nep-cba New Economics Papers
on Central Banking
Issue of 2010‒10‒02
38 papers chosen by
Alexander Mihailov
University of Reading

  1. Future of Central Banking under Globalization: Summary of the 2010 International Conference Organized by the Institute for Monetary and Economic Studies of the Bank of Japan By Shigenori Shiratsuka; Wataru Takahashi; Yuki Teranishi; Kozo Ueda
  2. Bretton-Woods systems, old and new, and the rotation of exchange-rate regimes By Stephen Hall; George Hondroyiannis; P.A.V.B Swamy; George Tavlas
  3. The Effect of Monetary Policy on Credit Spreads By Tolga Cenesizoglu; Badye Essid
  4. Consensus Forecasts and Inefficient Information Aggregation By Christopher W. Crowe
  5. The Cross-Country Incidence of the Global Crisis By Gian Maria Milesi-Ferretti; Philip R. Lane
  6. Recovery and Reinvestment Act Spending at the State Level: Keynesian Stimulus or Distributive Politics? By Russell S. Sobel; Andrew Young
  7. Time series analysis for financial market meltdowns By Young Shin Kim; Rachev, Svetlozar T.; Bianchi, Michele Leonardo; Mitov, Ivan; Fabozzi, Frank J.
  8. The EMU sovereign-debt crisis: Fundamentals, expectations and contagion By Arghyrou, Michael G; Kontonikas, Alexandros
  9. Towards a New Architecture for Financial Stability: Seven Principles By Luis Garicano; Rosa Lastra
  10. Austerity is Not a Solution: Why the Deficit Hawks are Wrong By Robert Pollin
  11. Long-run Determinants of Sovereign Yields By António Afonso; Christophe Rault
  12. European sovereign bond spreads: monetary unification, market conditions and financial integration. By Dimitris A. Georgoutsos; Petros Migiakis
  13. Nowcasting the Global Economy By James Rossiter
  14. Structural Change in Current Account and Real Exchange Rate Dynamics: Evidence from the G7 Countries By Masahiko Shibamoto; Shigeto Kitano
  15. How Well Does "Core" CPI Capture Permanent Price Changes? By Tara M. Sinclair; Dennis W. Jensen; Michael D. Bradley
  16. How well do the sticky price models explain the disaggregated price responses to aggregate technology and monetary policy shocks? By Jouchi Nakajima; Nao Sudo; Takayuki Tsuruga
  17. Rethinking the Liquidity Puzzle: Application of a New Measure of the Economic Money Stock By Logan Kelly; William Barnett; John Keating
  18. Dedollarization By Romain Veyrune; Annamaria Kokenyne; Jeremy Ley
  19. Macroeconomic and interest rate volatility under alternative monetary operating procedures By Petra Gerlach-Kristen; Barbara Rudolf
  20. Market-specific and Currency-specific Risk during the Global Financial Crisis: Evidence from the Interbank Markets in Tokyo and London By Shin-ichi Fukuda
  21. Downward nominal and real wage rigidity: survey evidence from European firms By Jan Babecký; Philip Du Caju; Theodora Kosma; Martina Lawless; Julián Messina; Tairi Rõõm
  22. Offshore markets for the domestic currency: monetary and financial stability issues By Dong he; Robert McCauley
  23. Labor-Market Heterogeneity, Aggregation, and the Lucas Critique By Yongsung Chang; Sun-Bin Kim; Frank Schorfheide
  24. Rational Expectations And Inflation Targeting -An Analysis For Ten Countries By Fromlet, Pia
  25. Still Minding the Gap - Inflation Dynamics during Episodes of Persistent Large Output Gaps By André Meier
  26. Bayesian inference for hedge funds with stable distribution of returns By Güner, Biliana; Rachev, Svetlozar T.; Edelman, Daniel; Fabozzi, Frank J.
  27. The Case for Reforming Euro Area Entry Criteria By Zsolt Darvas
  28. Exchange Rate Asymmetry and Flexible Exchange Rates under Inflation Targeting Regimes: Evidence from Four East and Southeast Asian Countries By Pontines, Victor; Siregar, Reza Y.
