nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒03‒20
fourteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary Policy under Model and Data-Parameter Uncertainty By Gino Cateau
  2. THE ROLE AND NATURE OF MARKET SENTIMENT IN THE 1992 ERM CRISIS By Oreste Napolitano; Alberto Montagnoli; Rosaria Rita Canale
  3. Inflation in open economies with complete markets By Marco Celentani; J. Ignacio Conde-Ruiz; Klaus Desmet
  4. Testing the BalassA-Samuelson hypothesis in two different groups of countries: OECD and Latin America By José García Solanes; Fernando Torrejón Flores
  5. Time Consistency of Fiscal and Monetary Policy: A Solution By Persson , Mats; Persson , Torsten; Svensson, Lars E.O.
  6. On the Link between Exchange-Rate Regimes and Monetary-Policy Autonomy: The European Experience By Forssbaeck, Jens; Oxelheim, Lars
  7. Some Further Evidence on Interest-Rate Smoothing: The Role of Measurement Errors in the Output Gap By Apel, Mikael; Jansson, Per
  8. Exchange Rates and Asymmetric Shocks in Small Open Economies By Alexius, Annika; Post, Erik
  9. Monetary Policies and Fiscal Policies in Emerging Markets By Ugo Panizza
  10. Self-Fulfilling Currency Crises: The Role of Interest Rates By Christian Hellwig; Arijit Mukherji; Aleh Tsyvinski
  11. Money Market Liquidity under Currency Board – Empirical Investigations for Bulgaria By Petar Chobanov; Nikolay Nenovsky
  12. Volatile Interest Rates, Volatile Crime Rates: A new argument for interest-rate smoothing By Garett Jones; Ali M. Kutan
  13. Beliefs about Exchange-Rate Stability: Survey Evidence From the Currency Board in Bulgaria By Neven T. Valev; John A. Carlson
  14. Stabilization via Currency Board By Jutta Maute

  1. By: Gino Cateau
    Abstract: Policy-makers in the United States over the past 15 to 20 years seem to have been cautious in setting policy: empirical estimates of monetary policy rules such as Taylor's (1993) rule are much less aggressive than those derived from optimizing models. The author analyzes the effect of an aversion to model and data-parameter uncertainty on monetary policy. Model uncertainty arises because a central bank finds three competing models of the economy to be plausible. Data uncertainty arises because real-time data are noisy estimates of the true data. The central bank explicitly models the measurement-error processes for both inflation and the output gap, and it acknowledges that it may not know the parameters of those processes precisely (which leads to data-parameter uncertainty). The central bank chooses policy according to a Taylor rule in a framework that allows an aversion to the distinct risk associated with multiple models and dataparameter configurations. The author finds that, if the central bank cares strongly enough about stabilizing the output gap, this aversion generates significant declines in the coefficients of the Taylor rule, even if the bank's loss function assigns little weight to reducing interest rate variability. He also finds that an aversion to model and data-parameter uncertainty can yield an optimal Taylor rule that matches the empirical Taylor rule. Under some conditions, a small degree of aversion is enough to match the historical rule.
    Keywords: Uncertainty and monetary policy
    JEL: E5 E58 D8 D81
    Date: 2005
  2. By: Oreste Napolitano; Alberto Montagnoli; Rosaria Rita Canale
    Abstract: This paper attempts to explain the importance of the role of the speculators in determining the 1992 ERM crisis, and the effects that the policy of maintaining external parity had on internal growth. We focus on a different way through which expectations are formed about the macroeconomic fundamentals independently of the behaviour of the monetary policy. In the present model, agents’ rational beliefs do not emerge from arbitrary circumstances but only when the value of the exchange rate, kept under control by the central bank, did not correspond to the expected value and to the current wide-spread beliefs in the market.
  3. By: Marco Celentani; J. Ignacio Conde-Ruiz; Klaus Desmet
    Abstract: This paper uses an overlapping generations model to analyze monetary policy in a two-country model with asymmetric shocks. Agents insure against risk through the exchange of a complete set of real securities. Each central bank is able to commit to the contingent monetary policy rule that maximizes domestic welfare. In an attempt to improve their country's terms of trade of securities, central banks may choose to commit to costly inflation in favorable states of nature. In equilibrium the effects on the terms of trade wash out, leaving both countries worse off. Countries facing asymmetric shocks may therefore gain from monetary cooperation.
