insulate themselves from global financial developments proved inadequate in the face of the credit crunch and decline in international trade that followed the Lehman bankruptcy in September 2008.
    JEL: F3 F36 F41
    Date: 2009–06
  8. By: Gregory, DE WALQUE; Olivier, PIERRARD; Abdelaziz, ROUABAH
    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 Based 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: DGSE; Banking sector; Default risk; Supervision; Central Bank
    JEL: E13 E20 G21 G28
    Date: 2009–02–05
  9. By: Fritz Breuss (WIFO)
    Abstract: Inspired by Dornbusch's model of exchange rate overshooting we develop a theory of stock market behaviour. The idea is that stock market prices overshoot and undershoot their long-run equilibrium values which are determined by the development in the real economy. The overshooting is fuelled primarily by a loose monetary policy. The simple macro model consists of three markets – the money market, the stock market and the goods market – interacting with different speeds of adjustment. The goods market slowly adjusts relative to the money and the asset market. This model can explain some of the major features of the global financial crisis, having its origin in the loose monetary policy in the USA and spreading its recession-plagued effects all over to the world economy. The model focuses primarily on the monetary interpretation of the present crisis leaving aside the complex interactions of the real estate bubble in the USA, followed by the innovation of new financial instruments which were sold all over the world, hoping to disperse the risks involved with it. Nor does this model deal with the institutional aspects of the financial crisis (the failed behaviour of banks, the banking crises, unregulated financial markets, etc.). These are questions of better international regulation of the financial industry touched upon by the G-20 summit in London.
    Keywords: Financial Crisis, Open Economy Macroeconomics, Stock Markets, Business Cycles
    Date: 2009–04–27
  10. By: Eduardo Fernandez-Arias; Andrew Powell; Alessandro Rebucci
    Abstract: The paper reviews the case for a strong multilateral response to the global crisis in emerging markets (EMs). It discusses modalities and feasibility of intervention and its associated risks, depending on country circumstances of fiscal space and liquidity needs. The specific role of Multilateral Development Banks (MDBs) in ensuring the development effectiveness of the fiscal response is also discussed. The paper concludes by highlighting the international financial architecture issues raised by the global crisis that cannot be addressed immediately but will need to be dealt with once the current crisis has been tamed.
    Keywords: Global Crisis, Latin America and Caribbean, Multilateral Development Banks, Policy Responses.
    JEL: F3 F33 F53
    Date: 2009–06
  11. By: James Feyrer; Jay C. Shambaugh
    Abstract: This paper examines the effect of exogenous shocks to savings on world capital markets. Using the exogenous shocks to US tax policy identified by Romer & Romer, we trace the impact of an exogenous shock to savings through the income accounting identities of the US and the rest of the world. We find that exogenous tax increases are only partially offset by changes in private savings (Ricardian equivalence is not complete). We also find that only a small amount of the resulting change in US saving is absorbed by increased domestic investment (contrary to Feldstein & Horioka). Almost half of the fiscal shock is transmitted abroad as an increase in the US current account. Positive shocks to US savings generate current account deficits and increases in investment in other countries in the world. We cannot reject that the shock is uniformly transmitted across countries with different currency regimes and different levels of development. The results suggest highly integrated world capital markets with rapid adjustment. In short we find that the US acts like a large open economy and the world acts like a closed economy.
    JEL: E2 E21 E22 F15 F32 F36 F41 F42
    Date: 2009–06
  12. By: Maarten Dossche (National Bank of Belgium, Research Department; Ghent University)
    Abstract: I summarize recent progress made in the literature on inflation dynamics. This has been a very productive area of research due to the development of the so-called New Keynesian model and the availability of new macroeconomic and microeconomic evidence. Nevertheless, a number of problems still subsist. In particular the importance of temporary price markdowns to inflation dynamics and the characteristics of the information set price-setters use for their price adjustment decision currently constitute unresolved issues
    Keywords: Inflation dynamics, New Keynesian model, sticky prices
    JEL: E30 E50 E60
    Date: 2009–06
  13. By: Andreas Schabert; Markus Hörmann
    Abstract: Active interest rate policy is frequently recommended based on its merits in reducing macroeconomic volatility and being a simple and transparent policy device. In a standard NewKeynesian model,we show that an even simpler policy, namely an interest rate peg, can be welfare enhancing:The minimum state variable solution and an autoregessive solution under a peg can lead to lower welfare losses than the unique solution under an active interest rate rule. Given that a peg is usually blamed to facilitate endogenous fluctuations, we further show that a peg can be implemented in a way that ensures equilibrium determinacy.
