nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒05‒14
thirteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Informational Accuracy and the Optimal Monetary Regime By David Demery; Nigel W. Duck
  4. Pass-Through of Exchange Rate Changes and Macroeconomic Shocks to Domestic Inflation in East Asian Countries By Takatoshi Ito; Yuri N. Sasaki; Kiyotaka Sato
  5. Optimal Choice of Monetary Instruments in an Economy with Real and Liquidity Shocks By Bhattacharya, Joydeep; Singh, Rajesh
  6. Common Currencies and FDI Flows By Stefano Schiavo
  7. Hellenic Export Prices and European Monetary Integration, 1970- 1995. By Theodoros V. Stamatopoulos
  8. UK Monetary Policy under Inflation Forecast Targeting: Is evidence of Asymmetry an Illusion? By Naveen Srinivasan; Vidya Mahambare; M Ramachandran
  9. Currency Futures and Currency Crises By Andreas Röthig
  10. The Role of Money Demand in a Business Cycle Model with Staggered Wage Contracts By Rafel Gerke; Jens Rubart
  11. Drifts and Volatilities: Monetary Policies and Outcomes in the Post WWII US By Timothy Cogley; Thomas Sargent
  12. a structural common factor approach to core inflation estimation and forecasting By Claudio Morana
  13. The Japanese Deflation: Has It Had Real Effects? Could It Have Been Avoided? By Claudio Morana

  1. By: David Demery; Nigel W. Duck
    Abstract: King (1997) develops a framework for assessing four monetary regimes: an optimal state-contingent rule; a non-contingent rule; pure discretion; and a Rogoffian conservative central banker. Using this framework we show (a) that King is wrong to claim that it implies that an optimally-conservative central banker always dominates a fixed-rule monetary regime; (b) that if the private sector has a signal of the shock to which monetary policy responds - the accuracy of which is exogenously fixed - then either the optimal state-contingent rule or the optimally-conservative central bank can dominate; and (c) that if the private sector optimally chooses the accuracy of its signal then any regime can dominate.
    Keywords: Monetary policy, expectations, Rogoffian central banker.
    JEL: E3 E52
    Date: 2005–04
  2. 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 ting. 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 around 15% receives higher gains than those countries with different levels of 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;
    JEL: E31
    Date: 2005–02–28
    Abstract: Utilizando un modelo macroeconómico de pequeña escala para la economía colombiana, se investiga el problema de seleccionar una regla de política simple; una regla que utilice un conjunto reducido de información, que sea consistente con un régimen de inflación objetivo. A pesar de que las reglas de política simples no son tan eficientes como lo serían las reglas de política óptimas, en la literatura se ha mostrado que algunas reglas simples pueden aproximarlas muy bien. Se explican las características de los parámetros de reacción y de producto en reglas simples de Taylor e IFB, así como el horizonte óptimo de pronóstico para inflación objetivo. Mediante el uso de simulaciones estocásticas del modelo se encuentra que, como se esperaba, las reglas simples que utilizan proyecciones de la inflación en lugar de la inflación contemporánea tienen mejores propiedades de estabilización.
    JEL: C45
    Date: 2004–12–31
  4. By: Takatoshi Ito; Yuri N. Sasaki; Kiyotaka Sato
    Abstract: We examine the pass-through effects of exchange rate changes on the domestic prices among the East Asian countries using the conventional pass-through equation and a VAR analysis. First, dynamics of pass-through from the exchange rate to import prices and consumer prices is analyzed using the conventional model of pass-through based on the micro-foundations of the exporter's pricing behavior. Both the short-run and long-run elasticities of the exchange rate pass-through are estimated. Second, a vector autoregression (VAR) technique is applied to the pass-through analysis. A Choleski decomposition is used to identify structural shocks and to examine the pass-through of each shock to domestic price inflation by the impulse response function and variance decomposition analyses. Both the conventional analysis and VAR analysis show that while the degree of exchange rate pass-through to import prices is quite high in the crisis-hit countries, the pass-through to CPI is generally low, with a notable exception of Indonesia. The VAR analysis shows that the size of the pass-through of monetary shocks is even larger in Indonesia. Thus, it was Indonesia's accommodative monetary policy as well as the high degree of the CPI responsiveness to exchange rates that contributed to high domestic price inflation, resulting in the loss of its export competitiveness, even when the currency depreciated sharply in nominal terms in 1997-98.
