nep-cba New Economics Papers
on Central Banking
Issue of 2010‒06‒26
forty-four papers chosen by
Alexander Mihailov
University of Reading

  1. Understanding Policy in the Great Recession: Some Unpleasant Fiscal Arithmetic By John H. Cochrane
  2. Optimal monetary policy in open economies By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
  3. Optimal Monetary Stabilization Policy By Michael Woodford
  4. The Optimal Inflation Rate in New Keynesian Models By Olivier Coibion; Yuriy Gorodnichenko; Johannes F. Wieland
  5. The Optimal Inflation Rate in New Keynesian Models By Olivier Coibion; Yuriy Gorodnichenko; Johannes Wieland
  6. Endogenous Persistence in an Estimated DSGE Model under Imperfect Information By Paul Levine; Joseph Pearlman; George Perendia; Bo Yang
  7. States in Fiscal Distress By Robert P. Inman
  8. On borrowing limits and welfare By Francesc Obiols-Homs
  9. Business fluctuations in a credit-network economy By Domenico Delli Gatti; Mauro Gallegati; Bruce Greenwald; Alberto Russo; Joseph E. Stiglitz
  10. The Diversity of Forecasts from Macroeconomic Models of the U.S. Economy By Volker Wieland; Maik Wolters
  11. Sustainable monetary policy and inflation expectations By Roc Armenter
  12. Monetary Policy in an Uncertain World: Probability Models and the Design of Robust Monetary Rules By Paul Levine
  13. Do Sticky Prices Increase Real Exchange Rate Volatility at the Sector Level? By Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
  14. The role of model uncertainty and learning in the U.S. postwar policy response to oil prices By Francesca Rondina
  15. Money and Capital as Competing Media of Exchange in a News Economy By Fernando Martin; David Andolfatto
  16. Building Bridges Between Structural and Program Evaluation Approaches to Evaluating Policy By James J. Heckman
  17. Optimal money demand in a heterogeneous-agent cash-in-advance economy By Yi Wen
  18. Financial Stability and Monetary Policy By Christopher Martin; Costas Milas
  19. Price, Wage and Employment Response to Shocks: Evidence from the WDN Survey By Bertola, G.; Dabusinskas, A.; Hoeberichts, M.; Izquierdo, M.; Kwapil, C.; Montornès, J.; Radowski, D.
  20. The micro-macro disconnect of purchasing power parity By Paul R. Bergin; Reuven Glick; Jyh-Lin Wu
  21. The illusive quest: do international capital controls contribute to currency stability? By Reuven Glick; Michael Hutchison
  22. How Should Macroeconomic Policy Respond to Foreign Financial Crises? By Anthony J Makin
  23. Monetary and Fiscal Policy Interactions in a Monetary Union with Country-size Asymmetry By Celsa Machado; Ana Paula Ribeiro
  24. Wage-setting Behavior in France: Additional Evidence from an Ad-hoc Survey By Montornès, J. Author-Name: Sauner-Leroy, J-B.
  25. Government Policy in Monetary Economies By Fernando M. Martin;
  26. The crisis of orthodox macroeconomic policy : The case for a renewed commitment to full employment By Muhammed Muqtada
  27. Banking Crises and Short and Medium Term Output Losses in Developing Countries: The Role of Structural and Policy Variables By Davide Furceri; Aleksandra Zdzienicka
  28. Banking Crises and Short and Medium Term Output Losses in Developing Countries: The Role of Structural and Policy Variables By Davide Furceri; Aleksandra Zdzienicka-Durand
  29. The Exchange Rate Regime in Asia: From Crisis to Crisis By Ila Patnaik; Ajay Shah; Anmol Sethy; Vimal Balasubramaniam
  30. Productivity, the Terms of Trade, and the Real Exchange Rate: Balassa-Samuelson Hypothesis Revisited By Ehsan U. Choudhri; Lawrence L. Schembri
  31. Evaluating real-time VAR forecasts with an informative democratic prior By Jonathan H. Wright
  32. Markups and the Welfare Cost of Business Cycles : A Reappraisal By Jean-Olivier Hairault; François Langot
  33. International Business Cycle Synchronization in Historical Perspective By Michael D. Bordo; Thomas F. Helbling
  34. International Transmission of Business Cycles: Evidence from Dynamic Correlations By Jarko Fidrmuc; Taro Ikeda; Kentaro Iwatsubo
  35. Welfare implications of country size in a monetary union By Mykhaylova, Olena
  36. The Fed's TRAP: A Taylor-type Rule with Asset Prices By Drescher, Christian; Erler, Alexander; Krizanac, Damir
  37. Yield-Curve Based Probability Forecasts of U.S. Recessions: Stability and Dynamics By Heikki Kauppi
  38. Resource abundance: A curse or blessing? By Victor Polterovich, Vladimir Popov, Alexander Tonis
  39. Nominal Rigidities and Retail Price Dispersion in Canada over the Twentieth Century By Ross D. Hickey; David S. Jacks
  40. A Floating versus Managed Exchange Rate Regime in a DSGE Model of India By Nicoletta Batini; Vasco Gabriel; Paul Levine; Joseph Pearlman
  41. Monetary Theory from a Chinese Historical Perspective By Zheng Xueyi; Yaguang Zhang; John Whalley
  42. Identifying the bank lending channel in Brazil through data frequency By Christiano Arrigoni Coelho; João Manoel Pinho de Mello; MArcio Gomes Pinto Garcia
  43. Has Core Inflation Been Doing a Good Job in Brazil? By Da Silva Filho, Tito Nícias Teixeira; Figueiredo, Francisco Marcos Rodrigues

  1. By: John H. Cochrane
    Abstract: I use the valuation equation of government debt to understand fiscal and monetary policy in and following the great recession of 2008-2009, to think about fiscal pressures on US inflation, and what sequence of events might surround such an inflation. I emphasize that a fiscal inflation can come well before large deficits or monetization are realized, and is likely to come with stagnation rather than a boom.
