nep-cba New Economics Papers
on Central Banking
Issue of 2010‒06‒18
35 papers chosen by
Alexander Mihailov
University of Reading

  1. The Monetary Pillar and the Great Financial Crisis By Jordi Galí
  2. Money growth and inflation: a regime switching approach By Gianni Amisano; Gabriel Fagan
  3. Optimal Price Setting with Observation and Menu Costs By Fernando Alvarez; Francesco Lippi; Luigi Paciello
  4. Numerical solution of continuous-time DSGE models under Poisson uncertainty By Olaf Posch; Timo Trimborn
  5. Numerical solution of continuous-time DSGE models under Poisson uncertainty By Posch, Olaf; Trimborn, Timo
  6. Epstein-Zin preferences and their use in macro-finance models: implications for optimal monetary policy By Matthieu Darracq Pariès; Alexis Loublier
  7. The Realities and Relevance of Japan’s Great Recession: Neither Ran nor Rashomon By Adam S. Posen
  8. Modeling Asset Prices By James E. Gentle; Wolfgang Karl Härdle
  9. Financial Stress, Monetary Policy, and Economic Activity By Fuchun Li; Pierre St-Amant
  10. Relative house price dynamics across euro area and US cities: convergence or divergence? By Paul Hiebert; Moreno Roma
  11. Informal Labour and Credit Markets: A Survey By Nicoletta Batini; Young-Bae Kim; Paul Levine; Emanuela Lotti
  12. Towards a robust monetary policy rule for the euro area By Tobias S. Blattner; Emil Margaritov
  13. On the Sources of Euro Area Money Demand Stability. A Time-Varying Cointegration Analysis By Matteo Barigozzi; Antonio Conti
  14. Has the Euro changed the Business Cycle? By Zeno Enders; Philip Jung; Gernot J. Mueller
  15. Euro area governance: What went wrong in the euro area? How to repair it? By Jean Pisani-Ferry
  16. Trend inflation, endogenous mark-ups and the non-vertical Phillips curve By Giovanni Di Bartolomeo; Patrizio Tirelli; Nicola Acocella
  17. Money in a Model of Prior Production and Imperfectly Directed Search By Adrian Masters
  18. Implications de l’imperfection des marchés financiers pour la politique monétaire. By Meixing Dai
  19. Markups and the Welfare Cost of Business Cycles : A Reappraisal. By Jean-Olivier Hairault; François Langot
  20. Reverse causality in global current accounts By Gunther Schnabl; Stephan Freitag
  21. Episodic Nonlinearity in Leading Global Currencies By Serletis, Apostolos; Malliaris, Anastasios; Hinich, Melvin; Gogas, Periklis
  22. A Reinterpretation of the Keynesian Consumption Function and Multiplier Effect By Ryu-ichiro Murota; Yoshiyasu Ono
  23. Oil and the macroeconomy: A quantitative structural analysis By Francesco Lippi; Andrea Nobili
  24. Price Bargaining, the Persistence Puzzle, and Monetary Policy By Dennis Wesselbaum
  25. "Infinite-variance, Alpha-stable Shocks in Monetary SVAR" By Greg Hannsgen
  26. The Multiplier-Effects of Non-Wasteful Government Expenditure By L. Marattin; M. Marzo
  27. Fiscal Crisis in Europe or a Crisis of Distribution? By Özlem Onaran
  28. "Fiscal Responsibility: What Exactly Does It Mean?" By Jan Kregel
  29. Long Memory and Fractional Integration in High Frequency Financial Time Series By Guglielmo Maria Caporale; Luis A. Gil-Alana
  30. Forecast Combinations By Carlos Capistrán; Allan Timmermann; Marco Aiolfi
  31. Analyzing Three-Dimensional Panel Data of Forecasts By Kajal Lahiri; Antony Davies; Xuguang Sheng
  32. Exchange Rate Misalignments and World Imbalances: A Fundamental Equilibrium Exchange Rate Approach for Emerging Countries By Nabil Aflouk; Jacques Mazier; Jamel Saadaoui
  33. On the Selection of Leading Economic Indicators for China By Bill Adams; Pieter Bottelier; Ataman Ozyildirim; Jing Sima-Friedman
  34. Choice of exchange rate regimes for African countries: Fixed or Flexible Exchange rate regimes? By Simwaka, Kisu
  35. Monetary and Fiscal Policies in Bulgaria: Lessons from the Historical Record By Kalina Dimitrova

  1. By: Jordi Galí
    Abstract: Since its inception, a most distinctive (and controversial) feature of the ECB monetary policy strategy has been its emphasis on money and monetary analysis, which constitute the basis of the so-called monetary pillar. The present paper examines the performance of the monetary pillar around the recent financial crisis episode, and discusses its prospects in light of the renewed emphasis on financial stability and the need for enhanced macro-prudential policies.
    Keywords: monetary policy strategy, two pillar strategy, monetarism, financial stability.