  4. By: José García Solanes; Fernando Torrejón Flores
  5. By: Persson , Mats (Institute for International Economic Studies, Stockholm University); Persson , Torsten (Institute for International Economic Studies, Stockholm University); Svensson, Lars E.O. (Department of Economics, Princeton University)
    Abstract: This paper demonstrates how time consistency of the Ramsey policy–the optimal fiscal and monetary policy under commitment–can be achieved. Each government should leave its successor with a unique maturity structure for the nominal and indexed debt, such that the marginal benefit of a surprise inflation exactly balances the marginal cost. Unlike in earlier papers on the topic, the result holds for quite a general Ramsey policy, including time varying polices with positive inflation and positive nominal interest rates. We compare our results with those in Persson, Persson, and Svensson (1987), Calvo and Obstfeld (1990), and Alvarez, Kehoe, and Neumeyer (2004).
    Keywords: time consistency; Ramsey policy; surprise inflation
    JEL: E31 E52 H21
    Date: 2004–10–01
  6. By: Forssbaeck, Jens (Institute of Economic Research); Oxelheim, Lars (The Research Institute of Industrial Economics)
    Abstract: We investigate monetary-policy autonomy under different exchange-rate regimes in small, open European economies during the 1980s and 1990s. We find no systematic link between ex post monetary-policy autonomy and exchange rate regimes. This result is enforced for countries/periods with alternative nominal targets. Our interpretation of the results is that over the medium and long term following an ‘independent’ target for monetary policy, which does not deviate much from the targets of those countries to which one is closely financially integrated, is as constraining as locking the exchange rate to some particular level
    Keywords: Exchange Rate Regimes; Monetary Policy Autonomy; Capital Mobility
    JEL: E42 E52 F41
    Date: 2005–03–15
  7. By: Apel, Mikael (Monetary Policy Department, Central Bank of Sweden); Jansson, Per (Monetary Policy Department, Central Bank of Sweden)
    Abstract: It has been suggested that interest-rate smoothing may be partly explained by an omitted variable that relates to conditions in financial markets. We propose an alternative interpretation that suggests that it relates to measurement errors in the output gap.
    Keywords: Interest-rate smoothing; Measurement errors; Output gap
    JEL: E43 E44 E52
    Date: 2005–03–01
  8. By: Alexius, Annika (Department of Economics); Post, Erik (Department of Economics)
    Abstract: If floating exchange rates stabilize shocks rather than create shocks, a country that joins a monetary union or fixes its exchange rate looses a stabilizing mechanism. We use a first difference structural VAR on trade weighted macroeconomic data to study the role of floating exchange rates for five "small open economies" with inflation targets. By including both domestic and foreign variables and using a combination of long and short-run restrictions, we identify asymmetric shocks more carefully than previous studies. Only in Sweden and Canada does the nominal exchange rate appreciate significantly in response to asymmetric demand shocks and depreciate to asymmetric supply shocks. Most exchange rate movements are caused by speculation and are not responses to fundamental shocks. However, these exchange rate shocks have negligible effects on output and inflation. Our findings indicate that exchange rates are neither stabilizing nor destabilizing but may be loosely characterized as disconnected from the rest of the economy.
    Keywords: Exchange rates; asymmetric shocks; structural VAR
    JEL: F31
    Date: 2005–03–15
  9. By: Ugo Panizza (Research Department, Inter-American Development Bank)
    Abstract: This paper surveys possible monetary policy options for emerging market countries. As the paper does not seek to enter into the fix versus flex debate, it only considers monetary policy options for countries with a flexible exchange rate. After making the point that the conduct of monetary policy requires a nominal anchor and surveying different types of nominal anchors, the paper suggests that most academics and policymakers agree on the fact that inflation targeting should be the nominal anchor of choice. Hence, the paper describes the main characteristics of an inflation targeting regime and discusses its applicability to emerging market countries. Next, the paper recognizes the necessity of coordination between fiscal and monetary policy and points out that, in order to conduct countercyclical fiscal policies, emerging market countries need to build fiscal institutions that allow accumulating surpluses during periods of economic expansion. The paper concludes by studying the applicability of inflation targeting to Egypt and finds mixed support for this option.
    Keywords: Monetary Policy, Fiscal Policy, Inflation targeting, Egypt
    Date: 2004–12
  10. By: Christian Hellwig; Arijit Mukherji; Aleh Tsyvinski
    Abstract: We develop a stylized currency crises model with heterogeneous information among investors and endogenous determination of interest rates in a noisy rational expectations equilibrium. Our model captures three key features of interest rates: the opportunity cost of attacking the currency responds to the investors' behavior; the domestic interest rate may influence the central bank's preferences for a fixed exchange rate; and the domestic interest rate serves as a public signal which aggregates private information about fundamentals. We explore the payoff and informational channels through which interest rates determine devaluation outcomes, and examine the implications for equilibrium selection by global games methods. Our main conclusion is that multiplicity is not an artifact of common knowledge. In particular, we show that multiplicity emerges robustly, either when a devaluation is triggered by the cost of high domestic interest rates as in Obstfeld (1996), or when a devaluation is triggered by the central bank's loss of foreign reserves as in Obstfeld (1986), provided that the domestic asset supply is sufficiently elastic in the interest rate and shocks to the domestic bond supply are sufficiently small.