    JEL: E3 E31 E4 E5 E52 E6
    Date: 2010–06
  2. By: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
    Abstract: Research in the international dimensions of optimal monetary policy has long been inspired by a set of fascinating questions, shaping the policy debate in at least two eras of progressive cross-border integration of goods, factors, and assets markets in the years after World War I and from Bretton Woods to today. Namely, should monetary policy respond to international variables such as exchange rates, global business cycle conditions, or global imbalances beyond their in uence on the domestic output gap and inflation? Do exchange rate movements have desirable stabilization and allocative properties? Or, on the contrary, should policymakers curb exchange rate fltuations and be concerned with, and attempt to correct, currency isalignments? Are there large gains the international community could reap by strengthening cross-border monetary cooperation? ; We revisit these classical questions by building on the choice-theoretic monetary literature encompassing the research agenda of he New Keynesian models (see, e.g., Rotemberg and Woodford 1997), the New Classical Synthesis (see, e.g., Goodfriend and King 1997), and especially the New Open Economy Macroeconomics, henceforth NOEM (see, e.g., Svensson and van Wijnbergen 1989, Obstfeld and Rogo¤ 1995). In doing so, we will naturally draw on a well-established set of general principles in stabilization theory, which go beyond open-economy issues. Yet, the main goal of our analysis is to shed light on monetary policy trade-o¤s that are inherently linked to open economies which engage in cross-border trade in goods and assets.
    Keywords: Monetary policy
    Date: 2010
  3. By: Michael Woodford
    Abstract: This paper reviews the theory of optimal monetary stabilization policy, with an emphasis on developments since the publication of Woodford (2003). The structure of optimal policy commitments is considered, both when the objective of stabilization policy is defined by an arbitrarily specified quadratic loss function, and when the objective of policy is taken to be the maximization of expected utility. Issues treated include the time inconsistency of optimal policies and the need for commitment; the relation of optimal policy from a “timeless perspective” to the Ramsey conception of optimal policy; and the advantages of forecast targeting procedures as an approach to the implementation of optimal stabilization policy. The usefulness of characterizing optimal policy in terms of a target criterion is illustrated in a range of examples. These include models with a variety of assumptions about the nature of price and wage adjustment; models that allow for sectoral heterogeneity; cases in which policy must be conducted on the basis of imperfect information; and cases in which the zero lower bound on the policy rate constrains the conduct of policy.
    JEL: E52 E61
    Date: 2010–06
  4. By: Olivier Coibion; Yuriy Gorodnichenko; Johannes F. Wieland
    Abstract: We study the effects of positive steady-state inflation in New Keynesian models subject to the zero bound on interest rates. We derive the utility-based welfare loss function taking into account the effects of positive steady-state inflation and show that steady-state inflation affects welfare through three distinct channels: steady-state effects, the magnitude of the coefficients in the utility-function approximation, and the dynamics of the model. We solve for the optimal level of inflation in the model and find that, for plausible calibrations, the optimal inflation rate is low, less than two percent, even after considering a variety of extensions, including price indexation, endogenous price stickiness, capital formation, model-uncertainty, and downward nominal wage rigidities. In our models, price level targeting delivers large welfare gains and a very low optimal inflation rate consistent with price stability.
    JEL: E3 E4 E5
    Date: 2010–06
  5. By: Olivier Coibion (Department of Economics, College of William and Mary); Yuriy Gorodnichenko (Department of Economics, University of California, Berkeley); Johannes Wieland (Department of Economics, niversity of California, Berkeley)
    Abstract: We study the effects of positive steady-state inflation in New Keynesian models subject to the zero bound on interest rates. We derive the utility-based welfare loss function taking into account the effects of positive steady-state inflation and show that steady-state inflation affects welfare through three distinct channels: steady-state effects, the magnitude of the coefficients in the utility-function approximation, and the dynamics of the model. We solve for the optimal level of inflation in the model and find that, for plausible calibrations, the optimal inflation rate is low, less than two percent, even after considering a variety of extensions, including price indexation, endogenous price stickiness, capital formation, model uncertainty, and downward nominal wage rigidities. On the normative side, price level targeting delivers large welfare gains and a very low optimal inflation rate consistent with price stability.
    Keywords: Optimal inflation, New Keynesian, zero bound, price level targeting
    JEL: E3 E4 E5
    Date: 2010–06–15
  6. By: Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University); George Perendia (London Metropolitan University); Bo Yang (University of Surrey)
    Abstract: We provide a tool for estimating DSGE models by BayesianMaximum-likelihood methods under very general information assumptions. This framework is applied to a New Keynesian model where we compare the standard approach, that assumes an informational asymmetry between private agents and the econometrician, with an assumption of informational symmetry. For the former, private agents observe all state variables including shocks, whereas the econometrician uses only data for output, inflation and interest rates. For the latter both agents have the same imperfect information set and this corresponds to what we term the 'informational consistency principle'. We first assume rational expectations and then generalize the model to allow some households and firms to form expectations adaptively. We find that in terms of model posterior probabilities, impulse responses, second moments and autocorrelations, the assumption of informational symmetry by rational agents significantly improves the model fit. We also find qualified empirical support for the heterogenous expectations model. JEL Classification: C11, C52, E12, E32.
