nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒07‒11
seventeen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Can option smiles forecast changes in interest rates? An application to the US, the UK and the euro area By Marcello Pericoli
  3. Euroland, Euro and Dollar - Trilogy or Trilemma? By Elke Muchlinski
  4. Inflation inertia and the optimal hybrid inflation/price-level target By Øistein Røisland
  5. China's exchange rate policy: the case against abandoning the dollar PEG By Laurenceson,James; Qin,Fengming
  6. Explaining British Policy on the Euro By Howarth, David
  7. Monetary integration and the cost of borrowing By Marta Gómez-Puig
  8. Monetary policy rules, credibility and inflation: The Spanish experience By Carmen Díaz-Roldán; Alberto Montero Soler
  9. Intrinsic and inherited inflation persistence By Jeff Fuhrer
  10. The Eurosystem money market auctions: a banking perspective By Nikolaus Bartzsch; Ben Craig; Falko Fecht
  11. Identifying the effects of central bank intervention By Christopher J. Neely
  12. A new federal funds rate target series: September 27, 1982, - December 31, 1993 By Daniel L. Thornton
  13. Currency Boards and Chinese Banking Development in pre-World War II Southeast Asia: Malaya and the Philippines By W. G. Huff
  14. Quo vadis Euro? By Enrique Alberola; Susana Garcia-Cervero; Humberto López; Angel Ubide
  16. The Fed and the Stock Market By Antonello D'Agostino; Luca Sala; Paolo Surico
  17. Is There a Direct Effect of Money?: Money's Role in an Estimated Monetary Business Cycle Model of the Japanese Economy By Ippei Fujiwara

  1. By: Marcello Pericoli (Bank of Italy, Economic Research Department)
    Abstract: This paper evaluates the use of risk-neutral probability density functions implied in 3-month interest-rate futures options to assess market perceptions regarding future monetary policy moves options allow the information content implied in simpler derivatives to be extended by providing indicators for asymmetry and extreme values. First, a cubic spline is implemented to evaluate the densities. Second, the methodology is applied to quotes on deposits denominated in US dollars, euros and sterling from January 1999 toMay 2004 results show that markets correctly forecast the monetary easing of 2001 in the United States in the course of the second half of 2000, but not in the euro area and the United Kingdom. The evidence for the tightening cycle of 1999 is mixed: markets expected an increase in euro area policy rates at the beginning of 1999 expectations were less clear for the United States’ interest-rate increases. In the case of the United Kingdom the increase was not foreseen.
    Keywords: risk-neutral density, cubic spline, monetary policy, interest-rate futures options
    JEL: C52 E58 G13 G14 G15
    Date: 2005–02
  2. By: Andrea Nobili (Bank of Italy, Economic Research Department)
    Abstract: This paper deals with the usefulness of several measures of financial spreads (the slope of the yield curve, the reverse yield gap, the credit quality spread) for fore-casting real economic activity and inflation in the euro area. A quarterly Bayesian vector autoregression model is used to assess the marginal forecasting power of fi-nancial spreads for real economic activity and inflation. A benchmark BVAR is set up, containing real GDP, inflation and key indicators of monetary policy and foreign macroeconomic variables. The properties of the spreads as leading indicator are then assessed by augmenting the benchmark BVAR with the spreads, one at a time. We find that financial spreads have no or negligible marginal predictive con-tent for either target variable. Overall, there is no ready-to-use financial indicator that can replace an encompassing multivariate model for the prediction of target variables in the euro area.
    Keywords: financial spreads, bayesian VAR models, bayesian analysis, forecasting
    JEL: C11 C32 C53
    Date: 2005–02
  3. By: Elke Muchlinski (Free University of Berlin, Department of Economics)
    Abstract: This paper argues that Euroland is a representation of a monetary union with a heterogeneous capital market, tax system, regulation of consumer savings, and methods of financing investments. Contrary to that, the Dollar represents a homogeneous capital market. Euroland and the Euro as an anchor currency will not be a representation of a unified economic performance, as for instance the Dollar was in 1944 implemented by the Bretton Woods Agreements. According to a trilogy composed three parts of a work as a whole, the relationship between Euroland, Euro (as an anchor currency) and Dollar could be interpreted as a workable unity. This required the perception of the inherent fragility of this triad. It is the result of all the different functions held by each part.