  29. Regional Inflation (Price) Behaviors: Heterogeneity and Convergence By Nagayasu, Jun
  30. Relative-Price Changes and Demand Factors in the Period of Quantitative Easing in Japan By Bernd Hayo; Hiroyuki Ono
  31. A Monetary Policy Model Without Money for India By Michael Patra; Muneesh Kapur
  32. India’s trilemma: financial liberalization, exchange rates and monetary policy By Hutchison, Michael; Sengupta, Rajeswari; Singh, Nirvikar
  33. Forecasting Monetary Policy Rules in South Africa By Ruthira Naraidoo; Ivan Paya
  34. Forecasting Monetary Policy Rules in South Africa By Ivan Paya; Ruthira Naraidoo
  35. Forecasting Key Macroeconomic Variables of the South African Economy: A Small Open Economy New Keynesian DSGE-VAR Model By Rangan Gupta; Rudi Steinbach
  36. Asset Prices, Credit Growth, Monetary and Other Policies: An Australian Case Study By Paul Bloxham; Christopher Kent; Michael Robson
  37. The Natural Rate of Unemployment in Brazil, Chile, Colombia and Venezuela: some results and challenges By Tito Nícias Teixeira da Silva Filho
  38. The Determinants and Stability of Real Money Demand in Vietnam, 1999-2009 By NGUYEN Huyen Diu; Wade D. Pfau

  1. By: Shigenori Shiratsuka (Associate Director-General, Head of Economic and Financial Studies Division, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: shigenori.shiratsuka; Wataru Takahashi (Director-General, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: wataru.takahashi; Yuki Teranishi (Deputy Director, Institute for Monetary and Economic Studies (currently, Financial Systems and Bank Examination Department), Bank of Japan (E-mail: yuuki.teranishi; Kozo Ueda (Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: kouzou.ueda
    Date: 2010–09
  2. By: Stephen Hall (Leicester University); George Hondroyiannis (Bank of Greece and Harokopio University); P.A.V.B Swamy (Federal Reserve Board (retired)); George Tavlas (Bank of Greece)
    Abstract: A recent contribution to the literature argues that the present international monetary system in many ways operates like the Bretton-Woods system. Asia is the new periphery of the system and pursues an export-led development strategy based on undervalued exchange rates and accumulated foreign reserves. The United States remains the centre country, pursuing a monetary-policy strategy that overlooks the exchange rate. Under both regimes the United States does not take external factors into account in conducting monetary policy while the periphery does take external factors into account. We provide results of a test of this hypothesis. Then, we present a new method for decomposition of a seasonally adjusted series the business cycle and other components using a time-varying-coefficient technique that allows us to test the relationship between the cycle and macroeconomic policies under both regimes.
    Keywords: Revived Bretton-Woods system, asymmetry hypothesis, time-series, decomposition, time-varying-coefficient estimation
    JEL: C22 E32 F33
    Date: 2010–04
  3. By: Tolga Cenesizoglu; Badye Essid
    Abstract: In this paper, we analyze the effect of monetary policy on yield spreads between corporate bonds with different credit ratings over changing conditions in the economy. Using futures data on the Fed funds rate, we distinguish between expected and unexpected changes in monetary policy. We find that unexpected changes in the Fed funds rate do not have a significant effect on changes in credit spreads when we do not control for different conditions in the economy. We then distinguish between three different cycles in the economy: business, credit and monetary policy cycles. In line with predictions of imperfect capital market theories, credit spreads widen (narrow) following an unexpected monetary policy tightening (easing) during periods of poor economic and credit market conditions. Several robustness tests suggest that our results are not due to possible endogeneity problems, lack of control variables or identification methodology or different cycles.
    Keywords: Business Cycle, Moody's Bond Indices, Fed Funds Rate Futures, Monetary Policy Surprises, Credit Spreads
    JEL: E44 E52
    Date: 2010
  4. By: Christopher W. Crowe
    Abstract: Consensus forecasts are inefficient, over-weighting older information already in the public domain at the expense of new private information, when individual forecasters have different information sets. Using a cross-country panel of growth forecasts and new methodological insights, this paper finds that: consensus forecasts are inefficient as predicted; this is not due to individual forecaster irrationality; forecasters appear unaware of this inefficiency; and a simple adjustment reduces forecast errors by 5 percent. Similar results are found using US nominal GDP forecasts. The paper also discusses the result’s implications for users of forecaster surveys and for the literature on information aggregation.
    Keywords: Cross country analysis , Economic forecasting , Economic growth , Gross domestic product ,
    Date: 2010–07–30
  5. By: Gian Maria Milesi-Ferretti; Philip R. Lane
    Abstract: We examine whether the cross-country incidence and severity of the 2008-2009 global recession is systematically related to pre-crisis macroeconomic and financial factors. We find that the pre-crisis level of development, increases in the ratio of private credit to GDP, current account deficits, and openness to trade are helpful in understanding the intensity of the crisis. International risk sharing did little to shield domestic demand from the country-specific component of output declines, while those countries with large pre-crisis current account deficits saw domestic demand fall by much more than domestic output during the crisis.
    Date: 2010–07–26
  6. By: Russell S. Sobel (Department of Economics, West Virginia University); Andrew Young (Department of Economics, West Virginia University)
    Abstract: We examine the US state-level pattern of American Recovery and Reinvestment Act (ARRA) spending. We relate spending to (1) Keynesian determinants of countercyclical policy, (2) congressional power and dominance, and (3) presidential electoral vote importance. We find that the ARRA is, in practice, poorly-designed countercyclical stimulus. After controlling for political variables, coefficients on Keynesian variables are often statistically insignificant. When they are statistically significant they are often the “incorrect” sign. On the other hand, statistically significant effects associated with political variables are almost always of the sign predicted by public choice theory. One striking result is that the elasticity of ARRA spending with respect to the pre-ARRA levels of federal grants and payments to state and local governments is between 0.254 and 0.361. States previously capturing large amounts of federal funds continue to do so under the ARRA stimulus.
