nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒02‒13
thirty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Interest Rate Determination in the Interbank Market By Gaspar, Vítor; Pérez-Quirós, Gabriel; Rodriguez, Hugo
  2. The Term Structure of Real Rates and Expected Inflation By Ang, Andrew; Bekaert, Geert
  3. Deflationary Bubbles By Buiter, Willem H; Sibert, Anne
  4. Price Clustering in the FX Market: A Disaggregate Analysis Using Central Bank Intervention By Fischer, Andreas M
  5. Monetary Policy in an Estimated Open-Economy Model with Imperfect Pass-Through By Lindé, Jesper; Nessen, Marianne; Söderström, Ulf
  6. Has the Transmission Mechanism of European Monetary Policy Changed in the Run-Up to EMU? By Ciccarelli, Matteo; Rebucci, Alessandro
  7. Exchange Rates and Inflation Under EMU: An Update By Honohan, Patrick; Lane, Philip R.
  8. Optimal Monetary Policy Under Discretion with a Zero Bound on Nominal Interest Rates By Adam, Klaus; Billi, Roberto M
  9. Federal Funds Rate Prediction By Sarno, Lucio; Thornton, Daniel L; Valente, Giorgio
  10. Optimal Monetary Policy with Imperfect Common Knowledge By Adam, Klaus
  11. Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank By Jeanne, Olivier; Svensson, Lars E O
  12. Money Market Pressure and the Determinants of Banking Crises By Ho, Tai-Kuang; von Hagen, Jürgen
  13. Optimal Operational Monetary Policy in the Christiano-Eichenbaum-Evans Model of the US Business Cycle By Schmitt-Grohé, Stephanie; Uribe, Martin
  14. Monetary and Exchange Rate Policy in Korea: Assessments and Policy Issues By Eichengreen, Barry
  15. Monetary Magic? How the Fed Improved the Flexibility of the Economy By Bayoumi, Tamim; Sgherri, Silvia
  16. Bank Loan Components and the Time-Varying Effects of Monetary Policy Shocks By Den Haan, Wouter; Sumner, Steven; Yamashiro, Guy
  17. Banks' Loan Portfolio and the Monetary Transmission Mechanism By Den Haan, Wouter; Sumner, Steven; Yamashiro, Guy
  18. The Elusive Welfare Economics of Price Stability As A Monetary Policy Objective: Should New Keynesian Central Bankers Persue Price Stability By Buiter, Willem H
  19. Caution or Activism? Monetary Policy Strategies in an Open Economy By Ellison, Martin; Sarno, Lucio; Vilmunen, Jouko
  20. Real Determinacy with Nominal Assets By Pradeep Dubey; John Geanakoplos
  21. On the Optimality of Decisions made by Hub-and-Spokes Monetary Policy Committees By Jan Marc Berk; Beata K. Bierut
  22. The Predictive Power of the Yield Spread: Further Evidence and a Structural Interpretation By Carlo Favero; Iryna Kaminska; Ulf Soderstrom
  23. Money Growth and Interest Rates By Seok-Kyun Hur
  24. Monetary Policy, Asset-Price Bubbles and the Zero Lower Bound By Tim Robinson; Andrew Stone
  25. Inflation Persistence and Exchange Rate Regimes: Evidence from Developing Countries By Manuela Francisco; Michael Bleaney
  26. Understanding the Stock Market's Response to Monetary Policy Shocks By Johann Scharler
  27. Explaining the forward interest rate term structure By Jean-Philippe Bouchaud; Andrew Matacz
  28. An empirical investigation of the forward interest rate term structure By Jean-Philippe Bouchaud; Andrew Matacz
  29. Phenomenology of the interest rate curve By Marc Potters; Jean-Philippe Bouchaud; Rama Cont; Nicolas Sagna; Nicole El-Karoui
  30. Money and the (C)CAPM: Theory and Evaluation By Ronald J. Balvers; Dayong Huang
  31. Optimal Monetary Policy in the Presence of Pricing-to-Market By Jochen Michaelis

  1. By: Gaspar, Vítor; Pérez-Quirós, Gabriel; Rodriguez, Hugo
    Abstract: The purpose of this Paper is to study the determinants of equilibrium in the market for daily funds. We use the EONIA panel database which includes daily information on the lending rates applied by contributing commercial banks. The data clearly shows an increase in both the time series volatility and the cross-section dispersion of rates towards the end of the reserve maintenance period. These increases are highly correlated. With respect to quantities, we find that the volume of trade as well as the use of the standing facilities is also larger at the end of the maintenance period. Our theoretical model shows how the operational framework of monetary policy causes a reduction in the elasticity of the supply of funds by banks throughout the reserve maintenance period. This reduction in the elasticity together with market segmentation and heterogeneity are able to generate distributions for the interest rates and quantities traded with the same properties as in the data.