    Keywords: Central banking, monetary policy regimes and arrangements
    JEL: F02 F33 E58
  4. By: Øistein Røisland (Norges Bank; Norges Bank)
    Abstract: A hybrid inflation/price-level target combines elements of both inflation and price-level targets. The paper derives a hybrid target within a new Keynesian model with inflation persistence due to price indexation. The result generalizes a result by Vestin (2005) that the optimal policy could be implemented with a price-level targeting regime. We show that the optimal price-level drift in the hybrid target is equal to the degree of price indexation.
    Keywords: Price-level target, Inflation persistence, Commitment
    JEL: E52 E61 E63
    Date: 2005–07–04
  5. By: Laurenceson,James; Qin,Fengming (Tilburg University, Center for Economic Research)
    Abstract: This paper critically evaluates the policy literature surrounding China's exchange rate regime. It first discusses several popularly raised contentions in relation to the dollar peg employed by China, which in fact are poorly grounded in evidence. These include notions that the RMB is clearly undervalued and that its value is a prominent cause of the U.S trade deficit. The paper then describes a consensus position that has emerged which argues that China should abandon the peg in favour of a flexible exchange rate regime. We see numerous weaknesses in this position but a few stand out. Moving to a flexible regime is far from the most proximate policy response to the problems that the consensus literature itself identifies in China's economy. Institutional realities that make moving to a flexible regime difficult also appear to have been seriously overlooked. The paper concludes by noting that in the longer term moving to a managed float may be in China's best interests - but for now the focus needs to be firmly in the area of domestic financial reform.
    JEL: E58 F31
    Date: 2005
  6. By: Howarth, David
    Abstract: Four overlapping analytical frameworks focusing upon domestic British politics are applied to explain the detailed development of the policy on the euro maintained by the Conservative Government then Party in opposition and the Labour Party opposition and then Government: intra-party politics; inter-party politics; public opinion and the nature of British democracy; and neo-pluralism (competing economic and other interests). This article posits that British government - and in particular Labour Government - reluctance to hold a referendum on euro membership and actively push a pro-euro policy can be best explained in terms of ideologically infused intra- (rather than inter-) party politics and the realities of pluralist politics, while explanations rooted in an analysis of public opinion are less helpful.
    Keywords: U.K.; Euro; EMU; media; pluralism; political parties; public opinion; national autonomy; political science
    Date: 2004–10–06
  7. By: Marta Gómez-Puig
    Abstract: With the beginning of the European Monetary Union (EMU), euro-area sovereign securities’ adjusted spreads over Germany (corrected from the foreign exchange risk) experienced an increase that caused a lower than expected decline in borrowing costs. The objective of this paper is to study what explains that rising. In particular, if it took place a change in the price assigned by markets to domestic (credit risk and/or market liquidity) or to international risk factors. The empirical evidence supports the idea that a change in the market value of liquidity occurred with the EMU. International and default risk play a smaller role.
  8. By: Carmen Díaz-Roldán; Alberto Montero Soler
    Abstract: Starting from inflation rates above the European average, Spain was able to conduct her monetary policy and control inflation in order to join the EMU from its start. In this paper we explore whether the credibility of the monetary policy performed by the Bank of Spain would have contributed to these developments.
  9. By: Jeff Fuhrer
    Abstract: In the now conventional view of the inflation process, the New Keynesian Phillips Curve (NKPC) captures most of the persistence in inflation. The sources of persistence are twofold. First, the “driving process” for inflation—the output gap or, more commonly, real marginal cost—is itself quite persistent, and a casual inspection of the NKPC reveals that inflation must “inherit” this persistence. Second, a modest amount of backward-looking or indexing behavior imparts some “intrinsic” persistence to inflation. This latter source is generally thought to be of less importance than the former, as the degree of autocorrelation in the driving processes is substantial. This paper shows that in practice inflation in the NKPC inherits very little of the persistence of the driving process, and, contrary to conventional wisdom, it is intrinsic persistence that constitutes the dominant source of persistence. The paper explores the reasons for this and links them to two empirical observations. First, it has been difficult to develop a sizable coefficient on the driving process in NKPCs. Second, the shock that enters the NKPC, while often difficult to motivate economically, is large and is critical in distinguishing the sources of inflation persistence. While these observations help to clarify the behavior of inflation in NKPCs, they raise other fundamental questions about how to model inflation.
