nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒04‒16
58 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Inflation, Central Bank Independence and the Legal System. By Bernd Hayo; Stefan Voigt
  2. Nominal rigidities and inflation persistence in Luxembourg: a comparison with EU 15 member countries with particular focus on services and regulated prices By Thomas Y. Mathä; Patrick Lünnemann
  3. Banking Sector Strenght and the Transmission of Currency Crises By Allard Bruinshoofd; Bertrand Candelon; Katharina Raabe
  4. Interest Rate Smoothing versus Serially Correlated Errors in Taylor Rules: Testing the Tests By Welz, Peter; Österholm, Pär
  5. "The Transmission Mechanism of Monetary Policy: A Critical Review" By Greg Hannsgen
  7. Monetary policy and asset prices: the investment channel By Fernando Alexandre; Pedro Bação
  8. New-Keynesian Macroeconomics and the Term Structure By Seonghoon Cho; Antonio Moreno; Geert Bekaert
  9. THE INFLATION IN EUROPEAN UNION By Giovanis Elephtherios
  10. Causation Delays and Causal Neutralization up to Three Steps Ahead: The Money-Output Relationship Revisited By Jonathan B. Hill
  11. Multifractal Modeling of the US Treasury Term Structure and Fed Funds Rate By Sutthisit Jamdee; Cornelis A. Los
  12. Central Banks and how they affect your retirement savings By Joseph_ F_ Dunphy_ MBA_ MFP; Chris_Stone;; Poor_Richard's_Shoebox
  13. Currency preferences and the Australian dollar By Geoffrey Kingston; Martin Melecky
  14. Does Asian foreign exchange intervention really hurt Europe? Lessons from a three-asset portfolio model By Sebastian Dullien
  15. The Changing Role of the Yen/Dollar Exchange Rate for Japanese Monetary Policy By Gunther Schnabl; Christian Danne
  17. The Effects of the Euro-Conversion on Prices and Price Perceptions By Giovanni Mastrobuoni
  18. Early Locking to the Euro: Some Estimates for the New EU Countries based on Equilibrium Exchange Rates By Martin Melecky
  20. The Portuguese Disinflation Process: Analysis of Some Costs and Benefits By António Portugal Duarte
  21. Price Deflators for High Technology Goods and the New Buyer Problem By Ana Aizcorbe
  22. Monetary Convergence of the EU Candidates to the Euro: A Theoretical Framework and Policy Implications By Lucjan T Orlowski
  23. Money Rules For The Eurozone Candidate Countries By Lucjan T Orlowski
  24. Exchange Rate Risk and Convergence to the Euro By Lucjan T Orlowski
  26. Monetary Convergence And Risk Premiums In The EU Candidate Countries By Lucjan T Orlowski
  27. A Dynamic Approach to Inflation Targeting in Transition Economies By Lucjan T Orlowski
  28. Does Monetary Policy Have Asymmetric Effects on Stock Returns? By Shiu-Sheng Chen
  32. On the Coexistence of Money and Bonds By David Andolfatto
  33. Monetary Policy Transparency in the Inflation Targeting By Mariusz Jarmuzek; Lucjan T. Orlowski; Artur Radziwill
  34. Inflation Targeting and Inflation Behavior: A Successful Story? By Marco Vega; Diego Winkelried
  35. The Inflation Dynamics of Pegging Interest Rates By David Eagle
  38. A learning hypothesis of the term structure of interest rates By Balázs Romhányi
  39. The CNB’s Policy Decisions – Are They Priced in by the Markets? By David Navrátil; Viktor Kotlán
  41. Interest Rate Rules and the Response to the Output Gap By Juan Paez-Farrell
  42. Monetary Aggregation By William Barnett
  43. Monetary Policy Adjustments on the Final Passage towards the Euro By Lucjan T Orlowski
  44. Structural Factor-Augmented VAR (SFAVAR) and the Effects of Monetary Policy By Francesco Belviso; Fabio Milani
  45. Quantity Theory of Money By B.V. GOPINATH
  46. Do Actions Speak Louder than Words? The Response of Asset Prices to Monetary Policy Actions and Statements By Refet Gurkaynak; Brian Sack; Eric Swanson
  47. Monetary Policy Shifts, Indeterminacy and Inflation Dynamics By Paolo Surico
  48. Is the Price Elasticity of Money Demand Always Unity? By Paul Evans; Xiaojun Wang
  49. Incomplete markets and monetary policy. By Pascal Gourdel; Leila Triki
  50. Monetary policy transmission in the CEECs : revisited results using alternative econometrics. By Jérôme Héricourt
  51. The CNB’s Policy Decisions – Are They Priced in by the Markets? By David Navrátil; Viktor Kotlán
  52. Price Convergence: What Can the Balassa–Samuelson Model Tell Us? By Tomáš Holub; Martin Čihák
  53. Optimum Currency Area Indices – How Close is the Czech Republic to the Eurozone? By Luboš Komárek; Zdeněk Čech; Roman Horváth
  54. ERM II Membership – the View of the Accession Countries By Luboš Komárek; Zdeněk Čech, Roman Horváth
  55. Modelling the Second-Round Effects of Supply-Side Shocks on Inflation By Tibor Hlédik
  56. EU Enlargement and Endogeneity of some OCA Criteria: Evidence from the CEECs By Ian Babetskii
  57. The Role of Banks in the Czech Monetary Policy Transmission Mechanism By Anca Pruteanu
  58. The dynamics of inflation and currency substitution in a small open economy By Miguel Lebre de Freitas

  1. By: Bernd Hayo; Stefan Voigt
    Abstract: We argue that a higher degree of de facto independence of the legal system from the other government branches as well as public trust in the legal system may reduce the average inflation record of countries through a direct and an indirect channel. The direct channel works by affecting potential output, while the indirect channel helps to increase the de facto independence of the central bank. In the empirical section of the paper, we present evidence in favor of both channels in a sample containing both industrial and Third World countries. A model that contains legal trust in addition to de jure central bank independence, checks and balances within government, and openness can explain 60% of the variation in the logarithm of the inflation rate.
    Keywords: Judicial Independence; Legal Trust; Central Bank Independence; Inflation
    JEL: D D H K
    Date: 2005–01
  2. By: Thomas Y. Mathä; Patrick Lünnemann
    Abstract: This paper analyses the degree of price rigidity and of inflation persistence across different product categories with particular focus on regulated prices and services for the individual EU15 countries, as well as for the EU15 and the euro area aggregates. We show that services and those HICP sub-indices considered being subject to price regulation exhibit larger degrees of nominal price rigidities, with less frequent but larger price index changes as well as stronger asymmetries between price index increases and decreases. With regard to what extent services and regulated prices contribute to the degree of overall inflation persistence, we find that, for most of the EU15 countries as well as for the EU15 and the euro area aggregates, excluding services from the full HICP results in a reduction in the measured degree of inflation persistence; for regulated indices such an effect is also discernible, albeit to a lesser extent.
