nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒05‒07
thirty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Is the Proposed East African Monetary Union an Optimal Currency Area? A Structural Vector Autoregression Analysis By Steven K. Buigut; Neven Valev
  2. From a Currency Board to the Euro: Public Attitudes toward Unilateral Euroization in Bulgaria By Neven T. Valev
  3. Beliefs about Exchange-Rate Stability: Survey Evidence from the Currency Board in Bulgaria By Neven T. Valev; John A. Carlson
  4. Eastern and Southern Africa Monetary Integration: A Structural Vector Autoregression Analysis By Steven K. Buigut; Neven T. Valev
  5. Disinflation Costs Under Inflation Targeting in Small Open Economy Economy By Paulina Restrepo Echavarría
  6. Deconstructing the Art of Central Banking By Bayoumi, Tamim; Sgherri, Silvia
  7. Interest Rate Setting by the ECB: Words and Deeds By Gerlach, Stefan
  8. The European Bond Markets Under EMU By Pagano, Marco; von Thadden, Ernst-Ludwig
  9. Welfare-Maximizing Operational Monetary and Tax Policy Rules By Kollmann, Robert
  10. Fiat Money and the Natural Scale of Government By Martin Shubik; Eric Smith
  11. Commodity Money and the Valuation of Trade By Eric Smith; Martin Shubik
  12. Were Verbal Efforts to Support the Euro Effective? A High-Frequency Analysis of ECB Statements By David-Jan Jansen; Jakob de Haan
  13. Price Convergence in Europe from a Macro Perspective: Product Categories and Reliability By Riemer P. Faber; Ad C.J. Stokman
  14. Financial Acceleration of Booms and Busts By Jan Kakes; Cees Ullersma
  15. Adjustment to the Asymmetric Shocks and Currency Unions: the Case of Belarus and Russia By Charnavoki Valery
  16. International Monetary Policy Coordination By Michael Carlberg
  17. Robust Monetary Policy in a Small Open Economy By Kai Leitemo; Ulf Söderstrom
  18. Is the Taylor Rule Missing? A Statistical Investigation By Bunzel, Helle; Enders, Walter
  19. Learning and the Welfare Implications of Changing Inflation Targets By Kevin Moran
  20. On the Renminbi: The Choice between Adjustment under a Fixed Exchange Rate and Adjustment under a Flexible Rate By Jeffrey Frankel
  21. Taylor Rules, McCallum Rules and the Term Structure of Interest Rates By Michael Gallmeyer; Burton Hollifield; Stanley E. Zin
  22. The Impact of Monetary Policy on the Exchange Rate: A Study Using Intraday Data By Jonathan Kearns; Phil Manners
  23. The Variability of Velocity of Money in a Search Model By Weimin Wang; Shouyong Shi
  24. Money, Price Dispersion and Welfare By Brian Peterson; Shouyong Shi
  25. Third-Currency Effects in a Tri-Polar Model of Foreign Exchange By Martin Melecky
  26. Are Pound and Euro the Same Currency? By Raul Matsushita; Andre Santos; Iram Gleria; Annibal Figueiredo; Sergio Da Silva
  27. The Revived Bretton Woods System seen from the Benches - Lessons for Europe from a Three-Asset-Portfolio Model By Sebastian Dullien
  28. Exchange Rate Determination from Monetary Fundamentals: an Aggregation Theoretic Approach By William Barnett; Chang Ho Kwag
  30. Argentina and Inflation Targeting. ¿Can it be implemented? - Some considerations regarding the Brazilian Experience- By juancarlos soldanodeheza
  31. Openness, Centralized Wage Bargaining, and Inflation By Joseph P. Daniels; Farrokh Nourzad; David D. VanHoose

  1. By: Steven K. Buigut; Neven Valev (Andrew Young School of Policy Studies, Georgia State University)
    Abstract: The treaty of 1999 to revive the defunct East African Community (EAC) ratified by Kenya, Uganda, and Tanzania came into force on July 2000 with the objective of fostering a closer co-operation in political, economic, social, and cultural fields. To achieve this, an East Africa Customs Union protocol was signed in March 2004. A Common Market, a Monetary Union, and ultimately a Political Federation of East Africa states is planned. Though the question of a monetary union has been discussed in the political arena there has been no corresponding empirical study on the economic viability of such a union. This article fills the gap and assesses whether the political force driving the EAC towards a monetary union has economic basis. In particular, we focus on the symmetry of the underlying shocks across the East African economies as a precondition for forming an optimum currency area (OCA). As Mundell (1961) and McKinnon (1963) describe, the member countries of a monetary union do not have independent monetary policy, which differs from that of the union as a whole; governments cannot use monetary and exchange rate policies to react to a country-specific shock. How serious this limitation is for the union countries depends on the degree of asymmetry of shocks and the speed with which the economies adjust to these shocks. If disturbances are distributed symmetrically across union countries, a common response will suffice. If, however, the countries face mostly asymmetric shocks, the retention of policy autonomy is beneficial.
