nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒01‒02
nineteen papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Fiscal and Monetary Interaction: The Role of Asymmetries of the Stability and Growth Pact in EMU By Matteo Governatori; Sylvester Eijffinger
  2. Money As An Inflation Indicator In Chile – Does P* Still Work? By Tobias Broer; Rodrigo Caputo
  3. Inflation and Income Inequality: A Shopping-Time Aproach (Forthcoming, Journal of Development Economics) By Rubens Penha Cysne; Wilfredo Maldonado; Paulo Klinger Monteiro
  4. Excess Sensitivity and Volatility of Long Interest Rates: The Role of Limited Information in Bond Markets By Beechey, Meredith
  5. Inflation, Money Growth, and I(2) Analysis By Katarina Juselius
  6. Monetary Policy, Endogenous Inattention, and the Volatility Trade-off By Wiliam Branch; John Carlson; George W. Evans; Bruce McGough
  8. Quantifying Inflation Pressure and Monetary Policy Response in the United States By Diana N. Weymark; Mototsugu Shintani
  9. Inflation and unemployment in OECD countries: The role of political ideologies, Central Bank independance and industrial relations By Borghijs Alain; Di Bartolomeo Giovanni; Merlevede Bruno
  10. Macroeconomic stabilisation policies in the EMU: Spillovers, asymmetries and institutions By Di Bartolomeo Giovanni; Engwerda J.; Plasmans Jozef; Van Aarle Bas
  11. The Effect of Monetary Policy on Economic Output By Joe Haslag; R.W. Hafer; Garett Jones
  12. Inflation Contracts, Inflation and Exchange Rate Targeting, and Uncertain Central Bank Preferences By Ronald A. Ratti; Sang-Kun Bae
  13. Conservative Central Banks, and Nominal Growth, Exchange Rate and Inflation Targets By Ronald A. Ratti; Sang-Kun Bae
  14. Understanding the Roles of Money, or When is the Friedman Rule Optimal, and Why? By Joe Haslag; Joydeep Bhattacharya; Steven Russell
  15. Optimality of the Friedman Rule in Overlapping Generations Model with Spatial Separation By Joe Haslag; Antoine Martin
  16. Sub-Optimality of the Friedman Rule in Townsend’s Turnpike and Limited Communication Models of money: Do finite lives and initial dates matter? By Joseph H. Haslag; Joydeep Bhattacharya; Antoine Martin
  17. Monetary Policy and Welfare in a Small Open Economy By Bianca De Paoli
  18. Anticipation of monetary policy in UK financial markets By Peter Lildholdt; Anne Vila Wetherilt
  19. Core inflation: a critical guide By Alan Mankikar; Jo Paisley

  1. By: Matteo Governatori; Sylvester Eijffinger
    Abstract: The paper builds a simplified model describing the economy of a currency union with decentralised national fiscal policy, where the main features characterising the policy-making are similar to those in EMU. National governments choose the size of deficit taking into account the two main rules of the Stability and Growth Pact on public finance. Unlike previous literature the asymmetric working of those rules is explicitly modelled in order to identify its impact on the Nash equilibrium of deficits arising from a game of strategic interaction between fiscal authorities in the union.
    Keywords: Stability and Growth Pact, EMU, asymmetric fiscal rules, decentralised fiscal policy
    JEL: E61 H30 H60 H70
    Date: 2004
  2. By: Tobias Broer; Rodrigo Caputo
    Abstract: This paper analyses the information content of monetary aggregates for inflation in Chile. In particular, we adopt the P* framework that separates the effect of an estimated money overhang from those of the output gap. We use two variants of the model, the original Hallman et al (1991), and Gerlach and Svensson (2003), that conditions on an inflation target. We estimate both models for 6 different monetary aggregates, and 2 alternative estimates of equilibrium velocity. We find that over the estimation period, deviations of velocity from its equilibrium have significant effects on inflation, across models and definitions of the money gap, and for both narrow and broad money. The usual Chilean aggregate M1A, although it has some indicator properties, is outperformed by other money aggregates, first of all cash in the hands of the public, and a broad money aggregate containing time and foreign currency deposits. However, out-of sample forecasts show that over the recent past, most money gaps do not improve inflation forecasts. Also, inflation forecasts from broad and narrow money aggregates diverge in opposite directions in recent years, reflecting the estimated gaps that are large both for M1A and broader definitions of money, but opposite in sign. This finding puts a question mark behind the stability of money demand in recent times of stable and low inflation.
