nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒06‒14
thirty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. On the Identification of Monetary (and Other) Shocks By Martin Menner; Hugo Rodriguez Mendizabal
  2. Finding Optimal Measures of Core Inflation in the Kyrgyz Republic By Ainura Uzagalieva
  3. Monetary and Fiscal policy Interaction in the Euro Area with Different Assumptions on the Phillips Curve By Bofinger, Peter; Mayer, Eric
  4. Robust Monetary Policy in the New-Keynesian Framework By Leitemo, Kai; Söderström, Ulf
  5. What We Don't Know About the Monetary Transmission Mechanism and Why We Don't Know It By Beyer, Andreas; Farmer, Roger E A
  6. Monetary Policy Uncertainty and the Stock Market By Locarno, Alberto; Massa, Massimo
  7. The Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time By Orphanides, Athanasios; van Norden, Simon
  8. The Role of Asymmetries and Regime Shifts in the Term Structure of Interest Rates By Clarida, Richard; Sarno, Lucio; Taylor, Mark P; Valente, Giorgio
  9. Inflation Scares and Forecast-Based Monetary Policy By Orphanides, Athanasios; Williams, John C
  10. Central Bank Forecasts and Disclosure Policy: Why it Pays to be Optimistic By Eijffinger, Sylvester C W; Tesfaselassie, Mewael F.
  11. Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change By Hau, Harald; Massa, Massimo; Peress, Joël
  12. Optimal Monetary Policy Rules, Asset Prices and Credit Frictions By Faia, Ester; Monacelli, Tommaso
  13. Monetary Policies for Developing Countries: The Role of Institutional Quality By Huang, Haizhou; Wei, Shang-Jin
  14. Time Consistency of Fiscal and Monetary Policy: A Solution By Persson, Torsten; Persson, Mats; Svensson, Lars E O
  15. Monetary Policy with Single Instrument Feedback Rules By Adao, Bernardino; Correia, Isabel Horta; Teles, Pedro
  16. Insurance Policies for Monetary Policy in the Euro Area By Küster, Keith; Wieland, Volker
  17. Money Demand and Macroeconomic Stability Revisited By Schabert, Andreas; Stoltenberg, Christian
  18. Monetary Policy in Real Time By Giannone, Domenico; Reichlin, Lucrezia; Sala, Luca
  19. Money and the Size of Transactions By Zeira, Joseph
  20. A Cross-Country Financial Accelerator: Evidence from North America and Europe By Mody, Ashoka; Sarno, Lucio; Taylor, Mark P
  21. Measuring Income Elasticity for Swiss Money Demand: What Do the Cantons Say About Financial Innovation? By Fischer, Andreas M
  22. Rule-Based Monetary Policy Under Central Banking Learning By Aoki, Kosuke; Nikolov, Kalin
  23. Robust Monetary Policy in a Small Open Economy By Leitemo, Kai; Söderström, Ulf
  24. Monetary Policy with Judgement: Forecast Targeting By Svensson, Lars E O
  25. State-dependent pricing, inflation, and welfare in search economies By Ben R. Craig; Guillaume Rocheteau
  26. Who is afraid of the Friedman rule? By Joydeep Bhattacharya; Joseph Haslag; Antoine Martin; Rajesh Singh
  27. Free Banking and the Bank of Canada By David Laidler
  28. Money (Real and Fictitious)Game, Banking and Taxation By Krishna Gopal Misra
  29. Hellenic Export Prices and European Monetary Integration, 1970- 1995. By Theodoros Stamatopoulos
  30. Global Monetary Conditions versus Country-Specific Factors in the Determination of Emerging Market Debt Spreads By Mansoor Dailami; Paul Masson; Jean Jose Padou
  31. MONEY AND BUSINESS CYCLE IN A SMALL OPEN ECONOMY By Eduardo L. Gimenez; Jose M. Martin-Moreno
  32. Explaining the Early Years of the Euro Exchange Rate: an episode of learning about a new central bank By Manuel Gomez; Michael Melvin

  1. By: Martin Menner; Hugo Rodriguez Mendizabal
    Abstract: The purpose of this paper is twofold. First, we construct a DSGE model which spells out explicitly the instrumentation of monetary policy. The interest rate is determined every period depending on the supply and demand for reserves which in turn are affected by fundamental shocks: unforeseeable changes in cash withdrawal, autonomous factors, technology and government spending. Unexpected changes in the monetary conditions of the economy are interpreted as monetary shocks. We show that these monetary shocks have the usual effects on economic activity without the need of imposing additional frictions as limited participation in asset markets or sticky prices. Second, we show that this view of monetary policy may have important consequences for empirical research. In the model, the contemporaneous correlations between interest rates, prices and output are due to the simultaneous effect of all fundamental shocks. We provide an example where these contemporaneous correlations may be misinterpreted as a Taylor rule. In addition, we use the sign of the impact responses of all shocks on output, prices and interest rates derived from the model to identify the sources of shocks in the data.