    Date: 2005–04
  3. By: Allard Bruinshoofd; Bertrand Candelon; Katharina Raabe
    Abstract: We show that, complementary to trade and financial linkages, the strength of the bankingsector helps explain the transmission of currency crises. Specifically, we demonstrate that the Mexican, Thai, and Russian crises predominantly spread to countries with weaknesses in their banking sectors. At the same time, the role of banking sector strength varies per crisis; where the Mexican crisis spread to countries with a strong presence of foreign banks in domestic credit provision, the Thai crisis disproportionately contaminated countries where the banking sector was most sensitive to currency realignments, while the Russian crisis spread to countries with inefficiencies in the banking sector.
    Keywords: Banking Sector Strength; Currency Crisis; Transmission Channels.
    JEL: F30 F32 F34
    Date: 2005–04
  4. By: Welz, Peter (Department of Economics); Österholm, Pär (Department of Economics)
    Abstract: This paper contributes to the recent debate about the estimated high partial adjustment coefficient in dynamic Taylor rules, commonly interpreted as deliberate interest rate smoothing on the part of the monetary authority. We argue that a high coefficient on the lagged interest rate term may be a consequence of an incorrectly specified central bank reaction function. Focusing on omitted variables, our Monte Carlo study first generates the well-known fact that all coefficients in the misspecified equation are biased in such cases. In particular, if relevant variables are left out from the estimated equation, a high partial adjustment coefficient is obtained even when it is in fact zero in the data generating process. Misspecification also leads to considerable size distortions in two tests that were recently proposed by English, Nelson, and Sack (2003) in order to distinguish between interest rate smoothing and serially correlated disturbances. Our results question the common interpretation of very slow partial adjustment as interest rate smoothing in estimated dynamic Taylor rules.
    Keywords: Monetary policy; Taylor rule; Interest rate smoothing; Serially correlated error term; Omitted variables
    JEL: C12 C15 E52
    Date: 2005–03–31
  5. By: Greg Hannsgen
    Abstract: Recently, many economists have credited the late-1990s economic boom in the United States for the easy money policies of the Federal Reserve. On the other hand, observers have noted that very low interest rates have had very little positive effect on the chronically weak Japanese economy. Therefore, some theory of how money affects the economy when it is endogenous would be useful. This paper pursues several such explanations, including the effects of interest rate changes on (1) investment; (2) consumer spending; (3) the exchange rate; and (4) financial markets. The theories of such authors as Kalecki, Keynes, Minsky, and J. K. Galbraith are discussed and evaluated, with an emphasis on the role of cash flow. Some of these theories turn out to be stronger than others when subjected to tests of logic and empirical evidence.
    Date: 2004–10
  6. By: Jaan Masso; Karsten Staehr
    Abstract: The paper seeks to explain the inflationary dynamics in the Baltic countries since the mid-1990s. While single-equation estimations generally yield poor results, panel data estimations provide statistically and economically satisfactory findings. Our main result is that the observed gradual disinflation can to a large extent be explained by adjustment to international prices. Stringent fixed exchange rate systems have exerted downward pressure on inflation both directly and via expectations of future inflation. Measures of excess capacity in the labour market have no effect on inflation, while industrial output gaps have some explanatory power. Real oil price shocks have an immediate but short-lived impact on inflation.
    Keywords: Inflation, exchange rates, Phillips curve
    JEL: E31 E42 P24
    Date: 2005
  7. By: Fernando Alexandre (Universidade do Minho - NIPE and Birkbeck College); Pedro Bação (Universidade de Coimbra)
    Abstract: The role of monetary policy during periods of asset price volatility has been the subject of discussion among economists and policymakers at least since the 1920s and the Great Depression that followed. In this paper we survey the recent and rapidly growing literature on this topic, with an emphasis on the investment channel. We present a detailed discussion of the hypotheses that have been used to justify, or criticise, a response to asset prices. These hypotheses concern imperfections in financial markets, bubbles in asset prices, and the information on which firm managers and central banks base their decisions.
    Keywords: Investment; Asset Prices; Inflation Targeting; Fundamentals.
    Date: 2005
  8. By: Seonghoon Cho (Korea Development Institute); Antonio Moreno (School of Economics and Business Administration, University of Navarra); Geert Bekaert (Columbia Business School, Columbia University)
    Abstract: This article complements the structural New-Keynesian macro framework with a no-arbitrage affine term structure model. Whereas our methodology is general, we focus on an extended macro-model with an unobservable time varying inflation target and the natural rate of output which are filtered from macro and term structure data. We obtain large and significant estimates of the Phillips curve and real interest rate response parameters. Our model also delivers strong contemporaneous responses of the entire term structure to various macroeconomic shocks. The inflation target dominates the variation in the “level factor” whereas the monetary policy shocks dominate the variation in the “slope and curvature factors”.
    JEL: E31 E32 E43 E52 G12
    Date: 2005–04
  9. By: Giovanis Elephtherios (Graduate from the University of Thessaly in city of Volos)
    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 econometrics
    JEL: C1 C2 C3 C4 C5 C8
    Date: 2005–03–11
  10. By: Jonathan B. Hill (Florida International University)
    Abstract: In this paper, we develop a parametric test procedure for multiple horizon "Granger" causality and apply the procedure to the well established problem of determining causal patterns in aggregate monthly U.S. money and output. As opposed to most papers in the parametric causality literature, we are interested in whether money ever "causes" (can ever be used to forecast) output, when causation occurs, and how (through which causal chains). For brevity, we consider only causal patterns up to horizon h = 3. Our tests are based on new recursive parametric characterizations of causality chains which help to distinguish between mere noncausation (the total absence of indirect causal routes) and causal neutralization, in which several causal routes exists that cancel each other out such that noncausation occurs. In many cases the recursive characterizations imply greatly simplified linear compound hypotheses for multi-step ahead causation, and permit Wald tests with the usual asymptotic ÷²-distribution. A simulation study demonstrates that a sequential test method does not generate the type of size distortions typically reported in the literature, and null rejection frequencies depend entirely on how we define the "null hypothesis" of non-causality (at which horizon, if any). Using monthly data employed in Stock and Watson (1989), and others, we demonstrate that while Friedman and Kuttner's (1993) result that detrended money growth fails to cause output one month ahead continues into the third quarter of 2003, a significant causal lag may exist through a variety of short-term interest rates: money appears to cause output after at least one month passes, although in some cases using recent data conflicting evidence suggests money may never cause output and be truly irrelevant in matters of real decisions.
    Keywords: multiple horizon causation; multivariate time series; sequential tests.
    JEL: C1 C2 C3 C4 C5 C8
    Date: 2005–03–15
  11. By: Sutthisit Jamdee (Kent State University); Cornelis A. Los (Kent State University)
    Abstract: This paper identifies the Multifractal Models of Asset Return (MMARs) from the eight nodal term structure series of US Treasury rates as well as the Fed Funds rate and, after proper synthesis, simulates those MMARs. We show that there is an inverse persistence term structure in the sense that the short term interest rates show the highest persistence, while the long term rates are closer to the GBM's neutral persistence. The simulations of the identified MMAR are compared with the original empirical time series, but also with the simulated results from the corresponding Brownian Motion and GARCH processes. We find that the eight different maturity US Treasury and the Fed Funds rates are multifractal processes. Moreover, using wavelet scalograms, we demonstrate that the MMAR outperforms both the GBM and GARCH(1,1) in time-frequency comparisons, in particular in terms of scaling distribution preservation. Identified distributions of all simulated processes are compared with the empirical distributions in snapshot and over time-scale (frequency) analyses. The simulated MMAR can replicate all attributes of the empirical distributions, while the simulated GBM and GARCH(1,1) processes cannot preserve the thick-tails, high peaks and proper skewness. Nevertheless, the results are somewhat inconclusive when the MMAR is applied on the Fed Funds rate, which has globally a mildly anti-persistent and possibly chaotic diffusion process completely different from the other nodal term structure rates.