    Keywords: fiscal stimulus, fiscal policy, political economy, public choice, congressional dominance model, American recovery and reinvestment act
    JEL: D7 H5 E6
    Date: 2010
  7. By: Young Shin Kim; Rachev, Svetlozar T.; Bianchi, Michele Leonardo; Mitov, Ivan; Fabozzi, Frank J.
    Abstract: There appears to be a consensus that the recent instability in global financial markets may be attributable in part to the failure of financial modeling. More specifically, current risk models have failed to properly assess the risks associated with large adverse stock price behavior. In this paper, we first discuss the limitations of classical time series models for forecasting financial market meltdowns. Then we set forth a framework capable of forecasting both extreme events and highly volatile markets. Based on the empirical evidence presented in this paper, our framework offers an improvement over prevailing models for evaluating stock market risk exposure during distressed market periods. --
    Keywords: ARMA-GARCH model,»-stable distribution,tempered stable distribution,value-at-risk (VaR),average value-at-risk (AVaR)
    Date: 2010
  8. By: Arghyrou, Michael G (Cardiff Business School); Kontonikas, Alexandros
    Abstract: We offer a detailed empirical investigation of the European sovereign debt crisis based on the theoretical model by Arghyrou and Tsoukalas (2010). We find evidence of a marked shift in market pricing behaviour from a 'convergence-trade' model before August 2007 to one driven by macro-fundamentals and international risk thereafter. The majority of EMU countries have experienced contagion from Greece. There is no evidence of significant speculation effects originating from CDS markets. Finally, the escalation of the Greek debt crisis since November 2009 is confirmed as the result of an unfavourable shift in country specific market expectations. Our findings highlight the necessity of structural, competitiveness-inducing reforms in periphery EMU countries and institutional reforms at the EMU level enhancing intra-EMU economic monitoring and policy co-ordination.
    Keywords: euro-area; crisis; spreads; fundamentals; expectations; contagion; speculation
    JEL: E43 E44 F30 G12
    Date: 2010–09
  9. By: Luis Garicano; Rosa Lastra
    Abstract: In this paper we use insights from organizational economics and financial regulation to studythe optimal architecture of supervision. We suggest that the new architecture should revolvearound the following principles: (i) banking, securities and insurance supervision should befurther integrated; (ii) macro prudential supervisory function must be in the hands of thecentral bank; (iii) the relation between macro and micro supervisors must be articulatedthrough a management by exception system involving direct authority of the macrosupervisor over enforcement and allocation of tasks; (iv) given the difficulty of measuringoutput on supervisory tasks, the systemic risk supervisor must necessarily be moreaccountable and less independent than Central Banks are on their monetary task; (v) thesupervisory agency cannot rely on high powered incentives to motivate supervisors, and mustrely on culture instead; (vi) the supervisor must limit its reliance on self regulation; and (vii)the international system should substitute the current loose, networked structure for a morecentralized and hierarchical one.
    Keywords: Banks, international financial markets, systematic risk
    JEL: E61 G21
    Date: 2010–07
  10. By: Robert Pollin
    Abstract: Wall Street hyper-speculation brought the global economy to its knees in 2008-09.<span>  </span>To prevent a 1930s-level Depression at that time, economic policymakers throughout the world enacted extraordinary measures.<span>  </span>These included large-scale fiscal stimulus programs, financed by major expansions in central government fiscal deficits.<span>  </span>In the U.S., the fiscal deficit reached 9.9 percent of GDP in 2009, and is projected at 10.3 percent of GDP in 2010.<span>  </span>But roughly 18 months after these measures were introduced, a new wave of opposition to large-scale fiscal deficits has emerged.<span>   </span><p></p> This paper reviews the arguments developed by various leading deficit hawks.<span>  </span>In<span>  </span>fact, they are not advancing one main argument or even a unified set of positions, but rather four distinct claims:<span>  </span>1)<span>  </span>Large fiscal deficits will cause high interest rates, large government debts, and inflation; 2) Even if the current deficits have not caused high interest rates and inflation, they are eroding business confidence; 3) The multiplier for fiscal stimulus policies is always close to zero and has been so with the current measures; and 4) Regardless of short-term considerations, we are courting disaster in the long run with structural deficits that the recession only worsened.<span>  </span><p></p> This paper argues that none of these deficit hawk positions stand up to scrutiny.<span>  </span>I also argue that through critiquing the four deficit-hawk positions, we can also bring greater clarity toward developing a workable recovery program.<span>  </span>This will include fiscal deficits that can stabilize state and local government budgets; maintain sufficient funds for unemployment insurance; and continue support for long-term investments in traditional infrastructure and clean energy.<span>    </span>But such fiscal policies also need to combine with credit-market measures that are capable of ‘pulling on a string’—i.e. creating strong enough incentives for both lenders and borrowers to unlock credit markets.
    JEL: E60 E62 E50
    Date: 2010
  11. By: António Afonso; Christophe Rault
    Abstract: We study sovereign bond yields in OECD countries with a dynamic panel by checking for cross-section dependence; assessing panel cointegration; and estimating panel errorcorrection models. The results show that markets consider budgetary and external imbalances and inflation as relevant determinants of sovereign yields.