    Keywords: Imperfect Information, DSGE Model, Rational versus Adaptive Expectations, Bayesian Estimation
    JEL: E52 E37 E58
    Date: 2010–04
  7. By: Robert P. Inman
    Abstract: The 2007-2010 recession has imposed significant fiscal hardships on state and local governments. The result has been state deficits and the need to increase state taxes, cut spending, and withdraw funds from state rainy day accounts. The primary cause of state budget “gaps” has been the rise in the level of state unemployment. There is no evidence that gaps are related to state political institutions, the state’s prior receipt of federal funding, or possibly favored access to key congressional budget committees. The federal government has responded to these gaps with the passage of the American Recovery and Reinvestment Act (ARRA) of 2009 intended to aid states in fiscal distress and to provide an economic stimulus. As insurance for fiscal distress, ARRA covers at most $.23 of each additional dollar of a state’s budget gap; there is a large per capita payment that goes to all states, independent of the level of state deficits. As targeted assistance for stimulating local economies, ARRA funding is uncorrelated with state unemployment rates. ARRA funding appears to be decided by congressional politics, given the desire to pass a major spending and tax relief package as quickly as possible. States are important “agents” for federal macro-policy, but agents with their own needs and objectives.
    JEL: H71 H77 H81
    Date: 2010–06
  8. By: Francesc Obiols-Homs
    Abstract: We study the effect of borrowing limits on welfare in several versions of exchange and production economies. There is a "quantity" effect of a larger borrowing limit which is beneficial for liquidity constrained agents, but essentially irrelevant otherwise. There is also a "price effect" which tends to increase the interest rate so that lenders are better off and borrowers are worse off. The combination of these effects produces that aggregate welfare in equilibrium (or ex ante welfare) displays an inverted U-shape as a function of the borrowing limit. In infinite horizon economies with incomplete markets we find a sizable "middle class" of not liquidity constrained but indebted agents that observes small gains, or even loses, after the borrowing limit is enlarged.
    Keywords: Borrowing constraints, incomplete markets, welfare
    JEL: D52 D58 J22
    Date: 2009–10–14
  9. By: Domenico Delli Gatti; Mauro Gallegati; Bruce Greenwald; Alberto Russo; Joseph E. Stiglitz
    Abstract: We model a network economy with three sectors: downstream firms, upstream firms, and banks. Agents are linked by productive and credit relationships so that the behavior of one agent influences the behavior of the others through network connections. Credit interlinkages among agents are a source of bankruptcy diffusion: in fact, failure of fulfilling debt commitments would lead to bankruptcy chains. All in all, the bankruptcy in one sector can diffuse to other sectors through linkages creating a vicious cycle and bankruptcy avalanches in the network economy. Our analysis show how the choices of credit supply by both banks and firms are interrelated. While the initial impact of monetary policy is on bank behaviour, we show the interactive play between the choices made by banks, the choices made by firms in their role as providers of credit, and the choices made by firms in their role as producers.
    Date: 2010–06
  10. By: Volker Wieland (Goethe University Frankfurt, Center for Financial Studies, and CEPR); Maik Wolters (Goethe University Frankfurt)
    Abstract: This paper investigates the accuracy and heterogeneity of output growth and inflation forecasts during the current and the four preceding NBER-dated U.S. recessions. We generate forecasts from six different models of the U.S. economy and compare them to professional forecasts from the Federal Reserve’s Greenbook and the Survey of Professional Forecasters (SPF). The model parameters and model forecasts are derived from historical data vintages so as to ensure comparability to historical forecasts by professionals. The mean model forecast comes surprisingly close to the mean SPF and Greenbook forecasts in terms of accuracy even though the models only make use of a small number of data series. Model forecasts compare particularly well to professional forecasts at a horizon of three to four quarters and during recoveries. The extent of forecast heterogeneity is similar for model and professional forecasts but varies substantially over time. Thus, forecast heterogeneity constitutes a potentially important source of economic fluctuations. While the particular reasons for diversity in professional forecasts are not observable, the diversity in model forecasts can be traced to different modeling assumptions, information sets and parameter estimates.
    Keywords: Forecasting, Business Cycles, Heterogeneous Beliefs, Forecast Distribution, Model Uncertainty, Bayesian Estimation
    JEL: C53 D84 E31 E32 E37
    Date: 2010–05–20
  11. By: Roc Armenter
    Abstract: The author shows that the short-term nominal interest rate can anchor private-sector expectations into low inflation more precisely, into the best equilibrium reputation can sustain. He introduces nominal asset markets in an infinite horizon version of the Barro-Gordon model. The author then analyzes the subset of sustainable policies compatible with any given asset price system at date t = 0. While there are usually many sustainable inflation paths associated with a given set of asset prices, the best sustainable inflation path is implemented if and only if the short-term nominal bond is priced at a certain discount rate. His results suggest that policy frameworks must also be evaluated on their ability to coordinate expectations.