    Keywords: Eonia panel; monetary policy instruments; overnight interest rate
    JEL: E52 E58
    Date: 2004–08
  2. By: Ang, Andrew; Bekaert, Geert
    Abstract: Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, time-varying prices of risk and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve is fairly flat at 1.44%, but slightly humped. In one regime, the real term structure is steeply downward sloping. Real rates (nominal rates) are pro-cyclical (counter-cyclical) and inflation is negatively correlated with real rates. An inflation risk premium that increases with the horizon fully accounts for the generally upward sloping nominal term structure. We find that expected inflation drives about 80% of the variation of nominal yields at both short and long maturities, but during normal times, all of the variation of nominal term spreads is due to expected inflation and inflation risk.
    Date: 2004–08
  3. By: Buiter, Willem H; Sibert, Anne
    Abstract: We analyse deflationary bubbles in a model where money is the only financial asset. We show that such bubbles are consistent with the household’s transversality condition if and only if the nominal money stock is falling. Our results are in sharp contrast to those in several prominent contributions to the literature, where deflationary bubbles are ruled out by appealing to a non-standard transversality condition, originally due to Brock ([4], [5]). This condition, which we dub the GABOR condition, states that the consumer must be indifferent between reducing his money holdings by one unit and leaving them unchanged and enjoying the discounted present value of the marginal utility of that unit of money forever. We show that the GABOR condition is not part of the necessary and sufficient conditions for household optimality nor is it sufficient to rule out deflationary bubbles. Moreover, it rules out Friedman’s optimal quantity of money equilibrium and, when the nominal money stock is falling, it rules out deflationary bubbles that are consistent with household optimality. We also consider economies with real and nominal government debt and small open economies where private agents can lend to and borrow from abroad. In these cases, deflationary bubbles may be possible, even when the nominal money stock is rising. Their existence is shown to depend on the rules governing the issuance of government debt.
    Keywords: fiscal rules; government solvency; optimal quantity of money; transversality condition
    JEL: D90 E31 E63
    Date: 2004–08
  4. By: Fischer, Andreas M
    Abstract: Price clustering is a well-documented regularity of foreign exchange transactions. In this Paper, I present new empirical evidence of price clustering for central bank interventions. A feature of the price clustering in Swiss National Bank (SNB) transactions is market dependency. Evidence of clustering in the broker market is considerably smaller than in the dealer market. The empirical analysis for Swiss interventions uses a disaggregate approach to test the hypothesis whether intervention strategy matters. The most important determinants of price clustering are bank size and transaction volume. While the regression evidence for customer transactions is consistent with the efficiency hypothesis, the clustering results for intervention trades are not influenced by the SNB’s intervention tactics.