    Keywords: Interest rate rules, welfare losses, equilibrium determinacy, fundamental solutions
    JEL: E52 E51 E32
    Date: 2009–06
  14. By: P Samarasiri
    Abstract: The article focuses on understanding of the economics of the exchange control liberalisation in macroeconomic perspectives and, therefore, the article does not attempt to interpret or explore the legal background relating to exchange control and liberalization and details of liberalization measures and their impact. The exchange control is a part of the broad regulatory policy package to intervene in or guide economic activities and markets in terms of the relevant legal provisions that empower the authorities to apply such interventions in the public interest. Accordingly, the exchange control and its liberalisation involve a considerable volume of legal aspects and procedures. However, the exchange control as well as its liberalization should be applied and evaluated carefully with a good understanding of the underlying economics because their purpose is to promote the economic welfare of the general public. [Central Bank Public Seminar]
    Keywords: Foreign Exchange; Globalisation; liberalisation; Exchange Controls; Monetary Law Act; Exchange Control Act; Liberalisation Measures; Current Account Liberalisation; Capital Account Liberalisation; Sectoral imbalance; capital mobility; financial crises; economic impact
    Date: 2009
  15. By: David Peel; Ivan Paya; E Pavlidis
    Abstract: Previous empirical work on the Purchasing Power Parity does not explicitly account for time-varying trade costs. Motivated by the recent gravity literature we incorporate a microfounded measure of trade costs into two nonlinear regression models for the real exchange rate. Using data for the dollar-sterling real exchange rate from 1830 to 2005, we provide significant evidence in favor of a positive relation between the level of trade costs and the degree of persistence of the real exchange rate.
    Keywords: Real Exchange Rates, Time-Varying Trade Costs, Smooth Transition Nonlinearity, Persistence, Simulation Methods
    Date: 2009
  16. By: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
    Abstract: Identifying productivity and real demand shocks in the US with sign restrictions based on standard theory, we provide evidence on real and financial channels of their international propagation. Productivity gains in US manufacturing have substantial macroeconomic effects, raising US consumption, investment and the terms of trade, relative to the rest of the world, while lowering US net exports. Significant international nancial adjustment occurs via a rise in the global value of the US stock market, portfolio shifts in US foreign assets and liabilities, and especially real dollar appreciation. Positive demand shocks to US manufacturing also lead to real appreciation and raise investment, but have otherwise limited effects on trade flows. This evidence suggests a fundamental role of cross-country endogenous demand and wealth movements in shaping international macroeconomic interdependence.
    Keywords: Productivity ; Trade ; Foreign exchange rates
    Date: 2009
  17. By: Cecilia Frale; Massimiliano Marcellino; Gian Luigi Mazzi; Tommaso Proietti
    Abstract: In this paper we propose a monthly measure for the euro area Gross Domestic Product (GDP) based on a small scale factor model for mixed frequency data, featuring two factors: the first is driven by hard data, whereas the second captures the contribution of survey variables as coincident indicators. Within this framework we evaluate both the in-sample contribution of the second survey-based factor, and the short term forecasting performance of the model in a pseudo-real time experiment. We find that the survey-based factor plays a significant role for two components of GDP: Industrial Value Added and Exports. Moreover, the two factor model outperforms in terms of out of sample forecasting accuracy the traditional autoregressive distributed lags (ADL) specifications and the single factor model, with few exceptions for Exports and in growth rates.
    Keywords: Survey data, Temporal Disaggregation. Multivariate State Space Models. Dynamic factor Models. Kalman filter and smoother. Chain-linking
    JEL: E32 E37 C53
    Date: 2009
  18. By: Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: A striking and unexpected feature of the financial crisis has been the sharp appreciation of the US dollar against virtually all currencies globally. The paper finds that negative US-specific macroeconomic shocks during the crisis have triggered a significant strengthening of the US dollar, rather than a weakening. Macroeconomic fundamentals and financial exposure of individual countries are found to have played a key role in the transmission process of US shocks: in particular countries with low FX reserves, weak current account positions and high direct financial exposure vis-à-vis the United States have experienced substantially larger currency depreciations during the crisis overall, and to US shocks in particular. JEL Classification: F31, F4, G1.