    JEL: E52 E58
    Date: 2010–06
  2. By: Gianni Amisano (European Central Bank, DG Research, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Gabriel Fagan (European Central Bank, DG Research, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We develop a time-varying transition probabilities Markov Switching model in which inflation is characterised by two regimes (high and low inflation). Using Bayesian techniques, we apply the model to the euro area, Germany, the US, the UK and Canada for data from the 1960s up to the present. Our estimates suggest that a smoothed measure of broad money growth, corrected for real-time estimates of trend velocity and potential output growth, has important leading indicator properties for switches between inflation regimes. Thus money growth provides an important early warning indicator for risks to price stability. JEL Classification: C11, C53, E31.
    Keywords: money growth, inflation regimes, early warning, time varying transition probabilities, Markov Switching model, Bayesian inference.
    Date: 2010–06
  3. By: Fernando Alvarez (University of Chicago); Francesco Lippi (University of Sassari, EIEF); Luigi Paciello (EIEF)
    Abstract: We study the price setting problem of a firm in the presence of both observation and menu costs. In this problem the firm optimally decides when to collect costly information on the adequacy of its price, an activity which we refer to as a price “review”. Upon each review, the firm chooses whether to adjust its price, subject to a menu cost, and when to conduct the next price review. This behavior is consistent with recent survey evidence documenting that firms revise prices infrequently and that only a few price revisions yield a price adjustment. The goal of the paper is to study how the firm’s choices map into several observable statistics, depending on the level and relative magnitude of the observation vs the menu cost. The observable statistics are: the frequency of price reviews, the frequency of price adjustments, the size-distribution of price adjustments, and the shape of the hazard rate of price adjustments. We provide an analytical characterization of the firm’s decisions and a mapping from the structural parameters to the observable statistics. We compare these statistics with the ones obtained for the models with only one type of cost. The predictions of the model can, with suitable data, be used to quantify the importance of the menu cost vs. the information cost. We also consider a version of the model where several price adjustment are allowed between observations, a form of price plans or indexation. We find that no indexation is optimal for small inflation rates..
    Date: 2010
  4. By: Olaf Posch (Aarhus University, Denmark); Timo Trimborn (University of Hannover)
    Abstract: We propose a simple and powerful method for determining the transition process in continuous-time DSGE models under Poisson uncertainty numerically. The idea is to transform the system of stochastic differential equations into a system of functional differential equations of the retarded type. We then use the Waveform Relaxation algorithm to provide a guess of the policy function and solve the resulting system of ordinary differential equations by standard methods and fix-point iteration. Analytical solutions are provided as a benchmark from which our numerical method can be used to explore broader classes of models. We illustrate the algorithm simulating both the stochastic neoclassical growth model and the Lucas model under Poisson uncertainty which is motivated by the Barro-Rietz rare disaster hypothesis. We find that, even for non-linear policy functions, the maximum (absolute) error is very small.
    Keywords: Continuous-time DSGE, Optimal stochastic control, Waveform Relaxation
    JEL: E21 G11 O41
    Date: 2010–06–10
  5. By: Posch, Olaf; Trimborn, Timo
    Abstract: We propose a simple and powerful method for determining the transition process in continuous-time DSGE models under Poisson uncertainty numerically. The idea is to transform the system of stochastic differential equations into a system of functional differential equations of the retarded type. We then use the Waveform Relaxation algorithm to provide a guess of the policy function and solve the resulting system of ordinary differential equations by standard methods and fix-point iteration. Analytical solutions are provided as a benchmark from which our numerical method can be used to explore broader classes of models. We illustrate the algorithm simulating both the stochastic neoclassical growth model and the Lucas model under Poisson uncertainty which is motivated by the Barro-Rietz rare disaster hypothesis. We find that, even for non-linear policy functions, the maximum (absolute) error is very small.
    Keywords: Continuous-time DSGE, Optimal stochastic control, Waveform Relaxation
    JEL: E21 G11 O41
    Date: 2010–06
  6. By: Matthieu Darracq Pariès (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alexis Loublier
    Abstract: Epstein-Zin preferences have attracted significant attention within the macro-finance literature based on DSGE models as they allow to substantially increase risk aversion, and consequently generate non-trivial risk premia, without compromising the ability of standard models to achieve satisfactory macroeconomic data coherence. Such appealing features certainly hold for structural modelling frameworks where monetary policy is set according to Taylor-type rules or seeks to minimize an ad hoc loss function under commitment. However, Epstein-Zin preferences may have significant quantitative implications for both asset pricing and macroeconomic allocation under a welfare-based monetary policy conduct. Against this background, the paper focuses on the impact of such preferences on the Ramsey approach to monetary policy within a medium-scale model based on Smets and Wouters (2007) including a wide range of nominal and real frictions that have proven to be relevant for quantitative business cycle analysis. After setting an empirical benchmark that generates a mean value of 100 bp for the ten-year term premium, we show that Epstein-Zin preferences significantly affect the macroeconomic outcome when optimal policy is considered. The level and the dynamic pattern of risk premia are also markedly altered. We show that the effect of Epstein-Zin preferences is extremely sensitive to the presence of real rigidities in the form of quasi-kinked demands. We also analyse how this effect can be linked to a combined effect of capital accumulation and wage rigidities. JEL Classification: E44, E52, E61, G12.
