nep-cba New Economics Papers
on Central Banking
Issue of 2010‒10‒23
39 papers chosen by
Alexander Mihailov
University of Reading

  1. Global policy at the zero lower bound in a large-scale DSGE model By Sandra Gomes; Pascal Jacquinot; Ricardo Mestre; João Sousa
  2. International Reserves and Swap Lines in Times of Financial Distress: Overview and Interpretations By Joshua Aizenman
  3. Insulation impossible: monetary policy and regional fiscal spillovers in a federation By Cooper, R.; Kempf, H.; Peled, D.
  4. Weathering the financial storm: The importance of fundamentals and flexibility By Thorvardur Tjörvi Ólafsson; Thórarinn G. Pétursson
  5. Inflation, Human Capital and Tobin's q By Parantap Basu; Max Gillman; Joseph Pearlman
  6. Predicting recession probabilities with financial variables over multiple horizons By Fabio Fornari; Wolfgang Lemke
  7. Assessment on Valuation of RMB – a triangular analysis approach By Peijie Wang
  8. Appreciating the Renminbi By Rod Tyers; Ying Zhang
  9. Macroeconomic Effects of China’s Fiscal Stimulus By Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
  10. The Unending Search for a New Global Monetary and Financial Architecture By Gerardo della Paolera
  11. Reform of the Global Financial Architecture By Garry J. Schinasi; Edwin M. Truman
  12. Applying the Lessons of Asia: The IMF’s Crisis Management Strategy in 2008 By Shinji Takagi
  13. Economy and economics: the twin crises By Alessandro Vercelli
  14. The Impact of ECB and FED announcements on the Euro Interest Rates By Andrea Monticini; David Peel; Giacomo Vaciago
  15. Interbank Lending and the Demand for Central Bank Loans - a Simple Microfoundation By Markus Pasche
  16. Limits of Floats: The Role of Foreign Currency Debt and Import Structure By Pascal Towbin, Sebastian Weber
  17. On the Granger Causality between Median Inflation and Price Dispersion By Richard Ashley
  18. What do we know about real exchange rate nonlinearities? By R. KRUSE; M. FRÖMMEL; L. MENKHOFF; P. SIBBERTSEN
  19. Disaggregating Real Exchange Rate Dynamics: A Structural Approach By P. JACOB
  20. Fiscal developments in the euro area beyond the crisis: some lessons drawn from fiscal reaction functions By Dufrénot G.; Paul L.
  21. US post-war monetary policy: what caused the Great Moderation? By Minford, Patrick; Ou, Zhirong
  22. Nonlinearity and Inflation Rate Differential Persistence: Evidence from the Eurozone. By Nikolaos Giannellis
  23. Business Cycle Implications of Internal Consumption Habit for New Keynesian Models By Takashi Kano; James M. Nason
  24. "A Post Keynesian Perspective on the Rise of Central Bank Independence: A Dubious Success Story in Monetary Economics" By Jörg Bibow
  25. Long-Term Oil Price Forecasts: A New Perspective on Oil and the Macroeconomy By J. Isaac Miller; Shawn Ni
  26. Heterogeneous Expectations and the Predictive Power of Econometric Models By Maurizio Bovi
  27. Forecasting with Equilibrium-correction Models during Structural Breaks.. By Castle, Jennifer L.; Fawcett, Nicholas W.; Hendry, David F.
  28. What Do Outside Experts Bring To A Committee? Evidence From The Bank of England By Hansen, Stephen; McMahon, Michael
  29. What Do Outside Experts Bring To A Committee? Evidence From The Bank of England By Stephen Eliot Hansen; Michael McMahon
  30. The Federal Reserve, the Bank of England, and the Rise of the Dollar as an International Currency, 1914-1939 By Barry Eichengreen, Marc Flandreau
  31. The Forecasting Properties of Survey-Based Wage-Growth Expectations By Jonsson, Thomas; Österholm, Pär
  32. Monetary transmission in low income countries By Prachi Mishra; Antonio Spilimbergo; Peter Montiel
  33. Do Inflation-linked Bonds Contain Information about Future Inflation? By José Valentim Machado Vicente; Osmani Teixeira de Carvalho Guillen
  34. The Case for Reforming Euro Area Entry Criteria By Zsolt Darvas
  35. Monetary Policy and Real Estate Prices: A Disaggregated Analysis for Switzerland By Berlemann, Michael; Freese, Julia
  36. Modelling Italian potential output and the output gap By Antonio Bassanetti; Michele Caivano; Alberto Locarno
  37. How Does Monetary Policy Change? Evidence on Inflation Targeting Countries By Jaromír Baxa; Roman Horváth; Bořek Vašíček
  38. Fixed Exchange Rate Regimes in Mediterranean Countries and the Experience of Cyprus By George Syrichas
  39. Assessing the Equilibrium Exchange Rate of the Cyprus Pound at the time of Euro Adoption By George Kyriacou; Maria Papageorghiou

  1. By: Sandra Gomes (Bank of Portugal, R. Francisco Ribeiro, 2, 1150-165 Lisboa, Portugal.); Pascal Jacquinot (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Ricardo Mestre (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); João Sousa (Bank of Portugal, R. Francisco Ribeiro, 2, 1150-165 Lisboa, Portugal.)