    Keywords: East African, Monetary Union, Optimal Currency Area, Structural Vector Autoregression Analysis
    Date: 2004–09–01
  2. By: Neven T. Valev (Andrew Young School of Policy Studies, Georgia State University)
    Abstract: Bulgaria has operated a currency board since 1997. It is expected to join the EU in 2007 and the EMU thereafter. This paper uses survey data to analyze public attitudes toward adoption of the euro in advance of EMU membership. Bulgarians are equally split in support for and opposition to euroization. The reasons to support euroization include the eliminated risk of currency devaluation and the perception that the euro is already widely used in the economy. The opposition derives from people’s attachment to the national currency and from concerns about the conversion costs involved in a switch to the euro.
    Keywords: Euroization; Dollarization; Euro; Survey Data; Bulgaria; Currency Boards
    Date: 2004–11–01
  3. By: Neven T. Valev (Andrew Young School of Policy Studies, Georgia State University); 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
    Date: 2004–11–01
  4. By: Steven K. Buigut (Andrew Young School of Policy Studies, Georgia State University); Neven T. Valev (Andrew Young School of Policy Studies, Georgia State University)
    Abstract: This paper uses VAR techniques to investigate the potential for forming monetary unions in Eastern and Southern Africa. All countries in the sample are members of various regional economic organizations. Some of the organizations have a monetary union as an immediate objective whereas others consider it as a possibility in the more distant future. Our objective is to sort out which countries are suitable candidates for a monetary union based on the synchronicity of demand and supply disturbances. Although economic shocks are not highly correlated across the entire region, we tentatively identify three sub regional clusters of countries that may benefit from a currency union.
    Keywords: Eastern and Southern Africa Monetary Integration: Structural Vector Analysis
    Date: 2005–02–01
  5. By: Paulina Restrepo Echavarría
    Abstract: Since 1991, inflation in Colombia was reduced from 25% on average to about 6% more recently. Although this performance is in line with a long run inflation target of 3%, some analysts ask whether the Central Bank should continue disinflating. In this paper we present a dynamic stochastic general equilibrium model of inflation targeting for a small open economy to answer this question. We calibrate the model to the Colombian economy and compute the welfare cots and benefits of achieving the long run inflation target. We find that the long run welfare gains are about 4.54% in terms of capital. Furthermore, accounting for the transition the welfare gains are about 1.18% in terms of capital. Our results differ from previous findings because transition costs are introduced and our environment considers the presence of real rigidities (monopolistic competition) and nominal rigidities (sticky information) in a small open economy. We also analyze the sensitivity of the results to some key parameters and conclude that higher price flexibility leads to lower gains from reducing inflation and that a country with markups. The weight given to the inflation gap in the monetary policy rule is important, as a more aggressive Central Bank can improve welfare. Finally, we find that disinflation is more expensive in the case of a closed economy.
    Keywords: Small Open Economy,Inflation Targeting,Compensation;Colombia.