    Keywords: Inflation (Finance) ; Interest rates ; Asset pricing
    Date: 2010
  12. By: Paul Levine (University of Surrey)
    Abstract: The past forty years or so has seen a remarkable transformation in macro-models used by central banks, policymakers and forecasting bodies. This papers describes this transformation from reduced-form behavioural equations estimated separately, through to contemporarymicro-founded dynamic stochastic general equilibrium (DSGE) models estimated by systems methods. In particular by treating DSGE models estimated by Bayesian-Maximum-Likelihood methods I argue that they can be considered as probability models in the sense described by Sims (2007) and be used for risk-assessment and policy design. This is true for any one model, but with a range of models on offer it is possible also to design interest rate rules that are simple and robust across the rival models and across the distribution of parameter estimates for each of these rivals as in Levine et al. (2008). After making models better in a number of important dimensions, a possible road ahead is to consider rival models as being distinguished by the model of expectations. This would avoid becoming 'a prisoner of a single system' at least with respect to expectations formation where, as I argue, there is relatively less consensus on the appropriate modelling strategy.
    Keywords: structured uncertainty, DSGE models, robustness, Bayesian estimation, interest-rate rules
    JEL: E52 E37 E58
    Date: 2010–04
  13. By: Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
    Abstract: We introduce the real exchange rate volatility curve as a useful device to understand the role of price stickiness in accounting for deviations from the Law of One Price at the sector level. In the presence of both nominal and real shocks, the theory predicts that the real exchange rate volatility curve is a U-shaped function of the degree of price stickiness. Using sector-level European real exchange rate data and frequency of price changes, we estimate the volatility curve. The results are consistent with the predominance of real effects over nominal effects. Nonparametric analysis suggests the curve is convex and negatively sloped over the majority of its range. Good-by-good variance decompositions show that the relative contribution of nominal shocks is smaller at the sector level than what previous studies have found at the aggregate level. We conjecture that this is due to significant averaging out of good-specific real microeconomic shocks in the process of aggregation.
    JEL: F0 F33 F4 F41
    Date: 2010–06
  14. By: Francesca Rondina
    Abstract: This paper studies optimal monetary policy in a framework that explicitly accounts for policymakers' uncertainty about the channels of transmission of oil prices into the economy. More specfically, I examine the robust response to the real price of oil that US monetary authorities would have been recommended to implement in the period 1970 2009; had they used the approach proposed by Cogley and Sargent (2005b) to incorporate model uncertainty and learning into policy decisions. In this context, I investigate the extent to which regulator' changing beliefs over different models of the economy play a role in the policy selection process. The main conclusion of this work is that, in the specific environment under analysis, one of the underlying models dominates the optimal interest rate response to oil prices. This result persists even when alternative assumptions on the model's priors change the pattern of the relative posterior probabilities, and can thus be attributed to the presence of model uncertainty itself.
    Keywords: model uncertainty, learning, robust policy, Bayesian model averaging, oil prices
    JEL: C52 E43 E58 E65
    Date: 2010–06–11
  15. By: Fernando Martin (Simon Fraser University); David Andolfatto (Simon Fraser University)
    Abstract: Conventional theory suggests that fiat money will have value in capitalpoor economies. We demonstrate that fiat money may also have value in capital-rich economies, if the price of capital is excessively volatile. Excess asset-price volatility is generated by news; information that has no social value, but is privately useful in forming forecasts over the short-run return to capital. One advantage of fiat money is that its expected return is not linked directly to news concerning the prospects of an underlying asset. When money and capital compete as media of exchange, excess volatility in the short-term returns of liquid asset portfolios is mitigated and welfare is improved. A legal restriction that prohibits the use of capital as a payment instrument renders the expected return to money perfectly stable and, as a consequence, may generate an additional welfare benefit.
    Keywords: fiat money, capital, news shocks
    JEL: E41 E42 E52
    Date: 2009–09
  16. By: James J. Heckman
    Abstract: This paper compares the structural approach to economic policy analysis with the program evaluation approach. It offers a third way to do policy analysis that combines the best features of both approaches. We illustrate the value of this alternative approach by making the implicit economics of LATE explicit, thereby extending the interpretability and range of policy questions that LATE can answer.
    JEL: C21 D6 H43
    Date: 2010–06
  17. By: Yi Wen
    Abstract: Heterogeneity matters. This point is illustrated in a heterogeneous-agent, cash-in-advance economy where money serves both as a medium of exchange and as a store of value (as in Lucas, 1980). It is shown that heterogeneity can lead to dramatically different implications of monetary policies from those under the representative-agent assumption, including (i) the velocity of money is not constant but highly volatile, as in the data; (ii) lump-sum transitory money injections have expansionary effects on aggregate output despite flexible prices; and (iii) the welfare cost of anticipated inflation is potentially a couple of orders larger than the estimates of Cooley and Hansen (1989) based on a representative-agent, cash-in-advance economy.
    Keywords: Demand for money ; Monetary theory
    Date: 2010
  18. By: Christopher Martin (Department of Economics, University of Bath, UK); Costas Milas (Economics Group, Keele Management School, UK; The Rimini Centre for Economic Analysis, Italy)
    Abstract: We argue that although UK monetary policy can be described using a Taylor rule in 1992-2007, this rule fails during the recent financial crisis. We interpret this as reflecting a change in policymakers’ preferences to give priority to stabilising the financial system. Developing a model of optimal monetary policy with preference shifts, we show this provides a superior empirical model over crisis and pre-crisis periods. We find no response of interest rates to inflation during the financial crisis, possibly implying that the UK abandoned inflation targeting during the financial crisis.