    Abstract: The purpose of this paper is to analyse whether fiscal policies can alleviate the effects of the zero lower bound (ZLB) on interest rates and if they should be coordinated internationally. The analysis is carried out using EAGLE, a DSGE model of the global economy. We consider that the fiscal shocks are temporary and that fiscal policy retains full credibility at all times. In this setup we find significant non-linearities in a ZLB situation that amplify the effects of fiscal shocks compared to the non-ZLB case. International coordination is helpful but does not play a major role in the results. JEL Classification: E40, E62, E63, F42.
    Keywords: Zero Lower Bound, Fiscal Multipliers, Monetary Policy, DSGE models.
    Date: 2010–10
  2. By: Joshua Aizenman
    Abstract: In this paper I review the use of precautionary measures aimed at mitigating emerging markets’ exposure to fragility associated with financial integration. The discussion draws possible lessons from the ongoing global liquidity crisis. The fear of losing international reserves (IR) constrained most emerging markets more than the fear of floating. The fear of using IR during a crisis suggests that emerging markets (EMs) opt to revisit the gains from financial globalization. High levels of IR may be required for the self insurance offered by those reserves to be effective. Under such circumstances, countries may benefit by supplementing the hoarding of IR with Pigovian tax-cum-subsidy policies. These policies would reduce external borrowing, and would fund the marginal hoarding of IR. The fear of losing IR also suggests a greater demand for regional pooling arrangements and swap lines as well as possible new roles for international financial institutions (IFI). [ADBI Working Paper 192]
    Keywords: precautionary measures, markets, international reserves, financial globalization
    Date: 2010
  3. By: Cooper, R.; Kempf, H.; Peled, D.
    Abstract: This paper studies the effects of monetary policy rules in a fiscal federation, such as the European Union. The focus of the analysis is the interaction between the fiscal policy of member countries (regions) and the monetary authority. Each of the countries structures its fiscal policy (spending and taxes) with the interests of its citizens in mind. Ricardian equivalence does not hold due to the presence of monetary frictions, modeled here as reserve requirements. When capital markets are integrated, the fiscal policy of one country influences equilibrium wages and interest rates. Under certain rules, monetary policy may respond to the price variations induced by regional fiscal policies. Depending on the type of rule it adopts, interventions by the monetary authority affect the magnitude and nature of the spillover from regional fiscal policy.
    Keywords: Monetary Union, Inflation tax, Seigniorage, monetary rules, public debt.
    JEL: E31 E42 E58 E62
    Date: 2010
  4. By: Thorvardur Tjörvi Ólafsson (School of Economics and Management, Aarhus University, Denmark); Thórarinn G. Pétursson (Central Bank of Iceland)
    Abstract: The recent global financial tsunami has had economic consequences that have not been witnessed since the Great Depression. But while some countries suffered a particularly large contraction in economic activity on top of a system-wide banking and currency collapse, others came off relatively lightly. In this paper, we attempt to explain this cross-country variation in post-crisis experience, using a wide variety of pre-crisis explanatory variables in a sample of 46 medium-to-high income countries. We find that domestic macroeconomic imbalances and vulnerabilities were crucial for determining the incidence and severity of the crisis. In particular, we find that the pre-crisis rate of inflation captures factors which are important in explaining the post-crisis experience. Our results also suggest an important role for financial factors. In particular, we find that large banking systems tended to be associated with a deeper and more protracted consumption contraction and a higher risk of a systemic banking or currency crisis. Our results suggest that greater exchange rate flexibility coincided with a smaller and shorter contraction, but at the same time increased the risk of a banking and currency crisis. Countries with exchange rate pegs outside EMU were hit particularly hard, while inflation targeting seemed to mitigate the crisis. Finally, we find some evidence suggesting a role for international real linkages and institutional factors. Our key results are robust to various alterations in the empirical setup and we are able to explain a significant share of the cross-country variation in the depth and duration of the crisis and provide quite sharp predictions of the incidence of banking and currency crises. This suggests that country-specific initial conditions played an important role in determining the economic impact of the crisis and, in particular, that countries with sound fundamentals and flexible economic frameworks were better able to weather the financial storm.
