nep-cba New Economics Papers
on Central Banking
Issue of 2010‒12‒11
37 papers chosen by
Alexander Mihailov
University of Reading

  1. Production Chains By David K. Levine
  2. Financial Crises, Credit Booms, and External Imbalances: 140 Years of Lessons By Òscar Jordà; Moritz Schularick; Alan M. Taylor
  3. Factor Analysis of a Large DSGE Model By Alexei Onatski; Francisco J. Ruge-Murcia
  4. Confronting Model Misspecification in Macroeconomics By DANIEL F. WAGGONER; TAO ZHA
  5. Forecasting in the presence of recent structural change By Eklund, Jana; Kapetanios, George; Price, Simon
  6. Recent Developments in Monetary Policy By Peter Howells; Iris Biefang Frisancho-Mariscal
  7. The Inefficiency of Refinancing: Why Prepayment Penalties Are Good for Risky Borrowers By Christopher J. Mayer; Tomasz Piskorski; Alexei Tchistyi
  8. Asset Prices and Monetary Policy in a Sticky-Price Economy with Financial Frictions By NUTAHARA Kengo
  9. Nominal Rigidities and News-Driven Business Cycles in a Medium-Scale DSGE Economy By NUTAHARA Kengo
  10. Lessons From the Latest Data on U.S. Productivity By Jan P.A.M. Jacobs; Simon van Norden
  11. A Simple Model of the Relationship Between Productivity, Saving and the Current Account By Jean-Marc Fournier; Isabell Koske
  12. On monetary policy and stock market anomalies By Alexandros Kontonikas; Alexandros Kostakis
  13. Fiscal Policy and Economic Stability:Does PIGS stand for Procyclicality In Government. By Peter Claeys; Alessandro Maravalle
  14. Imprecision of central bank announcements and credibility By Daniel Laskar
  15. Inflation risk premia in the US and the euro area By Peter Hördahl; Oreste Tristani
  16. Downward wage rigidity and automatic wage indexation: evidence from monthly micro wage data By Patrick Lünnemann; Ladislav Wintr
  17. Deep habits and the macroeconomic effects of government debt By Aloui, Rym
  18. Interest rate effects of demographic changes in a New-Keynesian life-cycle framework By Engin Kara; Leopold von Thadden
  19. Should macroeconomic forecasters use daily financial data and how? By Elena Andreou; Eric Ghysels; Andros Kourtellos
  20. The Option Of Last Resort: A Two-Currency Emu By Arghyrou, Michael G; Tsoukalas, John D.
  21. Trends in International Prices By Philippe Andrade; Marios Zachariadis
  22. Monetary policy, capital inflows and the housing boom By Sa, Filipa; Wieladek, Tomasz
  23. Do fiscal imbalances deteriorate sovereign debt ratings? By António Afonso; Pedro Gomes
  24. Level, Slope, Curvature of Sovereign Yield Curve and Fiscal Behaviour By António Afonso; Manuel M. F. Martins
  25. Short and Long-run Behaviour of Long-term Sovereign Bond Yields By António Afonso; Christophe Rault
  26. World Food Prices and Monetary Policy By Luis Catão; Roberto Chang
  27. How Does Monetary Policy Change? Evidence on Inflation Targeting Countries By Jaromír Baxa; Roman Horvath; Borek Vasicek
  28. The choice of adopting inflation targeting in emerging economies: Do domestic institutions matter? By Yannick Lucotte
  29. Monetary Policy in the presence of Informal Labour Markets By Paul Castillo; Carlos Montoro
  30. The Dynamics of Portfolio Holdings in Emerging Europe By Vahagn Galstyan; Philip Lane
  31. Canadian Monetary Policy: Lessons from the Crisis By Angelo Melino
  32. The Long-Run Relationship between Inflation and Real Stock Prices: Empirical Evidence from South Africa By Riona Arjoon; Mariette Botes; Laban K. Chesang; Rangan Gupta
  33. The Long-Run Impact of Inflation in South Africa By Kafayat Amusa; Rangan Gupta; Shaakira Karaolia; Beatrice D. Simo Kengne
  34. The Indian Exchange Rate and Central Bank Action: A GARCH Analysis By Ashima Goyal; Sanchit Arora
  35. Exchange Rate Policy in Brazil By John Williamson
  36. Expectativas Inflacionárias e Inflação Implícita no Mercado Brasileiro By Flávio de Freitas Val; Claudio Henrique da Silveira Barbedo; Marcelo Verdini Maia
  37. Los Mecanismos de Transmisión de la Política Monetaria en Perú By Paul Castillo B.; Fernando Peréz F.; Vicente Tuesta R.