    JEL: E43 E44 E58 F30
    Date: 2005–03
  11. By: Petar Chobanov; Nikolay Nenovsky
    Abstract: Over the last years the efficiency and existence of an automatic adjustment mechanism of currency boards are in the centre of economic discussions. This study is intended to provide an empirical analysis of the volume and interest rate of unsecured overnight deposits at Bulgarian interbank market. Three empirical models are developed in order to explain the behaviour of demand, supply and interest rates. The impact of reserve requirements, operations connected with government budget, transactions in reserve currency (Euro) and some seasonal factors is discussed. The developments of interest rates and volumes are well captured by the employed variables and their statistically significant signs coincide with the theoretical literature.
    Keywords: money market, currency board, Bulgaria
    JEL: E4 E5
    Date: 2004–05–01
  12. By: Garett Jones; Ali M. Kutan
    Abstract: Good monetary policy requires estimates of all of its effects: monetary policy impacts traditional economic variables such as output, unemployment rates, and inflation. But does monetary policy influence crime rates? By extending the vector autoregression literature, we derive estimates of the dynamic effect of higher interest rates on crime rates. Higher interest rates have socially and statistically significant positive effects on rates of theft and knife robberies, while effects on rates of burglary and assault are smaller and statistically insignificant. Higher interest rates have no effect on homicide rates. We conclude that monetary policy influences the rate of economically-motivated crimes.
    Keywords: crime, monetary policy, vector autoregressive models (VARs)
    JEL: E5 C3
    Date: 2004–05–01
  13. By: Neven T. Valev; John A. Carlson
    Abstract: We use unique survey data from Bulgaria’s currency board to examine the reasons for persistent incomplete credibility of a financial stabilization regime. Although it produced remarkably positive effects in terms of sustained low inflation since 1997, the currency board has not achieved full credibility. This is not uncommon in other less-developed countries with fixed exchange rate regimes. Our results reveal that incomplete credibility is explained primarily by concerns about external economic shocks and the persistent high unemployment in the country. Past experiences with high inflation do not rank among the top reasons to expect financial instability in the future.
    Keywords: Credibility, Currency Boards, Financial Stabilization Programs
    JEL: E5 F3
    Date: 2004–06–01
  14. By: Jutta Maute (Universität Hohenheim)
    Abstract: The breakdown of the Argentine currency board in early 2002 produced a number of obituaries that often quite rashly declared the country’s monetary constitution since 1991 the main responsible for its recent near-catastrophic economic collapse. Contrary to such rather one-sided negative ascriptions to the currency board system, the intention of this paper is to give a comprehensive and balanced description of the currency board model in theory, as well as to name its functioning conditions under today’s economic and political conditions prevailing in developing and transforming countries. It will become clear that the success of a currency board in terms of lasting stabilization of an economy not only depends on its initial design (e.g. the choice of the anchor currency, of the exchange rate, the legal and institutional fixings) but also on an ongoing process of economic and institutional reform that extends from a general macroeconomic and especially public sector streamlining to banking sector reforms, product and labour market deregulation, and to a general realignment of the economy towards exportorientation and international competitiveness. The extent to which these reforms are tackled and completed decides over the degree to which the economy is able to absorb real shocks without incurring high economic and social adaptation costs, hence over the degree to which a country is able to benefit from the currency board’s strengths without falling victim to its potentially severe weaknesses. Along with some basic reflections about the concept and motivation of modern currency boards, sections 1-3 give a brief overview over the historical background of the currency board idea as well as of its implementation. Section 4 focuses on the constitutional elements of a currency board, while section 5 provides the core of the discussion of pros and cons of currency boards, depicting the system’s strengths and weaknesses as well as the conditions under which they materialize. Section 6 will discuss under which circumstances a currency board is a good choice for a country, and ask whether less strict stabilization policies might be able to deliver the hoped-for benefits less costly. Some problems related to the questions of duration and termination of currency boards are addressed in section 7. Finally, section 8 will give a brief exposition of the idea of dual currency boards as a theoretical extension of the currency board model which promises to eliminate one of the biggest immanent threats to a currency board.
    Keywords: New Economic Geography, Foreign Direct Investment, Multinational Enterprises
    JEL: E5

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