    Keywords: Global financial crisis, real economy impact, banking and currency crisis, initial conditions, cross-country analysis
    JEL: F30 F31 F32 F41
    Date: 2010–10–14
  5. By: Parantap Basu (Durham University); Max Gillman (Institute of Economics - Hungarian Academy of Sciences, Cardiff University); Joseph Pearlman (London Metropolitan University)
    Abstract: A less well-known empirical finding for the US and UK is a pronounced low frequency negative relationship between inflation and Tobin's q; a normalized market price of capital. This stylized fact is explained within a dynamic stochastic general equilibrium model using three key features: (i) a Lucas and Prescott (1971) physical capital adjustment cost with a rising marginal cost of investment, (ii) production of human capital with endogenous growth and (iii) an inflation tax cash-in-advance economy. The baseline endogenous growth model matches the US inflation and q long term correlation, while comparable exogenous growth are unable to do this, and it outperforms the exogenous growth models in explaining business cycle volatilities of q and of stock returns.
    Keywords: Low frequency, Tobin's q; inflation tax, endogenous growth
    JEL: E31 E44 G12
    Date: 2010–09
  6. By: Fabio Fornari (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Wolfgang Lemke (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We forecast recession probabilities for the United States, Germany and Japan. The predictions are based on the widely-used probit approach, but the dynamics of regressors are endogenized using a VAR. The combined model is called a ‘ProbVAR’. At any point in time, the ProbVAR allows to generate conditional recession probabilities for any sequence of forecast horizons. At the same time, the ProbVAR is as easy to implement as traditional probit regressions. The slope of the yield curve turns out to be a successful predictor, but forecasts can be markedly improved by adding other financial variables such as the short-term interest rate, stock returns or corporate bond spreads. The forecasting performance is very good for the United States: for the out-of-sample exercise (1995 to 2009), the best ProbVAR specification correctly identifies the ex-post classification of recessions and non-recessions 95% of the time for the one-quarter forecast horizon and 87% of the time for the four-quarter horizon. Moreover, the ProbVAR turns out to significantly improve upon survey forecasts. Relative to the good performance reached for the United States, the ProbVAR forecasts are slightly worse for Germany, but considerably inferior for Japan. JEL Classification: C25, C32, E32, E37.
    Keywords: Recessions, forecasting, probit, VAR.
    Date: 2010–10
  7. By: Peijie Wang (IESEG School of Management)
    Keywords: exchange rate, RMB, US dollar, euro
    JEL: F3
    Date: 2010–10
  8. By: Rod Tyers; Ying Zhang
    Abstract: International pressure to revalue China’s currency stems in part from the expectation that rapid economic growth should be associated with an underlying real exchange rate appreciation. This hinges on the Balassa-Samuelson hypothesis, which sees growth as stemming from improvements in traded sector productivity and associated rises in wages and non-traded prices. Yet, despite extraordinary growth after the mid-1990s China’s real exchange rate showed no tendency to appreciate until after 2004. We use a dynamic general equilibrium model to simulate the economy and show that, during this period, trade reforms and a rising national saving rate were offsetting forces in the presence of elastic labour supply. We then examine the possible determinants of the striking transition to real appreciation thereafter, noting mounting evidence that an improved rural terms of trade has tightened China’s labour market. We show that, should the Chinese government bow to international pressure by appreciating the renminbi either via an extraordinary monetary contraction or via export disincentives the consequences would be harmful for both Chinese and global interests.
    JEL: C68 C53 E27 F21 F43 F47 O11
    Date: 2010–10
  9. By: Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
    Abstract: This paper analyzes the macroeconomic impact of China’s 2009-2010 fiscal stimulus package by simulating a dynamic general equilibrium multi-country model of the world economy, showing that the effects on China’s economic activity are sizeable: absent fiscal stimulus China’s GDP would be 2.6 and 0.6 percentage points lower in 2009 and 2010, respectively. The effects are stronger under a US dollar peg because of the imported loose monetary policy stance from the United States. Higher Chinese aggregate demand stimulates higher (gross and net) imports from other regions, in particular from Japan and the rest of the world, and, only to a lesser extent, from the United States and the euro area. However, the overall GDP impact of the Chinese stimulus on the rest of the world is limited. These results warn that a fiscal policydriven increase in China’s domestic aggregate demand associated with a more flexible exchange rate regime have only a limited potential to contribute to an orderly resolution of global trade and financial imbalances.
    Keywords: Fiscal stimulus, Financial crisis
    JEL: E62 F41 F42 H30 H63
    Date: 2010–10
  10. By: Gerardo della Paolera (Global Development Network (GDN))
    Abstract: This paper analyzes some key features of the global monetary and financial crisis and the limitations faced by Central Banks. It also includes a brief description for the collectively previous efforts to anchor a Global Monetary and Financial regime. The main difficulties to “globalize” banking and financial reforms are illustrated in this paper. It is concluded with some open questions concerning the threats and opportunities that this crisis presents for emerging, developing and poorer countries.
    Date: 2010–10
  11. By: Garry J. Schinasi; Edwin M. Truman (Peterson Institute for International Economics)
    Abstract: This paper examines the implications of the global financial crisis of 2007-10 for reform of the global financial architecture, in particular the International Monetary Fund and the Financial Stability Board and their interaction. These two institutions are not fully comparable, but they must work more closely in the future to help prevent global financial crises. To this end, the paper identifies institutional and substantive reforms separately and in their joint work that would be desirable and appropriate.