    Keywords: MMAR, multifractal spectrum, long memory, scaling, term stucture, persistence, Brownian motion, GARCH, time-frequency analysis
    JEL: C19 C23 C52 C53 E44 G11
    Date: 2005–02–28
  12. By: Joseph_ F_ Dunphy_ MBA_ MFP (Joseph_ F_ Dunphy_ MBA); Chris_Stone (Harvard University); (; Poor_Richard's_Shoebox (
    Abstract: Radio show interview of expert in economics, on the role of central banks, and how various strategies result in inflation, deflation, recession and depression. Helps individual investors understand some of the current forces at work on the dollar and the euro, and retirement savings.
    Keywords: Central Banks, World Bank, International Monetary Fund, trade talks,NAFTA
    JEL: A E F3 F4 N
    Date: 2005–03–06
  13. By: Geoffrey Kingston (School of Economics, University of New South Wales); Martin Melecky (School of Economics, University of New South Wales)
    Abstract: We investigate the theory and empirics of currency substitution and currency complementarity. Analytical tractability is facilitated by focussing on a small currency. Data spanning 1985 to the turn of the century contain evidence of the Australian dollar’s substitution for the mark and complementarity with the yen, consistent with our theory that international variables will in general affect the demand for domestic money. Our theory also predicts third-currency effects, and the data reveal several of these. For example, rises in the US Federal Funds rate were associated with depreciations of the Australian dollar against the yen, controlling for the spread between interest rates in Australia and Japan.
    Keywords: Atemporally non-separable preferences; Money demand; Cash in advance; Third-currency effects; Uncovered Interest Parity
    JEL: E41 F31 F36
    Date: 2005–02–08
  14. By: Sebastian Dullien (Financial Times Deutschland)
    Abstract: In the current policy debate, it is often argued that foreign exchange interventions by Asian central banks lead to an excessive appreciation of the euro against the dollar. This paper shows that in a three asset portfolio model the opposite holds: Interventions by Japan's central bank strenghten the dollar against the euro.
    Keywords: China, Japan, foreign exchange interventions, portfolio model
    JEL: F31
    Date: 2005–02–28
  15. By: Gunther Schnabl (Tuebingen University); Christian Danne (Tuebingen University)
    Abstract: This paper studies the role of the yen/dollar exchange rate in the Bank of Japan’s monetary policy reaction function. In contrast to prior estimations of reaction functions based on the Taylor-rule, we allow for regime shifts by estimating rolling coefficients from January 1974 to March 1999. The results show a temporary impact of the exchange rate on monetary policy around 1978/79 and a persistently increasing impact of the yen/dollar exchange rate after 1986. The ris ing importance of the yen/dollar exchange rate for Japanese monetary policy is in line with increasing efforts to stabilize the yen/dollar exchange rate by foreign exchange intervention after March 1999, when the nominal interest rate reached the zero boundary.
    Keywords: Japan, Monetary Policy Reaction Function, Bank of Japan, Interest Rate Rules, Exchange Rates, Taylor Rule, GMM.
    JEL: E43 E52 E58 F41
    Date: 2005–03–04
  16. By: Abhijit Sen Gupta (University of Califonia, Santa Cruz)
    Abstract: This paper aims to look at the relationship between capital account openness and inflation in the 1990s. It argues that widespread capital account liberalization during the early 1990s appears to have contributed to the world-wide disinflation observed during that decade. The paper attempts to provide a theoretical and empirical evidence for a strong negative link between capital account liberalization and disinflation. Capital account openness appears to discipline monetary authorities, or to help them convince the private sector that they will be more disciplined in the future.
    Keywords: Capital Account, Openness and Inflation
    JEL: F36 F41 E32
    Date: 2005–03–10
  17. By: Giovanni Mastrobuoni (Princeton University)
    Abstract: Despite the expectations of economists that the euro changeover would have no effect on prices, I show that European consumers perceive the contrary. The data indicate that consumers based their perceptions about inflation on goods that are frequently purchased. I use this insight to develop and estimate a model of imperfect information that explains why these goods were subject to higher price growth after the changeover. The data indicate that Spain, Italy and France show a stronger euro- effect on prices. The data also suggest that this price growth is correlated with consumers' ability to adapt to the new currency.
    Keywords: euro, currency changeover, imperfect information, search costs, price setting
    JEL: D83 F33 L11
    Date: 2005–03–10
  18. By: Martin Melecky
    Abstract: The ECB recommends to prospective euro-area members that they choose the central parities, for fixing their currencies against the euro, consistent with a broad range of economic indicators while taking account of the market rate as well. In this paper, we estimate a behavioral model of the real exchange rates for a group of the EU 5 countries, along with equilibrium real exchange rates. In addition, we propose a methodology for estimating an optimal timing for ERM II entry based on convergence properties of the equilibrium real exchange rate. We find that the estimated optimal timing for ERM II entry derived from the analysis of the equilibrium real exchange rate suggests that fixing the national currencies of the EU 5 countries in forthcoming years would not be in contradiction with the convergence properties of the real equilibrium exchange rate.
    Keywords: Equilibrium Exchange Rate, ERM II Entry, Time-Series Panel Data
    JEL: C52 C53 E58 E61 F31
    Date: 2005–03–29
  19. By: Jerome Henry (ECB); Jens Weidmann (Bundesbank)
    Abstract: We investigate the consequences of the 1992-1993 EMS crises, which resulted in the widening of the exchange rate bands, on the long-run linkages between the daily 1-month-Eurorates on German Mark, US-Dollar and French Franc. First, within a Gaussian VAR, both the US Eurorate and the French-German Eurorate differential are found stationary between December 1990 and December 1993. Second, using various GARCH models to account for heteroskedasticity show that Gaussian models can be misleading as to the interpretation of the linkages. Third, the estimated variance parameters are stable and the July 1993 episode is not linked to especially high a volatility. Finally, focusing on the French rate, we find asymmetry in the stochastic volatility, positive shocks being more persistent.
