nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒01‒23
twelve papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Changes in the Federal Reserve’s Inflation Target: Causes and Consequences By Peter N. Ireland
  2. Persistence and the Role of Exchange Rate and Interest Rate Inertia in Monetary Policy By 300
  4. Optimal Monetary Policy Rules, Asset Prices and Credit Frictions By Ester Faia; Tommaso Monacelli
  5. Modelling UK Inflation: Persistence, Seasonality and Monetary Policy By D R Osborn; M Sensier
  6. Interest Rate, Inflation, and Housing Price: With an Emphasis on Chonsei Price in Korea By Dongchul Cho
  7. How Do Monetary and Fiscal Policy Interact in the European Monetary Union? By Matthew B. Canzoneri; Robert E. Cumby; Behzad T. Diba
  8. A Monetary Policy Rule for Automatic Prevention of a Liquidity Trap By Bennett T. McCallum
  9. THE INFLATION IN EUROPEAN UNION By Giovanis Elephtherios
  11. Price Indeterminacy Reinvented: Pegging Interest Rates While Targeting Prices, Inflation, or Nominal Income By David Eagle
  12. Pricing behavior and the introduction of the euro: evidence from a panel of restaurants By Eugenio Gaiotti; Francesco Lippi

  1. By: Peter N. Ireland (Boston College)
    Abstract: This paper estimates a New Keynesian model to draw inferences about the behavior of the Federal Reserve’s unobserved inflation target. The results indicate that the target rose from 1 1/4 percent in 1959 to over 8 percent in the mid-to-late 1970s before falling back below 2 1/2 percent in 2004. The results also provide some support for the hypothesis that over the entire postwar period, Federal Reserve policy has systematically translated short-run price pressures set off by supply-side shocks into more persistent movements in inflation itself, although considerable uncertainty remains about the true source of shifts in the inflation target.
    Keywords: inflation target, new Keynesian model, supply shocks, inflation
    JEL: E31 E32 E52
    Date: 2005–01–14
  2. By: 300
    Abstract: In a general equilibrium model, this paper investigates the importance of the exchange rate and the interpretation of the observed inertia in the policy interest rate. We derive an optimizing macroeconomic model that features habit formation in the consumer's utility function and uses a hybrid New Keynesian Phillips curve with inflation inertia. As a consequence, aggregate demand and supply shocks will have a persistent effect on output and inflation. In this framework, we assess the performance of simple, and perhaps non-optimal, interest rate rules under different degrees of habit formation and inflation persistence. We conclude that a policy rule that responds to expected inflation, as well as to output and the exchange rate, is able to reduce output and inflation volatility in the face of aggregate demand and foreign inflation shocks. This result must be interpreted with caution, because, as is found in other studies, i) the reduction in volatility is marginal and ii) the Taylor-type policy rule assessed here may be a restrictive one and, as mentioned before, non-optimal. On the other hand, the gains from adopting an inertial interest rate rule are directly related to the degree of inflation persistence in the model. In particular, when the degree of inflation persistence is high, an inertial policy rule attenuates the impacts that supply shocks have on inflation and the interest rate.
    Date: 2004–12
  3. By: Somnath Chatterjee
    Abstract: The purpose of this paper is to see how the term structure of interest rates has evolved in the sterling and euro treasury bond markets over the period 1999-2003. German bonds have been used as a proxy for euro-denominated bonds. A state-space representation for the single-factor Cox, Ingersoll and Ross (1985) model is employed to analyse the intertemporal dynamics of the term structure. Quasi-maximum likelihood estimates of the model parameters are obtained by using the Kalman filter to calculate the likelihood function. Results of the empirical analysis show that while the unobserved instantaneous interest rate exhibits mean reverting behaviour in both the UK and Germany, the mean reversion of the interest rate process has been relatively slower in the UK. The volatility component, which shocks the process at each step in time is also higher in the UK as compared to Germany.