    Keywords: Inflation (Finance)
    Date: 2005
  10. By: Nikolaus Bartzsch; Ben Craig; Falko Fecht
    Abstract: This paper analyzes the individual bidding behavior of German banks in the money market auctions conducted by the ECB from the beginning of the third quarter of 2000 to the end of the first quarter of 2001. Our approach takes a variety of characteristics of the individual banks into account. In particular, we consider variables that capture the different use of liquidity and the different attitude towards liquidity risk of the individual banks. It turns out that these characteristics are reflected in the banks’ respective bidding behavior to a large extent. Thus our study contributes to a deeper understanding of the way liquidity is managed in the banking sector.
    Keywords: Banks and banking, Central ; Bank liquidity ; European Central Bank
    Date: 2005
  11. By: Christopher J. Neely
    Abstract: Most intervention studies have been silent on the assumed structure of the economic system*implicitly imposing implausible assumptions*despite the fact that inference depends crucially on such issues. This paper proposes to identify the cross-effects of intervention with the level and volatility of exchange rates using the likely timing of intervention, macroeconomic announcements as instruments and the nonlinear structure of the intervention reaction function. Proper identification of the effects of intervention indicates that it is moderately effective in changing the levels of exchange rates but has no significant effect on volatility. The paper also illustrates that such inference depends on paying careful attention to seemingly innocuous identification assumptions.
    Keywords: Foreign exchange ; Banks and banking, Central
    Date: 2005
  12. By: Daniel L. Thornton
    Abstract: This paper creates a new series of the FOMC*s Target for the federal funds rate for the period September 27, 1982 through December 31, 1993. The creation of this series was motivated by Thornton (2005). Analyzing the verbatim transcripts of the FOMC, Thornton finds that most of the FOMC believed they began targeting the funds rate even before it deemphasized M1*s role in the Fed*s daily operating procedure. The new series was constructed using the verbatim transcripts of FOMC meetings, the FOMC Blue Book, the Report of Open Market Operations and Money Market Conditions, and data that the author obtained from the Desk for the Federal Reserve Bank of New York dealing with open market operations over the period March 1984 through December 1996. The new series compared with another widely used series presented in Thornton and Wheelock (2000). There are some differences in the dating and magnitude of target changes between the two series prior to but not after August 1989.
    Keywords: Monetary policy ; Interest rates
    Date: 2005
  13. By: W. G. Huff
    Abstract: This article examines the relationship between currency boards and the development of local Chinese deposit banking in pre-World War II Malaya and the Philippines. While in both countries Chinese banks filled an important gap in financial intermediation, the currency board system - an especially strict version of the classical gold standard - virtually ensured that these institutions remained small. Moreover, in the 1930s slump the currency board system's preclusion of a central bank and requirement to pay depositors in 100 per cent metropolitan currency, together with the volatility of highly staple-dependent export economies, pushed Chinese banks to the verge of bankruptcy or beyond. Examination of the 1930s crisis in Southeast Asia and role of banks in it reveals more differences from than parallels with 1990s experience.
  14. By: Enrique Alberola (Banco de España); Susana Garcia-Cervero (Deutsche Bank); Humberto López (World Bank); Angel Ubide (Tudor Investments)
    Abstract: This paper calculates the equilibrium exchange rates for the Euro and the rest of the G-7 currencies. Building on the methodology of Alberola et al., it is shown that the stock of net foreign assets and the evolution of productivity are the fundamentals underlying the behaviour of the real exchange rate. Panel cointegration techniques allow for the extraction, using an unobserved components methodology, of a time- varying equilibrium real exchange rate, and deviations from this equilibrium provide an estimate of the degree of multilateral misalignment. Finally, an algebraic transformation converts these multilateral equilibrium real rates into bilateral equilibrium nominal rates. The results uncover that the Euro was slightly undervalued by the start of Stage III of EMU and that, despite a faint fall of its fundamentals since then, the slide during 1999 has widened the misalignment above 10% against other main currencies.