    Keywords: International Monetary Fund, Financial Stability Board, Bank for International Settlements, Group of Twenty, banking supervision and regulation, financial crises, financial stability, financial reform
    JEL: F30 F33 F36 F53 G28
    Date: 2010–10
  12. By: Shinji Takagi
    Abstract: The paper examines the recent European crisis management programs of the International Monetary Fund (IMF) to see how the lessons of Asia were applied. Compared to the Asian programs of 1997, the European programs of 2008 were better funded and their structural conditionality more focused. Other than these, the overall thrust of the programs was similar: fiscal and monetary tightening, coupled with banking reforms. [ADBI Working Paper 206]
    Keywords: European crisis, International Monetary Fund, Asian, structural, fiscal, monetary
    Date: 2010
  13. By: Alessandro Vercelli
    Abstract: This paper explores the interaction between the Great recession triggered by the US subprime mortgages crisis and the twin crisis of macroeconomics. We argue that a major determinant of the subprime crisis and its dire consequences has been an approach to economics that is unable to deal with irregular phenomena. On the other hand, the unexpectedly deep financial crisis that has heavily affected the real economy makes clear that we need a major redirection of macroeconomic theory to make it able to explain, forecast and control irregular phenomena. The recent interaction between the crisis of the economy and the crisis of macroeconomics is analyzed in the light of similar preceding episodes in the 20th century: the Great contraction of the 1930s and the Great stagflation of the 1970s.
    Keywords: subprime crisis, Great recession, Great stagflation, Great contraction, Great depression, liberalism, laissez-faire, Keynesism, neoliberalism, new classical economics, theory and facts, scientific revolutions.
    JEL: A11 B22 B41 E E E G N1
    Date: 2010–06
  14. By: Andrea Monticini (Catholic University, Milan, Italy); David Peel; Giacomo Vaciago
    Abstract: Employing a new method of analysis suggested by Thornton (2009) we investigate the impact of news in the ECB and FED monetary policy announcements on daily changes in Euro interest rates. We document significant impacts of ECB announcements throughout the period but only until mid-2004 of FED announcements. The latter result on the news content of FED announcements is consistent with the analysis of Thornton (2009) who reports an insignificant impact of FED announcements on changes in US interest rates over a sample period that has significant overlap with the one employed in this letter.
    Keywords: monetary policy shocks, identification, wild bootstrap
    JEL: E40 E52
    Date: 2010–09
  15. By: Markus Pasche (School of Economics and Business Administration, Friedrich-Schiller-University Jena)
    Abstract: The paper presents a simple model of banking behavior where portfolio, liquidity, and liability management determine simultaneously the demand and supply of borrowed reserves on the interbank market. As the central bank is one player in this market due to its refinancing policy, it is able to determine the interest rate and henceforth the residual demand for central bank loans. Comparative static analysis shows how external or monetary policy shocks affect the behavior on the interbank market, the volume as well as the structure of the bank's balance sheet. It turns out that the banking firm behavior is non-linear and partially non-monotonous, indicating that the transmission of monetary measures is more complex when endogeneous banking behavior is taken into account.
    Keywords: banking firm, balance sheet, interbank market, borrowed reserves, central banking, liquidity, transmission
    JEL: E43 E58 G21
    Date: 2010–10–11
  16. By: Pascal Towbin, Sebastian Weber (IUHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: A traditional argument in favor of flexible exchange rates is that they insulate output better from real shocks, because the exchange rate can adjust and stabilize demand for domestic goods through expenditure switching. This argument is weakened in a model with high foreign currency debt and low exchange rate pass through to import prices. We analyze the transmission of real external shocks to the domestic economy under fixed and flexible exchange rate regimes for a broad sample of countries in a Panel VAR and let the responses vary with foreign currency indebtedness and import structure. We find that flexible exchange rates do not insulate output better from external shocks if the country imports mainly low pass-through goods and can even amplify the output response if foreign indebtedness is high.
    Keywords: Exchange Rate Regimes, Balance Sheet Effects, Pass-through, Interacted Panel VAR, External Shocks
    JEL: E30 F33 F34 F41
    Date: 2010–01–10
  17. By: Richard Ashley
    Abstract: The Granger-causal relationship between the size and dispersion of fluctuations in sub-components of the U.S. Consumer Price Index (CPI) is examined using both in-sample and post- sample tests and data from January 1968 to December 2008. Strong in-sample evidence is found for feedback between median inflation and price dispersion; the evidence for Granger-causation from median inflation to price dispersion remains strong in out-of-sample testing, but is less strong for Granger-causation in the opposite direction. The implications of these results for the variety of price-level determination models in the literature are discussed.