    Date: 2004–12
  3. By: Rubens Penha Cysne (EPGE/FGV); Wilfredo Maldonado; Paulo Klinger Monteiro (EPGE/FGV)
    Date: 2004–09
  4. By: Beechey, Meredith (Department of Economics, University of California, Berkeley)
    Abstract: Asymmetric information between the central bank and bond markets creates an inference problem that affects the behaviour of long interest rates. This paper employs a simple macroeconomic model with a time-varying infation target to illustrate the implications of asymmetry for the sensitivity of long rates and volatility of bond returns. When the central bank's infation target is not communicated and macroeconomic shocks are imperfectly observed, bond markets infer the value of the target from noisy signals. This heightens the sensitivity of long-run infation expectations to transitory shocks, thereby raising the measured reaction of long rates to monetary policy and to infation surprises. Calibrated coe±cients from such regressions are more than twice as large when bond markets lack knowledge of the target compared with a full information scenario. Time variation in the infation target is the main source of volatility, but learning adds to the ability of the model to explain the observed volatility of returns along the yield curve.
    Keywords: Term structure of interest rates; yield curve; limited information; learning; excess sensitivity; excess volatility.
    JEL: E43 E52
    Date: 2004–12–01
  5. By: Katarina Juselius (Institute of Economics, University of Copenhagen)
    Abstract: The paper discusses the dynamics of inflation and money growth in a stochastic framework, allowing for double unit roots in the nominal variables. It gives some examples of typical I(2) ’symptoms’ in empirical I(1) models and provides both a nontechnical and a technical discussion of the basic differences between the I(1) and the I(2) model. The notion of long-run and medium-run price homogeneity is discussed in terms of testable restrictions on the I(2) model. The Brazilian high inflation period of 1977:1-1985:5 illustrates the applicability of the I(2) model and its usefulness to address questions related to inflation dynamics.
    Keywords: cointegrated VAR; price homogeneity; Cagan model; hyper inflation
    JEL: C32 E41 E31
    Date: 2004–12
  6. By: Wiliam Branch (University of Californis - Irvine); John Carlson (Federal Reserve Bank of Cleveland); George W. Evans (University of Oregon Economics Department); Bruce McGough (Oregon State University)
    Abstract: This paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the "Great Moderation" that began in the 1980's.
    Keywords: expectations, optimal monetary policy, bounded rationality, economic stability, adaptive learning
    JEL: E52 E31 D83 D84
    Date: 2004–12–07
  7. By: Stanley C. W. Salvary
    Abstract: While economies in transition are not devoid of monetary policy, changes desired in the functioning of these economies may necessitate innovations to administer monetary policy consistent with newly established goals. Although some goals may essentially be the same (e.g., full employment or price stability), the instruments for achieving those goals may not be present. A variety of approaches to monetary policy are presented; however, while several operating models are discussed, it is made clear that the approach adopted, by an economy in transition, has to be consistent with the institutional structures in place. The recommended path for policymaking begins with an assessment of the institutional setting and the economic philosophy of the country in transition; this is followed by an information approach, which focuses on: objectives and goal variables, monetary policy models, the effect of changing conditions, the role of central banks, integration of monetary and fiscal policies, institutional design for monetary stability, alternative model variables, implications of monetarism, and a concluding caveat on monetary control.
    Keywords: sustainable economic growth, emerging market economies, monetary control, foreign exchange rate, price stability.
    JEL: E
    Date: 2004–12–24
  8. By: Diana N. Weymark (Department of Economics, Vanderbilt University); Mototsugu Shintani (Department of Economics, Vanderbilt University)
    Abstract: We propose a methodology for constructing operational indices of inflation pressure, the monetary authority's effort to reduce this pressure, and the degree to which inflation pressure is alleviated. We begin with model independent definitions of these concepts. When our definitions are applied to a specific model we obtain model-specific functional forms for these indices. We apply our methodology to a micro-founded aggregate model with rational expectations. GMM estimates of the model are used to obtain quarterly time series of our indices for the United States from 1966 to 2002.
    Keywords: Inflation pressure, monetary policy, stabilization policy
    JEL: E52
    Date: 2004–12
  9. By: Borghijs Alain; Di Bartolomeo Giovanni; Merlevede Bruno
    Abstract: This paper considers the effects of central bank independence, labor market institutions and the political partisanship on economic performance. In particular, we test if the partisanship of the government and the degree of central bank independence affect the relationship between labor market institutions and economic performance. We find evidence of interaction effects between the government’s partisanship and the labor market institutions. An increase in union density favors a left-wing government, while an increase in coordination favors a right-wing government. We also find that changes in the partisanship of the government have a larger impact on inflation and unemployment when the labor market is more institutionalized.