    Keywords: monetary policy, financial crisis
    JEL: C51 C52 E52 E58
    Date: 2010–01
  19. By: Bertola, G.; Dabusinskas, A.; Hoeberichts, M.; Izquierdo, M.; Kwapil, C.; Montornès, J.; Radowski, D.
    Abstract: This paper analyses information from survey data collected in the framework of the Eurosystem's Wage Dynamics Network (WDN) on patterns of firm-level adjustment to shocks. We document that the relative intensity and the character of price vs. cost and wage vs. employment adjustments in response to cost-push shocks depend - in theoretically sensible ways - on the intensity of competition in firms' product markets, on the importance of collective wage bargaining and on other structural and institutional features of firms and of their environment. Focusing on the pass-through of cost shocks to prices, our results suggest that the pass-through is lower in highly competitive firms. Furthermore, a high degree of employment protection and collective wage agreements tend to make this pass-through stronger.
    Keywords: Wage bargaining, Labour-market institutions, Survey data, European Union.
    JEL: J31 J38 P50
    Date: 2010
  20. By: Paul R. Bergin; Reuven Glick; Jyh-Lin Wu
    Abstract: The persistence of aggregate real exchange rates is a prominent puzzle, particularly since adjustment of international relative prices in microeconomic data is much faster. This paper finds that adjustment to the law of one price in disaggregated data is not just a faster version of the adjustment to purchasing power parity in the aggregate data; while aggregate real exchange rate adjustment works primarily through the foreign exchange market, adjustment in disaggregated data is a qualitatively distinct process, working through adjustment in local-currency goods prices. These distinct adjustment dynamics appear to arise from distinct classes of shocks generating macro and micro price deviations. A vector error correction model nesting aggregate and disaggregated relative prices permits identification of distinct macroeconomic and good-specific shocks. When half-lives are estimated conditional on shocks, the macro-micro disconnect puzzle disappears: microeconomic relative prices adjust to macro shocks just as slowly as do aggregate real exchange rates. These results provide evidence against theories of real exchange rate behavior based on sticky prices and on heterogeneity across goods.
    Keywords: Foreign exchange rates ; Purchasing power parity ; Prices
    Date: 2010
  21. By: Reuven Glick; Michael Hutchison
    Abstract: We investigate the effectiveness of capital controls in insulating economies from currency crises, focusing in particular on both direct and indirect effects of capital controls and how these relationships may have changed over time in response to global financial liberalization and the greater mobility of international capital. We predict the likelihood of currency crises using standard macroeconomic variables and a probit equation estimation methodology with random effects. We employ a comprehensive panel data set comprised of 69 emerging market and developing economies over 1975–2004. Both standard and duration-adjusted measures of capital control intensity (allowing controls to "depreciate" over time) suggest that capital controls have not effectively insulated economies from currency crises at any time during our sample period. Maintaining real GDP growth and limiting real overvaluation are critical factors preventing currency crises, not capital controls. However, the presence of capital controls greatly increases the sensitivity of currency crises to changes in real GDP growth and real exchange rate overvaluation, making countries more vulnerable to changes in fundamentals. Our model suggests that emerging markets weathered the 2007-08 crisis relatively well because of strong output growth and exchange rate flexibility that limited overvaluation of their currencies.
    Keywords: Financial crises ; Capital market ; Emerging markets ; Econometric models ; Panel analysis
    Date: 2010
  22. By: Anthony J Makin
    Keywords: global financial crisis, national income, exchange rate, monetary policy, fiscal stimulus
    JEL: F31 F33 F41
  23. By: Celsa Machado (ISCAP - Instituto Superior de Contabilidade e Administração do Porto); Ana Paula Ribeiro (Faculdade de Economia da Universidade do Porto and CEF.UP)
    Abstract: This paper analyses optimal discretionary non-coordinated monetary and fiscal stabilization policies in a micro-founded New-Keynesian model of a two-country monetary union with country-size asymmetry, under two policy scenarios. A balanced-budget policy scenario and a policy scenario where the presence of government debt limits the macroeconomic stabilization effort and enlarges the sources of strategic policy interactions. Numerical results indicate that non-cooperation exacerbates the fiscal policy activism of a small country while moderating that of a large country. In the balanced-budget scenario, non-cooperation improves (reduces) welfare for a small (large) country while, in the high-debt scenario, it produces the opposite results. Cooperation dominates non-cooperation for the union as a whole.
    Keywords: Monetary union; optimal fiscal and monetary policies; asymmetric countries.
    JEL: E52 E61 E62 E63
    Date: 2010–06
  24. By: Montornès, J. Author-Name: Sauner-Leroy, J-B.
    Abstract: We investigate the wage-setting behavior of French companies using an ad-hoc survey conducted specifically for this study. Our main results are the following. i) Wages are changed infrequently. The mean duration of wage contracts is one year. Wage changes occur at regular intervals during the year and are concentrated in January and July. ii) We find a lower degree of downward real wage rigidity and nominal wage rigidity in France compared to the European average. iii) About one third of companies have an internal policy to grant wage increases according to inflation. iv) When companies are faced with adverse shocks, only a partial response is transmitted into prices. Companies also adopt cost-cutting strategies. The wage of newly hired employees plays an important role in this adjustment.
    Keywords: Wage Rigidity, Wage-setting Behavior, Survey Data.
    JEL: E24 J3
    Date: 2010
  25. By: Fernando M. Martin (Simon Fraser University);
    Abstract: I study how the specific details of a micro founded monetary economy affect the determination of government policy. I consider three variants of the Lagos-Wright monetary framework: a benchmark were all markets are competitive; a case which allows for financial intermediaries; and a case with trading frictions. Although intitutions/frictions are shown to have a significant structural impact in the determination of policy, the calibrated artificial economies are observationally equivalent in steady state. The policy response to aggregate shocks is qualitatively similar in the variants considered. However, there are significant quantitative differences in the response of government policy to productivity shocks, mainly due to the idiosyncratic behavior of money demand. The variants with no trading frictions display the best fit to U.S. post-war data.
