nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒04‒30
ten papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Exchange Rates and Inflation under EMU: An Update By Philip Lane; Patrick Honohan
  2. Comparing Monetary Policy Reaction Functions: ECB versus Bundesbank By Bernd Hayo; Boris Hofmann
  3. The Expenditure Switching Effect, Welfare and Monetary Policy in a Small Open Economy By Alan Sutherland;
  4. Cost-Push Shocks and Monetary Policy in Open Economics By Philip R. Lane; Michael B. Devereux,Juanyi Xu
  5. Precautionary Balances and the Velocity of Circulation of Money By Miquel Faig; Belén Jerez
  6. Financial Globalisation and Exchange Rates By Philip R. Lane; Gian Maria Milesi-Ferretti
  7. Asymmetries in the Trans-Atlantic Monetary Policy Relationship: Does the ECB follow the Fed? By Ansgar Belke; Daniel Gros
  8. Accounting for the Relationship between Money and Interest Rates By Magnus Jonsson; Paul Klein
  9. Learning the inflation target By Ricardo Nunes
  10. Monetary Policy and Long-term Interest Rates By Shu Wu

  1. By: Philip Lane; Patrick Honohan
    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 per cent. 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.
    Date: 2005–01–28
  2. By: Bernd Hayo (Philipps-University Marburg); Boris Hofmann (ZEI, University of Bonn)
    Abstract: This paper compares the ECB’s conduct of monetary policy with that of the Bundesbank. Estimated monetary policy reaction functions for the Bundesbank (1979:4-1998:12) and the European Central Bank (1999:1- 2004:5) show that, while the ECB and the Bundesbank react similarly to expected inflation, the ECB reacts significantly stronger to the output gap. Theoretical considerations suggest that this stronger response to the output gap may rather be due to a higher interest rate sensitivity of the German output gap than to a higher weight given to output stabilisation by the ECB. Counterfactual simulations based on the estimated interest rate reaction functions suggest that German interest rates would not have been lower under a hypothetical Bundesbank regime after 1999. However, this conclusion crucially depends on the assumption of an unchanged long-run real interest rate for the EMU period. Adjusting the Bundesbank reaction function for the lower long-run real interest rate estimated for the ECB regime reverses this conclusion.
    Keywords: Taylor rule, monetary policy, ECB, Bundesbank
    JEL: E5
    Date: 2005–04–25
  3. By: Alan Sutherland;
    Abstract: This paper analyses the implications of the 'expenditure switching effect' for the role of the exchange rate in monetary policy in a small open economy. It is shown that, when elasticity of substitution between home and foreign goods is not equal to unity, welfare depends on the variances of producer prices and the terms of trade. Producer-price targeting is compared to consumer-price targeting and a fixed exchange rate. It is found that a fixed exchange rate yields higher welfare than the other regimes only when the elasticity of substitution between home and foreign goods is a very high. ownership.
    Keywords: monetary policy, exchange rates, welfare
    Date: 2005–01–28
  4. By: Philip R. Lane; Michael B. Devereux,Juanyi Xu
    Abstract: This paper compares alternative monetary policy rules in a model of an emerging market economy that experiences external shocks to world interest rates and the terms of trade. The model is a two-sector dynamic open economy, with endogenous capital accumulation and slow price adjustment. Two key factors are highlighted in examining the response of the economy to shocks, and in the assessment of the effectiveness of monetary rules.These are: a) balance-sheet related financial frictions in capital formation; and b) delayed pass-through of changes in exchange rates to imported goods prices. We find that, while financial frictions cause a magniFcation of real and financial volatility, they have no effect on the comparison or ranking of alternative monetary policies. But the degree of exchange rate pass-through is very important for the assessment of monetary rules. With high pass-through, there is a trade-off between between real stability (in output or employment) and inflation stability. Moreover, the best monetary policy rule in this case is to stabilise non-traded goods prices. But, with delayed pass-through, the same trade off between real stability and inflation stability disappears, and the best monetary policy rule is CPI price stability Classification-
    Keywords: Monetary Policy, Exchange Rate Pass-through, Balance Sheet Constraints
    Date: 2005–04–20
  5. By: Miquel Faig; Belén Jerez
    Abstract: The observed low velocity of circulation of money implies that households hold more money than they normally spend. A natural explanation for this behavior is that households face uncertain expenditure needs, so they have a precautionary motive for holding money. We investigate the precautionary demand for money in a search model where households are subject to preference shocks. The model predicts that the velocity of circulation of money is not only low but also interest elastic. The model closely fits United States data on the velocity of circulation of money and interest rates that span the period 1892-2003. The empirical analysis reveals a dramatic reduction in precautionary balances towards the end of our sample, probably linked to innovations in the information technology. This drop in precautionary balances is crucial for important issues of monetary economics such as the elasticity of the demand for money and the welfare cost of inflation.