    Keywords: CPI, Granger, Causal Relationship, Price Dispersion, Inflation
    Date: 2010
    Abstract: Nonlinear modeling of adjustments to purchasing power parity has recently gained much attention. However, a huge body of the empirical literature applies ES- TAR models and neglects the existence of other competing nonlinear models. Among these, the Markov Switching AR model has a strong substantiation in international finance. Our contribution to the literature is five-fold: First, we compare ESTAR and MSAR models from a unit root perspective. To this end, we propose a new unit root test against MSAR as the second contribution. Thirdly, we study the case of misspeci- fied alternatives in a Monte Carlo setup with real world parameter constellations. The ESTAR unit root test is not indicative, while the MSAR unit test is robust. Fourthly, we consider the case of correctly specified alternatives and observe low power of the ESTAR but not for the MSAR unit root test. Fifthly, an empirical application to real exchange rates suggests that they may indeed be explained by Markov Switching dy- namics rather than ESTAR.
    Keywords: Real exchange rates , unit root test , ESTAR , Markov Switching , PPP
    JEL: C12 C22 F31
    Date: 2010–09
  19. By: P. JACOB
    Abstract: This paper employs a small open economy DSGE model, estimated over 1986- 2009, to decompose the dynamic influence of domestic and international prices on the Canada-US real exchange rate. While the real exchange rate mimics the dynamic behavior of the relative price of non-tradables in terms of tradables in response to a non-tradable sector-specific disturbance, the purely tradable component dominates in the case of other shocks, irrespective of their structural origin. Variance decom- positions reveal that the sources of the movements in the tradable component lie in unsystematic deviations from uncovered interest parity as well as import price mark-up shocks. Consequently, these disturbances are far more potent than internal tradable or non-tradable sector-specific disturbances in driving real exchange rate .fluctuations.
    Keywords: New Open Economy Macroeconomics, Non-Tradables, Real Exchange Rate, Bayesian Inference, DSGE Estimation
    JEL: C11 F41
    Date: 2010–07
  20. By: Dufrénot G.; Paul L.
    Abstract: In this paper, we examine whether the fact that governments incorporate an objective of sustainability in their budgetary decisions is an element likely to increase the likelihood of a decrease in their deficit and debt ratios beyond the crisis (over the years from 2010 to 2015). We estimate a fiscal reaction function for the Euro area countries and demonstrate that the discretionary policies seem to be pro cyclical in average, thereby influencing the budget balance in the opposite direction than the automatic stabilizers. Our simulations of these rules over the next five years lead us to conclude that two groups of countries could emerge as regards their respective budgetary situations. On the one hand, some “virtuous” countries whose structural deficits will diminish whatever the “exit crisis” scenario envisaged, whereas on the other side, others will not succeed in stabilizing their national debt ratio, because their discretionary fiscal policy is less pro cyclical.
    Keywords: euro zone ; exit crisis scenario ; fiscal policy
    JEL: C23 H61 H63
    Date: 2010
  21. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School)
    Abstract: Using indirect inference based on a VAR we confront US data from 1972 to 2007 with a standard New Keynesian model in which an optimal timeless policy is substituted for a Taylor rule. We find the model explains the data both for the Great Acceleration and the Great Moderation. The implication is that changing variances of shocks caused the reduction of volatility. Smaller Fed policy errors accounted for the fall in inflation volatility. Smaller supply shocks accounted for the fall in output volatility and smaller demand shocks for lower interest rate volatility. The same model with differing Taylor rules of the standard sorts cannot explain the data of either episode. But the model with timeless optimal policy could have generated data in which Taylor rule regressions could have been found, creating an illusion that monetary policy was following such rules.
    Keywords: Great Moderation; Shocks; Monetary policy; New Keynesian model; Bootstrap; VAR; Indirect inference; Wald statistic
    JEL: E32 E42 E52 E58
    Date: 2010–10
  22. By: Nikolaos Giannellis (Department of Economics, University of Crete, Greece)
    Abstract: We employ a linear unit root test as well as a nonlinear two-regime Threshold Autoregressive (TAR) unit root test to determine whether inflation differentials in the Eurozone during the period 1970-2009 were persistent or transitory. The results imply that inflation rate differentials in the Eurozone are characterized by threshold nonlinearity. After modeling the nonlinear characteristics of the series with the appropriate unit root test, our test's results reveal that inflation rate differentials in the Eurozone are mainly persistent. Our findings imply that the higher the increase of the inflation rate differential, the more persistent the inflation rate differential is likely to be.
    Keywords: EMU; Inflation Rate Differential; Unit Root; Nonlinearity; Threshold
    JEL: C22 E31 F15 F36
    Date: 2010–07–01
  23. By: Takashi Kano; James M. Nason
    Abstract: This paper studies the implications of internal consumption habit for new Keynesian dynamic stochastic general equilibrium (NKDSGE) models. Bayesian Monte Carlo methods are employed to evaluate NKDSGE model fit. Simulation experiments show that consumption habit often improves the ability of NKDSGE models to match output and consumption growth spectra. Nonetheless, the fit of NKDSGE models with consumption habit is susceptible to the source of the nominal rigidity, to spectra identified by permanent productivity shocks, to the frequencies used for evaluation, and to the choice of monetary policy rule. These vulnerabilities suggest that NKDSGE model specification is fragile.