  4. By: Ester Faia; Tommaso Monacelli
    Abstract: We study optimal monetary policy in two prototype economies with sticky prices and credit market frictions. In the first economy, credit frictions apply to the financing of the capital stock, generate acceleration in response to shocks and the ”financial markup” (i.e., the premium on external funds) is countercyclical and negatively correlated with the asset price. In the second economy, credit frictions apply to the flow of investment, generate persistence, and the financial markup is procyclical and positively correlated with the asset price. We model monetary policy in terms of welfare-maximizing interest rate rules. The main finding of our analysis is that strict inflation stabilization is a robust optimal monetary policy prescription. The intuition is that, in both models, credit frictions work in the direction of dampening the cyclical behavior of inflation relative to its credit-frictionless level. Thus neither economy, despite yielding different inflation and investment dynamics, generates a trade-off between price and financial markup stabilization. A corollary of this result is that reacting to asset prices does not bear any independent welfare role in the conduct of monetary policy.
  5. By: D R Osborn; M Sensier
    Abstract: This paper studies monthly RPIX inflation in the UK in the context of the change to inflation targeting in 1992. Our empirical models take account of the strong and changing seasonal pattern of inflation, while also focusing on inflation persistence and Phillips curve explanations. In both univariate and Phillips curve models, we find strong evidence of a change in parameters around the end of 1992, at the time of the introduction of inflation targeting. All models point to a substantial decline in inflation persistence after this date.
    Date: 2004
  6. By: Dongchul Cho
    Abstract: This paper discusses the relationship between interest rate and inflation rate on one part and the house price relative to chonsei price (up-front lump-sum deposit from the tenant to the owner for the use of the property with no additional requirement for periodic rent payments) on the other. The key point of the paper is that the relative price of sales to chonsei depends on the ratio of inflation to real interest rate, and thus even when the monetary authority maintains a pre-announced target level of inflation rate, the relative price of sales to chonsei rises if the real interest rate is lowered. This finding seems to help understand the recent hikes of the house prices despite the stabilizing chonsei prices. Recognizing this relationship, it may be sensible to lower the target inflation rate in an economy where real interest rates permanently decline, if the society wishes to reduce its adverse effect on the wealth distribution between house owners and chonsei tenants.
    JEL: R2 E4 E1
    Date: 2005–01
  7. By: Matthew B. Canzoneri; Robert E. Cumby; Behzad T. Diba
    Abstract: Formation of the Euro area raises new questions about the coordination of monetary and fiscal policy. Using a New Neoclassical Synthesis (NNS) model, we show that a common monetary policy, responding to area-wide aggregates, has asymmetric effects on countries within the union, depending on whether they are large or small, or whether they have high or low debts. We analyze the implications of these asymmetries for the various countries welfare and for their fiscal policies. We also study rules for setting national tax and spending rates, rules that constrain movements in the deficit to GDP ratio. We ask whether these rules are necessary for the common monetary policy to be able to harmonize national inflation rates, and we analyze their effects on national welfare. We also discuss some potential failings of our model (and perhaps NNS models generally); in particular, our model%u2019s variance decompositions suggest that productivity shocks may play an inordinately large role, while fiscal shocks (or demand shocks generally) may play too small a role (even when 'rule of thumb' spenders are added).
    JEL: E63 F33
    Date: 2005–01
  8. By: Bennett T. McCallum
    Abstract: In analyses of "liquidity trap" problems associated with the zero lower bound (ZLB) on nominal interest rates, it is important to emphasize the difference between policy rule changes, intended to help escape an existing ZLB situation, and maintained policy rules designed so as to avoid ZLB situations. Analysis assuming that rule changes would lead to a new RE equilibrium immediately seems implausible. Accordingly, the paper focuses on the design of a rule that should retain stabilization effectiveness even if the economy is temporarily shocked into a ZLB situation. The rule considered is one that uses as its instrument variable a weighted average of an interest rate and the rate of depreciation of the nominal exchange rate. With a small weight attached to the depreciation term, it will be nearly irrelevant in normal situations but call for strong adjustments when the ZLB condition prevails. Stabilizing properties of this "MC" rule are studied within a small open economy model developed by McCallum and Nelson. Results indicate that under ZLB conditions the MC rule will provide strong stabilizing policy actions yet, under conditions such that the ZLB constraint is not relevant, the MC rule need not hinder monetary policy.