    Keywords: Optimal monetary policy, macroeconometric equivalence, non time-separable preferences, term premium.
    Date: 2010–06
  7. By: Adam S. Posen (Peterson Institute for International Economics)
    Abstract: Japan’s Great Recession was the result of a series of macroeconomic and financial policy mistakes. Thus, it was largely avoidable once the initial shock from the bubble bursting had passed. The aberration in Japan’s recession was not the behaviour of growth, which is best seen as a series of recoveries aborted by policy errors. Rather, the surprise was the persistent steadiness of limited deflation, even after recovery took place. This is a more fundamental challenge to our basic macroeconomic understanding than is commonly recognized. The UK and US economies are at low risk of having recurrent recessions through macroeconomic policy mistakes—but deflation itself cannot be ruled out. The United Kingdom worryingly combines a couple of financial parallels to Japan with far less room for fiscal action to compensate for them than Japan had. Also, Japan did not face poor prospects for external demand and the need to reallocate productive resources across export sectors during its Great Recession. Many economies do now face this challenge simultaneously, which may limit the pace of, and their share in, the global recovery.
    Keywords: Japan, deflation, fiscal stimulus, quantitative easing
    JEL: E31 E62 E63 O53
    Date: 2010–06
  8. By: James E. Gentle; Wolfgang Karl Härdle
    Abstract: As an asset is traded, its varying prices trace out an interesting time series. The price, at least in a general way, reflects some underlying value of the asset. For most basic assets, realistic models of value must involve many variables relating not only to the individual asset, but also to the asset class, the industrial sector(s) of the asset, and both the local economy and the general global economic conditions. Rather than attempting to model the value, we will confine our interest to modeling the price. The underlying assumption is that the price at which an asset trades is a "fair market price" that reflects the actual value of the asset. Our initial interest is in models of the price of a basic asset, that is, not the price of a derivative asset. Usually instead of the price itself, we consider the relative change in price, that is, the rate of return, over some interval of time. The purpose of asset pricing models is not for prediction of future prices; rather the purpose is to provide a description of the stochastic behavior of prices. Models of price changes have a number of uses, including, for investors, optimal construction of portfolios of assets and, for market regulators, maintaining a fair and orderly market. A major motivation for developing models of price changes of given assets is to use those models to develop models of fair value of derivative assets that depend on the given assets.
    Keywords: Discrete time series models, continuous time diffusion models, models with jumps, stochastic volatility, GARCH
    JEL: C15
    Date: 2010–06
  9. By: Fuchun Li; Pierre St-Amant
    Abstract: This paper examines empirically the impact of financial stress on the transmission of monetary policy shocks in Canada. The model used is a threshold vector autoregression in which a regime change occurs if financial stress conditions cross a critical threshold. Using the financial stress index developed by Illing and Liu (2006) as a measure of the Canadian financial stress conditions, the authors examine questions such as: Do contractionary and expansionary monetary policy shocks have symmetric effects? Do financial stress conditions play a role as a nonlinear propagator of monetary policy shocks? Does monetary policy have the same effect on the real economy in the low financial stress regime and in the high financial stress regime? Suppose that the economy is currently in a given financial stress regime, do monetary policy shocks have a substantial effect on the transition probability of moving from the given regime to the other? The empirical findings reveal that (i) contractionary monetary shocks typically have a larger effect on output than expansionary monetary shocks; (ii) the effects of large and small shocks are approximately proportional; (iii) expansionary monetary shocks have larger effects on output in the high financial stress regime than in the low financial stress regime; (iv) large expansionary monetary shocks increase the likelihood of moving to, or remaining in, the low financial stress regime; (v) typically, high financial stress regime has been characterized by weaker output growth, higher inflation, and higher interest rates.
    Keywords: Financial stability; Monetary policy and uncertainty
    JEL: E50 C01
    Date: 2010
  10. By: Paul Hiebert (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Moreno Roma (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper examines the time varying dispersion in city house price levels across the four biggest euro area countries compared with those in the United States. Using available city-level data over the period 1987-2008, it tests for price convergence and analyses key factors explaining price differentials in a panel regression framework including per capita income, population and relative distances. Results indicate limited evidence of convergence in city-level house prices despite synchronised cycles in the national aggregates for most countries since the 1990s. There is an important role for income differentials in explaining city-level house price dispersion in Germany, France, and the US (but not in Italy or Spain once unobserved city factors are taken into account). At the same time, population differences across cities play a role, though this appears to be associated with amenities specific to a particular location. In general, there has been a lower dispersion of city-level house prices in the four largest euro area economies compared with the US in conjunction with a lower estimated income elasticity for house price differentials. The results, particularly for income, appear to be robust to restricting the analysis to large urban centres. JEL Classification: R21, R31, E31.
    Keywords: House price convergence, house price dispersion, house price drivers, panel data analysis.