    Keywords: Central Bank Interventions; Clustering; E33; Intervention Strategy
    JEL: E31
    Date: 2004–08
  5. By: Lindé, Jesper; Nessen, Marianne; Söderström, Ulf
    Abstract: We develop a structural model of a small open economy with gradual exchange rate pass-through and endogenous inertia in inflation and output. We then estimate the model by matching the implied impulse responses with those obtained from a VAR model estimated on Swedish data. Although our model is highly stylized it captures very well the responses of output, domestic and imported inflation, the interest rate, and the real exchange rate. In order to account for the observed persistence in the real exchange rate and the large deviations from UIP, however, we need a large and volatile premium on foreign exchange.
    Keywords: calibration; estimation; new open-economy macroeconomics; structural open-economy model
    JEL: E52 F31 F41
    Date: 2004–08
  6. By: Ciccarelli, Matteo; Rebucci, Alessandro
    Abstract: This Paper studies empirically the transmission mechanism of European monetary policy by means of time-varying, heterogenous coefficient models estimated in a numerical Bayesian fashion. Based on pre-EMU evidence from Germany, France, Italy, and Spain, we find that (i) the long-run cumulative impact on output of a common, homoskedastic monetary policy shock has decreased in all countries after 1991. These declines are statistically significant and accompanied by some changes in the conduct of monetary policy over the same period. At the same time, we also find that (ii) cross-country differences in the effects of the shock analysed have not decreased over time.
    Keywords: Bayesian estimation; european monetary policy; Gibbs sampling; time-varying coefficient model; transmission mechanism
    JEL: C11 C33 E52
    Date: 2004–09
  7. By: Honohan, Patrick; Lane, Philip R.
    Abstract: In our recent Economic Policy article (Honohan and Lane, 2003), we argued that the strength of the US dollar 1999-2001 had an important impact on inflation divergence within the EMU and in particular the surge in Ireland’s inflation to over 7%. This hypothesis has been subjected to a grueling out-of-sample test: would the dollar’s subsequent weakness contribute to inflation convergence and in particular to a fall in Irish inflation? Fortunately for us, the theory has passed the test with flying colours. Irish inflation stopped dead in its tracks: consumer prices were unchanged between May and November of 2003. Regression analysis on quarterly inflation data across EMU members 1999.1-2004.1 confirms the importance of the exchange rate channel, although pinning down the exact dynamic specification will require a further span of data.
    Keywords: EMU; exchange rates; inflation
    JEL: E31 E42 F41
    Date: 2004–08
  8. By: Adam, Klaus; Billi, Roberto M
    Abstract: We determine optimal discretionary monetary policy in a New Keynesian model when nominal interest rates are bounded below by zero. Nominal interest rates should be lowered faster in response to adverse shocks than in the case without bound. Such ‘pre-emptive easing’ is optimal because expectations of a possibly binding bound in the future amplify the effects of adverse shocks. Calibrating the model to the US economy we find the easing effect to be quantitatively important. Moreover, the lower bound binds rather frequently and imposes significant welfare losses. Losses increase further when inflation is partly determined by lagged inflation in the Phillips curve. Targeting positive inflation rates reduces the frequency of a binding lower bound, but tends to reduce welfare compared to a target rate of zero. The welfare gains from policy commitment, however, appear significant and are much larger than in the case without lower bound.
    Keywords: C63; liquidity trap; nonlinear policy; zero lower bound
    JEL: E31 E52
    Date: 2004–08
  9. By: Sarno, Lucio; Thornton, Daniel L; Valente, Giorgio
    Abstract: We examine the forecasting performance of a range of time-series models of the daily US effective federal funds (FF) rate recently proposed in the literature. We find that: (i) most of the models and predictor variables considered produce satisfactory one-day-ahead forecasts of the FF rate; (ii) the best forecasting model is a simple univariate model where the future FF rate is forecast using the current difference between the FF rate and its target; (iii) combining the forecasts from various models generally yields modest improvements on the best performing model. These results have a natural interpretation and clear policy implications.