    Keywords: Monetary Policy, Shocks, Identification, Taylor Rules
    JEL: E32 E52 E58
    Date: 2005–05–27
  2. By: Ainura Uzagalieva
    Abstract: The ideal measure of inflation should reflect long-run price movements driven by actual demand in the economy and exclude short-term supply shocks. Considering that the CPI does not correspond to such a measure, the purpose of this research is to analyze alternative methods of core (or underlying) inflation and to choose a method suitable for measuring core inflation in the Kyrgyz Republic. The results can be useful for proper monetary policy reaction to inflationary shifts in the Kyrgyz Republic.
    Keywords: Kyrgyz Republic, inflation, core inflation, monetary policy, smoothing, optimality criteria.
    JEL: E31 E52
    Date: 2005–05
  3. By: Bofinger, Peter; Mayer, Eric
    Abstract: In this Paper we carry over a static version of a New Keynesian Macromodel a la Clarida Gali Gertler (1999) to a monetary union. We will show in particular that a harmonious functioning of a monetary union critically depends on the correlation of shocks that hit the currency area. Additionally a high degree of integration in product markets is advantageous for the ECB as it prevents that national real interest rates can drive a wedge between macroeconomic outcomes across member states. In particular small countries are vulnerable and therefore in need of fiscal policy as an independent stabilization agent with room to breath.
    Keywords: fiscal policy; inflation targeting; monetary policy; policy coordination
    JEL: E50 E60 H70
    Date: 2004–12
  4. By: Leitemo, Kai; Söderström, Ulf
    Abstract: We study the effects of model uncertainty in a simple New-Keynesian model using robust control techniques. Due to the simple model structure, we are able to find closed-form solutions for the robust control problem, analysing both instrument rules and targeting rules under different timing assumptions. In all cases but one, an increased preference for robustness makes monetary policy respond more aggressively to cost shocks but leaves the response to demand shocks unchanged. As a consequence, inflation is less volatile and output is more volatile than under the non-robust policy. Under one particular timing assumption, however, increasing the preference for robustness has no effect on the optimal targeting rule (nor on the economy).
    Keywords: Knightian uncertainty; min-max policies; model uncertainty; robust control
    JEL: E52 E58 F41
    Date: 2004–12
  5. By: Beyer, Andreas; Farmer, Roger E A
    Abstract: We study identification in a class of linear rational expectations models. For any given exactly identified model, we provide an algorithm that generates a class of equivalent models that have the same reduced form. We use our algorithm to show that a model proposed by Benhabib and Farmer [1] is observationally equivalent to the standard new-Keynesian model when observed over a single policy regime. However, the two models have different implications for the design of an optimal policy rule.