  1. By: David K. Levine
    Abstract: More advanced technologies demand higher degrees of specialization – and longer chains of production connecting raw inputs to final outputs. Longer production chains are subject to a “weakest link” effect: they are more fragile and more prone to failure. Optimal chain length is determined by the trade-off between the gains to specialization and the higher failure rate associated with longer chain length. There is a kind of reverse “Keynesian multiplier” that magnifies the effect of real shocks. Consequently, more advanced economies should have higher unemployment rates and be more prone to crisis. The implications of the theory both for measurement and government policy are examined.
    JEL: A1 A10 D00 E00 E01
    Date: 2010–12
  2. By: Òscar Jordà; Moritz Schularick; Alan M. Taylor
    Abstract: Do external imbalances increase the risk of financial crises? In this paper, we study the experience of 14 developed countries over 140 years (1870-2008). We exploit our long-run dataset in a number of different ways. First, we apply new statistical tools to describe the temporal and spatial patterns of crises and identify five episodes of global financial instability in the past 140 years. Second, we study the macroeconomic dynamics before crises and show that credit growth tends to be elevated and natural interest rates depressed in the run-up to global financial crises. Third, we show that recessions associated with crises lead to deeper recessions and stronger turnarounds in imbalances than during normal recessions. Finally, we ask if external imbalances help predict financial crises. Our overall result is that credit growth emerges as the single best predictor of financial instability, but the correlation between lending booms and current account imbalances has grown much tighter in recent decades.
    JEL: C14 C52 E51 F32 F42 N10 N20
    Date: 2010–12
  3. By: Alexei Onatski (Faculty of Economics, University of Cambridge); Francisco J. Ruge-Murcia (Department of Economics, University of Montréal; The Rimini Centre for Economic Analysis (RCEA))
    Abstract: We study the workings of the factor analysis of high-dimensional data using arti…cial series generated from a large, multi-sector dynamic stochastic general equilibrium (DSGE) model. The objective is to use the DSGE model as a laboratory that allow us to shed some light on the practical bene…ts and limitations of using factor analysis techniques on economic data. We explain in what sense the arti…cial data can be thought of having a factor structure, study the theoretical and fi…nite sample properties of the principal components estimates of the factor space, investigate the substantive reason(s) for the good performance of diffusion index forecasts, and assess the quality of the factor analysis of highly dissagregated data. In all our exercises, we explain the precise relationship between the factors and the basic macroeconomic shocks postulated by the model.
    Keywords: Multisector economies, principal components, forecasting, pervasiveness, FAVAR
    JEL: C3 C5 E3
    Date: 2010–01
    Abstract: We confront model misspecification in macroeconomics by proposing an analytic framework for merging multiple models. This framework allows us to 1) address uncertainty about models and parameters simultaneously and 2) trace out the historical periods in which one model dominates other models. We apply the framework to a richly parameterized DSGE model and a corresponding BVAR model. The merged model, fitting the data better than both individual models, substantially alters economic inferences about the DSGE parameters and about the implied impulse responses.
    Date: 2010–11
  5. By: Eklund, Jana (Bank of England); Kapetanios, George (Queen Mary College, London); Price, Simon (Bank of England)
    Abstract: We examine how to forecast after a recent break. We consider monitoring for change and then combining forecasts from models that do and do not use data before the change; and robust methods, namely rolling regressions, forecast averaging over different windows and exponentially weighted moving average (EWMA) forecasting. We derive analytical results for the performance of the robust methods relative to a full-sample recursive benchmark. For a location model subject to stochastic breaks the relative mean square forecast error ranking is EWMA < rolling regression < forecast averaging. No clear ranking emerges under deterministic breaks. In Monte Carlo experiments forecast averaging improves performance in many cases with little penalty where there are small or infrequent changes. Similar results emerge when we examine a large number of UK and US macroeconomic series.
    Keywords: monitoring; recent structural change; forecast combination; robust forecasts
    JEL: C10 C59
    Date: 2010–12–02
  6. By: Peter Howells (University of the West of England, Bristol); Iris Biefang Frisancho-Mariscal (University of the West of England, Bristol)
    Abstract: In the fifteen years leading up to the financial crisis in 2008, there emerged a great deal of agreement on the optimal design of monetary policy. This policy ‘consensus’ was accompanied also by a widely-shared view of how macroeconomies worked as the ‘Keynesian’ versus ‘monetarist’ debates slipped into the past. This paper charts the emergence of this consensus and then looks at the way in which the apparently settled ideas of monetary policy have been disrupted by recent events. In particular, it looks at the way in which the crisis has forced a revision of both the targets and instruments of monetary policy.