    Keywords: Interest rates, cointegration, heteroskedasticity, GARCH, EMS, Asymmetry in the ERM
    JEL: F3 F4
    Date: 2005–03–30
  20. By: António Portugal Duarte (Faculty of Economicas & GEMF, University of Coimbra)
    Abstract: This study aims to analyse the Portuguese economic policy of disinflation through a nominal stabilization policy of the Portuguese escudo. We study the pegging of the Portuguese escudo (PTE) to the Deutsch mark (DM) knowing the reputation of the Bundesbank for its anti- inflationary record and the role played by the Deutsch mark in the stability processes of foreign exchange and European price levels. The study was based on the attainment of co-integrating relations using Johansen’s methodology, the construction of a Near-VAR model and the establishment of a simulation analysis. The acceptance of German monetary policy and the pegging of the escudo to the Deutsch mark allowed the Portuguese economy to achieve its primary goal of price stability. However, despite the credibility and stability gains obtained, the adoption of a disinflation policy led to a real appreciation of the escudo. This study tries to clarify the influence that an appreciation of the real exchange rate can have on GDP and price levels. It cannot be denied that Portugal has made great progress in its European integration, successfully integrating into the group of EMU member-states. However we can point to a decrease in Portuguese competitiveness as the price paid for the disinflation process. This reflects itself in lower wages, which in turn limit output growth. We find that it is of primary importance to realise both the benefits of disinflation, and the costs of the policies in terms of output.
    Keywords: Monetary Policy, European Union, Disinflation, Co-Integration, Near-VAR and Simulation
    JEL: C32 C51 E42 E58 F31 F33
    Date: 2005–04–13
  21. By: Ana Aizcorbe (Bureau of Economic Analysis)
    Abstract: Some items in a household’s market basket, notably durable goods, are purchased only occasionally. In contrast, standard price measures implicitly assume that consumers purchase some amount of every available good in every period. The occasional purchase of an existing good by a new buyer generates a “new buyer” problem that is similar to the traditional “new goods” problem generated by the entry of new goods. This paper uses an idea introduced by Fisher and Griliches (1995) and Griliches and Cockburn (1995) to develop price indexes for goods that are not purchased in each period. A comparison of the resulting price indexes with those calculated under the standard assumption suggests that the sharp declines typically exhibited by price indexes for many high technology goods may be overstated. However, it is impossible to make any definitive statements about the numerical magnitude of this potential problem. These preliminary findings simply underscore the importance of further research to study this problem for high tech goods and to explore the possibility that similar problems may arise for other durable goods.
    Keywords: Price Indexes, durable goods demand, consumer heterogeneity
    JEL: L
    Date: 2005–02–09
  22. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: A flexible approach to direct inflation targeting is a viable monetary policy choice for transition economies that is believed to facilitate both the economic transition and the monetary convergence to the euro. Following this assumption, an analytical model investigating the link between the inflation process and monetary variables in transition economies is advanced in this study. The empirical testing is conducted for Poland, the Czech Republic and Hungary. The analysis recommends that the monetary convergence begins with inflation targeting and concludes with a full-fledged euroization. It further advocates the application of flexible benchmarks of monetary convergence that would accommodate various non-monetary factors affecting inflation in transition economies.
    Keywords: transition economies, European Union candidate countries, inflation targeting, inflation targeting, monetary convergence
    JEL: E32 E52 P33
    Date: 2005–01–28
  23. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study proposes the adoption of money growth rules as indicator variables of monetary policies by the countries converging to a common currency system, in particular, by the eurozone candidate countries. The analytical framework assumes an inflation target as the ultimate policy goal. The converging countries act in essence as “takers” of the inflation target, which, in this case, is the eurozone’s inflation forecast. The study advances a forward-looking money growth model that might be applied to aid monetary convergence to the eurozone. However, feasibility of adopting money growth rules depends on stable relationships between money and target variables, which are low inflation and stable exchange rate. Long-run interactions between these variables are examined for Poland, Hungary and the Czech Republic by employing a Johansen cointegration test, along with short-run effects assessed with a vector error correction procedure.
    Keywords: common currency system, eurozone, monetary convergence, money growth rules, inflation targeting.
    JEL: E42 E52 F36 P24
    Date: 2005–01–28
  24. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This paper proposes a new monetary policy framework for effectively navigating the path to adopting the euro. The proposed policy is based on relative inflation forecast targeting and incorporates an ancillary target of declining exchange rate risk, which is suggested as a key criterion for evaluating the currency stability. A model linking exchange rate volatility to differentials over the euro zone in both inflation (target variable) and interest rate (instrument variable) is proposed. The model is empirically tested for the Czech Republic, Poland and Hungary, the selected new Member States of the EU that use direct inflation targeting to guide their monetary policies. The empirical methodology is based on the TARCH(p,q,r)-M model.
    Keywords: exchange rate risk, inflation targeting, monetary convergence, euro area, new EU Member States
    JEL: E42 E52 F36 P24
    Date: 2005–01–28
  25. By: Edgar L. Feige (University of Wisconsin-Madison); M. Parkin (University of Manchester); R Avery (University of Wisconsin-Madison); C. Stones (University of Manchester)
    Abstract: What is the optimum quantity of money in a society? This paper answers this question both from the perspective of a utility maximizing model with real balances in the utility function, and employing an inventory theoretic model which focuses attention on the costs of transacting in different markets and on the storage costs of holding money. We find that socially optimal transactions patterns and inventory holdings can be induced by paying interest on money and bonds equal to the net rate of return on capital. This conclusion is however only valid if it is costless for the society to institute and operate such an interest payment mechanism. In a world where it is costly to institute and operate an interest payment mechanism, a social optimum requires that the rate of return on money and bonds must equal the net rate of return on capital minus the social cost of inducing individuals to hold optimal quantities of financial assets. It is therefore necessary to take account of both the potential gains in welfare from instituting interest payments on money and the real potential costs of such a policy. Reference: Economica, November, 1973 pp. 416-431
    JEL: E41 E50 E59 E52 E31 G11
    Date: 2005–01–30
  26. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study examines the link between various monetary policy regimes and the ability to manage inflation and exchange rate risk premiums in the EU candidate countries as they undergo monetary convergence to the eurozone. The underlying hypothesis is that a system of 'flexible inflation targeting' may be an optimal policy choice for managing these two categories of risk. A model of inflation and exchange rate risk premiums within the context of inflation targeting is proposed. Recent trends in these risk premiums in Hungary, the Czech Republic and Poland are tested by using the GARCH(1,1) methodology.
    Keywords: inflation risk premium, exchange rate risk premium, inflation targeting, monetary convergence, transition economies
    JEL: E32 E52 P33
    Date: 2005–01–31
  27. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study views inflation targeting as a viable regime for more advanced transition economies. A dynamic approach to the trajectory of disinflation and the flexibility of direct inflation targeting is presented in the context of achieving monetary convergence to the EU/EMU. The candidate countries are advised to begin from strict inflation targeting and to follow with a more flexible inflation targeting regime before they establish a necessary 'foundational credibility' and monetary stability. These steps, ultimately followed by the euro-peg, are necessary in preparing for accession to the eurozone. The early experiences of the Czech Republic and Poland with inflation targeting are examined.
    JEL: E32 E52 P33
    Date: 2005–01–31
  28. By: Shiu-Sheng Chen (Department of Economics, National Taiwan University)
    Abstract: This paper investigates whether monetary policy has asymmetric effects on stock returns using Markov-switching models. Different measures of the stance of monetary policy are adopted. Empirical evidence from monthly returns on the standard & Poor 500 (S&P 500) price index suggests that monetary policy has larger effects on stock returns in bear markets. Furthermore, it has been shown that contractionary monetary policy leads to a higher probability of switching to a recession in stock markets.