    Keywords: Benhabib-Farmer model; Identification; indeterminacy; new-Keynesian model
    JEL: C39 C62 D51 E52 E58
    Date: 2004–12
  6. By: Locarno, Alberto; Massa, Massimo
    Abstract: We study the relationship between inflation and stock returns focusing on the signalling content of inflation. Investors use inflation to learn about the stance of the monetary policy. Depending on investors’ beliefs, a change in consumption prices has different effects on the risk premium. A change in consumption prices that confirms investors' beliefs reduces stock risk premia, while a change that contradicts them increases risk premia. This may generate a negative correlation between returns and inflation that explains the Fisher puzzle. We model this intuition and test its implication on US data. We construct a market-based proxy of monetary policy uncertainty, we show that it is priced and that, by conditioning on it, the Fisher puzzle disappears.
    Keywords: asset pricing; learning risk; monetary policy uncertainty; risk factors
    JEL: G11 G12 G14
    Date: 2005–01
  7. By: Orphanides, Athanasios; van Norden, Simon
    Abstract: A stable predictive relationship between inflation and the output gap, often referred to as a Phillips curve, provides the basis for countercyclical monetary policy in many models. In this paper, we evaluate the usefulness of alternative univariate and multivariate estimates of the output gap for predicting inflation. Many of the ex post output gap measures we examine appear to be quite useful for predicting inflation. However, forecasts using real-time estimates of the same measures do not perform nearly as well. The relative usefulness of real-time output gap estimates diminishes further when compared to simple bivariate forecasting models which use past inflation and output growth. Forecast performance also appears to be unstable over time, with models often performing differently over periods of high and low inflation. These results call into question the practical usefulness of the output gap concept for forecasting inflation.
    Keywords: inflation forecasts; output gap; Phillips curve; real-timing data
    JEL: C53 E37
    Date: 2005–01
  8. By: Clarida, Richard; Sarno, Lucio; Taylor, Mark P; Valente, Giorgio
    Abstract: We examine the relationship between interest rates of different maturities for the US, Germany and Japan over the period 1982-2000, using a general, multivariate vector equilibrium correction modelling framework capable of simultaneously allowing for asymmetric adjustment and regime shifts. This approach has a very general underlying theoretical rationale that allows for time-varying term premia and other short-run deviations from the expectations model of the term structure. The resulting non-linear models provide good in-sample fits, display regime switches closely related to key state variables driving monetary policy decisions and have satisfactory out-of-sample forecasting properties.
    Keywords: forecasting; markov switching; term structure of interest rates
    JEL: E43 E47
    Date: 2005–01
  9. By: Orphanides, Athanasios; Williams, John C
    Abstract: Central bankers frequently emphasize the critical importance of anchoring private inflation expectations for successful monetary policy and macroeconomic stabilization. In most monetary policy models, however, expectations are already anchored through the assumption of rational expectations and perfect knowledge of the economy. In this Paper, we re-examine the role of inflation expectations by positing, instead, that agents have imperfect knowledge of the precise structure of the economy and policy-makers' preferences, and rely on a perpetual learning technology to form expectations. We find that with learning, disturbances can give rise to endogenous inflation scares, that is, significant and persistent deviations of inflation expectations from those implied by rational expectations, even at long horizons. The presence of learning increases the sensitivity of inflation expectations and the term structure of interest rates to economic shocks, in line with the empirical evidence. We also explore the role of private inflation expectations for the conduct of efficient monetary policy. Under rational expectations, inflation expectations equal a linear combination of macroeconomic variables and as such provide no additional information to the policy-maker. In contrast, under learning, private inflation expectations follow a time-varying process and provide useful information for the conduct of monetary policy.
    Keywords: inflation forecasts; learning; policy rules; rational expectations
    JEL: E52
    Date: 2005–01
  10. By: Eijffinger, Sylvester C W; Tesfaselassie, Mewael F.
    Abstract: In a simple macromodel with forward-looking expectations, this Paper looks into disclosure policy when a central bank has private information on future shocks. The main result is that advance disclosure of forecasts of future shocks does not improve welfare, and in some cases is not desirable as it impairs stabilization of current inflation and/or output. This result holds when there is no credibility problem or the central bank’s preference is common knowledge. When there is uncertainty about the central bank’s preference shock, and this uncertainty is not resolved in the subsequent period, advance disclosure does not matter for current outcomes. The reason lies in the strong dependence of one-period-ahead private sector inflation forecasts on central bank actions, which induces the central bank to focus exclusively on price stability in subsequent periods. Another implication of the model is that, in contrast to forecasts of current period shocks emphasized by the literature, forecasts of future shocks may not be revealed to the public by current policy choices because the central bank refrains from responding to its own forecasts.