    Keywords: Monetary policy, quantity theory, Phillips curve
    JEL: E4 E5
    Date: 2010–12
  7. By: Christopher J. Mayer; Tomasz Piskorski; Alexei Tchistyi
    Abstract: This paper explores the practice of mortgage refinancing in a dynamic competitive lending model with risky borrowers and costly default. We show that prepayment penalties improve welfare by ensuring longer-term lending contracts, which prevents the mortgage pools from becoming disproportionately composed of the riskiest borrowers over time. Mortgages with prepayment penalties allow lenders to lower mortgage rates and extend credit to the least creditworthy, with the largest benefits going to the riskiest borrowers, who have the most incentive to refinance in response to positive credit shocks. Empirical evidence from more than 21,000 non-agency securitized fixed rate mortgages is consistent with the key predictions of our model. Our results suggest that regulations banning refinancing penalties might have the unintended consequence of restricting access to credit and raising rates for the least creditworthy borrowers.
    JEL: D12 D14 D53 G14 G21 G28 R31 R38
    Date: 2010–12
  8. By: NUTAHARA Kengo
    Abstract: A recent study shows that equilibrium indeterminacy arises if monetary policy responds to asset prices, especially share prices, in a sticky-price economy. We show that equilibrium indeterminacy never arise if the working capital of firms is subject to their asset values by financial frictions.
    Date: 2010–12
  9. By: NUTAHARA Kengo
    Abstract: A news-driven business cycle is a positive comovement of consumption, output, labor, and investment from the news about the future. It is well-known that the standard real business cycle model cannot generate it. In this paper, we show that nominal rigidities, especially sticky prices, can cause it in an estimated medium-scale DSGE economy. We also find that sticky wages cannot cause it in our economy.
    Date: 2010–12
  10. By: Jan P.A.M. Jacobs; Simon van Norden
    Abstract: Productivity growth is carefully scrutinized by macroeconomists because it plays key roles in understanding private savings behaviour, the sources of macroeconomic shocks, the evolution of international competitiveness and the solvency of public pension systems, among other things. However, estimates of recent and expected productivity growth rates suffer from two potential problems: (i) recent estimates of growth trends are imprecise, and (ii) recently published data often undergo important revisions. This paper documents the statistical (un)reliability of several measures of aggregate productivity growth in the US by examining the extent to which they are revised over time. We also examine the extent to which such revisions contribute to errors in forecasts of US productivity growth. We find that data revisions typically cause appreciable changes in published estimates of productivity growth rates across a range of different productivity measures. Substantial revisions often occur years after the initial data release, which we argue contributes significantly to the overall uncertainty policymakers face. This emphasizes the need for means of reducing the uncertainty facing policymakers and policies robust to uncertainty about current economic conditions.
    JEL: C22 J24 O47
    Date: 2010–12
  11. By: Jean-Marc Fournier; Isabell Koske
    Abstract: This paper uses a simple dynamic stochastic general equilibrium model to explore the qualitative impact of productivity shocks on current account positions via their impact on the saving behaviour of households. The analysis shows that the direction of the impact is ambiguous from a theoretical point of view. This impact depends in particular on consumer’s willingness to shift consumption over time relative to their willingness to shift consumption between different types of goods, on whether they believe the shock to be temporary or permanent, and on the sector in which the shock occurs.<P>Un modèle simple reliant la productivité, l'épargne et la balance courante<BR>Cet article explore l’effet qualitatif de chocs de productivité sur la balance courante, via leur impact sur le comportement d’épargne des ménages, avec un modèle d’équilibre général stochastique simple. Cette analyse montre que le sens de l’effet est théoriquement ambigu. Cet effet dépend de la propension des consommateurs à modifier le niveau de leur consommation au cours du temps comparée à leur propension à modifier leur panier de biens, de la croyance par les agents que le choc est permanent ou temporaire, ou encore du secteur dans lequel le choc se produit.
    Keywords: productivity, current account adjustment, saving, productivité, épargne, ajustement de la balance courante
    JEL: E21 F32 O40
    Date: 2010–11–23
  12. By: Alexandros Kontonikas; Alexandros Kostakis
    Abstract: This study utilizes a macro-based VAR framework to investigate whether stock portfolios formed on the basis of their value, size and past performance characteristics are affected in a differential manner by unexpected US monetary policy actions during the period 1967-2007. Full sample results show that value, small capitalization and past loser stocks are more exposed to monetary policy shocks in comparison to growth, big capitalization and past winner stocks. Subsample analysis, motivated by variation in the realized premia and parameter instability, reveals that monetary policy shocks’ impact on these portfolios is significant and pronounced only during the pre-1983 period.