    Keywords: Monetary Policy, Stock Returns, Markov-switching
    JEL: E52 E32 G10
    Date: 2005–02–01
  29. By: Edgar L. Feige (University of Wisconsin-Madison)
    Abstract: This paper examines the problem of appropriately specifying and estimating the money demand function in the presence of adaptive expectations and partial adjustment mechanisms. The paper demonstrates the difficulty of interpreting distributed lag reduced form representations of the monetary sector when both expectation and adjustment mechanisms are present. It finally presents and empirically estimates an identified model of the monetary sector with partial adjustment mechanisms and multiple expectation formation mechanisms and finds that the elasticity of adjustment appears to be unity, and the adaptive expectation elasticity of income conforms to that proposed by Friedman’s permanent income hypothesis. Reference: American Economic Review, Vol. LVII, No. 2 May, 1967, pp. 462-473.
    Keywords: money demand, expectations, adjustments, distributed lags, identification, adaptive expectations, pasrtial adjustments, permanent income.
    JEL: E41 E42 C1 C3 D84
    Date: 2005–02–01
  30. By: Edgar L. Feige (University of Wisconsin-Madison)
    Abstract: This paper examines a broad set of alternative temporal cross- section specifications of the demand for money as a means of estimating the degree of substitution between demand deposits and other liquid assets. Despite differences in data bases, model specifications and estimation techniques, the results are surprisingly robust; suggesting that the own rate of return on demand deposits is an important argument of the demand function ; that other liquid assets are relatively weak substitutes for demand deposits; and that the income elasticity of demand deposits is less than unity. Reference: The Journal of Finance, Vol. XXIX No. 3, June 1974.
    Keywords: Money demand, substitutibility, liquid assets, temporal cross- section specifications, income elasticity.
    JEL: E41 E42 C1 C31
    Date: 2005–02–02
  31. By: stanley c. w. salvary (Canisius College)
    Abstract: In the literature, nominal money has been decried as a reliable measure. However, before condemning money as a defective measure, it is necessary to examine in a historical context the nature and the role of money in a money economic system, and the changes over time in the types of money (commodity money versus paper money). Using historical evidence and logical analysis, this paper attempts to establish the validity of nominal money as a valid device for the measurement of organizational perfor mance. This paper reveals that: (1) the deficiencies of commodity money (and the historical arguments associated with it) are attributed to paper (fiat) money; (2) in a historical setting, there are very restrictive conditions under which paper money would be a defective measuring device; and (3) under general economic conditions, paper money is a reliable measure.
    Keywords: organizing economic activities; commodity money; representative paper money; transaction cost reduction; extrinsic and intrinsic values; uncertain nominal value; non specified purchasing power; individual preferenc;stored entitlements.
    JEL: E
    Date: 2005–02–08
  32. By: David Andolfatto (Simon Fraser University)
    Abstract: This paper re-examines the so-called coexistence puzzle in terms of a modified version of the legal restrictions hypothesis initially put forth by Bryant and Wallace (1980). The modification is in terms of dropping a questionable assumption in the original hypothesis; i.e., that large denomination government bonds cannot be intermediated by private banks. This restriction is replaced by one that is arguably more palatable; i.e., that the intermediated monetary instruments created by private banks are not universally acceptable as payment for all exchanges (unlike government money). The friction that gives rise to this latter restriction is one that is commonly employed in monetary models where fiat money is essential for exchange.
    JEL: E
    Date: 2005–02–09
  33. By: Mariusz Jarmuzek (CASE Center for Social & Economic Research); Lucjan T. Orlowski (Sacred Heart University); Artur Radziwill (CASE Center for Social & Economic Research)
    Abstract: This paper quantifies transparency of monetary policy in the three EU New Member States that have adopted direct inflation targeting strategy. Two measures of transparency are applied. The institutional measure reflects the extent to which a central bank discloses information that is related to the policymaking process. The behavioural measure reflects the clarity among the financial market participants about the true course of monetary policy. The paper shows an ambiguous association between the two measures of transparency, which may be attributed to the active exchange rate management policy that undermines the actual transparency proxied by the behavioural measure.
    Keywords: monetary policy, institutional and behavioural transparency, direct inflation targeting, EU New Member States, European Monetary Union
    JEL: E52 E58 P52
    Date: 2005–02–12
  34. By: Marco Vega (Central Bank of Peru & London School of Economics); Diego Winkelried (Cambridge University)
    Abstract: This paper estimates the effects of inflation targeting (IT) adoption over inflation dynamics using a wide control group. We contribute to the current IT evaluation literature by considering the adoption of IT by a country as a treatment, just as in the program evaluation literature. Hence, we perform propensity score matching to determine suitable counterfactuals to the actual inflation targeters. With this approach we find that IT has helped in reducing the level and volatility of inflation in the countries that adopted it. This result is robust to alternative definitions of treatment and control groups. We also find that the e ect of IT in the persistence of inflation is rather weak and not as categorical as the one associated with the mean and volatility of inflation.
    Keywords: Inflation Targeting, matching methods
    JEL: E
    Date: 2005–02–16
  35. By: David Eagle (Eastern Washington University)
    Abstract: A relatively simple analysis of central banks pegging interest rates applies whenever prices are determined in a price-flexible model where the central bank pursues a singular price-level or nominal-income target. Applying the model empirically in the U.S. and find that prior to 1980, the Federal Reserve would have met its price-level or nominal- income targets best by using the M1 definition of money. However, after 1982, the Federal Reserve would have more effectively met is targets by pegging the interest rate. We also further the analysis in a general- equilibrium, cash-in-advance model with explicit state-contingent securities that complete markets.
    Keywords: interest-rate targeting, price-level targeting, nominal-income targeting, cash-in-advance models, monetary economics, price determinism
    JEL: E
    Date: 2005–02–25
  36. By: stanley c. w. salvary
    Abstract: The view that prediction is the only important concern when policy is to be developed has led to the strict adherence to a money supply rule via the Quantity Theory of Money with its debilitating consequences. The monetarists place the emphasis on the level of the money supply in the determination of price level changes and monetary control is exercised. Along with this line of thinking, statistical elegance transcends empirical reality. Thus, the ensuing consequences of monetary control are not surprising. There are continuous increases in the general level of prices and increasing problems of unemployment, which fuel the flames of business downsizing. In this paper, an alternative to the monetarist explanation of the determination of the price level is advanced. The alternative explanation does not rely on changes in the supply of money but on changes in the composition of aggregate demand and supply. Absent monetary dislocation or revaluation of the currency, change in the general price level is attributed to the net effect of the realignment of relative prices. It is argued that a rethinking of the situation would result in monetary policy that is compatible with the economic setting and not monetary control which crowds out fiscal policy.
    Keywords: endogenous nature of money; general price level; money supply; Quantity Theory; price instability; consumer loans outstanding; Fisher effect; money supply rule.