    Keywords: central bank disclosure; central bank forecasts; central bank transparency; forward-looking expectations; private information
    JEL: E42 E43 E52 E58
    Date: 2005–01
  11. By: Hau, Harald; Massa, Massimo; Peress, Joël
    Abstract: Do exchange rates react to exogenous capital movements? We explore this issue based on the redefinition of the MSCI international equity indices announced on 10 December 2000 and implemented in two steps on 30 November 2001 and 31 May 2002. The index changes implied major changes in the representation of different countries in the MSCI world index. Our event study shows a strong announcement effect in which countries with a decreasing equity representation vis-a-vis the US depreciated against the dollar. Around the two implementation dates, we find further systematic, but opposite, exchange rate effects, which can be interpreted as a result of excessive speculation on the first implementation date and insufficient speculation on the second date.
    Keywords: event study; exchange rates; Global Equity Index Funds; Limits of Arbitrage
    JEL: F31 G12 G24
    Date: 2005–01
  12. By: Faia, Ester; Monacelli, Tommaso
    Abstract: We study optimal monetary policy in two prototype economies with sticky prices and credit market frictions. In the first economy, credit frictions apply to the financing of the capital stock, generate acceleration in response to shocks and the ‘financial markup’ (i.e., the premium on external funds) is countercyclical and negatively correlated with the asset price. In the second economy, credit frictions apply to the flow of investment, generate persistence, and the financial markup is procyclical and positively correlated with the asset price. We model monetary policy in terms of welfare-maximizing interest rate rules. The main finding of our analysis is that strict inflation stabilization is a robust optimal monetary policy prescription. The intuition is that, in both models, credit frictions work in the direction of dampening the cyclical behaviour of inflation relative to its credit-frictionless level. Thus neither economy, despite yielding different inflation and investment dynamics, generates a trade-off between price and financial markup stabilization. A corollary of this result is that reacting to asset prices does not bear any independent welfare role in the conduct of monetary policy.
    Keywords: asset prices; financial distortions; optimal monetary policy rules; price stability
    JEL: E52 F41
    Date: 2005–01
  13. By: Huang, Haizhou; Wei, Shang-Jin
    Abstract: Weak public institutions, including high levels of corruption, characterize many developing countries. With a simple model, we demonstrate that institutional quality has important implications for the design of monetary policies and can produce several departures from the conventional wisdom. We find that a pegged exchange rate or dollarization, while sometimes prescribed as a solution to the problem of a lack of credibility, is typically not appropriate in developing countries with poor institutions. Such an arrangement is inferior to an optimal inflation targeting, or a Rogoff-style central banker, whose optimal degree of conservatism is proportional to the quality of institutions. Furthermore, our results cast doubt on the notion that a low inflationary target or a currency board can be used as an instrument to induce governments to strengthen quality of public institutions.
    Keywords: conservative central banker; corruption; currency board; dollarization; inflation targeting; institutional quality; monetary policy
    JEL: E52 E58 E61 E62 H50
    Date: 2005–02
  14. By: Persson, Torsten; Persson, Mats; Svensson, Lars E O
    Abstract: This paper demonstrates how time consistency of the Ramsey policy (the optimal fiscal and monetary policy under commitment) can be achieved. Each government should leave its successor with a unique maturity structure for the nominal and indexed debt, such that the marginal benefit of a surprise inflation exactly balances the marginal cost. Unlike in earlier papers on the topic, the result holds for quite general Ramsey policies, including time-varying polices with positive inflation and positive nominal interest rates. We compare our results with those in Persson, Persson and Svensson (1987), Calvo and Obstfeld (1990), and Alvarez, Kehoe and Neumeyer (2004).