    Keywords: Financial crisis, exchange rates, global imbalances, shocks, United States, US dollar, transmission channels.
    Date: 2009–06
  19. By: Bernd Hayo (Faculty of Business Administration and Economics, Philipps Universitaet Marburg); Ali M. Kutan (Southern Illinois University Edwardsville and the William Davidson Institute, Michigan); Matthias Neuenkirch (Faculty of Business Administration and Economics, Philipps Universitaet Marburg)
    Abstract: We examine the effects of federal funds target rate changes and all types of FOMC communication on European and Pacific equity market returns using a GARCH model. We show that both types of news have a significant statistical and economic impact, but that the effects are not symmetric: target rate changes exert a larger influence, although several communication variables are statistically significant. Third, Pacific markets react more strongly than do European markets to FOMC news, whereas the latter are influenced by a greater variety of communications.
    Keywords: Central Bank Communication, International Equity Markets, Federal Reserve Bank, U.S. Monetary Policy
    JEL: E52 G14 G15
    Date: 2009
  20. By: Hung-Ju Chen (Department of Economics, National Taiwan University); Jang-Ting Guo (Department of Economics, University of California Riverside)
    Abstract: Motivated by the substantial increase of nominal money supply in the U.S. economy since late 2008, this paper examines the equilibrium growth effect of money/inflation within a standard one-sector AK model of endogenous growth with wealth-enhanced preferences for social status and the most generalized cash-in-advance constraint. We show that the sign for the correlation between money and output growth depends crucially on (i) the liquidity-constrained ratio of consumption to investment, and (ii) how the shadow price of physical capital responds to a change in the monetary growth rate. This money-growth correlation, as well as the growth effect of social status, turns out to be closely related to the local stability properties of the economy's balanced growth path(s).
    Keywords: Money, Endogenous Growth, Cash-in-Advance Constraint, Social Status, In- determinacy
    JEL: E52 O42
    Date: 2009–06
  21. By: Alessandro Galesi (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Marco J. Lombardi (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Amid the recent commodity price gyrations, policy makers have become increasingly concerned in assessing to what extent oil and food price shocks transmit to the inflationary outlook and the real economy. In this paper, we try to tackle this issue by means of a Global Vector Autoregressive (GVAR) model. We first examine the short-run inflationary effects of oil and food price shocks on a given set of countries. Secondly, we assess the importance of inflation linkages among countries, by dis-entangling the geographical sources of inflationary pressures for each region. Generalized impulse response functions reveal that the direct inflationary effects of oil price shocks affect mostly developed countries while less sizeable effects are observed for emerging economies. Food price increases also have significative inflationary direct effects, but especially for emerging economies. Moreover, significant second-round effects are observed in some countries. Generalized forecast error variance decompositions indicate that considerable linkages through which inflationary pressures spill over exist among regions. In addition, a considerable part of the observed headline inflation rises is attributable to foreign sources for the vast majority of the regions. JEL Classification: C32, E31.
    Keywords: oil shock, commodity prices, inflation, second-round effects, Global VAR.
    Date: 2009–06
  22. By: Yuki Teranishi (Deputy Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: yuuki.teranishi
    Abstract: Recent studies argue that the spread-adjusted Taylor rule (STR), which includes a response to the credit spread, replicates monetary policy in the United State. We show (1) STR is a theoretically optimal monetary policy under heterogeneous loan interest rate contracts in both discretionay and commitment monetary policies, (2) however, the optimal response to the credit spread is ambiguous given the financial market structure in theoretically derived STR, and (3) there, a commitment policy is effective in narrowing the credit spread when the central bank hits the zero lower bound constraint of the policy rate.
    Keywords: Credit spread, optimal monetary policy
    JEL: E44 E52
    Date: 2009–06
  23. By: Ansgar Belke; Ingo G. Bordon; Torben W. Hendricks
    Abstract: This paper examines the interactions between money, consumer prices and commodity prices at a global level from 1970 to 2008. Using aggregated data for major OECD countries and a cointegrating VAR framework, we are able to establish long run and short run relationships among these variables while the process is mainly driven by global liquidity. According to our empirical findings, different price elasticities in commodity and consumer goods markets can explain the recently observed overshooting of commodity over consumer prices. Although the sample period is rather long, recursive tests corroborate that our CVAR fits the data very well.