    Keywords: Monetary policy, Federal funds rate, Market anomalies, Credit channel, Risk premia
    JEL: E44 E58 G12
    Date: 2010–11
  13. By: Peter Claeys (Universitat de Barcelona,); Alessandro Maravalle (University of the Basque Country,)
    Abstract: The Financial Crisis has hit particularly hard countries like Ireland or Spain. Procyclical fiscal policy has contributed to a boom-bust cycle that undermined fiscal positions and deepened current account deficits during the boom. We set up an RBC model of a small open economy, following Mendoza (1991), and introduce the effect of fiscal policy decisions that change over the cycle. We calibrate the model on data for Ireland, and simulate the effect of different spending policies in response to supply shocks. Procyclical fiscal policy distorts intertemporal allocation decisions. Temporary spending boosts in booms spur investment, and hence the need for external finance, and so generates very volatile cycles in investment and the current account. This economic instability is also harmful for the steady state level of output. Our model is able to replicate the relation between the degree of cyclicality of fiscal policy, and the volatility of consumption, investment and the current account observed in OECD countries.
    Keywords: RBC, current account, small open economy, fiscal rule, spending
    JEL: E32 E62 F41 H62
    Date: 2010–12–02
  14. By: Daniel Laskar
    Abstract: We consider a model where the central bank faces a credibility problem in its announcements, but also cares about its credibility and, therefore, wants to make truthful announcements. We show that, although the central bank would be able to perfectly transmit its information to the private sector through precise announcements, the central bank may nonetheless prefer to make imprecise announcements. This choice of the central bank would be suboptimal from the point of view of society. However, if the central bank gives enough weight to making truthful announcements, this suboptimality disappears, because the central bank would then prefer precise announcements to imprecise announcements.
    Date: 2010
  15. By: Peter Hördahl (Bank for International Settlements, Centralbahnplatz 2, CH-4002, Basel, Switzerland.); Oreste Tristani (European Central Bank, DG Research, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We use a joint model of macroeconomic and term structure dynamics to estimate inflation risk premia in the United States and the euro area. To sharpen our estimation, we include in the information set macro data and survey data on inflation and interest rate expectations at various future horizons, as well as term structure data from both nominal and index-linked bonds. Our results show that, in both currency areas, inflation risk premia are relatively small, positive, and increasing in maturity. The cyclical dynamics of long-term inflation risk premia are mostly associated with changes in output gaps, while their high-frequency fluctuations seem to be aligned with variations in inflation. However, the cyclicality of inflation premia differs between the US and the euro area. Long term inflation premia are countercyclical in the euro area, while they are procyclical in the US. JEL Classification: E43, E44.
    Keywords: Term structure of interest rates, inflation risk premia, central bank credibility.
    Date: 2010–12
  16. By: Patrick Lünnemann (Banque centrale du Luxembourg, 2, boulevard Royal, L-2983 Luxembourg.); Ladislav Wintr (Banque centrale du Luxembourg, 2, boulevard Royal, L-2983 Luxembourg.)
    Abstract: This paper assesses the degree of downward wage rigidity in Luxembourg using an administrative monthly data set on individual wages covering the entire economy over the period from January 2001 to January 2007. After limiting for measurement error, which would otherwise bias downwards the estimates of wage rigidity, we conclude that nearly all workers in Luxembourg are potentially subject to downward real wage rigidity. Our results are robust to different procedures to adjust for measurement error and methods for estimation of downward wage rigidity. We report relatively small differences in the frequency of nominal wage cuts across occupational groups and sectors. In addition, the observed rigidity does not seem to be driven predominantly by the absence of negative shocks. We show that the real wage rigidity is related to the automatic wage indexation, while additional factors might be necessary to explain the high degree of downward wage rigidity. JEL Classification: J31.
    Keywords: downward wage rigidity, wage indexation.