    Keywords: government policy; lack of commitment; financial intermediation; trading frictions; micro founded models of money
    JEL: E13 E52 E62 E63
    Date: 2010–06
  26. By: Muhammed Muqtada (International Labour Office, Employment Sector (retired in June 2010))
    Abstract: Critically reviews the macroeconomic experiences of the past three decades to argue the case against orthodox macroeconomics. Suggests that the prevailing orthodoxy in macroeconomics needs to give way to an alternative policy paradigm in which the Copenhagen commitment on full employment, subsequently incorporated as a Millennium Development Goal, plays a central role. The global recession of 2008-2009 reinforces the potency of this proposition.
    Keywords: employment, economic recession, economic policy, finance, international monetary system, developing countries
    Date: 2010
  27. By: Davide Furceri (OECD and University of Palermo); Aleksandra Zdzienicka (Université de Lyon, Lyon, F-69003, France; CNRS, GATE Lyon St Etienne, UMR 5824, 93, chemin des Mouilles, Ecully, F-69130, France; ENS-LSH, Lyon, France)
    Abstract: The aim of this work is to assess the short and medium term impact of banking crises on developing economies. Using an unbalanced panel of 159 countries from 1970 to 2006, the paper shows that banking crises produce significant output losses, both in the short and in the medium term. The effect depends on structural and policy variables. Output losses are larger for relatively more wealthy economies, characterized by a higher level of financial deepening and larger current account imbalances. Flexible exchange rates, fiscal and monetary policy have been found to be efficient tools to attenuate the effect of the crises. Among banking intervention policies, liquidity support resulted to be the one associated with lower output losses.
    Keywords: Output Losses, Financial Crisis
    JEL: G1 E6
    Date: 2010
  28. By: Davide Furceri (OCDE - Organisation de coopération et de développement économiques - OCDE); Aleksandra Zdzienicka-Durand (GATE Lyon Saint-Etienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - Ecole Normale Supérieure Lettres et Sciences Humaines)
    Abstract: The aim of this work is to assess the short and medium term impact of banking crises on developing economies. Using an unbalanced panel of 159 countries from 1970 to 2006, the paper shows that banking crises produce significant output losses, both in the short and in the medium term. The effect depends on structural and policy variables. Output losses are larger for relatively more wealthy economies, characterized by a higher level of financial deepening and larger current account imbalances. Flexible exchange rates, fiscal and monetary policy have been found to be efficient tools to attenuate the effect of the crises. Among banking intervention policies, liquidity support resulted to be the one associated with lower output losses.
    Keywords: Output Losses; Financial Crisis
    Date: 2010
  29. By: Ila Patnaik; Ajay Shah; Anmol Sethy; Vimal Balasubramaniam
    Abstract: Prior to the Asian financial crisis, most Asian exchange rates were de facto pegged to the US Dollar. In the crisis, many economies experienced a brief period of extreme flexibility. A `fear of floating' gave reduced flexibility when the crisis subsided, but flexibility after the crisis was greater than that seen prior to the crisis. Contrary to the idea of a durable Bretton Woods II arrangement, Asia then went on to slowly raise flexibility and reduce the role for the US Dollar. When the period from April 2008 to December 2009 is compared against periods of high in flexibility, from January 1991 to November 1991 and October 1995 to March 1997, the increase in flexibility is economically and statistically significant. This paper proposes a new measure of dollar pegging, the \Bretton Woods II score". [NIPFP WP No. 69].
    Keywords: flexibility, korea, economically, Exchange rate regime, Asia, Bretton Woods II hypothesis, dollar, pegging, US, Asia, financial crisis, china, India, macroeconomic policy, monetary policy
    Date: 2010
  30. By: Ehsan U. Choudhri (Department of Economics, Carleton University); Lawrence L. Schembri (International Department, Bank of Canada)
    Abstract: The paper examines how the Balassa-Samuelson hypothesis is affected by a modern variation of the standard model that allows product differentiation (within the traded and nontraded goods sectors) with the number of firms determined exogenously or endogenously. The hypothesis is found to be fragile in the modified framework. Small variations in the elasticity of substitution between home and foreign traded goods (within the range of estimates suggested in the literature), for example, can make the effect of a traded-goods productivity improvement on the real exchange rate negative or positive, as well as small or large. This result provides a potential explanation of the mixed empirical results that have been obtained on the relationship between productivity and the real exchange rate.
    Keywords: Real exchange rate; Balassa-Samuelson model; Productivity; Terms of trade
    JEL: F41 F31
    Date: 2010–05
  31. By: Jonathan H. Wright
    Abstract: This paper proposes Bayesian forecasting in a vector autoregression using a democratic prior. This prior is chosen to match the predictions of survey respondents. In particular, the unconditional mean for each series in the vector autoregression is centered around long-horizon survey forecasts. Heavy shrinkage toward the democratic prior is found to give good real-time predictions of a range of macroeconomic variables, as these survey projections are good at quickly capturing endpoint-shifts.
    Keywords: Forecasting ; Real-time data
    Date: 2010
  32. By: Jean-Olivier Hairault (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, IZA - Institute for the Study of Labor); François Langot (IZA - Institute for the Study of Labor, GAINS-TEPP - Université du Mans, CEPREMAP - Centre pour la recherche économique et ses applications)
    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.
