nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒09‒11
twenty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Financial Crises and Money Demand in Jamaica By Fiona Atkins
  2. Foreign Exchange Intervention and Monetary Policy in Japan, 2003-04 By Rasmus Fatum; Michael M. Hutchison
  3. Using federal funds futures contracts for monetary policy analysis By Refet S. Gurkaynak
  4. Seventy Years of Central Banking: The Bank of Canada in International Context, 1935-2005 By Michael D. Bordo; Angela Redish
  5. Optimal fiscal and monetary policy with sticky wages and sticky prices By Sanjay K. Chugh
  6. The Friedman rule meets the zero interest rate bound By Jangryoul Kim; Preston Miller
  7. The effects of inflation targeting on macroeconomic performance By Thórarinn G. Pétursson
  8. Daily Effects of Foreign Exchange Intervention: Evidence from Official Bank of Canada Data By Rasmus Fatum
  9. Incentives from exchange rate regimes in an institutional context By Ashima Goyal
  10. Globalisation and Monetary Policy By Paul Cavelaars
  11. The Incredible Volcker Disinflation By Marvin Goodfriend; Robert King
  12. Exchange Rate Interventions and Insurance: Is “Fear of Floating” a Cause For Concern? By Francisco Gallego; Geraint Jones
  13. Fiscal Policy and the Term Structure of Interest Rates By Qiang Dai; Thomas Philippon
  14. Discretionary Policy Interactions and the Fiscal Theory of the Price Level: A SVAR Analysis on French Data By Jerome Creel; Paola Monperrus-Veroni; Francesco Saraceno
  15. Financial Liberalization and Inflationary Dynamics: An Open Economy Analysis By Rangan Gupta
  16. Financial Liberalization and Inflationary Dynamics By Rangan Gupta
  17. Recovering market expectations of FOMC rate changes with options on federal funds futures By John B. Carlson; Ben R. Craig; William R. Melick
  18. Do Macro Variables, Asset Markets or Surveys Forecast Inflation Better? By Andrew Ang; Geert Bekaert; Min Wei
  19. Testing for Structural Breaks in Australia's Monetary Aggregates and Interest Rates: An Application of the Innovational Outlier and Additive Outlier Models By Pahlavani, Mosayeb; Valadkhani, Abbas; Worthington, Andrew
  20. Estimating the COP Exchange Rate Volatility Smile and the Market Effect of Central Bank Interventions: A CHARN Approach By Juan Manuel Julio; Norberto Rodríguez; Héctor Manuel Zárate
  21. Inflation Dynamics and the New Keynesian Phillips Curve: an Identification Robust Econometric Analysis By Jean-Marie Dufour; Lynda Khalaf; Maral Kichian
  22. Contractionary Currency Crashes in Developing Countries By Jeffrey A. Frankel

  1. By: Fiona Atkins (School of Economics, Mathematics & Statistics, Birkbeck College)
    Abstract: This paper estimates the money demand function for Jamaica using a Structural co-integrating VAR. This approach provides estimates of the long run structural relations and also reveals the complex short run feedbacks of monetary policy on key macro variables. In recent years Jamaican governments have adopted an inflation targeting framework for policy and have moved towards reliance on interest rates rather than direct money control as the primary instrument. This policy presumes that monetary transmission runs from the interest rate to directly affect the level of output which then feeds into the inflation process. However, in an economy with limited financial sector development interest rate transmission may be more circumspect, having a strong direct affect on money demand which then influences aggregate demand and output and hence inflation. These feedbacks are investigated within the error correction model.. Stability of Money demand is vital for predictable policy, and is investigated using CUSUM tests for parameter stability. The Jamaican financial sector suffered a major crisis in the mid 1990’s, the paper considers whether the stability of money demand was compromised. It is argued that the finding of stable money demand suggests that the specific policy responses may have successfully bolstered confidence and prevented financial implosion.