    Date: 2010–06
  11. By: Nicoletta Batini (University of Surrey and IMF); Young-Bae Kim (University of Surrey); Paul Levine (University of Surrey); Emanuela Lotti (University of Surrey)
    Abstract: This paper reviews the literature on the informal economy, focusing first on empirical findings and then on existing approaches to modelling informality within both partial and general equilibrium environments. We concentrate on labour and credit markets, since these tend to be most affected by informality. The phenomenon is particularly important in emerging and other developing economies, given their high degrees of informal labour and financial services and the implications these have for the effectiveness of macroeconomic policy. We emphasize the need for dynamic general equilibrium (DGE) and ultimately dynamic stochastic general equilibrium (DSGE) models for a full understanding of the costs, benefits and policy implications of informality. The survey shows that the literature on informality is quite patchy, and that there are several unexplored areas left for research. JEL Classification: J65, E24, E26, E32
    Keywords: Informal economy, labour market, search-matching models
    JEL: E52 E37 E58
    Date: 2009–12
  12. By: Tobias S. Blattner (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Emil Margaritov (Goethe University, Department of Money and Macroeconomics, House of Finance, Grueneburgplatz 1, 60323 Frankfurt am Main, Germany.)
    Abstract: Estimations of simple monetary policy rules are often very rigid. Standard practice requires that a decision is made as to which indicators the central bank is assumed to respond to, ignoring the data-rich environment in which policy-makers typically form their decisions. However, the choice of the feedback variables in the estimations of simple rules bears non-trivial implications for the prescriptions borne from these rules. This paper addresses this issue for the euro area using a new comprehensive real-time database for the euro area and examines the ECB’s past interest-rate setting behaviour in two complementary ways that are designed to deal with both model and data uncertainty. In a first step we follow the “thick-modelling” approach suggested byGranger and Jeon (2004) and estimate a series of 3,330 policy rules. In a second step we employ a factor-model approach similar to Bernanke and Boivin (2003) for the US Fed, but with structurally interpretable factors à la Belviso and Milani (2006). Taken together, we find a strong justification for the need of adopting robust approaches to describe the historical evolution of euro area monetary policy. We also find that the ECB is neither purely backward nor forward-looking, but reacts to a synthesis of the available information on the current and future state of the economy. JEL Classification: C50, E52, E58.
    Keywords: Taylor rules, Monetary policy, Real-time data.
    Date: 2010–06
  13. By: Matteo Barigozzi; Antonio Conti
    Abstract: We adopt a time-varying cointegration test to discriminate among different empirical studies claiming to find a stable Euro Area money demand equation. A time invariant relation explaining real balances is rejected by data, even when accounting for housing, financial and labour markets. Conversely, an international portfolio allocation approach provides stabilization. In particular, international financial markets, rather than monetary policy, are the key determinant of the observed diverging path of money growth. In terms of policy, we provide empirical support for a New Two Pillars Strategy aimed to achieve financial stability through money and credit and price stability through interest rates.
    Keywords: Euro Area Money Demand; Time-Varying Vector Error Correction Model; International Portfolio Allocation; Financial Stability
    JEL: E41 E44 C32
    Date: 2010
  14. By: Zeno Enders (University of Bonn); Philip Jung (University of Mannheim); Gernot J. Mueller (University of Bonn)
    Abstract: In this paper we analyze European business cycles before and under EMU. Across the two periods we find 1) a significant decline in real exchange rate volatility, 2) significant changes in cross-country correlations, and 3) the volatility of macroeconomic fundamentals largely unchanged. We develop a two-country business cycle model and show that the calibrated model is able to replicate key features of the data prior to and under EMU. We find that the euro has a strong bearing on the transmission mechanism as cross-country spillovers increase substantially under EMU. As a result, foreign shocks become more and domestic shocks less important in accounting for the (unchanged) volatility of macroeconomic fundamentals.
    Keywords: European business cycles, Euro, Optimum Currency Area, EMU, Monetary Policy, Exchange rate regime, Cross-country spillovers
    JEL: F41 F42 E32
    Date: 2010–05–31
  15. By: Jean Pisani-Ferry
    Abstract: Bruegel Director Jean Pisani-Ferry focuses on the institutional response to the euro area crisis with the Van Rompuy Task Force being set up to reform economic governance. The task force is due to present its progress report shortly and the author examines two basic questions in this context? what went wrong in the euro area (and the lessons learnt from this) and consequently what are the three choices for reforming governance. He explains why implementation of existing rules need to be strengthened and why the Van Rompuy Task Force should revisit the fundamental principles on which the EMU is founded and resist the temptation to solely address divergences. 
    Date: 2010–06
  16. By: Giovanni Di Bartolomeo; Patrizio Tirelli; Nicola Acocella
    Abstract: Recent developments in macroeconomics resurrect the view that wel- fare costs of inflation arise because the latter acts as a tax on money balances. Empirical contributions show that wage re-negotiations take place while expiring contracts are still in place. Bringing these seemingly unrelated aspects together in a stylized general equilibrium model, we ?nd a disciplining e¤ect of a positive inflation target on the wage markup and identify a long-term trade-off between in?ation and output.
    Keywords: trend inflation, long-run Phillips curve, in?ation targeting, real money balances.