    Date: 2003–02
  10. By: Di Bartolomeo Giovanni; Engwerda J.; Plasmans Jozef; Van Aarle Bas
    Abstract: This paper studies the spillover sizes and signs and the institutional design of the co-ordination of macroeconomic stabilisation policies within the European Economic and Monetary Union (EMU). Moreover, in a dynamic setup, the consequences of this institutional design on macroeconomic outcomes and policies are analysed. We distinguish two types of co-ordination: ex-ante - related to the institutional framework; and ex-post concerning the actual policy decisions. The first type is modeled as the result of an endogenous coalition formation process that leads to the formation of policymakers’ coalitions. Ex-post co-ordination implies then the implementation by each coalition of its internally co-ordinated macroeconomic stabilisation policies in a non-cooperative dynamic game with the other coalitions, and subject to the constraints of the internal dynamics of the EMU economy. The paper shows that the institutional setting of macroeconomic policy co-ordination is of crucial importance in reaching the Pareto-optimal equilibrium of the game, especially when the number and the magnitude of asymmetries increase. The specific recommendations depend on the particular characteristics of the shocks and the economic structure. In the case of a common shock, fiscal co-ordination is counterproductive but full policy co-ordination is desirable. When asymmetric shocks are considered, fiscal co-ordination improves the performance but full policy co-ordination doesn’t produce further gains in policymakers’ welfare. In general, structural asymmetries reduce the gains from co-operation so that in many cases co-operation cannot be supported without introduction of exogenous factors, e.g. a transfer system.
    Date: 2003–06
  11. By: Joe Haslag (Department of Economics, University of Missouri-Columbia); R.W. Hafer (Southern Illinois University Edwardsville); Garett Jones (Southern Illinois University Edwardsville)
    Abstract: There is substantial research effort devoted to identifying a sufficient statistic for monetary policy. The purpose of this paper is to broaden the scope of the on-going investigation along three dimensions. First, we follow up the Rudebusch-Svensson claim of parameter instability in the output regressions by examining the statistical stability of the parameter estimates with post-1996 data. Second, we examine whether alternative measures of the cyclical component affect the correlation between money supply, interest rates and output. Third, we consider alternative measures of the money supply, permitting us to assess the distinct roles of inside and outside money in terms of the correlation between each component and output.
    JEL: E31 E52 E61
    Date: 2004–12–27
  12. By: Ronald A. Ratti (Department of Economics, University of Missouri-Columbia); Sang-Kun Bae
    Abstract: When central bank preferences are uncertain, delegation implemented by inflation or exchange rate targeting may be superior to delegation implemented through an inflation contract combined with an optimal inflation target. Distortion introduced by uncertainty about preferences into stabilization of shocks is largest under the contract regime. With targeting regimes this distortion is reduced by government increasing incentives to stabilize the targeted variable if uncertainty about preferences increases. A central banker with a populist bias improves outcomes under exchange rate targeting and the contract/optimal inflation target regime by reducing the distortion in stabilization induced by uncertain preferences.
    JEL: E42 E52 E58 F41
    Date: 2004–12–21
  13. By: Ronald A. Ratti (Department of Economics, University of Missouri-Columbia); Sang-Kun Bae
    Abstract: A framework is developed in which inflation biases with different target variables are compared. A nominal growth target measured in consumer prices yields less stabilization bias than a nominal income growth target. Exchange rate and inflation targets result in less stabilization bias in absolute value than an income growth target the more government cares about real exchange rate stabilization and the more open the economy. A conservative central bank may not be best under exchange rate and nominal growth targets. Greater openness reduces biases of discretionary policy and raises the chance that a conservative central bank is optimal in replication of commitment equilibrium.
    JEL: E52 E58 F41
    Date: 2004–12–21
  14. By: Joe Haslag (Department of Economics, University of Missouri-Columbia); Joydeep Bhattacharya (Iowa State University); Steven Russell (IUPUI)
    Abstract: In this paper, we study the optimal steady state monetary policy in overlapping generations (OG) models. In contrast to economies populated by inÞnitely-lived representative agents (ILRA), the Friedman Rule is frequently not the policy that maximizes the welfare of two-period lived consumers. Our principal goal is to understand why the Friedman Rule is suboptimal in OG economies. To this end, we construct a mechanism.speciÞcally, a monetary policy regime.that renders money useless in the sense of executing intergenerational transfers. Under this governmental regime, we show that the optimal monetary policy is the Friedman Rule. Our Þnding is robust to alternative rationales for valued Þat money; speciÞcally, whether money is held voluntarily or involuntarily.