    Keywords: ramsey policy; surprise inflation; time consistency
    JEL: E31 E52 H21
    Date: 2005–03
  15. By: Adao, Bernardino; Correia, Isabel Horta; Teles, Pedro
    Abstract: We consider standard cash-in-advance monetary models and show that there are interest rate or money supply rules such that equilibria are unique. The existence of these single instrument rules depends on whether the economy has an infinite horizon or an arbitrarily large but finite horizon.
    Keywords: interest rate rules; monetary policy; unique equilibrium
    JEL: E31 E40 E52 E58 E62 E63
    Date: 2005–03
  16. By: Küster, Keith; Wieland, Volker
    Abstract: In this paper, we examine the cost of insurance against model uncertainty for the euro area considering four alternative reference models, all of which are used for policy analysis at the ECB. We find that maximal insurance across this model range in terms of a Minimax policy comes at moderate costs in terms of lower expected performance. We extract priors that would rationalize the Minimax policy from a Bayesian perspective. These priors indicate that full insurance is strongly oriented towards the model with highest baseline losses. Furthermore, this policy is not as tolerant towards small perturbations of policy parameters as the Bayesian policy rule. We propose to strike a compromise and use preferences for policy design that allow for intermediate degrees of ambiguity-aversion. These preferences allow the specification of priors but also give extra weight to the worst uncertain outcomes in a given context.
    Keywords: euro area; minimax; model uncertainty; monetary policy rules; robustness
    JEL: E52 E58 E61
    Date: 2005–03
  17. By: Schabert, Andreas; Stoltenberg, Christian
    Abstract: This paper examines how money demand induced real balance effects contribute to the determination of the price level, as suggested by Patinkin (1949,1965), and if they affect conditions for local equilibrium uniqueness and stability. There exists a unique price level sequence that is consistent with an equilibrium under interest rate policy, only if beginning-of-period money enters the utility function. Real money can then serve as a state variable, implying that interest rate setting must be passive for unique, stable, and non-oscillatory equilibrium sequences. When end-of-period money provides utility, an equilibrium is consistent with infinitely many price level sequences, and equilibrium uniqueness requires an active interest rate setting. The stability results are, in general, independent of the magnitude of real balance effects, and apply also when prices are sticky. In contrast, under a constant money growth policy, equilibrium sequences are (likely to be) locally stable and unique for all model variants.
    Keywords: monetary policy rules; predetermined money; price level determination; real balance effects; real determinacy
    JEL: E32 E41 E52
    Date: 2005–03
  18. By: Giannone, Domenico; Reichlin, Lucrezia; Sala, Luca
    Abstract: We analyse the panel of the Greenbook forecasts (sample 1970-96) and a large panel of monthly variables for the US (sample 1970-2003) and show that the bulk of dynamics of both the variables and their forecasts is explained by two shocks. Moreover, a two factor model which exploits, in real time, information on many time series to extract a two dimensional signal, produces a degree of forecasting accuracy of the federal funds rate similar to that of the markets, and, for output and inflation, similar to that of the Greenbook forecasts. This leads us to conclude that the stochastic dimension of the US economy is two. We also show that dimension two is generated by a real and nominal shock, with output mainly driven by the real shock and inflation by the nominal shock. The implication is that, by tracking any forecastable measure of real activity and price dynamics, the Central Bank can track all fundamental dynamics in the economy.
    Keywords: forecasting; large datasets; monetary policy; real time analysis; Taylor rules
    JEL: C33 C53 E52 E58
    Date: 2005–03
  19. By: Zeira, Joseph
    Abstract: Consumers make transactions of different sizes over time. This paper shows that this fact, together with transaction costs of various assets, can help in developing a theory of liquidity. Assets with different cost structures are used to purchase different sizes of transactions. This can explain the demand for money itself, the precautionary demand for money, and the demand for cash and demand deposits. Thus consumers use cash for small transactions, demand deposits for larger transactions, and use savings for the largest transactions. Finally, the paper shows that modeling banks as suppliers of liquidity leads to a better understanding of their success as financial intermediaries.