    JEL: E31 E32 E52 F41
  6. By: Bayoumi, Tamim; Sgherri, Silvia
    Abstract: This Paper proposes a markedly different transmission from monetary policy to the macroeconomy, focusing on how policy changes nominal inertia in the Phillips curve. Using recent theoretical developments, we examine the properties of a small, estimated US monetary model distinguishing four monetary regimes since the late 1950s. We find that changes in monetary policy are linked to shifts in nominal inertia, and that these improvements in supply-side flexibility are indeed the main channel through which monetary policy lowers the volatility of inflation and, even more importantly, output.
    Keywords: inflation; monetary policy; rational expectation models
    JEL: E31 E32
    Date: 2004–10
  7. By: Gerlach, Stefan
    Abstract: This Paper discusses interest rate setting by the ECB between 1999 and 2004. I develop from the Monthly Bulletins quantitative indicators of the Governing Council’s assessment of inflation, economic activity, and M3 growth, and investigate their impact on its interest rate decisions. I also estimate reaction functions with ordered probit techniques, using the Monthly Bulletins to guide the choice of variables for the analysis. The results show that the ECB reacts strongly to economic sentiment indicators as measures of the state of the real economy. Furthermore, I find statistically significant reactions to inflation and M3 growth.
    Keywords: ECB; empirical reaction functions; ordered probit
    JEL: E43 E52 E58
    Date: 2004–12
  8. By: Pagano, Marco; von Thadden, Ernst-Ludwig
    Abstract: In this Paper, we document how in the wake of monetary unification the markets for euro area sovereign and private-sector bonds have become increasingly integrated. Issuers and investors alike have come to regard the euro area bond market as a single one. Primary and secondary bond markets have become increasingly integrated on a pan-European scale. Issuance of corporate bonds has taken off on an unprecedented scale in continental Europe. In the process, both investors and issuers have reaped the considerable benefits afforded by greater competition in the underwriting of private bonds and auctioning of public ones, and by the greater liquidity of secondary markets. Bond yields have converged dramatically in the transition to EMU. The persistence of small and variable yield differentials for sovereign debt under EMU indicates that euro area bonds are still not perfect substitutes. However, to a large extent this does not reflect persistent market segmentation but rather small differentials in fundamental risk. Liquidity differences play at most a minor role, and this role appears to arise partly from their interaction with fundamental risk. The challenges still lying ahead are numerous. They include the unbalance between the German-dominated futures and the underlying cash market; the vulnerability of the cash markets’ prices to free-riding and manipulation by large financial institutions; the possibility of joint bond issuance by euro area countries; the integration of clearing and settlement systems in the euro area bond market, and the participation of new accession countries’ issuers to this market.
    Keywords: bond market; bond yield differential; euro; financial integration
    JEL: G15 G32
    Date: 2004–12
  9. By: Kollmann, Robert
    Abstract: This Paper computes welfare-maximizing monetary and tax policy feedback rules, in a calibrated dynamic general equilibrium model with sticky prices. The government makes exogenous final good purchases, levies a proportional income tax, and issues nominal one-period bonds. A quadratic approximation method is used to solve the model, and to compute household welfare. Optimized policy has a strong anti-inflation stance and implies persistent fluctuations of the tax rate and of public debt. Very simple optimized policy rules, under which the interest rate just responds to inflation and the tax rate just responds to public debt, yield a welfare level very close to that generated by richer rules.
    Keywords: fiscal policy; monetary policy; welfare
    JEL: E50 E60 H60
    Date: 2004–12
  10. By: Martin Shubik (Cowles Foundation, Yale University); Eric Smith (Sante Fe Institute)
    Abstract: The competitive market structure of a decentralized economy is converted into a self-policing system treating the bureaucracy and enforcement of the legal system endogenously. In particular we consider money systems as constructs to make agents' economic strategies predictable from knowledge of their preferences and endowments, and thus to support coordinated resource production and distribution from independent decision making. Diverse rule systems can accomplish this, and we construct minimal strategic market games representing government-issued fiat money and ideal commodity money as two cases. We endogenize the provision of money and rules for its use as productive activities within the society, and consider the problem of transition from generalist to specialist production of subsistence goods as one requiring economic coordination under the support of a money system to be solved. The scarce resource in a society is labor limited by its ability to coordinate (specifically, calling for the expenditure of time and effort on communication, computation, and control), which must be diverted from primary production either to maintain coordinated group activity, or to provide the institutional services supporting decentralized trade. Social optima are solutions in which the reduced costs of individual decision making against rules (relative to maintenance of coalitions) are larger than the costs of the institutions providing the rules, and in which the costs of the institutions are less than the gains from the trade they enable to take place.