    Keywords: E47; federal fund rate; forecasting; nonlinearity; term structure
    JEL: E43
    Date: 2004–09
  10. By: Adam, Klaus
    Abstract: This Paper studies optimal nominal demand policy in a flexible price economy with monopolistic competition and inattentive firms (Shannon). Inattentiveness gives rise to idiosyncratic information errors and imperfect common knowledge about the shocks hitting the economy. Strategic complementarities in the price-setting game between firms then strongly amplify the effects of information frictions and the real effects of monetary policy. Therefore, strategic complementarities make it optimal to stabilize the output gap by nominally accommodating shocks to firms’ desired mark-up. As mark-up shocks become more persistent, however, optimal policy is again increasingly characterized by price level stabilization. Shocks to the natural rate of output are found not to generate a policy trade-off.
    Keywords: information imperfections; nominal demand management; Private information; rational inattention; Shannon capacity
    JEL: D82 E31 E52
    Date: 2004–09
  11. By: Jeanne, Olivier; Svensson, Lars E O
    Abstract: An independent central bank can manage its balance sheet and its capital so as to commit itself to a depreciation of its currency and an exchange-rate peg. This way, the central bank can implement the optimal escape from a liquidity trap, which involves a commitment to higher future inflation. This commitment mechanism works even though, realistically, the central bank cannot commit itself to a particular future money supply. It supports the feasibility of Svensson’s Foolproof Way to escape from a liquidity trap.
    Keywords: deflation; zero lower bound for interest rates
    JEL: E52 F31 F41
    Date: 2004–09
  12. By: Ho, Tai-Kuang; von Hagen, Jürgen
    Abstract: Identifying banking crises is the first step in the research on determinants of banking crises. The prevailing practice is to employ market events to identify a banking crisis. Researchers justify the usage of this method on the grounds that either direct and reliable indicators of banks’ assets quality are not available, or that withdrawals of bank deposits are no longer a part of financial crises in a modern financial system with deposits insurance. Meanwhile, most researchers also admit that there are inherent inconsistency and arbitrariness associated with the events method. This paper develops an index of money market pressure to identify banking crises. We define banking crises as periods in which there is excessive demand for liquidity in the money market. We begin with the theoretical foundation of this new method and show that it is desirable, and also possible, to depend on a more objective index of money market pressure rather than market events to identify banking crises. This approach allows one to employ high frequency data in regression, and avoid the ambiguity problem in interpreting the direction of causality that most banking literature suffers. Comparing the crises dates with existing research indicates that the new method is able to identify banking crises more accurately than the events method. The two components of the index, changes in central bank funds to bank deposits ratio and changes in short-term real interest rate, are equally important in the identification of banking crises. Bank deposits, combined with central bank funds, provide valuable information on banking distress. With the newly defined crisis episodes, we examine the determinants of banking crises using data complied from 47 countries. We estimate conditional logit models that include macroeconomic, financial, and institutional variables in the explanatory variables. The results display similarities to and differences with existing research. We find that slowdown of real GDP, lower real interest rates, extremely high inflation, large fiscal deficits, and over-valued exchange rates tend to precede banking crises. The effects of monetary base growth on the probability of banking crises are negligible.
    Keywords: conditional logit model; events method; identification of banking crises; index of money market pressure
    JEL: C43 E44 G21
    Date: 2004–10
  13. By: Schmitt-Grohé, Stephanie; Uribe, Martin
    Abstract: This Paper identifies optimal interest-rate rules within a rich, dynamic, general equilibrium model that has been shown to account well for observed aggregate dynamics in the post-war United States. We perform policy evaluations based on second-order accurate approximations to conditional and unconditional expected welfare. We require that interest-rate rules be operational, in the sense that they include as arguments only a few readily observable macroeconomic indicators and respect the zero bound on nominal interest rates. We find that the optimal operational monetary policy is a real-interest-rate targeting rule. That is, an interest-rate feedback rule featuring a unit inflation coefficient, a mute response to output, and no interest-rate smoothing. Contrary to existing studies, we find a significant degree of optimal inflation volatility. A key factor driving this result is the assumption of indexation to past inflation. Under indexation to long-run inflation the optimal inflation volatility is close to zero. Finally, we show that initial conditions matter for welfare rankings of policies.