    Keywords: long-term yields, panel cointegration, bootstrap
    JEL: C23 E62 G10 H62
    Date: 2010–09
  12. By: Dimitris A. Georgoutsos (Athens University of Economics & Business); Petros Migiakis (Bank of Greece)
    Abstract: In this paper we examine the dynamics of European sovereign bond yield spreads focusing on issues related to financial integration and market conditions. The finding of near-unit-root effects highlights the need for careful econometric specification. Thus we formulate sovereign bond yield spreads, for eleven EMU countries against the Bund for the period 1992:1-2009:12, as AR(1) processes, while allowing for regime switching effects, along the lines of a Markovian probabilistic specification. Specifically, by taking into account regime switching effects we examine, rather than assume, that monetary unification affected sovereign bond yield spreads, allowing for states of higher and lower interactions to be revealed. Next, we examine the effects of several exogenous explanatory variables. Our results indicate that European sovereign bonds achieved only partial integration even before the recent financial crisis, while financial integration and financial stability are found to be interconnected. Specifically, we find evidence of different effects exercised by the same deterministic factors on sovereign bond yield spreads even before the recent crisis. Additionally, it appears that a negative relation exists between low-volatility conditions and the magnitude of effects exercised by idiosyncratic risk factors on bond yield spreads.
    Keywords: financial integration; sovereign bond spreads; near unit root; regime shifts
    JEL: F21 G12 G32
    Date: 2010–06
  13. By: James Rossiter
    Abstract: Forecasts of global economic activity and inflation are important inputs when conducting monetary policy in small open economies such as Canada. As part of the Bank of Canada's broad agenda to augment its short-term forecasting tools, the author constructs simple mixed-frequency forecasting equations for quarterly global output, imports, and inflation using the monthly global Purchasing Managers Index (PMI). When compared against two benchmark models, the results show that the PMIs are useful for forecasting developments in the global economy. As the forecasts are updated throughout the quarter with the monthly release of the PMI, forecasting performance generally improves. An analysis of the forecasts over the period of the Great Recession (in particular, 2008Q4 to 2009Q2) shows that, while models that include the "soft" PMI indicators did not fully capture the sharp deterioration in the global economy, they nevertheless improved the forecasts relative to the benchmark models. This finding highlights the usefulness of such indicators for short-term forecasting.
    Keywords: Economic models; International topics
    JEL: E37 F47
    Date: 2010
  14. By: Masahiko Shibamoto (Research Institute for Economics and Business Administration, Kobe University); Shigeto Kitano (Research Institute for Economics and Business Administration, Kobe University)
    Abstract: Lee and Chinn (2006) and Chinn and Lee (2009) decomposed the current account and real exchange rate into temporary and permanent shocks, and argued that a temporary shock creates the combination of current account surplus (deficit) and real exchange rate depreciation (appreciation). This paper extends their framework by examining a possible structural break in the current account and real exchange rate dynamics. Using the data of the G7 countries during the period 1980--2007, we find structural changes in two-variable dynamics for all the countries during the mid 1990s. Since the mid 1990s, the temporary shocks have not been the main source of fluctuations in the current account. Our empirical results imply that the conventional mechanism has played a limited role in explaining the dynamics of the two variables.
    Keywords: Current account, Real exchange rate, Structural change, Global imbalances
    JEL: F31 F41
    Date: 2010–09
  15. By: Tara M. Sinclair (Department of Economics/Institute for International Economic Policy, George Washington University); Dennis W. Jensen (Department of Economics, Texas A&M University); Michael D. Bradley (Department of Economics, George Washington University)
    Abstract: We decompose core CPI and the food and energy CPI measures into permanent and transitory components using a correlated unobserved components model, to examine the behavior of core CPI when subject to shocks and to examine the claim that core CPI captures the persistent part of headline CPI. We find that the permanent component of core CPI is more volatile than core CPI, or that the permanent and transitory components are highly correlated. We find that the excluded food and energy components have important permanent components, and that core CPI has an important transitory component. We examine impulse response functions and find that headline CPI inflation responds more sharply to shocks than core CPI inflation, and after the first year the impact of shocks on headline inflation is less than the impact on core inflation.
    Keywords: unobserved components, CPI, price indices, inflation, core
    JEL: C32 E31
    Date: 2009–10
  16. By: Jouchi Nakajima (Currently in the Personnel and Corporate Affairs Department (studying at Duke University, E-mail:; Nao Sudo (Deputy Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Takayuki Tsuruga (Associate Professor, Kyoto University (Email:
    Abstract: This paper documents empirically and analyzes theoretically the responses of disaggregated prices to aggregate technology and monetary policy shocks. Based on the price data of US personal consumption expenditure, we find that disaggregated price responses have features across shocks and across sectors that are difficult to explain using standard multi-sector sticky price models. In terms of shocks, a substantial fraction of disaggregated prices initially rise in response to a contractionary monetary policy shock, while most prices fall immediately in response to an aggregate technological improvement. In terms of sectors, the disaggregated price responses are correlated weakly with the frequency of price changes. To reconcile these observations, we extend the standard model. We find that the cost channel of monetary policy and cross-sectional heterogeneity in real rigidity are possible avenues in accounting for these facts.