    Date: 2010–03
  33. By: Michael D. Bordo; Thomas F. Helbling
    Abstract: In this paper, we review and attempt to explain the changes in business cycle synchronization among 16 industrial countries and the over the past century and a quarter, demarcated into four exchange rate regimes. We find that there is a secular trend towards increased synchronization for much of the twentieth century and that it occurs across diverse exchange rate regimes. This finding is in marked contrast to much of the recent literature, which has focused primarily on the evidence for the past 20 or 30 years and which has produced mixed results. We then examine the role of global shocks and shock transmission in the trend toward synchronization. Our key finding here is that global (common) shocks generally are the dominant influence.
    JEL: F0 N0
    Date: 2010–06
  34. By: Jarko Fidrmuc (Austrian Central Bank, CESifo Munich, and Comenius University Bratislava); Taro Ikeda (Graduate School of Economics, Kobe University); Kentaro Iwatsubo (Graduate School of Economics, Kobe University)
    Abstract: We exploit dynamic correlations defined in the frequency domain to estimate determinants of output comovement of OECD countries between 1990 and 2008. We show that trade intensity, degree of financial integration and specialization pattern have significantly different effects on comovements at different frequencies. This can bias the results using aggregate data or statistical filters. For example, financial integration is shown to have the highest positive effect for the business cycle frequencies, while it is insignificant for the short-term frequencies.
    Keywords: Business cycle, Transmission, Financial Integration, Dynamic Correlation
    JEL: E32 F15 F41
    Date: 2010–06
  35. By: Mykhaylova, Olena
    Abstract: This paper calculates differences in welfare costs of nominal rigidities in large and small EMU countries. I use a two-country DSGE model characterized by optimizing agents, monopolistic wage and price setting, distortionary taxes and government debt dynamics. I find that these costs are virtually identical for all members of the EMU, and small countries are not at a disadvantage when it comes to the setting of the common monetary policy. This conclusion is primarily due to highly correlated technological processes in Europe, which cause national and Euro-wide inflations to move together. These findings are robust to the asset market structure, trade openness, and different specifications of the Taylor rule.
    Keywords: European monetary union; nominal rigidities; welfare costs
    JEL: E31 E58 E63 F33
    Date: 2009–08–31
  36. By: Drescher, Christian; Erler, Alexander; Krizanac, Damir
    Abstract: The paper examines if US monetary policy implicitly responds to asset prices. Using real-time data and a GMM framework we estimate a Taylor-type rule with an asset cycle variable, which refers to real estate prices. To analyze the Fed's responses we describe real estate price movements by means of an asset cycle dating procedure. This procedure reveals quasi real-time bull and bear markets. Our analysis yields two main findings. Firstly, the Fed does implicitly respond to real estate prices. Secondly, these responses are pro-cyclical and their intensity changes over time.
    Keywords: Fed; Monetary Policy; Taylor Rule; Asset Price Cycles; Real Estate
    JEL: E58 E52
    Date: 2010–06–14
  37. By: Heikki Kauppi (Department of Economics, University of Turku)
    Abstract: Various papers indicate that the yield-curve has superior predictive power for U.S. recessions. However, there is controversial evidence on the stability of the predictive relationship and it has remained unclear how the persistence of the underlying binary recession indicator should be taken into account. We show that a yield-curve based probit model treating the binary recession series as a nonhomogeneous first-order Markov chain sufficiently captures the persistence of the U.S. business cycles and produces recession probability forecasts that outperform those based on a conventional static model. We obtain evidence for instability in the predictive content of the yield-curve that centers on a structural change in the early 1980s. We conclude that the simple dynamic model with parameters estimated using data after the breakpoint is likely to provide useful probability forecasts of U.S. recessions in the future.
    Keywords: recession forecast, yield curve, dynamic probit models, parameter stability
    JEL: C22 C25 E32 E37
    Date: 2010–06
  38. By: Victor Polterovich, Vladimir Popov, Alexander Tonis
    Abstract: Is resource abundance a blessing or a curse? Typically, in resource rich countries, domestic fuel prices are lower, and energy intensity of GDP is higher. But they have higher investment in R&D and fixed capital stock, larger foreign exchange reserves and more inflows of FDI. They also have lower budget deficits and lower inflation. These are conducive for long term growth. We also find that in resource rich countries, real exchange rate is generally higher, accumulation of human capital is slower and institutions are worse, especially if they were not strong initially, which are detrimental for growth.
    Keywords: Resource curse, economic growth, inequality, institutions, real exchange rate, budget deficit, inflation, investment, industrial policy
    JEL: O25 O43 Q32 Q43 Q48
    Date: 2010–06
  39. By: Ross D. Hickey; David S. Jacks
    Abstract: We introduce a new data set on over 230,000 monthly prices for 10 goods in 50 Canadian cities over the 40 year period from 1910 to 1950. This coupled with previously published price information from the late twentieth century allows us to present one of the first comprehensive views of nominal rigidities and retail price dispersion over the past 100 years. We find that nominal rigidities have been conditioned upon prevailing rates of inflation with a greater frequency of price changes occurring in the 1920s and the 1970s. Additionally, the process of retail market integration has surprisingly followed a U-shaped trajectory, with many domestic markets being better integrated—as measured by the average dispersion of retail prices—at mid-century than in the 1990s. We also consider the linkages between nominal rigidities and price dispersion, finding results consistent with present-day data.