    Keywords: business cycles; inflation stabilization; monetary policy evaluation
    JEL: E52 E61 E63
    Date: 2004–10
  14. By: Eichengreen, Barry
    Abstract: This Paper considers monetary and exchange rate policy in Korea since the financial crisis of 1997-98. The Bank of Korea has adopted much of the apparatus of inflation targeting, with a band for target inflation and a Monetary Policy Report to the National Assembly. This regime has served the country well. But neither the Bank’s publications nor the statements of its Monetary Policy Committee make more than passing reference to the exchange rate. It would be surprising if in fact the exchange rate played little role in conduct of monetary policy, for in an economy as open and sensitive to foreign trade and investment as Korea, currency movements contain information useful for forecasting inflation and the output gap. My findings suggest that the Bank of Korea does care about the exchange rate – and not only because it movements provide information relevant for the inflation forecast. In addition, the central bank responds to movements in the exchange rate for other reasons, like its implications for the balance of investment in traded and nontraded goods and its implications for financial stability. My recommendations are thus for more clarity on the role of the exchange rate in the formulation and conduct of monetary policy. In particular, if the members of the Monetary Policy Committee are attentive to exchange rate movements, which is what is suggested by the evidence presented here, and especially if they care about such movements for reasons not limited to the utility of that variable for forecasting future inflation, then they should acknowledge this in their monthly press releases communicating the rationale for their decisions to the public and the markets.
    Keywords: exchange rate; inflation targeting; monetary policy; South Korea
    JEL: F10
    Date: 2004–10
  15. By: Bayoumi, Tamim; Sgherri, Silvia
    Abstract: Extending recent theoretical contributions on sources of inflation inertia, we argue that monetary policy uncertainty helps determine the sluggish adjustment of expectations to nominal disturbances. Estimating a model in which rational individuals learn over time about shifts in US monetary policy and the Phillips curve, we find strong evidence that this link exists. These results question the standard approach for evaluating monetary rules by assuming unchanged private sector responses, help clarify the role of monetary stability in reducing output variability in the US and elsewhere, and tell a subtle and dynamic story of the interaction between monetary policy and the supply-side of the economy.
    Keywords: inflation dynamics; Kalman filter; monetary policy
    JEL: C51 E31 E52
    Date: 2004–10
  16. By: Den Haan, Wouter; Sumner, Steven; Yamashiro, Guy
    Abstract: A robust finding for both small and large banks is that in response to a monetary tightening, real estate and consumer loans decrease while C&I loans increase. We also show that in a standard log-linear VAR the impulse response function of an aggregate variable is time varying. The finding that loan components move in opposite directions and the property that the impulse response of total loans is time-varying explain why studies that use total loans have had such a hard time finding a robust response of bank loans to a monetary tightening.
    Keywords: impulse response functions; small and large banks; VAR
    JEL: E40
    Date: 2004–11
  17. By: Den Haan, Wouter; Sumner, Steven; Yamashiro, Guy
    Abstract: This Paper compares the responses of bank loan components to a monetary tightening with the responses to negative output shocks. Real estate and consumer loans sharply decrease during a monetary tightening but not after a negative output shock. In contrast, C&I loans (and commercial paper) sharply decrease in response to output shocks, but not in response to a monetary tightening. These results are difficult to reconcile with a bank-lending channel of monetary transmission, in which the supply of commercial and industrial (C&I) loans is constrained. Hedging and bank capital regulation provide reasons why banks may want to substitute out of real estate and consumer loans, and into C&I loans during periods of high interest rates.