    Keywords: Disaggregated Prices, Technology Shocks, Monetary Policy Shocks, Sticky Price Models
    JEL: E31 F52
    Date: 2010–09
  17. By: Logan Kelly (University of Wisconsin, Department of Economics, River Falls, WI 54022); William Barnett (University of Kansas, Department of Economics, Lawrence, KS 66045); John Keating (University of Kansas, Department of Economics, Lawrence, KS 66045)
    Abstract: Historically, attempts to solve the liquidity puzzle have focused on narrowly defined monetary aggregates, such as non-borrowed reserves, the monetary base, or M1. Many of these efforts have failed to find a short-term negative correlation between interest rates and monetary policy innovations. More recent research uses sophisticated macroeconomic and econometric modeling. However, little research has investigated the role measurement error plays in the liquidity puzzle, since in nearly every case, work investigating the liquidity puzzle has used one of the official monetary aggregates, which have been shown to exhibit significant measurement error. This paper examines the role that measurement error plays in the liquidity puzzle by (i) providing a theoretical framework explaining how the official simple-sum methodology can lead to a liquidity puzzle, and (ii) testing for the liquidity effect by estimating an unrestricted VAR.
    Keywords: North-South, growth model, innovation assimilation
    JEL: E50 E43
    Date: 2010–04
  18. By: Romain Veyrune; Annamaria Kokenyne; Jeremy Ley
    Abstract: This paper provides a summary of the key policies that encourage dedollarization. It focuses on cases in which the authorities’ intention is to gain greater control of monetary policy and draws on the experiences of countries that have successfully dedollarized. Unlike previous work on the subject, this paper examines both macroeconomic stabilization policies and microeconomic measures, such as prudential regulation of the financial system. This study is also the first attempt to make extensive use of the foreign exchange regulation data reported in the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions. The main conclusion is that durable dedollarization depends on a credible disinflation plan and specific microeconomic measures.
    Date: 2010–07–21
  19. By: Petra Gerlach-Kristen; Barbara Rudolf
    Abstract: During the financial crisis of 2007/08 the level and volatility of interest rate spreads increased dramatically. This paper examines how the choice of the target interest rate for monetary policy affects the volatility of inflation, the output gap and the yield curve. We consider three monetary policy operating procedures with different target interest rates: a one-month market rate, a three-month market rate and an essentially riskless one-month repo rate. The implementation tool is the one-month repo rate for all three operating procedures. In a highly stylised model, we find that using a money market rate as a target rate generally yields lower variability of the macroeconomic variables. This holds under discretion as well as under commitment both in times of financial calm or turmoil. Whether the one month or three month rate procedure performs best depends on the maturity of the specific rate that enters the IS curve.
    Keywords: optimal monetary policy rules, monetary operating procedures, yield curve
    Date: 2010–09
  20. By: Shin-ichi Fukuda (University of Tokyo)
    Abstract: This paper explores how international money markets reflected credit and liquidity risks during the global financial crisis. After matching the currency denomination, we investigate how the Tokyo Interbank Offered Rate (TIBOR) was synchronized with the London Interbank Offered Rate (LIBOR) denominated in the US dollar and the Japanese yen. Regardless of the currency denomination, TIBOR was highly synchronized with LIBOR in tranquil periods. However, the interbank rates showed substantial deviations in turbulent periods. We find remarkable asymmetric responses in reflecting market-specific and currency-specific risks during the crisis. The regression results suggest that counter-party credit risk increased the difference across the markets, while liquidity risk caused the difference across the currency denominations. They also support the view that a shortage of US dollar as liquidity distorted the international money markets during the crisis. We find that coordinated central bank liquidity provisions were useful in reducing liquidity risk in the US dollar transactions. But their effectiveness was asymmetric across the markets.
    Date: 2010–09
  21. By: Jan Babecký (Czech National Bank); Philip Du Caju (National Bank of Belgium); Theodora Kosma (Bank of Greece); Martina Lawless (Central Bank and Financial Services Authority of Ireland); Julián Messina (World Bank and University of Girona); Tairi Rõõm (Bank of Estonia)
    Abstract: It has been well established that the wages of individual workers react little, especially downwards, to shocks that hit their employer. This paper presents new evidence from a unique survey of firms across Europe on the prevalence of downward wage rigidity in both real and nominal terms. We analyse which firm-level and institutional factors are associated with wage rigidity. Our results indicate that it is related to workforce composition at the establishment level in a manner that is consistent with related theoretical models (e.g. efficiency wage theory, insider-outsider theory). We also find that wage rigidity depends on the labour market institutional environment. Collective bargaining coverage is positively related with downward real wage rigidity, measured on the basis of wage indexation. Downward nominal wage rigidity is positively associated with the extent of permanent contracts and this effect is stronger in countries with stricter employment protection regulations.
    Keywords: J30, J31, J32, C81, P5.
    Date: 2010–02
  22. By: Dong he; Robert McCauley
    Abstract: We show in this paper that offshore markets intermediate a large chunk of financial transactions in major reserve currencies such as the US dollar. We argue that, for emerging market economies that are interested in seeing some international use of their currencies, offshore markets can help to increase the recognition and acceptance of the currency while still allowing the authorities to retain a measure of control over the pace of capital account liberalisation. The development of offshore markets could pose risks to monetary and financial stability in the home economy which need to be prudently managed. The experience of the Federal Reserve and of the authorities of the other major reserve currency economies in dealing with the euromarkets shows that policy options are available for managing such risks.