    JEL: E
    Date: 2005–02–27
  37. By: Stanley C. W. Salvary
    Abstract: Perceptions of money do influence monetary policy, and monetary policy does have an impact on the functioning of the economy. For instance, a high interest rate policy usually entails high levels of bankruptcies and unemployment. Also, given a loss of confidence in the issuing authority (monetary dislocation), paper money can and does fail in all its functions as a medium of exchange, a unit of account, and a store of nominal value. In a money economy in which nominal money is the medium of exchange, nominal money prices reflect the underlying exchange ratios of the various commodities that are produced and exchanged for nominal money. In the absence of monetary dislocation (monetary revaluation or devaluation), any change in the nominal price of a commodity reflects a change in its purchasing power (a change in its exchange ratio vis-a-vis other commodities). Monetary policy prescriptions, which ignore this reality, result in significant displacement costs to members of society. A ‘pure science’ approach to economic research engenders policy prescriptions based upon assumptions of the economic system which are not aligned with the empirical reality. Hence, to avoid severe social costs, the ‘pure science’ approach to economics needs to be modified to deal with social reality.
    Keywords: monetary policy decisions; economic policy; federal funds target range; purchasing power uncertainty; interest rate targeting; reserves targeting; instruments for the prediction of observable phenomena.
    JEL: E
    Date: 2005–02–28
  38. By: Balázs Romhányi (Hungarian Ministry of Finance)
    Abstract: Recent empirical results about the US term structure are difficult to reconcile with the classical hypothesis of rational expectations even if time-varying but stationary term premia are allowed for. A hypothesis of rational learning about the conditional variance of the log pricing kernel is put forward. In a simple, illustrative consumption-based asset pricing model the long-term interest rate turns out to have an economic meaning distinct from both price stability and full employment, namely to measure the market perception of aggregate level of future risk in the economy. Implications for economic modeling and monetary policy are explored.
    Keywords: term structure; interest rate; learning; uncertainty; monetary policy
    JEL: D8 E4 E5 G12
    Date: 2005–03–02
  39. By: David Navrátil (Èeská spoøitelna); Viktor Kotlán (Èeská spoøitelna)
    Abstract: This paper asks to what extent the market prices in the future monetary policy decisions of the Czech National Bank (CNB), how this policy predictability has evolved over time, and whether the change in the central bank’s forecasting methodology in mid-2002 had any impact. Using a sample up to mid-2004, the results are threefold. First, three- quarters of the CNB’s decisions were in line with medium-term money market expectations. Notwithstanding this relatively high predictability of CNB policy, the average mistake in the expectations was biased upwards: over the entire IT period the market has priced in a higher repo rate than has actually turned out to be the case. Second, our analysis shows that the period in which forecasts with an active monetary policy (unconditional forecasts) have been used is characterized by smaller “surprises” of the money market. On the one hand, this may be connected with a change in the CNB’s communication of the forecast, including releases of verbal comments on the interest rate trajectory that is consistent with the outlook. On the other hand, it may reflect a different economic environment in the second stage of IT in the Czech Republic. Third, we analyze whether there is convergence or divergence between the central bank’s forecast-consistent interest rate trajectory and market forward rates. We show that in most cases market rates converged toward the CNB’s interest rate trajectory after the publication of the forecast.
    Keywords: Financial market reaction, inflation targeting, monetary policy predictability, term structure of interest rates.
    JEL: E43 E44 E52
    Date: 2005–03–10
  40. By: Ferda Halicioglu (The University of Greenwich, London)
    Abstract: This study is concerned with the components of the total seigniorage revenues that have been collected by the Turkish governments during the years 1970-1997. Traditionally, a government can increase the monetary base in order to finance its expenditures partially. This form of monetary finance is related to active seigniorage revenues. On the other hand, as real economic growth takes place, a government can also benefit from this process as a result of an increase in demand for the real money balances which is termed as passive seignoirage revenues. This paper presents empirically that Turkish governments have benefited from both types of seignoirage revenues in order to finance its budget deficits during the years 1970-1997 but this policy seems to lose its effectiveness in the recent years due to the financial liberalization.
    Keywords: Seigniorage, Monetary, Policies, Budget Deficits, Turkey
    JEL: E52 E62
    Date: 2005–03–11
  41. By: Juan Paez-Farrell (Hull University)
    Abstract: Modern monetary policy analysis is built around the concept of an interest rate rule that responds to both inflation and output. This paper evaluates the quantitative implications of having a policy rule target different definitions of the output gap in a New Keynesian model with endogenous capital. One crucial result is that different model specifications result in alternative values for potential output, raising the issue of which output gap to target. The results of this paper suggest that targeting the true output gap can be well approximated by a rule that only reacts to inflation.
    Keywords: Monetary Policy Rules, Output Gap
    JEL: E31 E32 E43 E52 E58
    Date: 2005–03–21
  42. By: William Barnett (University of Kansas)
    Abstract: This entry on monetary aggregation will appear under that title in The New Palgrave Dictionary of Economics, 2nd edition, edited by Steven Durlauf and Lawrence Blume. The entry provides an up-to-date overview of state-of-the-art research on monetary aggregation and index number theory, from its origins in 1980 to the current time. At the end of this dictionary entry, emphasis is placed on ongoing research on extensions to risk and to multilateral aggregation within multicountry areas, such as the euro area. Research on monetary aggregation theory has been especially successful in solving the 'puzzles' that have appeared in the monetary economics literature over the past 35 years.
    Keywords: monetary aggregation, Divisia index, money demand, monetary policy, dictionary, Divisia monetary aggregates
    JEL: E41 G12 C43 C22
    Date: 2005–03–21
  43. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study reviews monetary policy options that are seemingly viable for adopting the euro by the new Member States of the European Union. A fully autonomous direct inflation targeting is believed to be suboptimal for convergence to the euro as it does not incorporate convergence parameters into the central bank reaction function and instrument rules. In an attempt to correct for such deficiency, this study advocates adopting a framework of relative inflation forecast targeting where a differential between the domestic and the eurozone inflation forecasts becomes the main objective of the central bank’s decisions. At the same time, some attention to the exchange rate stability objective becomes necessary for facilitating the monetary convergence process. Foreign exchange market interventions, rather than interest rate adjustments, are viewed as a preferred way of achieving this objective.
    Keywords: Monetary convergence, euro adoption, ERM II, new Member States
    JEL: E58 E61 F33 P24
    Date: 2005–03–29
  44. By: Francesco Belviso (Princeton University & University of Chicago); Fabio Milani (Princeton University)
    Abstract: Factor-augmented VARs (FAVARs) have combined standard VARs with factor analysis to exploit large data sets in the study of monetary policy. FAVARs enjoy a number of advantages over VARs: they allow a better identification of the monetary policy shock; they can avoid the use of a single variable to proxy theoretical constructs, such as the output gap; they allow researchers to compute impulse responses for hundreds of variables. Their shortcoming, however, is that the factors are not identified and, therefore, lack any economic interpretation. This paper seeks to provide an interpretation to the factors. We propose a novel Structural Factor-Augmented VAR (SFAVAR) model, where the factors have a clear meaning: 'Real Activity' factor, 'Price Pressures' factor, 'Financial Market' factor, 'Credit Conditions' factor, 'Expectations' factor, etc. The paper employs a Bayesian approach to extract the factors and jointly estimate the model. This framework is then suited to study the effects on a wide range of macroeconomic variables of monetary policy and non-policy shocks.