    Keywords: bank capital regulation; hedging; interest rates
    JEL: E40
    Date: 2004–11
  18. By: Buiter, Willem H
    Abstract: The Paper studies the inflation rate associated with optimal monetary policy in a standard suite of DSGE models, when fiscal policy is either unrestricted optimal or restricted but supportive of monetary policy. Full nominal price flexibility, nominal prices set one period in advance and Calvo-style staggered overlapping price contracts with a variety of indexation rules for constrained price setters are considered. For all price setting models, optimal monetary policy implements the Bailey-Friedman Optimal Quantity of Money (OQM) rule: the pecuniary opportunity cost of holding money is equal to zero. There is an optimal inflation rate for producer prices in the Calvo model, given by the 'core inflation' process generated by the indexation rule of the constrained price setters. It is constant only if core inflation is constant. A zero rate of producer price inflation is necessary for optimality in the Calvo model, only if all of the following conditions hold. (1) There is no money or the nominal interest rate on money can be set freely. (2) The constrained price setters of the Calvo model implement an ill-posed, arbitrary price indexation rule, such as the lagged partial indexation rule used by Woodford to make a case for price stability. (3) The authorities use neither their tax instruments nor the nominal interest rate to validate the core inflation process. These results are global – they do not depend on linear approximations at a deterministic, zero-inflation steady state.
    Keywords: dsge; inflation targeting; monetary and fiscal stabilization policy; New Keynesian macroeconomics; nominal price rigidities
    JEL: E30 E40 E50 E60
    Date: 2004–11
  19. By: Ellison, Martin; Sarno, Lucio; Vilmunen, Jouko
    Abstract: We examine optimal policy in a two-country model with uncertainty and learning, where monetary policy actions affect the real economy through the real exchange rate channel. Our results show that whether policy should be cautious or activist depends on the size of one country relative to another. If one country is small relative to the other then activism is optimal. In contrast, if the two countries are equal sized then caution prevails. Caution is induced in the latter case because of the interaction between the home and foreign central banks. In a two-country symmetric equilibrium, learning is shown to be detrimental to welfare, implying that optimal policy is cautious.
    Keywords: learning; monetary policy; open economy
    JEL: E52 E58 F41
    Date: 2004–11
  20. By: Pradeep Dubey (SUNY, Stony Brook); John Geanakoplos (Cowles Foundation, Yale University)
    Abstract: We build a finite horizon model with inside and outside money, in which interest rates, price levels and commodity allocations are determinate, even though asset markets are incomplete and asset deliveries are purely nominal.
    Keywords: Central bank, Inside money, Outside money, Incomplete assets, Monetary equilibrium, Real determinacy
    JEL: D50 E40 E50 E58
    Date: 2003–06
  21. By: Jan Marc Berk; Beata K. Bierut
    Abstract: Most monetary policy committees decide on interest rates using a simple majority voting rule. Given the inherent heterogeneity of committee members, this voting rule is suboptimal in terms of the quality of the interest rate decision, but popular for other (political) reasons. We show that a clustering of committee members into two subgroups, as is the case in hub-and-spokes systems of central banks (e.g. the Fed or the ESCB), can eliminate this inefficiency whilst retaining the simple majority voting rule.
    JEL: D71 D78 E58
    Date: 2005–02
  22. By: Carlo Favero; Iryna Kaminska; Ulf Soderstrom
    Abstract: This paper brings together two strands of the empirical macro literature:the reduced-form evidence that the yield spread helps in forecasting output and the structural evidence on the difficulties of estimating the effect of monetary policy on output in an intertemporal Euler equation. We show that including a short-term interest rate and inflation in the forecasting equation improves the forecasting performance of the spread for future output but the coefficients on the short rate and inflation are difficult to interpret using a standard macroeconomic framework. A decomposition of the yield spread into an expectations-related component and a term premium allows a better understanding of the forecasting model. In fact, the best forecasting model for output is obtained by considering the term premium, the short-term interest rate and inflation as predictors. We provide a possible structural interpretation of these results by allowing for time-varying risk aversion, linearly related to our estimate of the term premium, in an intertemporal Euler equation for output.