    Keywords: offshore markets; currency internationalisation; monetary stability; financial stability
    Date: 2010–09
  23. By: Yongsung Chang (University of Rochester); Sun-Bin Kim (Department of Economics, Korea University); Frank Schorfheide (Department of Economics, University of Pennsylvania)
    Abstract: This paper assesses biases in policy predictions due to the lack of invariance of “structural†parameters in representative-agent models. We simulate data under various fiscal policy regimes from a heterogeneous-agents economy with incomplete asset markets and indivisible labor supply. Imperfect aggregation manifests itself through preference shocks in the estimated representative-agent model. Preference and technology parameter estimates are not invariant with respect to policy changes. As a result, the bias in the representative-agent model’s policy predictions is large compared to the length of predictive intervals that reflect parameter uncertainty.
    Keywords: Aggregation; Fiscal Policy; Heterogeneous Agents Economy; Lucas Critique; Representative Agent Models.
    Date: 2010–09
  24. By: Fromlet, Pia (Department of Economics)
    Abstract: In this paper I evaluate inflation targeting for ten countries. The evaluation is based on unconditional as well as conditional measures of the variance of inflation around target. With strict inflation targeting, expectations of the future deviation from target given information about the deviation from the target today should be equal to zero. Using the Consumer Price Index (CPI) when calculating the inflation rate, I find that the null hypothesis can be rejected for six of ten countries. In an extended approach I add lagged output gap as an information variable for countries where data was available. I then get the result that rational expectations and strict inflation targeting can be rejected for five countries. Out of the ten countries, the United Kingdom has conducted in‡ation targeting most in line with the theory of rational expectations and strict inflation targeting, and Poland the least.
    Keywords: Inflation targeting; rational expectations; monetary policy
    JEL: E31 E52 E58
    Date: 2010–09–17
  25. By: André Meier
    Abstract: This paper studies inflation dynamics during 25 historical episodes in advanced economies where output remained well below potential for an extended period. We find that such episodes generally brought about significant disinflation, underpinned by weak labor markets, slowing wage growth, and, in many cases, falling oil prices. Indeed, inflation declined by about the same fraction of the initial inflation rate across episodes. That said, disinflation has tended to taper off at very low positive inflation rates, arguably reflecting downward nominal rigidities and well-anchored inflation expectations. Temporary inflation increases during episodes were, in turn, systematically related to currency depreciation or higher oil prices. Overall, the historical patterns suggest little upside inflation risk in advanced economies facing the prospect of persistent large output gaps.
    Keywords: Production , Deflation , Disinflation , Exchange rates , Inflation rates , Labor markets , Oil prices ,
    Date: 2010–08–10
  26. By: Güner, Biliana; Rachev, Svetlozar T.; Edelman, Daniel; Fabozzi, Frank J.
    Abstract: Recently, a body of academic literature has focused on the area of stable distributions and their application potential for improving our understanding of the risk of hedge funds. At the same time, research has sprung up that applies standard Bayesian methods to hedge fund evaluation. Little or no academic attention has been paid to the combination of these two topics. In this paper, we consider Bayesian inference for alpha-stable distributions with particular regard to hedge fund performance and risk assessment. After constructing Bayesian estimators for alpha-stable distributions in the context of an ARMA-GARCH time series model with stable innovations, we compare our risk evaluation and prediction results to the predictions of several competing conditional and unconditional models that are estimated in both the frequentist and Bayesian setting. We find that the conditional Bayesian model with stable innovations has superior risk prediction capabilities compared with other approaches and, in particular, produced better risk forecasts of the abnormally large losses that some hedge funds sustained in the months of September and October 2008. --
    Date: 2010
  27. By: Zsolt Darvas (Bruegel, Hungarian Academy of Sciences, Corvinus University of Budapest)
    Abstract: The global economic and financial crisis has raised further concerns about the euro-entry criteria, in addition to other factors, such as the effective tightening of the criteria due to the enlargement of the EU from 12 to 27 members, the highly unfavourable property of business cycle dependence, the internal inconsistency of the criteria due to the structural price level convergence of Central and Eastern European countries, and the continuous violation of the criteria by euro-area members. The interest rate criterion became a highly volatile measure. Many US metropolitan areas would fail to qualify to be members of the US monetary union by applying the currently used inflation criterion to the US. It is time to reform the criteria and to strengthen their economic rationale within the legal framework of the EU treaty. A good solution would be to relate all criteria to the average of the euro area and simultaneously to extend the compliance period from the currently considered one year to a longer period.