    Keywords: Bureaucracy, Contract enforcement, Taxes, Money
    JEL: C7 D5 H5 K42
    Date: 2005–04
  11. By: Eric Smith (Sante Fe Institute); Martin Shubik (Cowles Foundation, Yale University)
    Abstract: In a previous essay we modeled the enforcement of contract, and through it the provision of money and markets, as a production function within the society, the scale of which is optimized endogenously by labor allocation away from primary production of goods. Government and a central bank provided fiat money and enforced repayment of loans, giving fiat a predictable value in trade, and also rationalizing the allocation of labor to government service, in return for a fiat salary. Here, for comparison, we consider the same trade problem without government or fiat money, using instead a durable good (gold) as a commodity money between the time it is produced and the time it is removed by manufacture to yield utilitarian services. We compare the monetary value of the two money systems themselves, by introducing a natural money-metric social welfare function. Because labor allocation both to production and potentially to government of the economy is endogenous, the only constraint in the society is its population, so that the natural money-metric is labor. Money systems, whether fiat or commodity, are valued in units of the labor that would produce an equivalent utility gain among competitive equilibria, if it were added to the primary production capacity of the society.
    Keywords: Bureaucracy, Contract enforcement, Taxes, Money
    JEL: C7 D5 H5 K42
    Date: 2005–04
  12. By: David-Jan Jansen; Jakob de Haan
    Abstract: This paper studies the effects of verbal interventions by European cen-tral bankers on high-frequency euro-dollar exchange rates. We find that ECB verbal interventions have had only small and short-lived effects. Ver- bal interventions which are reported in news report headlines are more likely to be successful, whereas verbal interventions on days with releases of macroeconomic data are less successful. There is no difference in the effects of comments by members of the ECB Executive Board and presi- dents of national central banks.
    Keywords: verbal intervention; high-frequency exchange rates; European Central Bank; sign test
    JEL: E58 F31 C14
    Date: 2005–04
  13. By: Riemer P. Faber; Ad C.J. Stokman
    Abstract: In an earlier study of ours, we provided evidence of consumer price level convergence in Europe,particularly in the 1960s and the 1990s (Faber and Stokman, 2004). The analysis was based on transformations of country HICP indices into absolute price levels, by combining time series HICP data back to 1960 with nominal figures of HICP for one particular benchmark year (1999). In this paper, we demonstrate that this simple procedure delivers reliable estimates of absolute price levels both for short and longer time spans. We adopt this methodology to analyse price dispersion at the onedigit level of HICP in the former EU-15 member states (1980-2003). We find strong price level convergence for most of the product groups in the early 1990s. However, price dispersion levels for tradable products are still much smaller than for non-tradable products. Compared to the US, the dispersion level of consumer prices has always been higher in the euro area, but EMU is narrowing the gap. Price dispersion within the smaller DM-zone is below American levels.
    Keywords: Economic integration; Price level convergence; HICP product groups; EMU
    JEL: E31 E50 F15 F40
    Date: 2005–04
  14. By: Jan Kakes; Cees Ullersma
    Abstract: For a panel of 20 industrialized countries from 1970 through 2002,we analyze the role of financial variables in economic cycles. We focus on equity busts, which are considered a proxy for downward revisions of economic prospects. Our empirical findings provide support for financial accelerator effects around asset price busts. The financial accelerator mechanism appears to have become stronger over time. The typical bust is followed by a reduction in nominal policy interest rates, sometimes to levels close to the zero lower bound.