    Keywords: VAR, Dynamic Factors, Monetary Policy, Structural FAVAR.
    JEL: C32 C43 E50 E52 E58
    Date: 2005–03–30
  45. By: B.V. GOPINATH (No affiliation)
    Abstract: Quantity Theory is a foolproof theory. This Theory is based on Law of Conservation of Wealth. This Theory tests positive with Law of Mass Action of reversible economic (chemical) reactions. Study of utility ( I call utility as all that a human being needs) helps us understand Quantity Theory better. Utility and water have similarities. Water is a form of matter and utility is a form of wealth. Water is universal solvent and so is utility. All other forms of wealth dissolve in utility. Water is in the form of H + OH. Similarly utility exists in the form of Goods and services which are otherwise called as WANTS by economists + money and money related forms of wealth that are called as MEANS by economists. According to Law of Law of Conservation, value of wants = value of means. Any economic entity, be it an individual, a family, a society, a business firm, a state or a nation tries to attain equilibrium between wants and means. Quantity Theory is relevant to all branches of Economics.
    Keywords: Law of Conservation of Wealth, Utility, Law of Mass Action of reversible chemical reactions, Economic reactions
    JEL: D1
    Date: 2005–04–01
  46. By: Refet Gurkaynak (Federal Reserve Board); Brian Sack (Federal Reserve Board); Eric Swanson (Federal Reserve Board)
    Abstract: We investigate the effects of U.S. monetary policy on asset prices using a high frequency event-study analysis. We test whether these effects are adequately captured by a single factor—changes in the federal funds rate target—and find that they are not. Instead, we find that two factors are required. These factors have a structural interpretation as a “current federal funds rate target” factor and a “future path of policy” factor, with the latter closely associated with FOMC statements. We measure the effects of these two factors on bond yields and stock prices using a new intraday dataset going back to 1990. According to our estimates, both monetary policy actions and statements have important but differing effects on asset prices, with statements having a much greater impact on longer-term Treasury yields.
    JEL: E
    Date: 2005–04–07
  47. By: Paolo Surico (Bank of England & University of Bari)
    Abstract: The New-Keynesian Phillips curve plays a central role in modern macroeconomic theory. A vast empirical literature has estimated this structural relationship over various postwar full-samples. While it is well know that in a New-Keynesian model a weak central bank response to inflation generates sunspot fluctuations, the consequences of pooling observations from different monetary policy regimes for the estimates of the Phillips curve had not been investigated. Using Montecarlo simulations from a purely forward-looking model, this paper shows that indeterminacy can introduce a sizable persistence in the estimated process of inflation. This persistence however is not an intrinsic feature of the economy; rather it is the result of self full-filling expectations. By neglecting indeterminacy the estimates of the forward- looking term of the Phillips curve are shown to be biased downward. The implications are in line with the empirical evidence for the UK and US.
    Keywords: indeterminacy, New-Keynesian Phillips curve, Montecarlo, bias, persistence
    JEL: E58 E31 E32
    Date: 2005–04–08
  48. By: Paul Evans (Department of Economics, Ohio State University); Xiaojun Wang (Department of Economics, University of Hawaii at Manoa)
    Abstract: Including both monetary gold and nonmonetary gold in a standard money-in-utility model, we establish a presumption that the price elasticity of money demand should be less than one under commodity standards. Applying cointegration methods to data of the world, the United Kingdom, and the United States, we find support for the new theory.
    Keywords: money demand, price homogeneity, commodity standard
    JEL: E41 E42
    Date: 2005
  49. By: Pascal Gourdel (CERMSEM); Leila Triki (CERMSEM)
    Abstract: We consider an extension of a general equilibrium model with incomplete markets that considers cash-in-advance constraints. The total amount of money is supplied by an authority, which produces at no cost and lends money to agents at short term nominal rates of interest, meeting the demand. Agents have initial nominal claims, which in the aggregate, are the counterpart of an initial public debt. The authority covers its expenditures, including initial debt, through public revenues that consists of taxes and seignorage, and distributes its eventual budget surpluses through transfers to individuals, while no further instruments are available to correct eventual budget deficits. We define a concept of equilibrium in this extended model, and prove that there exists a monetary equilibrium with no transfers. Moreover, we show that if the price level is high enough, a monetary equilibrium with transfers exists.
    Keywords: Cash-in-advance constraints, incomplete markets, nominal assets, monetary equilibrium, money, nominal interest rate
    JEL: C62 D52 E40 E50 G10
    Date: 2005–01
  50. By: Jérôme Héricourt (TEAM)
    Abstract: This paper aims at providing better supported results regarding monetary policy transmission in Central and Eastern European countries (CEECs). In the general frame of VAR models, our study differs from previous research in two main respects. Firstly, we provide estimations that do not rely on the hypothesis of cointegration usually exploited in the related literature, but economically meaningless over less than ten years spans and statistically very fragile. Secondly, we present another set of results, relying on real GDP monthly data that have been rebuilt using the Chow and Lin (1971) method; this allows for an alternative to the traditional industrial production data, a partial and highly unstable proxy variable for output. These original methodological insights lead to results emphasizing the general prevalence of exchange rate and domestic credit channels for monetary policy transmission across the studied countries, despite some persistent national specificity. The empirical evidence also incites to be reasonably optimistic regarding the relevancy of a close integration of these countries into euro area.
    Keywords: Monetary policy transmission, VAR models, CEECs
    JEL: E52 E58 F47
    Date: 2005–03
  51. By: David Navrátil; Viktor Kotlán
    Abstract: This paper asks to what extent the market prices in the future monetary policy decisions of the Czech National Bank (CNB), how this policy predictability has evolved over time, and whether the change in the central bank’s forecasting methodology in mid-2002 had any impact. Using a sample up to mid-2004, the results are threefold. First, three-quarters of the CNB’s decisions were in line with medium-term money market expectations. Notwithstanding this relatively high predictability of CNB policy, the average mistake in the expectations was biased upwards: over the entire IT period the market has priced in a higher repo rate than has actually turned out to be the case. Second, our analysis shows that the period in which forecasts with an active monetary policy (unconditional forecasts) have been used is characterized by smaller “surprises” of the money market. On the one hand, this may be connected with a change in the CNB’s communication of the forecast, including releases of verbal comments on the interest rate trajectory that is consistent with the outlook. On the other hand, it may reflect a different economic environment in the second stage of IT in the Czech Republic. Third, we analyze whether there is convergence or divergence between the central bank’s forecast-consistent interest rate trajectory and market forward rates. We show that in most cases market rates converged toward the CNB’s interest rate trajectory after the publication of the forecast.
    Keywords: Financial market reaction, inflation targeting, monetary policy predictability, term structure of interest rates.