    Keywords: Euro, EU institutions, financial crisis, Maastricht-criteria
    JEL: F33 F36 F53
    Date: 2010–09–15
  28. By: Pontines, Victor; Siregar, Reza Y.
    Abstract: We demonstrate that the economies of Indonesia, Korea, Philippines and Thailand, which are among the first group of emerging markets to embrace the inflation targeting framework of monetary policy, tend to adopt a form of an asymmetrical exchange rate behaviour wherein appreciation pressures are restrained more substantially than depreciation pressures. In short, these four Asian economies exemplify aversion to appreciations such that greater flexibility is allowed only one side of the market. Formal econometric tests using the smooth transition autoregressive and the Markov regime switching models confirm this hypothesis of aversion to appreciation and show that the central banks of these four economies tend to tolerate more of depreciations than of appreciations of their local currencies against the US dollar.
    Keywords: Exchange Rate Asymmetry Inflation Targeting; Fear of Floating; Fear of Appreciation; Regime Switching Models.
    JEL: E58 F41 F31
    Date: 2010–08–28
  29. By: Nagayasu, Jun
    Abstract: It is generally thought that members in monetary union experience a similar level of inflation. This paper verifies this conventional belief. Using regional data, we present statistical evidence of heterogeneous inflation in Japan. Not only does the average inflation differ significantly across regions, but regional inflation responds differently to common economic and monetary factors. Furthermore, we show no evidence of price convergence in a group of entire regions although there is some evidence of convergence in subgroups. These results suggest that diversified regional inflation can exist within monetary union.
    Keywords: Regional inflation; monetary policy; factor models; convergence
    JEL: F3 E3
    Date: 2010–09
  30. By: Bernd Hayo (Philipps-University Marburg); Hiroyuki Ono (Philipps-University Marburg)
    Abstract: Concentrating on the period of quantitative easing in Japan, this paper reexamines the correlation between the asymmetry of sectoral relative-price changes and the aggregate inflation rate. This correlation is widely interpreted as evidence that short-run inflation is determined by supply-side factors; however, we study whether, in addition to the inflation rate, monetary environment and aggregate demand explain this correlation. Using producer price index data, we show, first, that the positive and significant effect of relative-price change asymmetries on inflation is not robust with respect to various indicators of asymmetry. Second, indicators of aggregate demand and monetary environment affect the measures of asymmetries, which raises doubt about whether they can be interpreted as pure supply-side indicators. Third, in addition to the indirect effect via measures of asymmetries, demand and monetary factors directly affect inflation. Thus, we reject the claim that the recent disinflation/deflation period can be understood as primarily a supply-side phenomenon.
    Keywords: Japan, supply side, inflation, deflation, price-change asymmetries, quantitative easing
    JEL: E20 E31 E52 E65 O53
    Date: 2010
  31. By: Michael Patra; Muneesh Kapur
    Abstract: A New Keynesian model estimated for India yields valuable insights. Aggregate demand reacts to interest rate changes with a lag of at least three quarters, with inflation taking seven quarters to respond. Inflation is inertial and persistent when it sets in, irrespective of the source. Exchange rate pass-through to domestic inflation is low. Inflation turns out to be the dominant focus of monetary policy, accompanied by a strong commitment to the stabilization of output. Recent policy actions have raised the effective policy rate, but the estimated neutral policy rate suggests some further tightening to normalize the policy stance.
    Date: 2010–08–04
  32. By: Hutchison, Michael; Sengupta, Rajeswari; Singh, Nirvikar
    Abstract: A key challenge for macroeconomic policy in open economies is how to simultaneously manage exchange rates, interest rates and capital account openness—the trilemma. This paper calculates a trilemma index for India and investigates its evolution over time. We find that financial integration has increased markedly after the mid-2000s, with corresponding limitations on monetary independence and exchange rate stability. This tradeoff has been mitigated, however, with the rise of international reserves as a partially independent instrument of macroeconomic policy. In addition, we confirm that the weighted sum of the three indexes adds up to a constant, validating the notion that a rise in one trilemma variable should be traded-off with a drop of the weighted sum of the other two. Finally, we consider the implications of changes in the trilemma index for macroeconomic outcomes. We find some evidence that greater financial integration and corresponding loss of monetary autonomy and exchange rate stability has influenced inflation and inflation volatility, though not in a consistent manner.
    Keywords: Financial trilemma; Indian economy; International reserves; Foreign exchange intervention; Monetary policy
    JEL: F4 F3 E5 E4
    Date: 2010–09–22
  33. By: Ruthira Naraidoo; Ivan Paya
    Abstract: This paper is the first one to: (i) provide in-sample estimates of linear and nonlinear Taylor rules augmented with an indicator of financial stability for the case of South Africa, (ii) analyse the ability of linear and nonlinear monetary policy rule specifications as well as nonparametric and semiparametric models in forecasting the nominal interest rate setting that describes the South African Reserve Bank (SARB) policy decisions. Our results indicate, first, that asset prices are taken into account when setting interest rates; second, the existence of nonlinearities in the monetary policy rule; and third, forecasts constructed from combinations of all models perform particularly well and that there are gains from semiparametric models in forecasting the interest rates as the forecasting horizon lengthens.