    Keywords: asset price busts; financial accelerator
    JEL: E44 E32
    Date: 2005–04
  15. By: Charnavoki Valery
    Abstract: The paper analyzes mechanism of adjustment to the asymmetric shocks in terms of trade in possible currency union of Belarus and Russia. It is emphasized the role of real exchange rate in this process. An empirical analysis based on panel data confirms the asymmetric effect of fuel price changes on the equilibrium real exchange rate in two countries. At the same time, according to our estimates, real exchange rate changes affect significantly real output and its structure in Belarus. On the base of analysis provided, conclusion is made about necessity to create a fiscal stabilization mechanism which would allow to smooth negative effect of asymmetric shocks on Belarusian economy under currency union.
    Keywords: Belarus, Russia, currency union, asymmetric shocks, terms of trade, real exchange rate.
    JEL: C23 E42 F31 F33
    Date: 2005–05–04
  16. By: Michael Carlberg
    Abstract: This paper studies the international coordination of monetary policies in the world economy. It carefully discusses the process of policy competition and the structure of policy cooperation. As to policy competition, the focus is on monetary competition between Europe and America. Similarly, as to policy cooperation, the focus is on monetary cooperation between Europe and America. The spillover effects of monetary policy are negative. The policy targets are price stability and full employment.
    Keywords: European Monetary Union, International Policy Coordination, Monetary Policy
    JEL: E52 F33 F41 F42
    Date: 2005–05–04
  17. By: Kai Leitemo; Ulf Söderstrom
    Abstract: This paper studies how a central bank’s preference for robustness against model misspecification affects the design of monetary policy in a New-Keynesian model of a small open economy. Due to the simple model structure, we are able to solve analytically for the optimal robust policy rule, and we separately analyze the effects of robustness against misspecification concerning the determination of inflation, output and the exchange rate. We show that an increased central bank preference for robustness makes monetary policy respond more aggressively or more cautiously to shocks, depending on the type of shock and the source of misspecification.
  18. By: Bunzel, Helle; Enders, Walter
    Abstract: We conduct a fairly thorough statistical analysis of the empirical foundations for the existence of a Taylor rule. Inflation, the output gap and the federal funds rate appear to be non-stationary variables that are not cointegrated. Although this lack of cointegration could be caused by missing variables or structural breaks, we are unable to ‘salvage’ the rule using several plausible candidate variables and break dates. We also investigate the possibility that the Taylor rule should be modeled as a non-linear relationship. We find that a simple threshold model makes significant progress towards rectifying some of the shortcomings of the standard model.
    JEL: E0
    Date: 2005–05–01
  19. By: Kevin Moran
    Abstract: This paper computes the welfare consequences, for a representative agent, of a shift in the inflation target of monetary authorities. The welfare computations are conducted first by comparing the two steady states that the different inflation targets entail, and next by accounting for the transition from one steady-state to the next. Further, the paper allows this transition to be characterized by incomplete information, under which private agents learn about the inflation target shift using Bayesian updating. The analysis is repeated in a variety of model parameterizations, to test the robustness of the results. We find that the welfare benefits of reducing the target rate of inflation from 2% initially to 0% may at first appear to be significant. When measured by comparing steady states, these benefits are worth up to 0.5% of steady-state consumption. However, accounting for the transition towards the new, low inflation steady state significantly reduces the computed benefits, by at least one half.
    Keywords: Inflation targeting, welfare benefits of lower inflation, new keynesian model
    JEL: E31 E52 E58
    Date: 2005
  20. By: Jeffrey Frankel
    Abstract: Fixed and flexible exchange rates each have advantages, and a country has the right to choose the regime suited to its circumstances. Nevertheless, several arguments support the view that the de facto dollar peg may now have outlived its usefulness for China. (1) China's economy is on the overheating side of internal balance, and appreciation would help easy inflationary pressure. (2) Although foreign exchange reserves are a useful shield against currency crises, by now China's current level is fully adequate, and US treasury securities do not pay a high return. (3) It becomes increasingly difficult to sterilize the inflow over time, exacerbating inflation. (4) Although external balance could be achieved by expenditure reduction, e.g., by raising interest rates, the existence of two policy goals (external balance and internal balance) in general requires the use of two independent policy instruments (e.g., the real exchange rate and the interest rate). (5) A large economy like China can achieve adjustment in the real exchange rate via flexibility in the nominal exchange rate more easily than via price flexibility. (6) The experience of other emerging markets points toward exiting from a peg when times are good and the currency is strong, rather than waiting until times are bad and the currency is under attack. (7) From a longer-run perspective, prices of goods and services in China are low -- not just low relative to the United States (.23), but also low by the standards of a Balassa-Samuelson relationship estimated across countries (which predicts .36). In this specific sense, the yuan was undervalued by approximately 35% in 2000, and is by at least as much today. The paper finds that, typically across countries, such gaps are corrected halfway, on average, over the subsequent decade. These seven arguments for increased exchange rate flexibility need not imply a free float. China is a good counter-example to the popular "corners hypothesis" prohibition on intermediate exchange rate regimes.