    Date: 2005–05
  5. By: Bhattacharya, Joydeep; Singh, Rajesh
    Abstract: Poole (1970) using a stochastic IS-LM model presented the first formal treatment of the classic question: how should a monetary authority decide whether to use the money stock or the interest rate as the policy instrument? We update the seminal work of Poole in a microfounded flexible-price general equilibrium model of money using explicit welfare criteria. Specifically, we study the optimal choice of monetary policy instruments in a overlapping-generations economy where limited communication and stochastic relocation creates an endogenous transactions role for fiat money. We characterize stationary welfare maximizing monetary and inflation targets for settings in which the economy is separately hit with i.i.d endowment and liquidity shocks. Our analysis suggests that the central insight of Poole survives: when the shocks are real, welfare is higher under money growth targeting; when the shocks are nominal and not large, welfare is higher under inflation rate targeting.
    JEL: E0
    Date: 2005–05–10
  6. By: Stefano Schiavo
    Abstract: The paper investigates the impact of EMU on foreign direct investment flows. Using the option value approach to investment decisions, it is possible to show how exchange rate uncertainty hinders cross-border investment flows. By permanently fixing bilateral exchange rates, a currency union can then be expected to spur international investment. Results from a gravity model on a sample of OECD countries confirm the hypothesis that currency unions have a positive impact on FDI; moreover, adopting the same currency appears to do more than merely eliminating exchange rate volatility. These findings closely resemble those recently obtained in the trade literature.
    Keywords: EMU, Currency Union, FDI, Uncertainty, Investment.
  7. By: Theodoros V. Stamatopoulos (TEI of Crete & University of Piraeus, Greece. C.E.F.I. Universite d'Aix Marseille II)
    Abstract: We aim to explain the variability of the Hellenic Export Index Unit Value, during the period 1970-1995. The Hellenic index of unit labour cost, an effective index of unit value of European competitors’ exports and the effective exchange rate of the Greek Drachma (GRD) are used as explanatory variables, suggested by the literature and much more by the consequences of the Hellenic accession into the EEC. We found evidence with regards to the sample’s split in the accession’s year 1981 and the equilibrium relationship between Hellenic export prices and exchange rate of GRD during the second subperiod. In addition, in spite of the small size of the Hellenic economy we detected the Greek exporters’ discreet pricing policy, for the first sub-period, this was possible due to the diversification of their destination markets and for the second, the sliding rate policy of the Bank of Greece. The latter policy combined with the European competitors’ pricing policy re-established their margins, with at the most a year lag, whenever the Hellenic labour cost was increased.
    Keywords: Decomposition Approach; Export Prices Equations; Discreet Pricing Policy; Inconsistent triad; European Monetary Integration; Integration and Co-integration Analysis.
    JEL: F3 F4
    Date: 2005–05–12
  8. By: Naveen Srinivasan (Cardiff Business School); Vidya Mahambare (Cardiff Business School); M Ramachandran (Institute for Social & Economic Change)
    Abstract: This paper examines how the Bank of England conducts monetary policy in practice and assesses whether the pursued policy is consistent with its mandate. Our empirical results using quarterly as well as monthly ex post (or model generated) forecast suggest that monetary policy in the UK can be characterised by a nonlinear policy reaction function. Specifically, the Bank has tended to adjust its policy instrument when model generated inflation forecast is above its inflation target, but the response has been much less vigorous when it has been below the target. These results are however, not robust to the use of the Bank’s own ex ante forecasts which we argue is a better way of assessing its objectives. Overall this paper has sought to demonstrate that the way to identify and indeed to quantify the policy authorities’ objectives is to examine their ex ante forecasts.
    JEL: E52 E58
    Date: 2005–05–09
  9. By: Andreas Röthig (Institut für Volkswirtschaftslehre (Department of Economics), Technische Universität Darmstadt (Darmstadt University of Technology))
    Abstract: Since financial derivatives are key instruments for risk taking as well as risk reduction, it is only straightforward to examine their role in currency crises. This paper addresses this issue by investigating the impact of currency futures trading on the underlying exchange rates. After a discussion of trading mechanisms and trader types, the linkage between futures trading activity and spot market turbulence is modelled using a VAR-GARCH approach for the exchange rates of Australia, Canada, Japan, Korea and Switzerland in terms of the US dollar. The empirical results indicate that there is a positive relationship between currency futures trading activity and spot volatility. Moreover, in the case of four out of the total of five currencies discussed in this paper, futures trading activity adds significantly to spot volatility.