    JEL: E10 E20 E32
    Date: 2010–10
  24. By: Jörg Bibow
    Abstract: This paper critically assesses the rise of central bank independence (CBI) as an apparent success story in modern monetary economics. As to the observed rise in CBI since the late 1980s, we single out the role of peculiar German traditions in spreading CBI across continental Europe, while its global spread may be largely attributable to the rise of neoliberalism. As to the empirical evidence alleged to support CBI, we are struck by the nonexistence of any compelling evidence for such a case. The theoretical support for CBI ostensibly provided by modeling exercises on the so-called time-inconsistency problem in monetary policy is found equally wanting. Ironically, New Classical modelers promoting the idea of maximum CBI unwittingly reinstalled a (New Classical) “benevolent dictator” fiction in disguise. Post Keynesian critiques of CBI focus on the money neutrality postulate as well as potential conflicts between CBI and fundamental democratic values. John Maynard Keynes’s own contributions on the issue of CBI are found worth revisiting.
    Keywords: Central Banks; Central Bank Independence; Democratic Accountability; Monetary Policy; Time-inconsistency
    JEL: B31 B59 E50 E61
    Date: 2010–09
  25. By: J. Isaac Miller (Department of Economics, University of Missouri-Columbia); Shawn Ni (Department of Economics, University of Missouri-Columbia)
    Abstract: We examine how future real GDP growth relates to changes in the forecasted long-term average of discounted real oil prices and to changes in unanticipated fluctuations of real oil prices around the forecasts. Forecasts are conducted using a state-space oil market model, in which global real economic activity and real oil prices share a common stochastic trend. Changes in unanticipated fluctuations and changes in the forecasted long-term average of discounted real oil prices sum to real oil price changes. We find that these two components have distinctly different relationships with future real GDP growth. Positive and negative changes in the unanticipated fluctuations of real oil prices correlate with asymmetric responses of future real GDP growth. In comparison, changes in the forecasted long-term average are smaller in magnitude but are more influential on real GDP. Persistent upward revisions of forecasts in the 2000s had a substantial negative impact on real GDP growth, according to our estimates..
    Keywords: oil price and the macroeconomy, oil market fundamental, oil price forecasts, Kalman filter
    JEL: E31 E32 Q43
    Date: 2010–10–11
  26. By: Maurizio Bovi (ISAE - Institute for Studies and Economic Analyses)
    Abstract: A recent literature questions the mainstream omniscient rational agent, suggesting that agents act as, and have the same bounded rationality of, econometricians. Heterogeneous expectations may then arise because of the different forecasting models used by individuals, who select disparate predictors according to the peculiar net benefits of each model. Net benefits are assumed to be a function of mean square forecasting errors (MSE). Consequently, as in Carroll’s epidemiological approach, an implicit assumption is that the level of disagreement across agents cannot Granger cause model-based MSE. Instead, survey expectations on GDP growth show that the information flow runs exclusively from heterogeneity to MSE. Moreover, variance decompositions point out that survey expectations entropy and MSE are not contemporaneously correlated, enforcing the detected causal chain. Results are robust to several predictors, nonlinearities, and suggest looking also at other possible causes of disagreement.
    Keywords: Survey Expectations, Forecasting Models.
    JEL: C53 D84 E27
    Date: 2010–01
  27. By: Castle, Jennifer L.; Fawcett, Nicholas W.; Hendry, David F.
    Abstract: When location shifts occur, cointegration-based equilibrium-correction models (EqCMs) face forecasting problems. We consider alleviating such forecast failure by updating, intercept corrections, differencing, and estimating the future progress of an 'internal' break. Updating leads to a loss of cointegration when an EqCM suffers an equilibrium-mean shift, but helps when collinearities are changed by an 'external' break with the EqCM staying constant. Both mechanistic corrections help compared to retaining a pre-break estimated model, but an estimated model of the break process could outperform. We apply the approaches to EqCMs for UK M1, compared with updating a learning function as the break evolves.
    JEL: C1 C53
    Date: 2010–10
  28. By: Hansen, Stephen (Universitat Pompeu Fabra); McMahon, Michael (University of Warwick)
    Abstract: We test whether outside experts have information not available to insiders by using the voting record of the Bank of England's Monetary Policy Committee. Members with more private information should vote more often against conventional wisdom, which we measure as the average belief of market economists about future interest rates. We nd evidence that external members indeed have information not available to internals, but also use a quasi-natural experiment to show they may exaggerate their expertise to obtain reappointment. This implies that an optimal committee, even outside monetary policy, should potentially include outsiders, but needs to manage career concerns.