    Keywords: Commodity prices, cointegration, CVAR analysis, global liquidity, inflation, international spillovers
    JEL: E31 E52 C32 F42
    Date: 2009
  24. By: Stéphane Auray (Université Lille 3 (GREMARS), Université de Sherbrooke (GREDI) and CIRPÉE); Beatriz de Blas (Universidad Autonoma de Madrid, Departamento de Analisis Economico); Aurélien Eyquem (GATE, UMR 5824, Université de Lyon and Ecole Normale Supérieure Lettres et Sciences Humaines, France)
    Abstract: In this paper we study jointly optimal ¯scal and monetary policies in a small open economy framework with capital and sticky prices. We consider the case of distor- tionary taxes on labor and capital, and no public debt. As in a closed economy set{up, in the steady state, the optimal in°ation rate is zero, as well as the optimal tax on capital. The dynamic properties of optimal monetary and ¯scal policies in an open economy are qualitatively the same as those of a closed economy: the tax rate on capital income remains constant over the cycle, while both the nominal interest rate and the tax rate on labor income move although very smoothly, respectively to minimize the distortions implied by nominal rigidities and balance the budget.
    Keywords: small open economy, sticky prices, optimal monetary and ¯scal policies
    JEL: E52 E62 E63 F41
    Date: 2009–06–15
  25. By: Takashi Kano (Faculty of Economics, University of Tokyo); James M. Nason (Research Department, Federal Reserve Bank of Atlanta)
    Abstract: This paper studies the implications of internal consumption habit for propagation and monetary transmission in new Keynesian dynamic stochastic general equilibrium (NKDSGE) models. Bayesian methods are employed to evaluate the role of internal consumption habit in NKDSGE model propagation and monetary transmission. Simulation experiments show that internal consumption habit often improves NKDSGE model fit to output and consumption growth spectra by dampening business cycle periodicity. Nonetheless, habit NKDSGE model fit is vulnerable to the nominal rigidity, to the choice of monetary policy rule, to the frequencies used for evaluation, and to spectra identified by permanent productivity shocks.
    Date: 2009–06
  26. By: Glenn Otto (School of Economics, University of New South Wales); Graham Voss (Department of Economics, University of Victoria)
    Abstract: We examine whether models of inflation forecast targeting are consistent with the observed behaviour of the central banks of Australia, Canada, and the United States. The target criteria from these models restrict the conditionally expected paths of variables targeted by the central bank, in particular inflation and the output gap. We estimate various moment conditions, providing a description of monetary policy for each central bank under different maintained hypotheses. We then test whether these estimated conditions satisfy the predictions of models of optimal monetary policy. The overall objective is to examine the extent to which and the manner in which these central banks successfully balance inflation and output objectives over the near term. For all three countries, we obtain reasonable estimates for both the strict and flexible inflation forecast targeting models, though with some qualifications. Most notably, for Australia and the United States there are predictable deviations from forecasted targets, which is not consistent with models of inflation targeting. In contrast, the results for Canada lend considerable support to simple models of flexible inflation forecast targeting.
    Keywords: Monetary policy, inflation, inflation targeting, central banks
    JEL: E31 E58
    Date: 2009–06–16
  27. By: Van Poeck A.
    Abstract: In January 1999 the Economic and Monetary Union was established. The member countries abandoned their national currencies and adopted a common currency, the euro, and a common monetary policy. Adopting a common currency is supposed to bring a number of advantages to the member states of a monetary union, such as deeper product and financial market integration, increased trade and capital flows and ultimately increased growth. But by joining a monetary union, a country forgoes the ability to use domestic monetary policy to respond to country-specific macroeconomic disturbances. Monetary policy in a monetary union is the responsibility of the central monetary authority, in this case the European Central Bank (ECB). This central authority pursues monetary policy taking into account the overall situation in the union. Hence, for an individual country, the more its macroeconomic position is in line with the union’s average, the less the costs for that country of belonging to the union. Put differently, the more similarity between the individual countries belonging to a monetary union, the easier the task of the union’s central bank. One could even argue that the long run success and political viability of a monetary union depends on it. In this paper we analyze whether the ECB’s monetary policy has become more balanced towards the needs of the individual member states with the passage of time. We assume that the ECB’s monetary policy stance is in line with a Taylor rule and based on the overall situation in the Euro area, more specifically on the Euro area inflation rate and the overall business cycle position in the area. This assumption is confirmed by many researchers (see e.g. Breuss, 2002; Fourçans and Vranceanu, 2002, Sauer and Sturm, 2003, Ulrich, 2003). The question therefore boils down to investigating whether inflation and business cycles have converged since the start of the monetary union.