    JEL: E52 E58 J51 E24
    Date: 2010–05
  17. By: Adrian Masters
    Abstract: This paper considers the effect of monetary policy and inflation on retail markets. It analyzes a model in which: goods are dated and produced prior to being retailed, buyers direct their search on the basis of price and general quality and, buyers' match specific tastes are their private information. Sellers set the same price for all buyers but some do not value the good highly enough to purchase it. The market economy is typically inefficient as a social planner would have the good consumed. The Friedman rule represents optimal policy as long as there is free-entry of sellers. When the upper bound on the number of participating sellers binds sufficiently, moderate levels of inflation can be welfare improving.
    Date: 2010
  18. By: Meixing Dai
    Abstract: Dans une économie de marchés financiers, soumis au risque de disfonctionnement, où les actifs financiers sont des substituts imparfaits, on ne peut pas négliger les marchés financiers et monétaires dans les décisions de politique monétaire comme le suppose actuellement la littérature de ciblage d’inflation et des règles du taux d’intérêt. Le disfonctionnement des marchés financiers et monétaires, débouchant sur une crise financière majeure caractérisée par l’éclatement des bulles spéculatives importantes sur les prix des actifs réels et financiers, pourrait obliger la banque centrale à mener une politique du taux d’intérêt zéro associée avec des politiques d’assouplissement quantitatif et/ou de crédit pour sortir de (ou éviter) la trappe à liquidité. Après la sortie de crise, il est indispensable de réviser la stratégie et la conduite de la politique monétaire en prenant en compte le fonctionnement imparfait des marchés financiers et monétaires.
    Keywords: Assouplissement quantitatif, assouplissement de crédit, politique du taux d’intérêt zéro, ciblage d’inflation, trappe à liquidité, disfonctionnement des marchés financiers, stratégie à deux piliers.
    JEL: E44 E51 E52 E58 E61
    Date: 2010
  19. By: Jean-Olivier Hairault (Paris School of Economics - Centre d'Economie de la Sorbonne et IZA); François Langot (GAINS-TEPP - Université du Mans, CEPREMAP et IZA)
    Abstract: Gali et al. (2007) have recently shown in a quantitative way that inefficient fluctuations in the allocation of resources do not generate sizable welfare costs. In this note, we show that their evaluation underestimates the welfare costs of inefficient fluctuations and propose a biased estimate of the impact of structural distortions on business cycle costs. As monopolistic suppliers, both firms and households aim at preserving their expected markups ; the interaction between aggregate fluctuations in the efficiency gap and price-setting behaviors results in making average consumption and employment lower than their counterparts in the flexible price economy. This level increases the welfare cost of business cycles. It is all the more sizable in that the degree of inefficiency is structurally high at the steady state.
    Keywords: Business cycle costs, inefficiency gap, new-Keynesian macroeconomics.
    JEL: E32 E12
    Date: 2010–03
  20. By: Gunther Schnabl (Leipzig University, Grimmaische Straße 12, 04109 Leipzig, Germany.); Stephan Freitag (Leipzig University, Grimmaische Straße 12, 04109 Leipzig, Germany.)
    Abstract: The paper discusses global imbalances under the aspect of an asymmetric world monetary system. It identifies the US and Germany as center countries with rising / high current account deficits (US) and surpluses (Germany). These are matched by current account surpluses of countries stabilizing their exchange rates against the dollar (dollar periphery) and current account deficits of countries stabilizing their exchange rate against the euro (euro periphery). Meanwhile, the aggregate current account balance of the euro area has been by and large balanced. The paper finds that changes of world current account positions are affected by the macroeconomic policy decisions both in the centers and peripheries, albeit the centers – due to structural characteristics related to size – are argued to have a higher degree of freedom in macroeconomic policy making. In specific, expansionary monetary policy in the US as well as exchange rate stabilization and sterilization policies in the dollar periphery are found to have contributed to global current account imbalances. Given that the sample period for the analysis extends from 1981-2008, the results for Germany mostly capture the situation before the euro was created. JEL Classification: F31, F32.
    Keywords: Global Imbalances, Asymmetric World Monetary System, Twin Deficit, Twin Surplus, International Currency, Sterilization, Granger Causality Tests.
    Date: 2010–06
  21. By: Serletis, Apostolos (University of Calgary); Malliaris, Anastasios (Loyola University of Chicago); Hinich, Melvin (The University of Texas at Austin); Gogas, Periklis (Democritus University of Thrace, Department of International Economic Relations and Development)
    Abstract: We perform non-linearity tests using daily data for leading currencies that include the Australian dollar, British pound, Brazilian real, Canadian dollar, euro, Japanese yen, Mexican peso, and the Swiss franc to resolve the issue of whether these currencies are driven by fundamentals or exogenous shocks to the global economy. In particular, we use a new method of testing for linear and nonlinear lead/lag relationships between time series, introduced by Brooks and Hinich (1999), based on the concepts of cross-correlation and cross-bicorrelation. Our evidence points to a relatively rare episodic nonlinearity within and across foreign exchange rates. We also test the validity of specifying ARCH-type error structures for foreign exchange rates. In doing so, we estimate Bollerslevs (1986) general- ized ARCH (GARCH) model and Nelsons (1988) exponential GARCH (EGARCH) model,using a variety of error densities [including the normal, the Student-t distribution, and the Generalized Error Distribution (GED)] and a comprehensive set of diagnostic checks. We apply the Brooks and Hinich (1999) nonlinearity test to the standardized residuals of the optimal GARCH/EGARCH model for each exchange rate series and show that the nonlinearity in the exchange rates is not due to ARCH-type e¤ects. This result has important implications for the interpretation of the recent voluminous literature which attempts to model fi nancial asset returns using this family of models.