    Keywords: Taylor rules, nonlinearity, nonparametric, semiparametric, forecasting
    JEL: C14 C51 C52 C53 E52 E58
    Date: 2010
  34. By: Ivan Paya; Ruthira Naraidoo
    Abstract: This paper is the .rst one to: (i) provide in-sample estimates of linear and nonlinear Taylor rules augmented with an indicator of .nancial stability for the case of South Africa, (ii) analyse the ability of linear and nonlinear monetary policy rule speci.cations as well as nonparametric and semiparametric models in forecasting the nominal interest rate setting that describes the South African Reserve Bank (SARB) policy decisions. Our results indicate, .rst, that asset prices are taken into account when setting interest rates; second, the existence of nonlinearities in the monetary policy rule; and third, forecasts constructed from combinations of all models perform particularly well and that there are gains from semiparametric models in forecasting the interest rates as the forecasting horizon lengthens.
    Keywords: Taylor rules, nonlinearity, nonparametric, semiparametric, forecasting
    Date: 2010
  35. By: Rangan Gupta (Department of Economics, University of Pretoria); Rudi Steinbach (South African Reserve Bank, Pretoria)
    Abstract: The paper develops a Small Open Economy New Keynesian DSGE-VAR (SOENKDSGEVAR) model of the South African economy, characterised by incomplete pass-through of exchange rate changes, external habit formation, partial indexation of domestic prices and wages to past inflation, and staggered price and wage setting. The model is estimated using Bayesian techniques on data for South Africa and the United States (US) from the period 1990Q1 to 2003Q2, and then used to forecast output growth, inflation and a measure of nominal short-term interest rate for one- to eight-quarters-ahead over an out-ofsample horizon of 2003Q3 to 2008Q4. The forecast performance of the SOENKDSGEVAR model is then compared with an independently estimated DSGE model, the classical VAR and BVAR models, with the latter being estimated based on six alternative priors, namely, Non-Informative and Informative Natural Conjugate priors, the Minnesota prior, Independent Normal-Wishart Prior, Stochastic Search Variable Selection (SSVS) prior on VAR coefficients and SSVS prior on both VAR coefficients and error covariance. Overall, we can draw the following conclusions: First, barring the BVAR model based on the SSVS prior on both VAR coefficients and the error covariance, the SOENKDSGE-VAR model is found to perform competitively, if not, better than all the other VAR models for most of the one- to eight-quarters-ahead forecasts. Second, there is no significant gain in forecasting performance by moving to a DSGE-VAR framework when compared to an independently estimated SOENKDSGE model. Finally, there is overwhelming evidence that the BVAR model based on the SSVS prior on both VAR coefficients and the error covariance is the best-suited model in forecasting the three variables of interest.
    Keywords: Bayesian Methods; Macroeconomic Forecasting; New Keynesian DSGE; Small Open Economy; Vector Autoregressions
    JEL: C11 C53 E37
    Date: 2010–09
  36. By: Paul Bloxham (Reserve Bank of Australia); Christopher Kent (Reserve Bank of Australia); Michael Robson (Reserve Bank of Australia)
    Abstract: The long-running debate about the role of monetary policy in responding to rising asset prices has received renewed attention in the wake of the global financial crisis.This paper contributes to this debate by describing the Australian experience of a cycle in house prices and credit from 2002 to 2004, and discussing the role played by various policies during this episode. In particluar, it focuses on the efforts by the Reserve Bank of Australia to draw attention to the risks associated with large, ongoing increases in housing prices and household borrowing.
    Keywords: asset prices; credit growth; lending standards; monetary policy; regulatory policy
    JEL: E58 G28
    Date: 2010–09
  37. By: Tito Nícias Teixeira da Silva Filho
    Abstract: This paper summarises the research results obtained by the group of central banks (Brazil, Chile, Colombia and Venezuela) that joined the research program on the Natural Rate of Unemployment – under the coordination of the Central Bank of Brazil – within the Joint Investigation on Non Observable Variables Project, and whose final results were presented at the XII Meeting of the Network of America Central Bank Researchers (CEMLA) held at Madrid in November 2007. The evidence obtained shows that the natural rate of unemployment is estimated with great uncertainty: besides sizable parameter uncertainty, estimates are very sensitive to the particular method used. This marked imprecision reflects the difficulties and challenges involved in the natural rate’s estimation. Nonetheless, the research also shows that there seems to be much room available for improvement, especially those stemming from a more careful modelling process and better care with the data, particularly regarding supply shocks proxies, given their importance in inflation dynamics. Indeed, this “channel” seems to be the most promising one to both narrow down the uncertainty about the NAIRU and improve the reliability of inferences.
    Date: 2010–09
  38. By: NGUYEN Huyen Diu (National Graduate Institute for Policy Studies); Wade D. Pfau (National Graduate Institute for Policy Studies)
    Abstract: Understanding the money demand function is highly important for monetary policy implementation, especially in a monetary targeting framework. The paper uses cointegration analysis and a reduced-form short-run error correction model to investigate the demand for money in Vietnam between 1999 and 2009. We find evidence for a cointegrating relationship between the real money demand, income, the foreign interest rate, and the real stock price. More importantly, statistical tests show that real money demand in Vietnam is stable in this period.
    Keywords: International Diversification, Utility Maximization, EPF, Hypothetical Worker, Modern Portfolio Theory, Sri Lanka
    JEL: E41 E58 C23
    Date: 2010–09

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