    JEL: F0
    Date: 2005–04
  21. By: Michael Gallmeyer; Burton Hollifield; Stanley E. Zin
    Abstract: Recent empirical research shows that a reasonable characterization of federal-funds-rate targeting behavior is that the change in the target rate depends on the maturity structure of interest rates and exhibits little dependence on lagged target rates. See, for example, Cochrane and Piazzesi (2002). The result echoes the policy rule used by McCallum (1994) to rationalize the empirical failure of the `expectations hypothesis' applied to the term- structure of interest rates. That is, rather than forward rates acting as unbiased predictors of future short rates, the historical evidence suggests that the correlation between forward rates and future short rates is surprisingly low. McCallum showed that a desire by the monetary authority to adjust short rates in response to exogenous shocks to the term premiums imbedded in long rates (i.e. "yield-curve smoothing"), along with a desire for smoothing interest rates across time, can generate term structures that account for the puzzling regression results of Fama and Bliss (1987). McCallum also clearly pointed out that this reduced-form approach to the policy rule, although naturally forward looking, needed to be studied further in the context of other response functions such as the now standard Taylor (1993) rule. We explore both the robustness of McCallum's result to endogenous models of the term premium and also its connections to the Taylor Rule. We model the term premium endogenously using two different models in the class of affine term structure models studied in Duffie and Kan (1996): a stochastic volatility model and a stochastic price-of- risk model. We then solve for equilibrium term structures in environments in which interest rate targeting follows a rule such as the one suggested by McCallum (i.e., the "McCallum Rule"). We demonstrate that McCallum's original result generalizes in a natural way to this broader class of models. To understand the connection to the Taylor Rule, we then consider two structural macroeconomic models which have reduced forms that correspond to the two affine models and provide a macroeconomic interpretation of abstract state variables (as in Ang and Piazzesi (2003)). Moreover, such structural models allow us to interpret the parameters of the term-structure model in terms of the parameters governing preferences, technologies, and policy rules. We show how a monetary policy rule will manifest itself in the equilibrium asset-pricing kernel and, hence, the equilibrium term structure. We then show how this policy can be implemented with an interest-rate targeting rule. This provides us with a set of restrictions under which the Taylor and McCallum Rules are equivalent in the sense if implementing the same monetary policy. We conclude with some numerical examples that explore the quantitative link between these two models of monetary policy.
    JEL: G0 G1 E4
    Date: 2005–04
  22. By: Jonathan Kearns (Reserve Bank of Australia); Phil Manners (Reserve Bank of Australia)
    Abstract: This paper uses intraday data to estimate the effect of changes in monetary policy on the exchange rate. We use an event study with carefully selected sample periods for four countries (Australia, Canada, New Zealand and the United Kingdom) to ensure that the change in monetary policy is exogenous to the exchange rate. Intraday data allow us to use a short event window, which improves the accuracy of estimates, and demonstrates that the change in policy is rapidly incorporated into the exchange rate. On average, an unanticipated tightening of 25 basis points is found to appreciate the exchange rate by around 0.35 per cent, with estimates for the individual countries ranging from ¼–½ of a per cent. The estimation indicates that monetary policy changes account for only a small part of the observed variability of exchange rates in these countries. We also find that changes in monetary policy have substantially different effects on the exchange rate depending on how they alter expectations regarding future policy. Surprises that cause expectations of future policy to be revised by the full amount of the surprise are found to have a larger impact on the exchange rate (around 0.4 per cent) than surprises that only bring forward an anticipated change in policy and do not change expectations of future policy (around 0.2 per cent).