    Date: 2010–12
  17. By: Aloui, Rym
    Abstract: In this paper, we study the effects of government debt on macroeconomic aggregates in a non-Ricardian framework. We develop a micro-founded framework which combines time-varying markups, endogenous labor supply and overlapping generations based on infinitely-lived families. The main contribution of this paper is to provide a new transmission mechanism of public debt through the countercyclical markup movements induced by external deep habits. We analyze the effects of debt-financed tax cuts. We show that the interest rate rises, entailing higher markups, which imply a fall in employment and consumption. It is particularily noteworthy that, even without capital, a crowding out effect of government debt is obtained in the long run. However, the short-run expansionary effect of debt-financed tax cuts, which would eventually be expected in a non-Ricardian framework, fails to occur. This is due to our flexible-price framework. On the other hand, we show that incorporating sticky prices in our model causes debt-financed tax cuts to have a short-run expansionary effect while preserving the long-run contractionary effect. --
    Keywords: Wealth Effects,Fiscal Policy,Public Debt Shock,Deep Habits,Overlapping Generations,Monopolistic Competition
    JEL: E63 E52
    Date: 2010
  18. By: Engin Kara (Economics Department, University of Bristol, 8 Woodland Road, BS8 1TN, Bristol.); Leopold von Thadden (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: This paper develops a small-scale DSGE model which embeds a demographic structure within a monetary policy framework. We extend the tractable, though non-monetary overlapping-generations model of Gertler (1999) and present a small synthesis model which combines the set-up of Gertler with a New-Keynesian structure, implying that the short-run dynamics related to monetary policy are similar to the paradigm summarized in Woodford (2003). In sum, the model offers a New-Keynesian platform which can be used to investigate in a closed economy set-up the response of macroeconomic variables to demographic shocks, similar to technology, government spending or monetary policy shocks. Empirically, we use a calibrated version of the model to discuss a number of macroeconomic scenarios for the euro area with a horizon of around 20 years. The main finding is that demographic changes, while contributing slowly over time to a decline in the equilibrium interest rate, are not visible enough within the time horizon relevant for monetary policy-making to require monetary policy reactions. JEL Classification: D58, E21, E50, E63.
    Keywords: Demographic change, Monetary policy, DSGE modelling.
    Date: 2010–12
  19. By: Elena Andreou; Eric Ghysels; Andros Kourtellos
    Abstract: We introduce easy to implement regression-based methods for predicting quarterly real economic activity that use daily financial data and rely on forecast combinations of MIDAS regressions. Our analysis is designed to elucidate the value of daily information and provide real-time forecast updates of the current (nowcasting) and future quarters. Our findings show that while on average the predictive ability of all models worsens substantially following the financial crisis, the models we propose suffer relatively less losses than the traditional ones. Moreover, these predictive gains are primarily driven by the classes of government securities, equities, and especially corporate risk.
    Keywords: MIDAS, macro forecasting, leads, daily financial information, daily factors.
    Date: 2010–11
  20. By: Arghyrou, Michael G (Cardiff Business School); Tsoukalas, John D.
    Abstract: This article, originally published at on 7 February 2010, spells out our two-currency EMU proposal as a plan of last resort for resolving the present EMU sovereign-debt crisis. The key ingredients of our proposal involve a temporary split of the euro into two currencies, both run by the European Central Bank. The hard euro will be maintained by the core-EMU members whereas periphery EMU countries will adopt for a suitable period of time the weak euro. All existing debts will continue to be denominated in strong-euro terms. The plan involves a one-off devaluation of the weak euro versus the strong one, simultaneously with the introduction of far-reaching reforms and rapid fiscal consolidation in the periphery EMU countries. We argue that due to enhanced market credibility, our two-tier euro plan has a realistic chance of success in resolving the EMU crisis, if all other approaches fail.
    Keywords: euro; two-currency EMU
    JEL: E44 F30
    Date: 2010–11
  21. By: Philippe Andrade; Marios Zachariadis
    Abstract: We exploit the panel dimension of a price levels dataset for more than one hundred product items across 140 cities in 90 countries for the period from 1990 to 2009 in order to improve our understanding of international price dispersion and the evolution of prices over time. We consider a panel data model with exchangeable units that allows for the possibility of common components for different dimensions of the panel. This allows one to gauge the contribution of each dimension of the data to total variation and to disentangle the sources of potential non-stationarity. It also allows us to identify differences in the speed of convergence for different time-varying components in response to location-specific, product-specific, and idiosyncratic shocks. Finally, we proceed to identify the economic determinants of different components to show that particular dimensions of the data are more suited for examining particular theories.