    Keywords: Global nancial markets; Currencies; Episodic nonlinearity; Conditional heteroskedasticity.
    JEL: C22 C45 D40 G10 Q40
    Date: 2010–06–07
  22. By: Ryu-ichiro Murota; Yoshiyasu Ono
    Abstract: We propose a microeconomic foundation of the multiplier effect and that of the consumption function using a dynamic optimization model that explains a shortage of aggregate demand and unemployment. We show that government purchases boost aggregate demand through a multiplier-like process but that the implication is quite different. It works through not an increase in disposable income but moderation of deflation, which makes money holding costly and stimulates consumption.
    Date: 2010–06
  23. By: Francesco Lippi (University of Sassary, EIEF); Andrea Nobili (Bank of Italy)
    Abstract: We model an economy where the cost of the oil input, industrial production, and other macroeconomic variables fluctuate in response to fundamental oil supply shocks, as well as aggregate demand and supply shocks generated domestically and in the world economy. We estimate the effects of these structural shocks on US monthly data over 1973.1-2007.12, using robust sign restrictions suggested by the model. It is shown that the interplay between the oil market and the US economy goes in both ways. First, US output falls below the baseline for a prolonged period of time after a negative oil supply shock. However, oil-supply shocks explain a relatively modest part of overall output fluctuations (about 10%). Second, most variations of (real) oil prices occur in response to shocks originated in the global economy and in the US. In particular, supply shocks in the rest of the world and in the US explain more than half of the variance of oil price fluctuations. Finally, the correlation between oil prices and the US business cycle depends on the nature of the fundamental shock: a negative correlation emerges in periods when oil-supply shocks or global demand shocks occur, while a positive correlation emerges in periods of supply shocks in the global economy or the US. The unconditional correlation between oil prices and US production over a long sample period is tenuous because it blends conditional correlations with different signs.
    JEL: C32 E3 F4
    Date: 2010
  24. By: Dennis Wesselbaum
    Abstract: In the recent New Keynesian literature a standard assumption is that the price for which an intermediate good is sold to the final good firm is equal to the marginal costs of the intermediate good firm. However, there is empirical evidence that this need not to hold. This paper introduces price bargaining into an otherwise standard New Keynesian DSGE model and show that this model performs reasonably well in replicating the observed persistence values. We further discuss the role of those product market imperfections for monetary policy and find a trade-off between stabilizing intermediate or final good inflation. In addition, the Ramsey optimal monetary policy can be approximated reasonably well with a Taylor-type interest rate rule with weights on both inflation rates and output
    Keywords: Inflation and Output Persistence, Monetary Policy, Price Bargaining
    JEL: E31 E52 L10
    Date: 2010–06
  25. By: Greg Hannsgen
    Abstract: The process of constructing impulse-response functions (IRFs) and forecast-error variance decompositions (FEVDs) for a structural vector autoregression (SVAR) usually involves a factorization of an estimate of the error-term variance-covariance matrix V. Examining residuals from a monetary VAR, this paper finds evidence suggesting that all of the variances in V are infinite. Specifically, this study estimates alpha-stable distributions for the reduced-form error terms. The ML estimates of the residuals' characteristic exponents "alpha" range from 1.5504 to 1.7734, with the Gaussian case lying outside 95 percent asymptotic confidence intervals for all six equations of the VAR. Variance-stabilized P-P plots show that the estimated distributions fit the residuals well. Results for subsamples are varied, while GARCH(1,1) filtering yields standardized shocks that are also all likely to be non-Gaussian alpha stable. When one or more error terms have infinite variance, V cannot be factored. Moreover, by Proposition 1, the reduced-form DGP cannot be transformed, using the required nonsingular matrix, into an appropriate system of structural equations with orthogonal, or even finite-variance, shocks. This result holds with arbitrary sets of identifying restrictions, including even the null set. Hence, with one or more infinite-variance error terms, structural interpretation of the reduced-form VAR within the standard SVAR model is impossible.
    Keywords: Structural Vector Autoregression; VAR; Levy-stable Distribution; Infinite Variance; Monetary Policy Shocks; Heavy-tailed Error Terms; Factorization; Impulse Response Function; Transformability Problem
    JEL: C32 C46 E30 E52
    Date: 2010–05
  26. By: L. Marattin; M. Marzo
    Abstract: Macroeconomic literature has traditionally regarded public expenditure as yielding no utility per se to any agent in the economy. In line with a few previous contributions (Linneman and Schabert 2004, Bouakez and Rebei 2007) we build a New Keynesian DSGE model with real and nominal rigidities and distortionary fiscal policy rules, calibrated on the Euro-area (1990:Q1-2008:Q4), where part of public spending is allowed to either Edgeworth complement or substitute private consumption by affecting its marginal utility. We show that the the interaction between the share of usefulness of public spending and the specification of fiscal and monetary policy rules is able to deliver private consumption multipliers which are in line with the empirical findings for the Euro-Area.