    Keywords: exchange rates; monetary policy; intraday data
    JEL: F31 G14
    Date: 2005–04
  23. By: Weimin Wang; Shouyong Shi
    Abstract: We construct a dynamic equilibrium model where there is costly search in the goods market and the labor market. Incorporating shocks to money growth and productivity, we calibrate the model to the US time series data to examine the model's quantitative predictions on aggregate variables and, in particular, on the variability of consumption velocity of money. Despite the fact that money is the only asset, the model captures most of the variability of velocity in the data. It also generates realistic predictions on the moments of other variables and provides peresistent propagation of the shocks. The model generates these results largely because costly search gives an important role to the extensive margin of trade.
    JEL: E40 E30 D83
  24. By: Brian Peterson; Shouyong Shi
    Abstract: We introduce heterogeneous preferences into a tractable model of monetary search to generate price dispersion, and then examine the effects of money growth on price dispersion and welfare. With buyers' search intensity fixed, we find that money growth increases the range of (real) prices and lowers welfare as agents shift more of their consumption to less desirable goods. When buyers' search intensity is endogenous, multiple equilibria are possible. In the equilibrium with the highest welfare level, money growth reduces welfare and increases the range of prices, while having ambiguous effects on search intensity. However, there can be a welfare-inferior equilibrium in which an increase in money growth increases search intensity, increases welfare, and reduces the range of prices.
    Keywords: Price dispersion; Search; Efficiency
    JEL: E31 D60
  25. By: Martin Melecky (School of Economics, University of New South Wales)
    Abstract: This paper investigates possible contribution of third-currency effects to exchange rate movements. It reopens the subject of currency substitution and examines whether the third-currency effects change when the third-currency is a complement as opposed to when it is a substitute for currencies appearing in a bilateral exchange rate quote. The analysis and tests are carried out within a simple macro-econometric model with one common permanent component driving the system of bilateral exchange rates for the US dollar, the Japanese yen and the euro.
    Keywords: Exchange Rate Modeling, Currency Substitution, Third-currency Effects
    JEL: F31 F36 F42
    Date: 2005–04–29
  26. By: Raul Matsushita (University of Brasilia); Andre Santos (Federal University of Santa Catarina); Iram Gleria (Federal University of Alagoas); Annibal Figueiredo (University of Brasilia); Sergio Da Silva (Federal University of Santa Catarina)
    JEL: G
    Date: 2005–05–04
  27. By: Sebastian Dullien (Financial Times Deutschland)
    Abstract: The paper develops a three-asset-portfolio model to analyse consequences of foreign exchange market operations by Asian central banks on the exchange rates between euro, dollar and yen. Both an analytical as well as a graphical solution is presented. It is found that -- contrary to public belief -- the purchase of dollar assets by Asian central banks strengthens the dollar against both euro and yen. A diversification of Asian central bank reserves from dollar into euro would weaken the dollar against both other currencies. Thus, such a diversification would be incompatible with Asian currency pegs. However, it is shown that Asian central banks could alter their relative portfolio composition while keeping the peg intact if they would shift from intervening against the dollar into intervening against the euro.
    Keywords: foreign exchange interventions, exchange rates, revived Bretton-Woods-System
    JEL: F31
    Date: 2005–05–05
  28. By: William Barnett (University of Kansas); Chang Ho Kwag (POSCO Research Institute)
    Abstract: We incorporate aggregation and index number theory into monetary models of exchange rate determination in a manner that is internally consistent with money market equilibrium. Divisia monetary aggregates and user-cost concepts are used for money supply and opportunity-cost variables in the monetary models. We estimate a flexible price monetary model, a sticky price monetary model, and the Hooper and Morton (1982) model for the US dollar/UK pound exchange rate. We compare forecast results using mean square error, direction of change, and Diebold-Mariano statistics. We find that models with Divisia indexes are better than the random walk assumption in explaining the exchange rate fluctuations. Our results are consistent with the relevant theory and the 'Barnett critique.'