    Keywords: Price levels, Variance decomposition, Convergence, Non-stationarity, International price dispersion
    Date: 2010–01
  22. By: Sa, Filipa (Trinity College, University of Cambridge; IZA); Wieladek, Tomasz (Bank of England)
    Abstract: A range of hypotheses have been put forward to explain the boom in house prices that occurred in the United States from the mid-1990s to 2007. This paper considers the relative importance of two of these hypotheses. First, global imbalances increased liquidity in the US financial system, driving down long-term real interest rates. Second, the Federal Reserve kept interest rates low in the first half of the 2000s. Both factors reduced the cost of borrowing and may have encouraged the boom in house prices. This paper develops an empirical framework to separate the relative contributions of these two factors to the US housing market. The results suggest that capital inflows to the United States played a bigger role in generating the increase in house prices than monetary policy loosening. Using VAR methods, we find that compared to monetary policy, the effect of a capital inflows shock on US house prices and residential investment is about twice as large and substantially more persistent. Results from variance decompositions suggest that, at a forecast horizon of 20 quarters, capital flows shocks explain 15% of the variation in real house prices, while monetary policy shocks explain only 5%. In a simple counterfactual exercise, we find that if the ratio of the current account deficit to GDP had remained constant since the end of 1998, real house prices by the end of 2007 would have been 13% lower. Similar exercises with constant policy rates and the path of policy rates implied by the Taylor rule deliver smaller effects.
    Keywords: house prices; capital inflows; monetary policy
    JEL: E50 F30
    Date: 2010–11–29
  23. By: António Afonso; Pedro Gomes
    Abstract: We use sovereign debt rating estimations from Afonso, Gomes and Rother (2009, 2010) for Fitch, Moody’s, and Standard & Poor’s, to assess to what extent the recent fiscal imbalances are being reflected on the sovereign debt notations. We use macro and fiscal data up to 2009, and macro and fiscal projections, to obtain the expected rating for several OECD countries. The answer to the title question is yes, but in a diverse way for each country. Our average model predictions point to a heterogeneous behaviour of rating agencies across countries.
    Keywords: credit ratings; sovereign debt; rating agencies.
    JEL: C23 E44 G15
    Date: 2010–11
  24. By: António Afonso; Manuel M. F. Martins
    Abstract: We study fiscal behaviour and the sovereign yield curve in the U.S. and Germany in the period 1981:I-2009:IV. The latent factors, level, slope and curvature, obtained with the Kalman filter, are used in a VAR with macro and fiscal variables, controlling for financial stress conditions. In the U.S., fiscal shocks have generated (i) an immediate response of the short-end of the yield curve, associated with the monetary policy reaction, lasting between 6 and 8 quarters, and (ii) an immediate response of the longend of the yield curve, lasting 3 years, with an implied elasticity of about 80% for the government debt ratio shock and about 48% for the budget balance shock. In Germany, fiscal shocks entail no significant reactions of the latent factors and no response of the monetary policy interest rate. In particular, while (i) budget balance shocks created no response from the yield curve shape, (ii) surprise increases in the debt ratio caused some increase in the short-end and the long-end of the yield curve in the following 2nd and 3rd quarters.
    Keywords: yield curve, fiscal policy, financial markets.
    JEL: E43 E44 E62 G15 H60
    Date: 2010–11
  25. By: António Afonso; Christophe Rault
    Abstract: This study assesses the short and long-run behaviour of long-term sovereign bond yields in OECD countries, for the period 1973-2008. We employ a dynamic panel approach to reflect financial and economic integration, and to increase the performance and accuracy of the tests. Given the existence of cross-country dependence regarding sovereign yields and its determinants, we resort to simulation and bootstrap methods for the analysis. Results based on the Common Correlated Effect estimator of Pesaran (2006) and on Panel Error Correction Models to sort out short- and long-run fiscal developments show that in addition to common movements in sovereign yields, investors also consider country differences arising from specific factors (inflation, budgetary and current account imbalances, real effective exchange rates, and liquidity).
    Keywords: long-term yields, EU, financial integration, panel cointegration, bootstrap.
    JEL: C23 E43 E62 G15 H62
    Date: 2010–11
  26. By: Luis Catão; Roberto Chang
    Abstract: In recent years, large fluctuations in world food prices have renewed interest in the question of how monetary policy in small open economies should react to imported price shocks. We address this issue in an open economy setting similar to previous ones except that food plays a distinctive role in utility. A key novelty of our model is that the real exchange rate and the terms of trade can move in opposite directions in response to food price shocks. This has several consequences for observables and for policy. Under a variety of model calibrations, broad CPI targeting emerges as welfare-superior to alternative policy rules once the variance of food price shocks is as large as in real world data.