    JEL: E52 E3 F41
    Date: 2005–01
  9. By: Giovanis Elephtherios (University of Thessaly)
    Abstract: The significance of stability of P.C.I. (Price consumer index) is reported in the situation of economy in which the price consumer index does not present tendencies of important change so much to inflation,- as down,- deflation. This is also the aim of E.E. (European Union), to maintain in a constant level the price consumer index. In this article we will present a model of forecast of inflation of E.E. in the 15 states, with result the possibility that is given to us to be able forecast with a great precision the inflation of separately states which it helps us to forecast also the inflation of E.E. of the 15 and to take in a short time the essential measures of economic policy, those who from them are feasible and to deter undesirable situations.
    Keywords: basic ecocometrics forecasting
    JEL: C
    Date: 2005–01–16
  10. By: Edgar L. Feige (University of Wisconsin-Madison)
    Abstract: One of the more intractable problems in the area of monetary economics is the measurement of cash payments. Whereas the stock of currency in circulation [C] is well defined and readily measured, the transactions velocity of currency [Vc] (the average number of times currency turns over in any given period) is difficult to measure. This paper examines alternative methods for estimating the average velocity of currency and the denomination specific velocity of cash employing data for the Netherlands. Estimates of the volume of cash payments are necessary to meaningfully measure the volume of total payments [MV] in an economy and hence, the total volume of transactions [PT]. Once the volume of cash payments is known, it is possible to employ Fisher’s equation of exchange [MV=PT] as a more general conceptual and empirical alternative to Keynes’ more limited income-expenditure [Y= C+I+G] identity.
    Keywords: Cash payments, Velocity of currency, Equation of exchange, total transactions, underground economy.
    JEL: E1 E4 E5 B4
    Date: 2005–01–20
  11. By: David Eagle (Eastern Washington University)
    Abstract: Contrary to Sargent and Wallace (1975), a central bank’s use of an interest-rate instrument does determine prices when the central bank pursues either a short-term or long-term price target. However, in order for a central bank’s pursuit of a long-term price target to be credible, the public still needs something like a Taylor or McCallum-Woodford rule. The use of an interest-rate instrument also determines prices when the central bank targets nominal income in either the short-term or long-term. However, if the central bank targets interest rates in the short term with a long-term inflation target, then prices are indeterminate.
    Keywords: price indeterminancy, pegging interest rates, inflation targeting, nominal-income targeting, nominal-aggregate-demand targeting, price-level targeting
    JEL: E
    Date: 2005–01–20
  12. By: Eugenio Gaiotti (Banca d'Italia); Francesco Lippi (Banca d'Italia)
    Abstract: This paper assembles an original panel of data from 2,500 restaurants in Italy over the 1998-2004 period. The main objective is to study whether the euro cash changeover had an impact on individual pricing behavior, as it seems to be perceived by consumers. Although the sample is not representative of the whole sector, our interest stems from the possibility of gaining deeper insights from individual data, as well as from the fact that restaurant prices were at the center of the public discussion. First, the paper analyzes the distribution of price changes in several years, to identify what features may contribute to explain the widespread perception of a large effect of the introduction of the euro on prices. Second, the paper discusses the economic mechanisms which may help explaining the impact of the cash changeover on prices. The data show that restaurant prices recorded sizeable increases in both 2001 and 2002 (around 10 and 9 per cent, respectively). The cumulated increase in the price of a meal between 1998 and 2003 is substantial (the index rises by 40 per cent). The changeover might have focussed the public attention over this medium-run trend, prompting the attribution of the whole increase to the introduction of the euro. The analysis suggests that such increases reflect in part unfavorable developments on the costs side (strong increases in unit labor costs and fresh food inputs in both years) and strong increases in demand (especially in 2001). Part of the restaurant price increase recorded in 2002, however, does seem ascribable to the effect of the changeover. We find evidence consistent with a “menu-cost” hypothesis for pricing behavior: the rise in the average meal price is mainly due to a greater fraction of agents who revise their price, rather than to greater individual price revisions. Moreover, more market power (as proxied by a local concentration index) is associated with greater than average price increases during the changeover. A simple interpretation is proposed for this finding, which may also explain why the effects of the cash changeover may have been especially pronounced in this industry as opposed to more competitive ones.
    Keywords: euro cash changeover; menu cost
    JEL: E
    Date: 2005–01–20

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