    Keywords: banks; demand deposits; demand for money; transactions
    JEL: E40 E41 E51
    Date: 2005–04
  20. By: Mody, Ashoka; Sarno, Lucio; Taylor, Mark P
    Abstract: A growing literature has examined the importance of credit market imperfections for macroeconomic fluctuations, the so-called financial accelerator. A related literature has provided evidence of international and regional co-movements in macroeconomic fluctuations. We tie together these strands of the literature in that we investigate the importance of both cross-country and country-specific credit cycles in explaining output fluctuations. Using data for four major economies and two world regions from 1973 to 2001, we find that both regional and country-specific components of indicators of credit availability are powerful in explaining output movements. This research provides the first empirical evidence of a cross-country financial accelerator.
    Keywords: credit cycle; financial accelerator; international business cycles; Kalman filter
    JEL: E32 E51 F36
    Date: 2005–05
  21. By: Fischer, Andreas M
    Abstract: Recent time-series evidence has reconfirmed the forecasting ability of Swiss broad money. The same money demand studies and others, however, find that the income elasticity is greater than one. Such parameter estimates are difficult to reconcile with transactions demand theory. This study re-examines the estimates for income elasticity in money demand based on cross-regional evidence for Switzerland. Particular attention is given to the influence of regional financial sophistication. The cross-cantonal results find that the income elasticity lies between 0.4 and 0.6. This discrepancy between the two empirical methodologies has important consequences for the conduct of Swiss monetary policy.
    Keywords: cross-regional estimates; money demand; regional financial sophistication
    JEL: C21 E41 E50
    Date: 2005–05
  22. By: Aoki, Kosuke; Nikolov, Kalin
    Abstract: The paper evaluates the performance of three popular monetary policy rules when the central bank is learning about the parameter values of a simple New Keynesian model. The three policies are: (1) the optimal non-inertial rule; (2) the optimal history-dependent rule; (3) the optimal price-level targeting rule. Under rational expectations rules (2) and (3) both implement the fully optimal equilibrium by improving the output-inflation trade off. When imperfect information about the model parameters is introduced, it is found that the central bank makes monetary policy mistakes, which affect welfare to a different degree under the three rules. The optimal history-dependent rule is worst affected and delivers the lowest welfare. Price level targeting performs best under learning and maintains the advantages of conducting policy under commitment. These findings are related to the literatures on feedback control and robustness. The paper argues that adopting integral representations of rules designed under full information is desirable because they deliver the beneficial output-inflation trade-off of commitment policy while being robust to implementation errors.
    Keywords: learning; monetary policy rules
    JEL: E31 E50
    Date: 2005–05
  23. By: Leitemo, Kai; Söderström, Ulf
    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 analyse 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.
    Keywords: Knightian uncertainty; min-max policies; model uncertainty; robust control
    JEL: E52 E58 F41
    Date: 2005–05
  24. By: Svensson, Lars E O
    Abstract: ‘Forecast targeting’, forward-looking monetary policy that uses central-bank judgment to construct optimal policy projections of the target variables and the instrument rate, may perform substantially better than monetary policy that disregards judgment and follows a given instrument rule. This is demonstrated in a few examples for two empirical models of the US economy, one forward looking and one backward looking. A complicated infinite-horizon central bank projection model of the economy can be closely approximated by a simple finite system of linear equations, which is easily solved for the optimal policy projections. Optimal policy projections corresponding to the optimal policy under commitment in a timeless perspective can easily be constructed. The whole projection path of the instrument rate is more important than the current instrument setting. The resulting reduced-form reaction function for the current instrument rate is a very complex function of all inputs in the monetary-policy decision process, including the central bank’s judgment. It cannot be summarized as a simple reaction function such as a Taylor rule. Fortunately, it need not be made explicit.