    Keywords: equilibrium exchange rates, panel cointegration, Euro, G-7 currencies
    JEL: F3 F4
    Date: 2005–07–08
  15. By: Enrique Alberola (Banco de España)
    Abstract: Exchange rates in Latin America display a large volatility, constitute a central element of the policy strategies and their evolution have an important impact on financial stability due to the dollarization of liabilities which most countries exhibit. However, assessments on equilibrium exchange rates are scarce in the region. This paper aims at both filling this gap and analysing the impact of the adjustment of the exchange rates to equilibrium on financial stability. Building on the methodology of Alberola et al (1999,2002), we show that the stock of net foreign assets and the evolution of productivity are the fundamentals underlying the behavior of the real exchange rate. Using an unobserved components methodology in a cointegration framework, a time-varying equilibrium real exchange rate is derived, and deviations from this equilibrium provide an estimate of the degree of multilateral misalignment. The results uncover among other things the large overvaluation of the Argentinean peso in 2001, which was only partially explained by the estimated dollar overvaluation. The adjustment of exchange rates in 2002 corrected this and, to a lesser extent, other misalignments. The final part of the paper addresses the impact of liability dollarization on the adjustment of exchange rates. It is argued that the real exchange rate will tend to overshoot its equilibrium level, due to the need to foster higher current account surplus in the aftermath of depreciation to make up for to the increase in liabilities. An adjustment to account for this effect is performed on the previous results. This overshooting, when coupled with sudden stops of capitals, may help explaining the higher volatility of real exchange rates in the region.
    Keywords: Equilibrium Exchange Rates, Liabilities dollarization, Overshooting
    JEL: F31 F41 C23
    Date: 2005–07–08
  16. By: Antonello D'Agostino (ECARES, Universite' Libre de Bruxelles & European Central Bank); Luca Sala (IGIER, Bocconi University); Paolo Surico (Bank of England & University of Bari)
    Abstract: The Fed closely monitors the stock market and the stock market continuously forms expectations about the Fed decisions. What does this imply for the relation between the fed funds rate and the S&P500? We find that the answer depends on the conditions prevailing on the financial market. During periods of high (low) volatility in asset price inflation an unexpected 5% fall in the stock market index implies that the Fed cuts the interest rate by 19 (6) basis points while an unanticipated policy tightening of 50 basis points causes a 4.7% (2.3%) decline in the S&P500. The Fed reaction to asset price return is however statistically different from zero only in the high volatility regime, whereas the fall in asset price return following an interest rate rise is highly significant during normal times only.
    Keywords: asset price volatility, nonlinear policy, threshold SVAR, system GMM
    JEL: E44 E52 E58
    Date: 2005–07–04
  17. By: Ippei Fujiwara (Research and Statistics Department, Bank of Japan, and Osaka University)
    Abstract: In this paper, I estimate the monetary business cycle model of the Japanese economy by the method advocated by Ireland (2002a), the max- imum likelihood estimation of the dynamic stochastic general equilibrium model in a state-space representation. The model estimated here includes the direct role of money on output and inflation so that we could study the alternative transmission mecha- nism of monetary policy to traditional interest rate channel, which may even work under the zero nominal interest rate as in Japan now. However, estimation results report that the direct effect of money is extremely small even if there could be. This nding is consistent with the ones obtained for US data in Ireland (2002a) and Euro area in Andres, Lopez-Salido and Valles (2001).
    Keywords: Direct Role of Money; Cross-Restriction; Maximum Likelihood Estimation; Dynamic Stochastic General Equilibrium Model
    JEL: C31 E32 E52
    Date: 2003–12

This nep-mon issue is ©2005 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.