  23. By: Seok-Kyun Hur
    Abstract: Our paper explores a transmission mechanism of monetary policy through bond market. Based on the assumption of delayed responses of economic agents to monetary shocks, we derive a system of equations relating the term structure of interest rates with the past history of money growth rates and test the equations with the US data. Our results confirm that the higher ordered moments of money growth rate(converted from the past history of money growth rates) influence the yields of bonds with various maturities in different timing as well as in different magnitudes and monetary policy targeting a certain shape of the term structure of interest rates could be implemented with certain time lags due to path-dependency of interest rates.
    JEL: E43 E44 E52
    Date: 2005–02
  24. By: Tim Robinson; Andrew Stone
    Abstract: We use a simple model of a closed economy to study the recommendations of monetary policy-makers, attempting to respond optimally to an asset-price bubble whose stochastic properties they understand. We focus on the impact which the zero lower bound (ZLB) on nominal interest rates has on the recommendations of such policy-makers. For a given target inflation rate, we identify several different forms of `insurance' which policy-makers could potentially take out against encountering the ZLB due to the future bursting of a bubble. Even with perfect knowledge of the bubble process, however, which of these will be optimal varies from one type of bubble to another and, for certain bubbles, from one period to the next. It is therefore difficult to say whether the ZLB should cause policy-makers to operate policy more tightly or loosely than they would otherwise do, while a bubble is growing -- even after abstracting from the informational difficulties they face in practice. We also examine the implications of the ZLB for policy-makers' preferences as to their inflation target. Policy-makers who wish to avoid concerns about the ZLB should take care not to set too low a target -- especially if the neutral real interest rate is low.
    JEL: E32 E52 E60
    Date: 2005–02
  25. By: Manuela Francisco (Universidade do Minho); Michael Bleaney (University of Nottingham)
    Abstract: Using data for 102 developing countries, it is shown that inflation persistence is particularly high in countries with severe inflationary problems, and particularly low in countries on hard pegs. Inflation persistence is similar under floating and soft pegs.
    Keywords: Inflation, persistence, exchange rates
    JEL: E31 F41
    Date: 2005
  26. By: Johann Scharler (Oesterreichische Nationalbank, Economic Analysis Division)
    Abstract: This paper explores whether a limited participation model of the monetary transmission mechanism can account for the observed re- sponse of stock market returns to monetary policy shocks. It is found that the model generates responses that broadly match the empiri- cal counterparts, although the magnitudes are somewhat too small. Moreover, the results suggest that the increased exposure of bank- dependent ¯rms to liquidity shocks cannot fully account for the het- erogenous responses of returns that are observed across ¯rms.
    Keywords: limited participation, asset pricing, stock market
    JEL: E4 E5 G1
    Date: 2004–12–29
  27. By: Jean-Philippe Bouchaud (Science & Finance, Capital Fund Management; CEA Saclay;); Andrew Matacz (Science & Finance, Capital Fund Management)
    Abstract: We present compelling empirical evidence for a new interpretation of the Forward Rate Curve (FRC) term structure. We find that the average FRC follows a square-root law, with a prefactor related to the spot volatility, suggesting a Value-at-Risk like pricing. We find a striking correlation between the instantaneous FRC and the past spot trend over a certain time horizon. This confirms the idea of an anticipated trend mechanism proposed earlier and provides a natural explanation for the observed shape of the FRC volatility. We find that the one-factor Gaussian Heath-Jarrow-Morton model calibrated to the empirical volatility function fails to adequately describe these features.