    Keywords: Exchange rate, forecasts, vector error correction, aggregation theory, index number theory, Divisia index number
    JEL: E
    Date: 2005–05–05
  29. By: Valery Chernookiy
    Abstract: This paper discusses the econometric model of inflation processes in the Republic of Belarus which makes it possible to explain major factors determining the dynamics of the GDP deflator, consumer price index and producer price index during the period 1994 - 2003. For estimation of the model the author used the statistical tools of nonstationary time series econometrics: cointegration analysis and error-correction models. The model has good statistical properties, it demonstrates stability of the coefficients and enables one to conduct analysis of the various choices in the field of monetary and foreign exchange policies, as well as in the area of labour remuneration, prices and tariffs.
    Keywords: inflation, GDP deflator, consumer price index, producer price index, Belarus, cointegration
    JEL: E31 C32 P24
    Date: 2005–05–02
  30. By: juancarlos soldanodeheza
    Abstract: Countries use different type of “anchors” with who intend to make the agents expectations to converge to a specified level of inflation. Those anchors could be either based on the exchange rate or some kind of monetary policy. Modern trend is to use Inflation Targeting rather than the traditional monetary aggregates. Countries that adopt Inflation Targeting could be classified as EIT (Eclectic Inflation Targeters), FFIT (Full Fledge Inflation Targeters) and ITL (Inflation Targeting Light). Argentina, if it walks through an IT regime, would be a very particular case, since there is no background that a country in default, with its financial system almost destroyed and a very low degree of credibility on its institutions, have had the capability of successfully implemented this kind of policies. A first issue that should be considered to adopt this monetary regime is to obtain a level of fiscal equilibrium that will allow the agents to believe in the long term solvency of the country. A second issue is reconstruction of credibility of the agents in the monetary authority, in such a way that its analysis would tend to a convergence of expectations and minimize doubts on the reasons the Central Bank should make interventions in the market. A third issue is the creation of an area of economic studies in the Central Bank that will allow the monetary authority to analyze the transmition mechanisms of monetary policy to prices. A fourth issue is renegotiating the public services contracts in which the definition of a new model for adjusting tariffs could be a good idea to avoid linking them to price indexes, but to link them to the cost structure of the companies, due to their impact on the structure of the price indexes usually used as reference for IT. A last issue that cannot be forgiven is that the argentine economy is, in fact, partially dollarized, because currency used for major transactions is US dollar, and also operate, at least with a majority of sectors linked to goods production, a foreign currency standard (US dollar price adjustment) in commercial contracts. The first three issues show us that Argentina seems to be very far of implementing a FFIT policy and with some difficulties to be considered an ITL. It seems that it does not seem an advantage to make public yet the new anchor to avoid consequences of a hypothetically change of system. The fourth issue introduces the need of a difficult and complex negotiation on public services prices in terms of its technical aspects that also has an extreme political sensitiveness. Finally, the last issue shows that it could be necessary to introduce into the predictive models an à la Peru bias, where the economy works under a heavily dollarized component, which is quite more superior than what it happens in Brazil.
    JEL: E
    Date: 2005–05–03
  31. By: Joseph P. Daniels (Department of Economics, Marquette University); Farrokh Nourzad (Department of Economics, Marquette University); David D. VanHoose (Hanmaker School of Business, Baylor University)
    Abstract: This paper develops a model of an open economy containing both sectors in which wages are market-determined and sectors with wage-setting arrangements. A portion of the latter group of sectors coordinate their wages, taking into account that their collective actions influence the equilibrium inflation outcome in an environment in which the central bank engages in discretionary monetary policymaking. Key predictions forthcoming from this model are (1) increased centralization of wage setting initially causes inflation to increase at low degrees of wage centralization but then, as wage centralization increases, results in an inflation dropoff; (2) a greater degree of centralized wage setting reduces the inflation-restraining effect of greater central bank independence; and (3) increased openness is more likely to reduce inflation in nations with less centralized wage bargaining. Analysis of data for seventeen nations for the period 1970-1999 provides generally strong and robust empirical support for all three of these predictions.
    Date: 2004–10

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