    Keywords: forecasts; inflation targeting; optimal monetary policy
    JEL: E42 E52 E58
    Date: 2005–05
  25. By: Ben R. Craig; Guillaume Rocheteau
    Abstract: This paper investigates the welfare effects of inflation in economies with search frictions and menu costs. We first analyze an economy where there is no transaction demand for money balances: Money is a mere unit of account. We determine a condition under which price stability is optimal and a condition under which positive inflation is desirable. We relate these conditions to a standard efficiency condition for search economies. Second, we consider a related economy in which there is a transaction role for money. In the absence of menu costs, the Friedman rule is optimal. In the presence of menu costs, the optimal inflation rate is negative for all our numerical examples. A deviation from the Friedman rule can be optimal depending on the extent of the search externalities.
    Date: 2005
  26. By: Joydeep Bhattacharya; Joseph Haslag; Antoine Martin; Rajesh Singh
    Abstract: We explore the connection between optimal monetary policy and heterogeneity among agents. We utilize a standard monetary economy with two types of agents that differ in the marginal utility they derive from real money balances-a framework that produces a nondegenerate stationary distribution of money holdings. Without type-specific fiscal policy, we show that the zero-nominal-interest-rate policy (the Friedman rule) does not maximize type-specific welfare; further, it may not maximize aggregate ex ante social welfare. Indeed one or, more surprisingly, both types of agents may benefit if the central bank deviates from the Friedman rule.
    Keywords: Monetary policy ; Interest rates ; Friedman, Milton ; Banks and banking, Central
    Date: 2005
  27. By: David Laidler (University of Western Ontario)
    Abstract: It is argued that today's Canadian monetary system has certain important characteristics in common with a free banking regime such as might have evolved had matters been left to market forces, and that the Bank of Canada's recent success probably has more than a little to do with this fact. It is also argued, however, that, in Canada at the current juncture, further progress towards "free banking" as this alternative is nowadays known, would likely involve unilateral adoption of the US dollar as the basis for the monetary system. Hence, on the 70th anniversary of the Bank of Canada's founding, the author's wish that it may enjoy many happy returns of its birthday is a particularly sincere one.
    Keywords: Bank of Canada; central banking; free banking; price stability rates; unemployment; multiplier
    JEL: B22 E24 E59
    Date: 2005
  28. By: Krishna Gopal Misra (QUALITYMETER.COM)
    Abstract: 'Reality of money' is curiously similar to uncertainty theory of (Hisenburg)quantum physics. To some (natural societies), legitimatimacy of exchange control is derived by associating it with certain physical signifiance of 'real' goods. Exchange control is thus decided by producers in commodity exchanges. Others (Republicans of Greek civilization) think, money can be only a symbolic or fictitious unit, and any physical significance attached to it will undermine sanctity (in respect to space and time) of money used as unit for measurement of the prices. Under these circumstanes, exchange control is monopoly of republics and debt engine produces competition and enterprises in people. There are two worlds. Performance of markets (Republics vrs Natural Societies) are going to test which of the prespective and understanding are true and for how long. This article discusses the valuation of prices, unit price or measuring unit for prices, ligitimacy of exchange control in markets, invention of commodity exchanges using 'real' money, invention of 'fictitious' money, banking, state monpoly of exchange control and mathematical legitimacy of interests and taxation.
    Keywords: money, price, economics, state, production
    JEL: A
    Date: 2005–06–10
  29. By: Theodoros Stamatopoulos (T.E.I. of Crete, University of Piraeus, Greece, & C.E.F.I./Mediterranean University of Aix-Marseille II, France.)