    Date: 2009–02
  28. By: Dai, Meixing; Sidiropoulos, Moïse
    Abstract: In a two-period model with distortionay tax and public investment, we reexamine the interaction between monetary policy transparency and fiscal bias. We find that the optimal decisions of tax and public investment allow eliminating the effects of fiscal bias and hence neutralizing the impact of monetary policy opacity (lack of political transparency) on the level and variability of inflation and output, independently of institutional quality. Our results are robust under alternative game structures between the private sector, the government and the central bank.
    Keywords: bank transparency; distortionay tax; public investment; fiscal bias
    JEL: E62 E58 E52 E63
    Date: 2009–06
  29. By: Beyer, Andreas; Gaspar, Vítor; Gerberding, Christina; Issing, Otmar
    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 policymakers at the time.
    Keywords: Inflation, Price Stability, Monetary Policy, Monetary Targeting, Policy Rules
    JEL: E31 E32 E41 E52 E58
    Date: 2009
  30. By: Rangan Gupta (University of Pretoria); Marius Jurgilas (Bank of England); Alain Kabundi (University of Johannesburg); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: Our paper considers this channel whereby monetary policy, a Federal funds rate shock, affects the dynamics of the US housing sector. The analysis uses impulse response functions obtained from a large-scale Bayesian Vector Autoregression (LBVAR) model that incorporates 143 monthly macroeconomic variables over the period of 1986:01 to 2003:12, including 21 variables relating to the housing sector at the national and four census regions. We find at the national level that housing starts, housing permits, and housing sales fall in response to the tightening of monetary policy. Housing sales reacts more quickly and sharply than starts and permits and exhibits more duration. Housing prices show the weakest response to the monetary policy shock. At the regional level, we conclude that the housing sector in the South drives the national data. The responses in the West differ the most from the other regions, especially for the impulse responses of housing starts and permits.
    Keywords: Monetary policy, Housing sector dynamics, Large-Scale BVAR models
    JEL: C32 R31
    Date: 2009–06
  31. By: Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
    Abstract: This paper assesses U.S. foreign-exchange intervention since the inception of generalized floating. We find that intervention was by and large ineffectual. We first identify which interventions were successful according to three criteria. Then, we test whether the number of observed successes significantly exceeds the amount that would randomly occur given the near-martingale nature of daily exchange-rate changes. Finally, we investigate whether the various characteristics of an intervention - its size, frequency, or coordination - can increase the probability of success. We find that intervention did tend to moderate same-day exchange-rate movements relative to the previous day, but this effect is not robust across subperiods or currencies and it occurs infrequently. Increasing the size of an intervention increases the probability of success, but no other variable consistently makes a difference, including coordinating interventions with other central banks.
    Keywords: Foreign exchange administration
    Date: 2009
  32. By: Michael Sturm (European Central Bank, Directorate General International and European Relations, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); François Gurtner (European Central Bank, Directorate General International and European Relations, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Juan Gonzalez Alegre (Universidad Pablo de Olavide, Economics Department, Seville, Spain.)
    Abstract: Fiscal policy choices have a particularly significant impact on economic performance in oil-exporting countries, owing to the importance of the oil sector in the economy and the fact that in most countries oil revenues accrue to the government. At the same time, fiscal policy in oil-centred economies s facing specific challenges, both in the long run, as regards intergenerational equity and fiscal sustainability, and in the short run, as regards macroeconomic stabilisation and fiscal planning. Institutional responses to the specific fiscal challenges in oil-exporting countries involve conservative oil price assumptions in the budget, the establishment of oil stabilisation and savings funds and fiscal rules. Fiscal policy in most oil-exporting countries has been expansionary over the past years in the wake of high oil prices. Fiscal expansion has added to inflationary pressure, and monetary policy has been constrained in tackling inflation as a result of prevailing exchange rate regimes. While, in this context, fiscal policy is the major tool for macroeconomic stabilisation, it has faced competing objectives and considerations. Cyclical considerations would have warranted fiscal restraint, but, in times of high oil prices, pressures to increase public spending have been mounting. Such pressures stem from primarily distribution-related considerations, development-related spending needs (e.g. in the areas of physical and social infrastructure) and international considerations in the context of, for example, global imbalances. The sharp fall in oil prices since mid-2008 has brought to the fore a different question – whether oil exporters can sustain spending levels reached in previous years. JEL Classification: E62, E63, H30, H60, Q32, Q38.