    Keywords: Caribbean, Jamaica, money demand
    JEL: C51 C52 E41 E52
    Date: 2005–09
  2. By: Rasmus Fatum (School of Business, University of Alberta); Michael M. Hutchison (Department of Economics, University of California)
    Abstract: This article examines the rationale behind the massive increase in Japanese foreign exchange market intervention operations in 2003-04, and evaluates its effectiveness both in limiting yen exchange rate appreciation and influencing the direction of monetary policy. The two main questions addressed in this study are: Was the intervention effective in slowing exchange rate appreciation compared to a counterfactual case with no intervention? And, has intervention on such a large scale authorized by the Ministry of Finance been able to directly influence liquidity creation or indirectly influence the stance of Bank of Japan policy?
    Keywords: foreign exchange intervention; Japanese monetary policy
    JEL: E51 E58 F31
    Date: 2004–10
  3. By: Refet S. Gurkaynak
    Abstract: Federal funds futures are popular tools for calculating market-based monetary policy surprises. These surprises are usually thought of as the difference between expected and realized federal funds target rates at the current FOMC meeting. This paper demonstrates the use of federal funds futures contracts to measure how FOMC announcements lead to changes in expected interest rates after future FOMC meetings. Using several 'surprises' at different horizons, timing, level, and slope components of unanticipated policy actions are defined. These three components have differing effects on asset prices that are not captured by the contemporaneous surprise measure.
    Keywords: Monetary policy ; Federal funds rate ; Federal funds market (United States)
    Date: 2005
  4. By: Michael D. Bordo; Angela Redish
    Abstract: On the seventieth birthday of the Bank of Canada, we evaluate the Bank's contribution to monetary policy in an international context. We focus on: the reasons for the establishment of the central bank in 1935, its unique record of floating in a sea of fixed currencies under Bretton Woods; its experience with the Great Inflation and monetarism; its pioneering adoption of inflation targeting; and recent innovations in the payments and the phasing out of reserve requirements.
    JEL: E58
    Date: 2005–08
  5. By: Sanjay K. Chugh
    Abstract: We determine the optimal degree of price inflation volatility when nominal wages are sticky and the government uses state-contingent inflation to finance government spending. We address this question in a well-understood Ramsey model of fiscal and monetary policy, in which the benevolent planner has access to labor income taxes, nominal riskless debt, and money creation. One main result is that sticky wages alone make price stability optimal in the face of government spending shocks, to a degree quantitatively similar as sticky prices alone. With productivity shocks also present, optimal inflation volatility is higher, but still dampened relative to the fully-flexible economy. Key for our results is an equilibrium restriction between nominal price inflation and nominal wage inflation that holds trivially in a Ramsey model featuring only sticky prices. We also show that the nominal interest rate can be used to indirectly tax the rents of monopolistic labor suppliers. Interestingly, a necessary condition for the ability to use the nominal interest rate for this purpose is positive producer profits. Taken together, our results uncover features of Ramsey fiscal and monetary policy in the presence of labor market imperfections that are widely-believed to be important.
    Keywords: Inflation (Finance) - Mathematical models ; Monetary policy - Mathematical models ; Fiscal policy - Mathematical models
    Date: 2005
  6. By: Jangryoul Kim; Preston Miller
    Abstract: This paper is an attempt to determine the relative importance of the efficiency and stability effects of monetary policy. The method is to find the policy that maximizes welfare in a general equilibrium model that generates both effects. It is found that the steady-state inflation rate under the optimal policy is significantly above the rate required for maximal efficiency and significantly below that required for maximal stability. Thus, both effects play important roles in determining the optimal rate of inflation. In addition, it is found that if a typical macroeconomic objective function is maximized as a substitute for welfare-maximization, the resultant policy rule puts too much weight on stability. It generates too much inflation and causes the policy instrument to respond too much to new information.