    JEL: E31 E51 E58
    Date: 2004–12–27
  15. By: Joe Haslag (Department of Economics, University of Missouri-Columbia); Antoine Martin (Research Department, Federal Reserve Bank of Kansas City)
    Abstract: Recent papers suggest that when intermediation is analyzed seriously, the Friedman rule does not maximize social welfare in overlapping generations model in which money is valued because of spatial separation and limited communication. These papers emphasize a trade-off between productive efficiency and risk sharing. We show financial intermediation or a trade-off between productive efficiency and risk sharing are neither necessary nor sufficient for that result. We give conditions under which the Friedman rule maximizes social welfare and show any feasible allocation such that money grows faster than the Friedman rule is Pareto dominated by a feasible allocation with the Friedman rule. The key to the results is the ability to make intergenerational transfers.
    JEL: E31 E51 E58
    Date: 2004–12–27
  16. By: Joseph H. Haslag (Department of Economics, University of Missouri-Columbia); Joydeep Bhattacharya; Antoine Martin
    Abstract: We construct an economy populated with infinitely-lived agents and show that the Friedman rule is suboptimal. We do that by showing that our economy and an overlapping generations model in which the Friedman rule is known to be suboptimal are homomorphic. We also discuss the importance of whether or not the economy has an initial date for this result.
    Keywords: Friedman rule; monetary policy; overlapping generations; turnpike.
    JEL: E31 E51 E58
    Date: 2004–12–21
  17. By: Bianca De Paoli
    Abstract: This paper characterizes welfare in a small open economy and derives the optimal monetarypolicy rule. It shows that the utility-based loss function for a small open economy is aquadratic expression on domestic inflation, the output gap and the real exchange rate. Incontrast to previous works, this paper demonstrates that a small open economy, completelyintegrated with the rest of the world, should be concerned about exchange rate variability.Therefore, the optimal policy in a small open economy is not isomorphic to a closed economyand does not prescribe a pure floating exchange rate regime. Domestic inflation targeting isoptimal only under a particular parameterization, where the only relevant distortion in theeconomy is price stickiness. When inefficient steady state output and trade imbalances arepresent, exchange rate targeting arises as part of the optimal monetary plan.
    Keywords: Welfare, Optimal Monetary Policy, Small Open Economy
    JEL: F41 E52 E58 E61
    Date: 2004–05
  18. By: Peter Lildholdt; Anne Vila Wetherilt
    Abstract: This paper examines the question of whether the ability of market interest rates to predict future policy rate changes in the United Kingdom has changed markedly over the period 1975-2003. Such improvements in predictability could arise from greater transparency in the monetary policy process, together with greater credibility of the Bank of England. Empirical tests, using a simple term structure model, show that predictability has indeed improved over the sample period as a whole, and most markedly after the introduction of inflation targeting in 1992. But closer inspection of the data reveals that predictability did not rise smoothly over time, nor is it possible to generalise this result across maturities. Furthermore, attempts to identify structural breakpoints in a formal way were on the whole unsuccessful. Nonetheless, the paper concludes that, over the longer sample period, the data show a clear improvement in the ability of market participants to predict policy rate changes by the Bank of England.
  19. By: Alan Mankikar; Jo Paisley
    Abstract: The term 'core inflation' is widely used by academics and central bankers. But despite its prevalence, there is neither a commonly accepted theoretical definition nor an agreed method of measuring it. The range of conceptual bases is potentially confusing, and can make the large number of available measures of core inflation difficult to interpret, particularly when they display different trends. Nevertheless, measures of core inflation can be helpful if they increase the signal to noise ratio in measured inflation. This paper examines a range of measures of core inflation for the United Kingdom, both conceptually and empirically, setting out their motivation and highlighting their potential limitations. No single measure performs well across the board, but a compromise conclusion on the usefulness of measures of core inflation is that each one may provide a different insight into the inflation process. There can be value in looking at a range of measures, as long as one bears in mind what information each type of indicator is best at providing. When all measures are giving the same message then, in a sense, monetary policy makers can reasonably consider that these measures are providing a reliable guide to inflationary pressures. It is when the measures start to diverge that policymakers need to take a much closer look at the reasons for those divergences.

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