    JEL: E31 L11 N82
    Date: 2010–06
  40. By: Nicoletta Batini (University of Surrey and IMF); Vasco Gabriel (University of Surrey); Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University)
    Abstract: We first develop a two-bloc model of an emerging open economy interacting with the rest of the world calibrated using Indian and US data. The model features a financial accelerator and is suitable for examining the effects of financial stress on the real economy. Three variants of the model are highlighted with increasing degrees of financial frictions. The model is used to compare two monetary interest rate regimes: domestic Inflation targeting with a floating exchange rate (FLEX(D)) and a managed exchange rate (MEX). Both rules are characterized as a Taylor-type interest rate rules. MEX involves a nominal exchange rate target in the rule and a constraint on its volatility. We find that the imposition of a low exchange rate volatility is only achieved at a significant welfare loss if the policymaker is restricted to a simple domestic in- flation plus exchange rate targeting rule. If on the other hand the policymaker can implement a complex optimal rule then an almost fixed exchange rate can be achieved at a relatively small welfare cost. This finding suggests that future research should examine alternative simple rules that mimic the fully optimal rule more closely. JEL Classification: E52, E37, E58
    Keywords: DSGE model, Indian economy, monetary interest rate rules, floating versus managed exchange rate, financial frictions.
    JEL: E52 E37 E58
    Date: 2010–04
  41. By: Zheng Xueyi; Yaguang Zhang; John Whalley
    Abstract: We discuss monetary thought in ancient China from the perspective of Western monetary theory. It sets out the structure of economic activity in the various dynasties of ancient China and emphasizes the differences in monetary structure from Europe (and later North America). Imperial China was a politically integrated structure with regional segmentation of economic activities and hence with regional money. Monetary policy was one body conducted at regional level, but overseen naturally politically before national integration under the Ming dynasty (14th century). In various regions different forms of money circulated, with gold, silver, copper, and paper all present at various times. Monetary policy was guided by monetary thought, such as later in Europe. Basic concepts such as monetary function, the velocity of circulation, inflation, interest rate parity and the quantity theory were all present. The economics of Imperial China witnessed boom and bust, inflation and deflation and monetary control much like Europe to follow. Monetary thought thus seemingly preceded Western thought, and had remarkable similarities. Whether much of this thought travelled down the silk road remains unknown, but the possibility is intriguing.
    JEL: N20
    Date: 2010–06
  42. By: Christiano Arrigoni Coelho (Banco Central do Brasil e Department of Economics PUC-Rio); João Manoel Pinho de Mello (Department of Economics PUC-Rio); MArcio Gomes Pinto Garcia (Department of Economics PUC-Rio)
    Abstract: Using the different response timings of credit demand and supply, we isolate supply shifts after monetary policy shocks. We show that the bank lending channel exists in Brazil: after an increase (decrease) in the basic interest rate (Selic), banks reduce (increase) the quantity of new loans and raise (lower) interest rates. However, contrary to the empirical literature for the US, we find evidence that large banks react more than smaller ones to monetary policy shocks. Results may have important implications for monetary policy transmission in light of the recent wave of concentration in the Brazilian banking industry.
    Keywords: monetary policy transmission; credit markets; bank lending channel. JEL Code: E52; E58
    Date: 2010–05
  43. By: Da Silva Filho, Tito Nícias Teixeira; Figueiredo, Francisco Marcos Rodrigues
    Abstract: This paper assesses the performance of the core inflation measures calculated by the Brazilian Central Bank (BCB). The evidence shows that they do not meet some key statistical criteria that a good core inflation should have: unbiasedness and the ability to forecast inflation. That performance stems, to a large extent, from the lack of a well-grounded statistical and economical basis behind them. Three new measures are built and assessed using the same criteria. The evidence shows that their behaviour is more in accordance to what the theory claims. However, they still lack the ability to help forecasting inflation. Hence both the BCB and the market should use core inflation cautiously.
    Keywords: Core inflation; inflation; supply shocks; relative prices; volatility
    JEL: C43 E31 E52
    Date: 2009–12
  44. By: Mohamed Benbouziane (Faculty of economics and management, Tlemcen University); Abdelhak Benamar; Mustapha Djennas
    Abstract: The objective of this paper is to test for the liquidity effect in Algeria and Morocco using multivariate threshold autoregressive model (MVTAR) as proposed by Tsay (1998). Our empirical results have several important implications. First, results do not support threshold behavior in the case of Algeria. Moreover, when using M1 as a proxy of monetary policy, the liquidity effect hypothesis is rejected in this country. When using bank deposit assets (BDA), results show that there is a negative relationship between monetary shocks and interest rate, and accordingly accepting the liquidity effect. Secondly, in the case of Morocco, however, results show an asymmetric response of interest rate to positive and negative shocks of monetary policy. Moreover, these results strongly support a threshold behavior when BDA is employed, while weakly supporting the same behavior using M1. Furthermore, and using the proxy of bank deposit assets, the liquidity effect are accepted in the low inflation regime, whereas it is rejected in the high inflation regime. Hence, the threshold behavior offers an interesting alternative for explaining the relationship between interest rates and monetary policy shocks. The results presented herein may give more insights on the transmission mechanism of monetary policy in different inflationary environments. Accordingly, a good inflation targeting policy would yield better results in this context. Indeed, the liquidity effect breaks down for the high inflation regime, as inflationary expectations are immediately responsive to money growth. In a low-inflation regime, however, money is not considered to be neutral, as it could affect output through the liquidity effect.
    Date: 2010–06

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