    Keywords: Expert Behavior ; Committees ; Monetary Policy JEL Classification: D70 ; E52
    Date: 2010
  29. By: Stephen Eliot Hansen; Michael McMahon
    Abstract: We test whether outside experts have information not available to insiders by using the voting record of the Bank of England's Monetary Policy Committee. Members with more private information should vote more often against conventional wisdom, which we measure as the average belief of market economists about future interest rates. We find evidence that external members indeed have information not available to internals, but also use a quasi-natural experiment to show they may exaggerate their expertise to obtain reappointment. This implies that an optimal committee, even outside monetary policy, should potentially include outsiders, but needs to manage career concerns.
    Keywords: Expert Behavior, Committees, Monetary Policy.
    JEL: D70 E52
    Date: 2010–10
  30. By: Barry Eichengreen, Marc Flandreau (IUHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: This paper provides new evidence on the rise of the dollar as an international currency, focusing on its role in the conduct of trade and the provision of trade credit. We show that the shift to the dollar occurred much earlier than conventionally supposed: during and immediately after World War I. Not just market forces but also policy support – the Fed in its role as market maker – was important for the dollar’s overtaking of sterling as the leading international currency. On balance, this experience challenges the popular notion of international currency status as being determined mainly by market size. It suggests that the popular image of strongly increasing returns and pervasive network externalities leaving room for only one monetary technology is misleading.
    Keywords: international currency, trade credit, network externalities
    Date: 2010–08
  31. By: Jonsson, Thomas (National Institute of Economic Research); Österholm, Pär (National Institute of Economic Research)
    Abstract: In this paper, we evaluate survey-based wage-growth expectations in Sweden. Results show that the expectations are neither unbiased nor efficient forecasts. Evaluating out-of-sample forecasting performance, we find that the survey participants generally perform worse than a con-stant forecast based on reasonable assumptions regarding the inflation target and productivity growth. Our findings indicate that caution should be exercised when relying on these data for policymaking.
    Keywords: Survey data;
    JEL: E52 J30
    Date: 2010–09
  32. By: Prachi Mishra (International Monetary Fund); Antonio Spilimbergo (International Monetary Fund); Peter Montiel (Williams College)
    Abstract: This paper reviews the monetary transmission mechanism in low income countries (LICs). We use monetary transmission in advanced and emerging markets as a benchmark to identify aspects of the transmission mechanism that may operate differently in LICs. In particular, we focus on the effects of financial market structure on monetary transmission. The weak institutional framework prevalent in LICs drastically reduces the role of securities markets and increases the cost of bank lending to private firms. Coupled with imperfect competition in the banking sector, this means that banks with chronically high excess reserves invest in domestic public bonds or (when possible) in foreign bonds. With the financial system not intermediating funds properly, the traditional monetary transmission channels (interest rate, bank lending, and asset price) are impaired. The exchange rate channel, on the other hand, tends to be undermined by central bank intervention in the foreign exchange market. These conclusions are supported by review of the institutional frameworks, statistical analysis, and previous literature.
    Keywords: monetary policy, exchange rate, interest rate, banks, credit, institutions
    Date: 2010–07
  33. By: José Valentim Machado Vicente; Osmani Teixeira de Carvalho Guillen
    Abstract: There is a widespread belief that inflation-linked bonds are a direct source of information about inflation expectations. In this paper we address this issue by analyzing the relationship between break-even inflation (the difference between nominal and real yields) and future inflation. The dataset is extracted from Brazilian Treasury bonds covering the period from April 2005 to July 2010. We find that break-even inflation is an unbiased forecast only of the 3-month and 6-month ahead inflation. For medium horizons (12 and 18 months) break-even inflation has weak explanatory power of future inflation. Over long horizons (24 and 30 months), we report a significant, but counterintuitive, negative relationship between the break-even and realized inflations.
    Date: 2010–10
  34. By: Zsolt Darvas (Institute of Economics - Hungarian Academy of Science, Bruegel-Brusselss)
    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
  35. By: Berlemann, Michael (Helmut Schmidt University, Hamburg); Freese, Julia (Helmut Schmidt University, Hamburg)
    Abstract: Most empirical studies found that monetary policy has a significant effect on house prices while stock markets remain unaffected by interest rate shocks. In this paper we conduct a more detailed analysis by studying various sub-segments of the real estate market. Employing a new dataset for Switzerland we estimate vector autoregressive models and find substitution effects between house and apartment prices on the one hand and rental prices on the other. Interestingly enough, commercial property prices do not react on interest rate variations.
    Keywords: monetary policy; interest rate shocks; real estate; stock market
    JEL: E43 E52 R21
    Date: 2010–10–14
  36. By: Antonio Bassanetti (Bank of Italy); Michele Caivano (Bank of Italy); Alberto Locarno (Bank of Italy)
    Abstract: The aim of the paper is to estimate a reliable quarterly time-series of potential output for the Italian economy, exploiting four alternative approaches: a Bayesian unobserved component method, a univariate time-varying autoregressive model, a production function approach and a structural VAR. Based on a wide range of evaluation criteria, all methods generate output gaps that accurately describe the Italian business cycle over the past three decades. All output gap measures are subject to non-negligible revisions when new data become available. Nonetheless they still prove to be informative about the current cyclical phase and, unlike the evidence reported in most of the literature, helpful at predicting inflation compared with simple benchmarks. We assess also the performance of output gap estimates obtained by combining the four original indicators, using either equal weights or Bayesian averaging, showing that the resulting measures (i) are less sensitive to revisions; (ii) are at least as good as the originals at tracking business cycle fluctuations; (iii) are more accurate as inflation predictors.