    Keywords: Currency crises; Exchange rate volatility; Currency futures trading activity; VAR-GARCH estimation.
    JEL: C13 C32 F31 G15
    Date: 2004–05
  10. By: Rafel Gerke (Ehemalig Institut für Volkswirtschaftslehre (Department of Economics), Technische Universität Darmstadt (Darmstadt University of Technology)); Jens Rubart (Institut für Volkswirtschaftslehre (Department of Economics), Technische Universität Darmstadt (Darmstadt University of Technology))
    Abstract: The question of the main determinants of persistent responses due to nominal shocks captures, at least since Chari et al. (2000), a major part of the recent macroeconomic debate. However, the question whether sticky wages and/or sticky prices are sufficient for persistent reactions of key economic variables remains open. In the present model we allow for nominal rigidities due to Taylor- like wage setting as well as price adjustment costs. However, as our analysis illustrates, smoothing marginal costs seems crucial to derive a contract multiplier, wage staggering alone is not sufficient. Without considering a more specific analysis of factor market frictions, we enforce a point made by Erceg (1997) by analyzing the structure of money demand. In particular, we analyze a `standard' consumption based money demand function by varying the interest rate elasticity of money demand as well as the steady state rate of money holdings. Our results show that the persistency of the output/price dynamics can be affected crucially by the form of the implicit money demand function. In particular, it is shown that staggered wage contracts have to be accompanied by a sufficiently low interest rate elasticity, otherwise the model fails to reproduce reasonable responses of real variables
    Keywords: Monetary Policy Shocks, Sticky Prices, Staggered Wages, Money Demand
    JEL: E32 E41
    Date: 2005–02
  11. By: Timothy Cogley (W. P. Carey School of Business Department of Economics); Thomas Sargent (Stanford University and Hoover Institution)
    Abstract: For a VAR with drifting coefficients and stochastic volatilities, we present posterior densities for several objects that are of interest for designing and evaluating monetary policy. These include measures of inflation persistence, the natural rate of unemployment, a core rate of inflation, and ‘activism coefficients’ for monetary policy rules. Our posteriors imply substantial variation of all of these objects for post WWII U.S. data. After adjusting for changes in volatility, persistence of inflation increases during the 1970s then falls in the 1980s and 1990s. Innovation variances change systematically, being substantially larger in the late 1970s than during other times. Measures of uncertainty about core inflation and the degree of persistence covary positively. We use our posterior distributions to evaluate the power of several tests that have been used to test the null of time-invariance of autoregressive coefficients of VARs against the alternative of timevarying coefficients. Except for one test, we find that those tests have low power against the form of time variation captured by our model. That one test also rejects time invariance in the data.
  12. By: Claudio Morana (SEMEQ Department - Faculty of Economics - University of Eastern Piedmont)
    Abstract: In the paper we propose a new methodological approach to core in- flation estimation, based on a frequency domain principal components estimator, suited to estimate systems of fractionally cointegrated processes. The proposed core inflation measure is the scaled common persistent factor in inflation and excess nominal money growth and bears the interpretation of monetary inflation. The proposed measure is characterised by all the properties that an “ideal” core inflation process should show, providing also a superior forecasting performance relative to other available measures.
    Keywords: long memory, common factors, fractional cointegration, Markov switching, core inflation, euro area.
    JEL: C22 E31 E52
    Date: 2004–02
  13. By: Claudio Morana (SEMEQ Department - Faculty of Economics - University of Eastern Piedmont)
    Abstract: Has deflation contributed to the long lasting stagnation of the Japanese economy? Could the Bank of Japan have stopped deflation by implementing a more expansionary monetary policy? Our tentative answers are probably not to the first question, and probably yes to the second question. We find that the total cost of deflation over the period 1995-2003 has been close to a 1.1% rate of lost GDP. Yet, on the basis of statistical significance and robustness to specification choices, this evidence is not compelling. On the other hand, the estimated positive linkage between nominal base money growth and inflation is significant and robust, even given current economic conditions. However, in order to be inflationary, monetary policy should have been more expansionary than what actually observed, even since the launch of the quantitative easing in 2001.
    Keywords: deflation, monetary policy, Friedman’s rule, Japan, generalised flexible least squares, time-varying parameter VAR, thick modelling.
    JEL: C32 E50
    Date: 2004–11

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