    JEL: E41 E52
  6. By: Philip R. Lane; Gian Maria Milesi-Ferretti
    Abstract: The founders of the Bretton Woods System sixty years ago were primarily concerned with orderly exchange rate adjustment in a world economy that was characterized by widespread restrictions on international capital mobility. In contrast, the rapid pace of financial globalization during recent years poses new challenges for the international monetary system. In particular, large gross cross-holdings of foreign assets and liabilities means that the valuation channel of exchange rate adjustment has grown in importance, relative to the traditional trade balance channel. Accordingly, this paper empirically explores some of the inter-connections between financial globalization and exchange rate adjustment and discusses the policy implications. Classification-
    Keywords: Financial integration, capital flows, external assets and liabilities
    Date: 2005–04–20
  7. By: Ansgar Belke; Daniel Gros
    Abstract: The belief that the ECB follows the US Federal Reserve in setting its policy is so entrenched with market participants and commentators that the search for empirical support would seem to be a trivial task. However, this is not the case. We find that the ECB is indeed often influenced by the Fed, but the reverse is true at least as often if one considers longer sample periods. There is empirically little support for the proposition that there has been for a long time a systematic asymmetric leader-follower relationship between the ECB and the Fed. Only after September 2001 is there more evidence of such an asymmetry. We also find a clear-cut structural break between the pre-EMU and the EMU period in terms of the relationship between short term interest rates on both sides of the Atlantic.
    Keywords: co-movement of interest rates, European Central Bank, Federal Reserve, monetary policy, policy coordination
    JEL: E52 E58 F41
    Date: 2005
  8. By: Magnus Jonsson (Sveriges Riksbank); Paul Klein (University of Western Ontario)
    Abstract: In time series from the United States, the relationship between the money to income ratio and the nominal interest rate is a negative and stable one. In Swedish data, there is no such stable relationship. In this paper, we argue that this difference can be explained by the differences in the shock processes that have hit the two countries. Using a dynamic general equilibrium model driven by shock processes estimated to fit the two countries, we find that we can account for the main properties of the data remarkably well.
    Date: 2005–04–22
  9. By: Ricardo Nunes (Universitat Pompeu Fabra)
    Abstract: The New Keynesian model with rational expectations unrealistically predicts that unanticipated credible changes in the inflation target lead to an immediate jump in the inflation level while the output gap is unaffected. We set up a theoretical model where agents learn the behaviour of the economy. In this context, a permanent change in the inflation target leads inflation to respond sluggishly while the output gap is temporarily affected. We extend the model to allow for both learners and forward looking agents to coexist. The calibrated model explains quite well transition dynamics during the Volker disinflation.
    Keywords: Learning, Policy shifts, Volker disinflation
    JEL: D83 E31 E52
    Date: 2005–04–25
  10. By: Shu Wu (Department of Economics, The University of Kansas)
    Abstract: This paper documents some new empirical results about the monetary policy and long-term interest rates in the United States. It shows that changes in the monetary policy stance are more predictable to the bond market in the 1990s than in the 1970s. This shift in the predictability of the monetary policy actions affects the policy¡¯s impact on long-term interest rates as well as the forecasting power of the yield spread for the future changes in short-term interest rates.
    Keywords: monetary policy, interest rates, predictability
    JEL: E52 E43
    Date: 2005–04

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