    JEL: E62 E63
    Date: 2010–05
  27. By: Özlem Onaran
    Abstract: <p>We are in a new episode of the global crisis: the struggle to distribute the costs of the crisis. The financial speculators and corporations are relabeling the crisis as a “sovereign debt crisis” and pressurizing the governments in diverse countries ranging from Greece to Britain to cut spending to avoid taxes on their profits and wealth. In Europe the crisis laid bare the historical divergences. At the root of the problem is the neoliberal model which turned the periphery of Europe into markets for the core. The restrained policy framework, which is based on strict inflation targeting, and which lacks fiscal transfers targeting productive investments in the periphery is the main cause of the divergences. </p><p>The EU’s current policies are still assuming that the problem is a lack of fiscal discipline and do not question the structural reasons behind the deficits and the “beggar my neighbor” policies of Germany. The deflationary consequences of wage cuts may turn the problem of debt to insolvency for private as well as the public sector.</p><p>The crisis calls for a major change in policy framework within Europe that places regional and social cohesion at the core of policy making. This is a crisis of distribution and a reversal of inequality at the expense of labor is the only real solution. </p>
    Date: 2010
  28. By: Jan Kregel
    Abstract: The use of government fiscal stimulus to support the economy in the recent economic crisis has brought increases in government deficits and increased government debt. This has produced an interest in sustainable government debt and the role of deficits in the economy. This paper argues in favor of a concept of "responsible" government policy, referring to positions held by Franklin and Marshall Professor Will Lyons. The idea is that government should be responsible to the needs and desires of its citizens, but that this should go beyond physical security and education, to economic security. Building on the fallacy of composition and misplaced concreteness, it suggests that in an integrated macro system an increased desire to save on the part of the private sector will be self-defeating unless the government acts in a responsible manner to support those desires. This can only be done by government dissaving via an expenditure deficit. The outstanding government debt simply represents the desires of the public to hold safe financial assets, and can only be unsustainable if the public’s desires change. The government should always be responsive to these desires, and adjust its expenditure policy.
    Keywords: Deficit Spending; Sustainable Deficits; Responsible Fiscal Policy; Will Lyons
    JEL: E61 E62 H31 H62
    Date: 2010–06
  29. By: Guglielmo Maria Caporale; Luis A. Gil-Alana
    Abstract: This paper analyses the long-memory properties of high frequency financial time series. It focuses on temporal aggregation and the influence that this might have on the degree of dependence of the series. Fractional integration or I(d) models are estimated with a variety of specifications for the error term. In brief, we find evidence that a lower degree of integration is associated with lower data frequencies. In particular, when the data are collected every 10 minutes there are several cases with values of d strictly smaller than 1, implying mean-reverting behaviour. This holds for all four series examined, namely Open, High, Low and Last observations for the British pound/US dollar spot exchange rate.
    Keywords: High frequency data; long memory; volatility persistence; structural breaks
    JEL: C22
    Date: 2010
  30. By: Carlos Capistrán; Allan Timmermann; Marco Aiolfi
    Abstract: We consider combinations of subjective survey forecasts and model-based forecasts from linear and non-linear univariate specifications as well as multivariate factor-augmented models. Empirical results suggest that a simple equal-weighted average of survey forecasts outperform the best model-based forecasts for a majority of macroeconomic variables and forecast horizons. Additional improvements can in some cases be gained by using a simple equal-weighted average of survey and model-based forecasts. We also provide an analysis of the importance of model instability for explaining gains from forecast combination. Analytical and simulation results uncover break scenarios where forecast combinations outperform the best individual forecasting model.
    Keywords: Factor Based Forecasts, Non-linear Forecasts, Structural Breaks, Survey Forecasts, Univariate Forecasts.
    JEL: C53 E
    Date: 2010–06
  31. By: Kajal Lahiri; Antony Davies; Xuguang Sheng
    Abstract: With the proliferation of quality multi-dimensional surveys, it becomes increasingly important for researchers to employ an econometric framework in which these data can be properly analyzed and put to their maximum use. In this chapter we have summarized such a framework developed in Davies and Lahiri (1995, 1999), and illustrated some of the uses of these multi-dimensional panel data. In particular, we have characterized the adaptive expectations mechanism in the context of broader rational and implicit expectations hypotheses, and suggested ways of testing one hypothesis over the others. We find that, under the adaptive expectations model, a forecaster who fully adapts to new information is equivalent to a forecaster whose forecast bias increases linearly with the forecast horizon. A multi-dimensional forecast panel also provides the means to distinguish between anticipated and unanticipated changes in the forecast target as well as volatilities associated with the anticipated and unanticipated changes. We show that a proper identification of anticipated changes and their perceived volatilities are critical to the correct understanding and estimation of forecast uncertainty. In the absence of such rich forecast data, researchers have typically used the variance of forecast errors as proxies for shocks. It is the perceived volatility of the anticipated change and not the (subsequently-observed) volatility of the target variable or the unanticipated change that should condition forecast uncertainty. This is because forecast uncertainty is formed when a forecast is made, and hence anything that was unknown to the forecaster when the forecast was made should not be a factor in determining forecast uncertainty. This finding has important implications on how to estimate forecast uncertainty in real time and how to construct a measure of average historical uncertainty, cf. Lahiri and Sheng (2010a). Finally, we show how the Rational Expectations hypothesis should be tested by constructing an appropriate variance-covariance matrix of the forecast errors when a specific type of multidimensional panel data is available.