    JEL: E43 E44 E52
    Date: 2005–02
  52. By: Tomáš Holub; Martin Čihák
    Abstract: The paper provides a theoretical reference point for discussions on adjustments in price levels and relative prices. The authors present a “nested†model integrating the Balassa–Samuelson model of the real equilibrium exchange rate with a model of accumulation of capital and with the demand side of the economy. Consequently, they show how the model can be generalised to a case of numerous commodities with different degrees of tradability. The predictions of the model are generally consistent with empirical findings for Central and Eastern European countries. The authors show how the theoretical model can be used for internally consistent simulations of the future convergence process in a transition economy.
    Keywords: Balassa–Samuelson model, inflation, relative prices.
    JEL: E31 E52 E58 F15 P22
    Date: 2003–12
  53. By: Luboš Komárek; Zdeněk Čech; Roman Horváth
    Abstract: In this paper we provide a survey of the optimum currency area theory, estimate the degree of the explanatory power of the optimum currency area criteria, and also calculate the optimum currency area index in the case of the Czech Republic. The results indicate that the traditional optimum currency area criteria to certain extent explain exchange rate variability. Our results may be interpreted as an attempt to assess the benefit-cost ratio of implementing a common currency for a pair of countries. Our results also suggest that from the point of view of the optimum currency area theory the costs of adopting the euro for the Czech Republic may be relatively low, at least in comparison with other EMU member countries. We conclude that if the European Monetary Union is sustainable, the accession of the Czech Republic should not change it.
    Keywords: Convergence, EU/eurozone, exchange rate, optimum currency area theory, transition.
    JEL: E58 E52 F42 F33
    Date: 2003–12
  54. By: Luboš Komárek; Zdeněk Čech, Roman Horváth
    Abstract: With EU accession looming, a new chapter has been opened in the debate about the candidate countries’ exchange rate strategies. A heated discussion has arisen in relation to ERM2 membership. The experience of the present eurozone members with ERM/ERM2 membership shows that none of them faced a significant challenge in the two-year “evaluation†period in terms of the exchange rate stability convergence criterion. This could also be attributable to the stability policies prescribed by the Maastricht Treaty. However, for catching-up countries in the run-up to joining the eurozone, given the existing functioning of the mechanism, the ERM2 appears be of little help for ensuring exchange rate stability. The mechanism should be viewed rather as a tool for “persuading†the markets of the appropriateness of the euro-locking rate. Since the Maastricht rules do not allow downward adjustment of the central parity within the ERM2 for two years before introduction of the euro, the authorities should be familiar with the preferred real exchange rate path prior to entering the mechanism. We conclude that countries could face large costs if they fail to do so.
    Keywords: EU/eurozone, convergence, exchange rate, transition.
    JEL: E58 E52 E32 F42 F33
    Date: 2003–12
  55. By: Tibor Hlédik
    Abstract: Since the introduction of inflation targeting in the Czech Republic in 1998, supply-side factors have had a strong direct influence on CPI inflation on several occasions. This paper uses a small-scale dynamic rational expectations model based on an open-economy version of Fuhrer– Moore-type staggered wage setting to quantify the second-round effects of selected supply-side shocks and of shocks to the nominal exchange rate on wages and subsequently on inflation. In order to analyse the desired reaction of the central bank to these shocks, optimal time-consistent policy rules are derived within the presented New-Keynesian framework. Impulse response analyses are then carried out to demonstrate the model’s dynamics under various policy rules corresponding to different loss functions of the central bank. The conclusions presented in the paper suggest that the second-round effects of shocks to import prices and the nominal exchange rate on inflation should not be ignored in practical policy-making.
    Keywords: monetary policy, optimal policy rules, inflation targeting.
    JEL: E52 E31 F41
    Date: 2003–12
  56. By: Ian Babetskii
    Abstract: There are two opposite points of view on the link between economic integration and business cycle synchronization. De Grauwe (1997) classifies these competing views as “The European Commission View†and “The Krugman Viewâ€. According to the European Commission (1990), closer integration leads to less frequent asymmetric shocks and to more synchronized business cycles between countries. On the other hand, for Krugman (1993) closer integration implies higher specialization and, thus, higher risks of idiosyncratic shocks. Drawing on the evidence from a group of transition countries which have experienced a notable increase in trade openness and economic integration with the European Union during the past decade, this paper tries to determine whose argument is supported by the data. This is done by confronting estimated time-varying coefficients of supply and demand shock asymmetry with indicators of trade intensity and exchange rates. We find that (i) an increase in trade intensity leads to higher symmetry of demand shocks; the effect of integration on supply shock asymmetry varies from country to country; (ii) a decrease in exchange rate volatility has a positive effect on demand shock convergence. The results for demand shocks can be interpreted in favor of “The European Commission Viewâ€, also known as the endogeneity argument by Frankel and Rose (1998) in the OCA criteria discussion, according to which trade links reduce asymmetries between countries. Overall, our results support Kenen’s (2001) argument that the impact of trade integration on shock asymmetry depends on the type of shock.
    Keywords: EU enlargement, business cycle, trade, OCA (optimal currency area)
    JEL: E32 F30 F42
    Date: 2004–03
  57. By: Anca Pruteanu
    Abstract: With this work, we aim to enrich the knowledge about the monetary policy transmission mechanism in the Czech Republic with empirical evidence on the impact of monetary policy on bank lending. Using a panel of quarterly time series for Czech commercial banks for the period 1996–2001, we study the overall effect of monetary policy changes on the growth rate of loans and the characteristics of the supply of loans. The characterization of the credit market’s supply side allows us to make inferences on the operativeness of the credit channel (the bank lending channel and the broad credit channel) of the monetary transmission mechanism. We find that changes in monetary policy alter the growth rate of loans with considerably stronger magnitude in the period 1999–2001 than in the period 1996–1998. From the analysis intended to capture the characteristics of the supply of loans, we conclude that the lending channel was operative in the period 1996–1998: we find cross-sectional differences in the lending reactions to monetary policy shocks due to degree of capitalization and liquidity. For the subsequent period 1999– 2001, the results also show distributive effects of monetary policy due to bank size and a bank’s proportion of classified loans. In the context of steadily decreasing interest rates, this bolsters the supposition of credit rationing and hence that of an operative broad credit channel. At the same time, we find evidence of linear relationships between bank characteristics and the growth rate of loans, and again these relationships change between the two time periods. This bodes well with the changes in the structure and attitude towards lending of the Czech commercial banks.
    Keywords: Bank lending channel, broad credit channel, credit rationing, monetary transmission mechanism.
    JEL: E52 E51 E58 G21
    Date: 2004–04
  58. By: Miguel Lebre de Freitas (Departamento de Economia e Gestão Industrial, Universidade de Aveiro)
    Abstract: In this paper, we analyse the relationship between money and inflation in a small open economy where domestic and foreign currencies are perfect substitutes as means of payment. It is shown that, if the path of domestic money supply is such that individuals find it optimal to change the currency in which transactions are settled, there will be an adjustment period during which domestic inflation adjusts so as to equalise the foreign inflation rate. In the case of a disinflation program, it is shown that the foreign currency is not necessarily abandoned as means of payment. The results obtained are consistent with both dollarisation hysteresis and reversibility, without requiring the specification of dollarisation costs.
    Keywords: currency substitution, dollarisation, money-demand and hysteresis
    JEL: E41 E52 F41
    Date: 2003–08

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