    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 sub-period. 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: 2005–06–05
  30. By: Mansoor Dailami (World Bank); Paul Masson (Rotman School of Management, University of Toronto); Jean Jose Padou (University of Toronto)
    Abstract: We offer evidence in this paper that US interest rate policy has an important influence in the determination of credit spreads on emerging market bonds over US benchmark treasuries, and therefore on their cost of capital. Our analysis improves upon the existing literature and understanding, by addressing the dynamics of market expectations in shaping views on interest rate and monetary policy changes, and by recognizing non-linearities in the link between US interest rates and emerging market bond spreads, as the level of interest rates affects the market's perceived probability of default and the solvency of emerging market borrowers. For a country with a moderate level of debt, repayment prospects would remain good in the face of an increase in US interest rates, so there would be little increase in spreads. A country close to the borderline of solvency would face a steeper increase in the spreads. Simulations of a 200 basis points (bps) increase in US short-term interest rates (ignoring any change in the US 10 year Treasury rate) show an increase in emerging market spreads ranging from 6 bps to 65 bps, depending on debt/GDP ratios.
    Keywords: emerging market spreads, currency crises, global monetary conditions
    JEL: F3 F4
    Date: 2005–06–06
  31. By: Eduardo L. Gimenez (Departamento de Fundamentos de Analisis Economico e Historia Economica. Universidad de Vigo.); Jose M. Martin-Moreno (Departamento de Fundamentos de Analisis Economico e Historia Economica. Universidad de Vigo.)
    Abstract: This paper examines the consequences of introducing a cash-in-advance constraint in a small open economy business cycle model for the Spanish economy. A business cycle model is built extending Correia, Neves and Rebelo (1995) small open economy framework and Cooley and Hansen (1995) monetary economy. Money is introduced through a cash-in-advance constraint. The stochastic simulation of the model and its comparation with Spanish data shows that the model is able to mimic the real dimension of the business cycle. In particular the high volatility of compsumtion for the Spanish economy is greatly reproduced. Some features of the nominal dimension are also reproduced. As a negative result the high correlation between money and output, and labor market relations are not reproduced.
    Keywords: Business Cycle, Cash-in-Advance Constraint, Small Open Economy
  32. By: Manuel Gomez (No affiliation); Michael Melvin (W. P. Carey School of Business Department of Economics)
    Abstract: Many observers were surprised by the depreciation of the euro after its launch in 1999. Handicapped by a short sample, explanations tended to appeal to anecdotes and lessons learned from the experiences of other currencies. Now sample sizes are just becoming large enough to permit reasonable empirical analyses. This paper begins with a theoretical model of pre- and post-euro foreign exchange trading that generates three possible causes of euro depreciation: a reduction in hedging opportunities due to the elimination of the legacy currencies, asymmetric information due to some traders having superior information regarding shocks to the euro exchange rate, and policy uncertainty on the part of the ECB. One empirical implication of the model is that higher transaction costs associated with the euro than the German mark may have contributed to euro depreciation. However, empirical evidence on percentage spreads tends to reject the hypothesis that percentage spreads were larger on the euro than the mark for all but the first few months. This seems like an unlikely candidate to explain euro depreciation over the prolonged period observed. Reviewing evidence on market dynamics around ECB, Bundesbank, and Federal Reserve meetings, there is no evidence suggesting that the market is "front running" in a different manner than the other central banks. However, we do find empirical support for the euro exchange rate to be affected by learning. By focusing on euro-area inflation as the key fundamental, the model is structured toward the dynamics of learning about ECB policy with regard to inflation. While a stated target inflation rate of 2 percent existed, it may be that market participants had to be convinced that the ECB would, indeed, generate low and stable inflation. The theory motivates an empirical model of Bayesian updating related to market participants learning about the underlying inflation process under the ECB regime. With a prior distribution drawn from the pre-euro EMS experience and updating based upon the realized experience each month following the introduction of the euro, the evidence suggests that it was not until the fall of 2000 that the market assessed a greater than 50 percent probability that the inflation process had changed to a new regime. From this point on, trend depreciation of the euro ends and further increases in the probability of the new inflation process are associated with euro appreciation.

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