    Date: 2010
  32. By: Nabil Aflouk (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII); Jacques Mazier (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII); Jamel Saadaoui (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII)
    Abstract: Since the mid-1990s, the world imbalances have increased significantly with a large US current deficit facing Asian surpluses, mainly Chinese. Since 2007, a partial reduction of these imbalances has been obtained, largely thanks to production's decreases, without large exchange rate adjustments. The Asian surpluses have remained important. The objective of this paper is to examine the exchange rate misalignments (ERM) of the main emerging countries in Asia and Latin America since the 1980s, so as to shed light on the 2000s by a long term analysis and compare with the industrialized countries' case. Our results confirm that ERM have been reduced since the mid-2000s at the world level, but the dollar remained overvalued against the East Asian countries, except the yen. Chinese, Indian and Brazilian exchange rate policies have been much contrasted since the 1980s. The Indian rupee has been more often overvalued while a more balance situation prevailed in Brazil only since the 2000s. The Latin American countries have faced wider and more dispersed ERM and current imbalances than East Asian countries. But Argentina, Chile and Uruguay benefits now of undervalued currencies while Mexico is closer to equilibrium.
    Keywords: Equilibrium Exchange Rate, Current Account Balance, Macroeconomic Balance, Emerging Countries
    Date: 2010–05–27
  33. By: Bill Adams (The Conference Board); Pieter Bottelier (The Conference Board); Ataman Ozyildirim (The Conference Board); Jing Sima-Friedman (The Conference Board)
    Abstract: Leading indicators represent variables that tend to precede and predict coincident indicators of general economic activity, which as a multivariate concept, can be measured with the help of metrics on employment, production, total income and sales in real (inflation adjusted) terms. In many countries, composite indexes of leading economic indicators (LEI) are used to help predict short-term cyclical fluctuations of the economy in conjunction with composite indexes of coincident economic indicators (CEI). They also serve to analyze short-term macroeconomic dynamics of the business cycle. This paper reviews the available monthly and quarterly leading indicators for China, and develops a composite index following the indicators approach of The Conference Board, which publishes the U.S. LEI. Predicting turning points in the business cycle is extremely difficult, but the long history of research on leading indicators provides empirical evidence that LEIs can help in this task. This paper discusses our selection of leading indicators of the Chinese economy over 1986-2009. We evaluate our selection of leading indicators against the chronology of business and growth cycles.
    Date: 2010–05
  34. By: Simwaka, Kisu
    Abstract: The choice of an appropriate exchange rate regime has been a subject of ongoing debate in international economics. The majority of African countries are small open economies and thus where the choice of the exchange rate regime is an important policy issue. Aside from factors such as interest rates and inflation, the exchange rate is one of the most important determinants of a country’s relative level of economic health. For this reason, exchange rates are among the most watched analyzed and governmentally manipulated economic variables. This paper revisits the debate on the choice of an appropriate exchange-rate regime for African countries. It starts by reviewing literature on the debate of appropriate exchange rate regimes. It then discusses relevant considerations for the choice of the exchange rate regimes for African countries. The debate revolves around the effect of exchange rate on macroeconomic management, particularly inflation and export competitiveness. The paper recommends the conventional peg arrangement as a viable option for the majority of low-income African countries. But this is contingent on a number of important pre-conditions. For middle-income African economies, with relatively developed financial markets and linkages to modern global capital markets, floating arrangements, including the managed floating exchange rate regime, look more promising. In conclusion, the paper cautions that no single exchange rate regime is right for all countries or at all times.
    Keywords: Exchange rate options; sub-Saharan African countries
    JEL: F30 F31 F33
    Date: 2010–03–15
  35. By: Kalina Dimitrova
    Abstract: There are two aspects through which an economic policy can influence the economic situation – monetary and fiscal. Monetary and fiscal policies have different and sometimes controversial goals to achieve by means of specific instruments. While the mission of central banks is generally price stability, governments usually set their goals in the realm of economic growth and employment. Fiscal institutions , however, often use inflation in order to derive revenues (seigniorage) and finance budget deficits. Hence, inflation is viewed as a public finance phenomenon (Barro, 1979; Mankiw, 1987; Grilli, 1989). The purpose of this paper is to present a historical perspective on the behaviour of the monetary and fiscal policies pursued in Bulgaria from 1879, when the Bulgarian National Bank was established (soon after the liberation from the Ottoman Empire). Furthermore, historical time series of monetary and fiscal indicators give us the chance to study the link between government budget problems, fluctuations of monetary variables and inflation dynamics in different monetary episodes.
    Keywords: monetary and fiscal policy, inflation, exchange rate.
    JEL: E31 E63
    Date: 2010–06

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