    JEL: E5 E6 F41
    Date: 2010–12
  27. By: Jaromír Baxa (Institute of Economic Studies, Charles University, Prague and Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic, Prague); Roman Horvath (Czech National Bank and Institute of Economic Studies, Charles University, Prague); Borek Vasicek (Departament d'Economia Aplicada, 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 moment- based estimator at 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 time-varying estimation framework. Second, the interest rate smoothing parameter is much lower that what previous time-invariant estimates of policy rules typically report. External factors matter for all countries, albeit the importance of exchange rate diminishes after the adoption of inflation targeting. Third, the response of interest rates on inflation is particularly strong during the periods, when central bankers want to break the record of high inflation such as in the U.K. or in Australia at the beginning of 1980s. Contrary to common wisdom, the response becomes less aggressive after the adoption of inflation targeting suggesting the positive effect of this regime on anchoring inflation expectations. This result is supported by our finding that inflation persistence as well as 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: 2010–09
  28. By: Yannick Lucotte (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans)
    Abstract: Over the last decade, a growing number of emerging countries has adopted inflation targeting as monetary policy framework. In a recent paper, Freedman and Laxton (2009) ask the question “Why Inflation Targeting?”. This paper empirically investigates this question by analyzing a large set of institutional and political factors potentially associated with a country's choice of adopting IT. Using panel data on a sample of thirty inflation targeting and non-inflation emerging countries, for the period 1980-2006, our results suggest that central bank independence, policy-makers' incentives, and characteristics of political system play an important role in the choice of IT, while the level of financial development and political stability do not seem to matter. Empirical findings are confirmed by extensive robustness tests.
    Keywords: Inflation targeting; central bank independence; financial development; political institutions; emerging countries
    Date: 2010
  29. By: Paul Castillo (Banco Central de Reserva del Perú); Carlos Montoro (Banco Central de Reserva del Perú and Bank for International Settlements)
    Abstract: In this paper we analyse the effects of informal labour markets on the dynamics of inflation and on the transmission of aggregate demand and supply shocks. In doing so, we incorporate the informal sector in a modified New Keynesian model with labour market frictions as in the Diamond-Mortensen-Pissarides model. Our main results show that the informal economy generates a "buffer" effect that diminishes the pressure of demand shocks on aggregate wages and inflation. Finding that is consistent with the empirical literature on the e¤ects of informal labour markets in business cycle fluctuations. This result implies that in economies with large informal labour markets the interest rate channel of monetary policy is relatively weaker. Furthermore, the model produces cyclical flows from informal to formal employment consistent with the data.
    Keywords: Monetary Policy, New Keynesian Model, Informal Economy, Labour Market Frictions.
    JEL: E32 E50 J64 O17
    Date: 2010–09
  30. By: Vahagn Galstyan (Institute for International Integration Studies, Trinity College Dublin); Philip Lane (Institute for International Integration Studies, Trinity College Dublin)
    Abstract: In this paper we examine shifts in the bilateral patterns in international portfolio holdings in emerging Europe during the 2001-2008 period. In relation to the 2001-2007 pre-crisis period, we find some evidence that shifts in the geographical composition of portfolio debt liabilities reflect shifts in bilateral trade patterns. In addition, we find that the new member states disproportionately attracted portfolio equity investment from other members of the European Union after 2004. During the crisis period, we find that the bilateral composition of the shift in portfolio positions is affected by the scale of pre-crisis holdings and the geographical proximity of creditors. We also find that countries in the euro area are more likely to maintain portfolio positions in emerging Europe than were investors from other regions.
    Keywords: Portfolio holdings, crises, emerging Europe
    JEL: F30 F32
    Date: 2010–11
  31. By: Angelo Melino (University of Toronto; The Rimini Centre for Economic Analysis (RCEA))
    Abstract: The following is a report from a panel of the same title held at the Rimini Conference in Economics and Finance, Rimini, Italy, 10-13 June 2010, and organized by the Rimini Conference for Economic Analysis (RCEA). Panel Chair: Angelo Melino (University of Toronto and RCEA). Panelists: David Andolfatto (Vice President and Economist, Federal Reserve Bank of St. Louis; Professor of Economics, Simon Fraser University; RCEA), David E.W. Laidler (Professor Emeritus, University of Western Ontario; Fellow-in-Residence, C.D. Howe Institute; FRSC; Honorary Senior Fellow RCEA), John Murray (Deputy Governor, Bank of Canada).
    Date: 2010–01
  32. By: Riona Arjoon (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa); Mariette Botes (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa); Laban K. Chesang (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa); Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: The existing literature on the theoretical relationship between the rate of inflation and real stock prices in an economy has shown varied predictions about the long run effects of inflation on real stock prices. In this paper, we present some time series evidence on this issue using South African data, by applying the structural bivariate vector autoregressive (VAR) methodology proposed by King and Watson (1997). Our empirical results provide considerable support of the view that, in the long run real stock prices are invariant to permanent changes in the rate of inflation. The impulse responses reveal a positive real stock price response to a permanent inflation shock in the long run, indicating that any deviations in short run real stock prices will be corrected towards the long run value. It is therefore concluded that inflation does not lower the real value of stocks in South Africa, at least in the long run.