    JEL: G10
  28. By: Jean-Philippe Bouchaud (Science & Finance, Capital Fund Management; CEA Saclay;); Andrew Matacz (Science & Finance, Capital Fund Management)
    Abstract: In this paper we study empirically the Forward Rate Curve (FRC) of 5 different currencies. We confirm and extend the findings of our previous investigation of the U.S. Forward Rate Curve. In particular, the average FRC follows a square-root law, with a prefactor related to the spot volatility, suggesting a Value-at-Risk like pricing. We find a striking correlation between the instantaneous FRC and the past spot trend over a certain time horizon, in agreement with the idea of an extrapolated trend effect. We present a model which can be adequately calibrated to account for these effects.
    JEL: G10
  29. By: Marc Potters (Science & Finance, Capital Fund Management); Jean-Philippe Bouchaud (Science & Finance, Capital Fund Management; CEA Saclay;); Rama Cont (Science & Finance, Capital Fund Management); Nicolas Sagna; Nicole El-Karoui
    Abstract: This paper contains a phenomenological description of the whole U.S. forward rate curve (FRC), based on an data in the period 1990-1996. We find that the average FRC (measured from the spot rate) grows as the square-root of the maturity, with a prefactor which is comparable to the spot rate volatility. This suggests that forward rate market prices include a risk premium, comparable to the probable changes of the spot rate between now and maturity, which can be understood as a `Value-at-Risk' type of pricing. The instantaneous FRC however departs form a simple square-root law. The distortion is maximum around one year, and reflects the market anticipation of a local trend on the spot rate. This anticipated trend is shown to be calibrated on the past behaviour of the spot itself. We show that this is consistent with the volatility `hump' around one year found by several authors (and which we confirm). Finally, the number of independent components needed to interpret most of the FRC fluctuations is found to be small. We rationalize this by showing that the dynamical evolution of the FRC contains a stabilizing second derivative (line tension) term, which tends to suppress short scale distortions of the FRC. This shape dependent term could lead, in principle, to arbitrage. However, this arbitrage cannot be implemented in practice because of transaction costs. We suggest that the presence of transaction costs (or other market `imperfections') is crucial for model building, for a much wider class of models becomes eligible to represent reality.
    JEL: G10
  30. By: Ronald J. Balvers (Division of Economics and Finance, West Virginia University); Dayong Huang (Division of Economics and Finance, West Virginia University)
    Abstract: We consider asset pricing in a monetary economy where liquid assets are held to lower transaction costs. The ensuing model extends the CAPM and the Consumption CAPM by deriving real money growth as an additional factor determining returns. Empirically, the unconditional version of this model compares favorably to other theoretical asset pricing models. Allowing for conditional variation in factor sensitivities improves model performance so the model performs as well as the a-theoretical Fama-French three factor model. The paper further introduces a technique that facilitates derivation of dynamic asset pricing results in discrete time by generalizing Stein’s Lemma to multivariate cases.
    Keywords: Asset Pricing, Money Supply Growth, Consumption CAPM, Stein’s Lemma
    JEL: G12
  31. By: Jochen Michaelis (Author-Workplace-Name: Department of Economics, University of Kassel)
    Abstract: This paper presents a general-equilibrium framework to revisit the issues of optimal monetary policies and international policy coordination in a two-country model, focusing on the role of a pricing-to-market (PTM) policy by firms. Both countries may be different with respect to PTM. Using the set-up developed by Corsetti and Pesenti (2001a) and Betts and Devereux (2000a,b), we show that (i) for a given Foreign monetary stance, a Home monetary expansion is beneficial for both countries only if Home PTM is at an intermediate range; (ii) in a world Nash equilibrium Home and Foreign welfare are bell-shaped in the degrees of PTM; (iii) relative welfare crucially depends on the degrees of PTM; (iv) there is a welfare gain from cooperation even in the cases of no and full PTM.
    Keywords: pricing to market, terms of trade, international coordination of monetary policies
    JEL: E40 F41 F42
    Date: 2004–11

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