    Keywords: Fiscal policy, oil-exporting countries, inflation, global imbalances.
    Date: 2009–06
  33. By: Coman, Florin (Universitatea Spiru Haret, Facultatea de Finante si Banci)
    Abstract: Taking some measures for diminuation the obligatory minimal reserves of the banking societies and for the decrease of the monetary policy rate of interest, the Romanian National Bank intended to make available certain amounts of money to be used by the banking societies to credit the activity of the trading companies and of the natural persons. A diminuation of the interest for the credits granted by the banking societies is required, along with taking some political and fiscal measures.
    Keywords: Romanian National Bank; banking societies; banking credits; (economic) crisis/ depression; standard of coinage; foreign credits; political and fiscal measures
    JEL: F23
    Date: 2009–06–16
  34. By: Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Livio Stracca (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: There is a broad consensus that the quality of the political system and its institutions are fundamental for a country’s prosperity. The paper focuses on political events in Italy over the past 35 years and asks whether the adoption of the euro in 1999 has helped insulate Italy’s financial markets from the adverse consequences of its traditionally unstable political system. We find that important political events have exerted a statistically and economically significant effect on Italy’s financial markets throughout the 1970s, 1980s and 1990s. The introduction of the euro appears to have indeed played a major role in insulating financial markets from such adverse shocks. The findings of the paper there-fore suggest another important economic dimension and channel through which Italy may have been affected by EMU. Our analysis could also be potentially interesting for other countries with weak institutions considering adopting a currency based on stronger institutions. JEL Classification: F31, F33, G14.
    Keywords: Euro, Italy, political economy, exchange rates, asset prices, financial markets, shocks.
    Date: 2009–06
  35. By: Fredrik Wulfsberg (Norges Bank (Central Bank of Norway))
    Abstract: I document price adjustments in both high and low inflation years from 14 milllion monthly price observations of 1,133 goods and services. The variation in the frequency of price changes explains all the variation in the inflation rate. On average, prices increase more often when inflation is high, and decrease more often when inflation is low. There is also substantial variation both in the duration and size of price changes within and between items.
    Keywords: Consumer prices, price rigidity
    JEL: E31 D40 C2
    Date: 2009–06–24
  36. By: Villagómez, F. Alejandro (Tecnológico de Monterrey, Campus Ciudad de México); Orellana Polo, Javier (McKinsey)
    Abstract: We estimate a small-scale macro model for the Mexican economy under the New Keynesian (NK) framework and alternative interest rate rules for Mexico. With these results we evaluate the performance of the Bank of Mexico against a set of optimality principles derived in the NK literature. We show that the Bank of Mexico holds a preference for stabilizing not only inflation around target, but also acts to achieve an output gap close to zero. Furthermore, we show the central bank responds non-linearly to real exchange rate depreciations. We also show that, although the central bank has attempted to contain inflation, it has not conclusively satisfied the Taylor principle, so moderate inflation during the period may be partly a consequence of a favorable macroeconomic environment, rather than active policy.
    Keywords: Taylor Rule, New Keynesian, Monetary Policy, Interest Rate Rules, Small Open Economy
    JEL: E52 E58
    Date: 2009–01
  37. By: Md. Akhtaruzzaman
    Abstract: The study uses co-integration and vector auto-regression (VAR) techniques to identify the determinants of income velocity of money (VM) in Bangladesh, covering both narrow and broad money. The study observes that financial development affects VM negatively. The VAR estimates show that two variables, real GDP growth and financial development, jointly account for around half of the variance of speed of VM for both M1 and M2. The results show that it is important for the monetary authorities to take into account both stages of economic and financial development in forecasting VM for designing effective monetary policy in Bangladesh.[PAU WP no.0806]
    Keywords: velocity of narrow and broad money; safe limit to monetary expansion; financial development; inflation expectation; Cambridge equation of exchange; money multiplier; rate of monetization; co-integration; unit root test; VAR; forecast error variance.
    Date: 2009

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