    Keywords: Inflation, Real stock prices, Vector autoregressive (VAR) model
    JEL: C32 E31 G12
    Date: 2010–12
  33. By: Kafayat Amusa (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa); Rangan Gupta (Department of Economics, University of Pretoria); Shaakira Karaolia (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa); Beatrice D. Simo Kengne (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa)
    Abstract: This paper evaluates the hypothesis of long-run super-neutrality of money (LRSN) within the context of the South African economy. The long-run impact of inflation on the interest rate and subsequently, output is estimated by employing a trivariate structural vector autoregression model. The estimation results suggest that the hypothesis of LRSN cannot be rejected, thereby potentially supporting the arguments asserted by Sidrauski (1967).
    Keywords: money neutrality, structural vector autoregression
    JEL: E5 E31
    Date: 2010–12
  34. By: Ashima Goyal; Sanchit Arora (Indira Gandhi Institute of Development Research)
    Abstract: We study, with daily and monthly data sets, the impact of conventional monetary policy measures such as interest rates, intervention and other quantitative measures, and of Central Bank communication on exchange rate volatility. Since India has a managed float, we also test if the measures affect the level of the exchange rate. Using dummy variables in the best of an estimated family of GARCH models, we find forex market intervention to be the most effective of all the CB instruments evaluated for the period of analysis. We also find that CB communication has a large potential but was not effectively used.
    Keywords: exchange rate volatility, monetary policy, intervention, communication, GARCH
    JEL: E52 E58 F31
    Date: 2010
  35. By: John Williamson (Peterson Institute for International Economics)
    Abstract: The macroeconomic regime implanted in Brazil during the second administration of Fernando Henrique Cardoso, and largely maintained by his successor, is typical of those of the advanced countries. The anchor is provided by an inflation-targeting regime (with a target inflation rate somewhat greater than in most advanced countries, of 4.5 percent a year, with a band around it of +/–2 percent). The exchange rate floats. The float is often described as free, but given the extent of recent reserve accumulation it would not qualify as a free float as understood by most economists. Fiscal policy has actually been more ambitious under the Lula regime, resulting for a time in a primary surplus of at least 4.25 percent of GDP (subsequently reduced to allow for a higher rate of public investment, and also temporarily reduced further to help combat the crisis). Monetary policy has then been directed at achieving the inflation target given fiscal policy, which--given history--has implied maintaining high interest rates. While the majority of the framework in Brazil is acceptable, it is a bit too laissez-faire in that the exchange rate should be targeted at a rate consistent with macroeconomic balance, which the authorities should treat as a reference rate.
    Keywords: exchange rates, inflation targeting, emerging-market economies, Brazil, reference rates
    JEL: F31 E50
    Date: 2010–12
  36. By: Flávio de Freitas Val; Claudio Henrique da Silveira Barbedo; Marcelo Verdini Maia
    Abstract: The trade volume of inflation indexed bonds has grown substantially in the treasury debt market. These bonds have been used as an important instrument for both diversifying investor´s portfolio, for managing firms´ liabilities and, mainly, for extracting inflation expectations by policymakers. This paper adds to the literature in twofold. First, we apply methodologies to obtain inflation expectations. Thus, we modified the method used in Durham (2007) to estimate the inflation risk premium. Second, we apply these methods in the Brazilian debt market for inflation indexed bonds issued from 2006 to 2008. Our results show that these methods perform better about inflation expectations, providing a more robust support for policymakers´ decisions.
    Date: 2010–11
  37. By: Paul Castillo B. (Banco Central de Reserva del Perú); Fernando Peréz F. (Banco Central de Reserva del Perú); Vicente Tuesta R. (Prima AFP y CENTRUM Católica.)
    Abstract: This paper presents an extension of the model proposed by Bernanke and Mihov (1998), which includes financial dollarization, in order to estimate the effects of monetary policy in Peru for the period 1995-2009. The results show that the effects of monetary policy in a dollarized economy are similar to the ones observed in non-dollarized economies. In particular, after a restrictive monetary policy shock, interest rates rise, monetary aggregates decrease, exchange rate drops, aggregate demand slows and inflation diminishes. However, exchange rate shocks are important determinants of the money market. Additionally, there is evidence that after the adoption of the inflation targeting regime in 2002 the Central Bank reacts more importantly to money demand shocks than to exchange rate shocks.
    Keywords: Mercado Interbancario, Mecanismo de transmisión, Choques Monetarios, Choques Externos.
    JEL: E51 E52 E58 F31 F41
    Date: 2010

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