    Keywords: potential output, business cycle, Phillips curve, output gap
    JEL: E37 C52
    Date: 2010–09
  37. By: Jaromír Baxa (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic); Roman Horváth (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Czech National Bank); Bořek Vašíček (Universitat Autonoma de Barcelona)
    Abstract: We examine the evolution of monetary policy rules in a group of inflation targeting countries (Australia, Canada, New Zealand, Sweden and the United Kingdom), applying a moment-based estimator in a time-varying parameter model with endogenous regressors. Using this novel flexible framework, our main findings are threefold. First, monetary policy rules change gradually, pointing to the importance of applying a time-varying estimation framework. Second, the interest rate smoothing parameter is much lower than typically reported by previous time-invariant estimates of policy rules. External factors matter for all countries, although the importance of the exchange rate diminishes after the adoption of inflation targeting. Third, the response of interest rates to inflation is particularly strong during periods when central bankers want to break a record of high inflation, such as in the UK or Australia at the beginning of the 1980s. Contrary to common wisdom, the response becomes less aggressive after the adoption of inflation targeting, suggesting a positive anchoring effect of this regime on inflation expectations. This result is supported by our finding that inflation persistence as well as the policy neutral rate typically decreased after the adoption of inflation targeting.
    Keywords: Taylor rule, inflation targeting, monetary policy, time-varying parameter model, endogenous regressors
    JEL: E43 E52 E58
    Date: 2010–10
  38. By: George Syrichas (Central Bank of Cyprus)
    Abstract: Mediterranean countries following a fixed exchange rate regime have been confronted with some challenges that test the efficacy of the regimes in place. These challenges mostly arise from the combination of inflationary pressures and the need for further capital account liberalisation amid conditions of ample liquidity in the banking system and rapid money and credit growth. In light of these developments, some of these exchange rate targeting Mediterranean countries are assessing the framework in place or even contemplating change to a more flexible arrangement, which would allow them greater freedom to pursue domestic objectives. Theoretical and empirical considerations do not point to the superiority of a particular exchange rate regime, but provide broad guidance on the factors and conditions that are predisposed to a fixed exchange rate regime and its sustainability in a liberalised environment. The case of Cyprus confirms the view that, under certain conditions, it is possible to maintain a credible fixed exchange rate regime while advancing capital account liberalisation and still achieve the primary objective of monetary policy. Adherence to a simple monetary rule, such as an exchange rate target, can confer credibility on a central bank and deliver price stability. Another important lesson drawn from the Cyprus case is that this strategy requires an independent central bank and needs to be supplemented by additional measures. Monetary aggregates, in particular credit, should be closely monitored and controlled, if necessary. The current account also warrants close monitoring, both as an indicator of inflationary pressures and as a warning signal helping to avoid unsustainable external imbalances. Finally, capital account liberalisation requires that the authorities have in advance a well-prepared and comprehensive plan, including, first and foremost, reforms in the conduct of monetary policy and banking supervision.
    Keywords: Exchange rate policy, exchange rate pegs, monetary policy, Mediterranean countries, Cyprus.
    JEL: E31 E4 E52 F31 F33
    Date: 2010–10
  39. By: George Kyriacou (Central Bank of Cyprus); Maria Papageorghiou (Central Bank of Cyprus)
    Abstract: One of the landmark events in the recent history of Cyprus was the adoption of the euro on 1 January 2008. A crucial element of the preparatory discussions between the Cypriot authorities and the competent European bodies was the search for an agreement on the conversion rate of the Cyprus pound vis-a-vis the euro, which was decided by the Economic and Financial Affairs Council (ECOFIN) on 10 July 2007. This paper describes part of the work undertaken at the Central Bank of Cyprus as background material for these discussions. Using a qualitative and quantitative approach, the paper suggests that the exchange parity rate of the Cyprus pound vis-a-vis the euro which existed for a number of years prior to euro adoption was broadly in line with economic fundamentals. Evidence examined include the stability of the Cyprus pound vis-a-vis the euro within a credible exchange rate policy framework, robust growth, low levels of unemployment, high Foreign Direct Investment (FDI) coverage of the current account deficit as well as low and stable inflation. This conclusion is also supported by a model-based approach using the Fundamental Equilibrium Exchange Rate (FEER) framework.
    Keywords: Equilibrium exchange rate, euro adoption, FEER
    JEL: F31 F32
    Date: 2010–09

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