    Date: 2004
  7. By: Thórarinn G. Pétursson
    Abstract: An increasing number of countries have adopted inflation targeting since New Zealand first adopted this framework in early 1990. Currently there are 21 countries using inflation targeting in every continent of the world. This paper discusses the economic effects of inflation targeting. The main conclusion is that inflation targeting has largely been a success. The new framework has made central banks, which previously lacked credibility, able to change the way they do monetary policy towards what is commonly considered best practice. In many respects they have even been leading in creating a new benchmark for how to formulate monetary policy.
    Date: 2004–06
  8. By: Rasmus Fatum (School of Business, University of Alberta)
    Abstract: This paper analyzes the effects of official, daily Bank of Canada intervention in the CAD/USD exchange rate market over the January 1995 to September 1998 period. Using an event study methodology and different criteria for effectiveness, movements in the CAD/USD exchange rate over the 1 through 10 days surrounding intervention events are investigated. It is shown that Bank of Canada intervention was systematically associated with both a change in the direction and a smoothing of the CAD/USD exchange rate. Bank of Canada intervention did not, however, succeed in reducing the volatility of the CAD/USD exchange rate. Additionally, the paper introduces the issue of currency co-movements to the intervention literature. It is shown that the effects of intervention are weakened when adjusting for general currency co-movements against the USD, suggesting that currency co-movements should be taken into account when addressing the effects of central bank intervention aimed at managing a minor currency vis-à-vis a major currency.
    Keywords: foreign exchange intervention; event studies; currency co-movement
    JEL: E58 F31 G14 G15
    Date: 2005–06
  9. By: Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: In a simple open EME macromodel, calibrated to the typical institutions and shocks of a densely populated emerging market economy, a monetary stimulus preceding a temporary supply shock can lower interest rates, raise output, appreciate exchange rates, and lower inflation. Simulations generalize the analytic result with regressions validating the parameter values. Under correct incentives, such as provided by a middling exchange rate regime, which imparts limited volatility to the nominal exchange rate around a trend competitive rate, forex traders support the policy. The policy is compatible with political constraints and policy objectives, but analysis of strategic interactions brings out cases where optimal policy will not be chosen. Supporting institutions are required to coordinate monetary, fiscal policy and markets to the optimal equilibrium. The analysis contributes to understanding the key issues for countries such as India and China that need to deepen markets in order to move to more flexible exchange rate regimes.
    Keywords: Exchange rate, hedging, supply shocks, EMEs, incentives, politics
    JEL: F31 F41
    Date: 2005–07
  10. By: Paul Cavelaars
    Abstract: This paper studies the implications of globalisation for the effectiveness of monetary policy in large open economies, such as the euro area and the United States. The analysis allows for imperfect competition and an endogenous home bias in consumption. I find that globalisation (a reduction in the costs of international trade) causes a monetary expansion to have a larger (smaller) e¤ect on prices (output). To the extent that globalisation also induces stronger competition in the goods market, I find that its impact on the incentive for activist monetary policy is ambiguous. Finally, globalisation reduces the beggary-thy-neighbour effects of monetary policy.
    Keywords: trade costs; openness; monetary policy.
    JEL: F15 F41
    Date: 2005–08
  11. By: Marvin Goodfriend; Robert King
    Abstract: Using a simple modern macroeconomic model, we argue that the real effects of the Volcker disinflation in the early 1980s were mainly due to imperfect credibility, evident in volatility and stubbornness of long-term interest rates. Studying recently released transcripts of the Federal Open Market Committee, we find -- to our surprise -- that Volcker and other FOMC members also regarded long-term interest rates as key indicators of inflation expectations and of their disinflationary policy's credibility. We also consider the interplay of monetary targets, operating procedures, and credibility during the Volcker disinflation.
    JEL: E3 E4 E5 N1
    Date: 2005–08
  12. By: Francisco Gallego; Geraint Jones
    Abstract: Fear of floating” is one of the central empirical characteristics of exchange rate regimes in emerging markets. However, while some view “fear of floating” in terms of the optimal ex post monetary response to external shocks, protecting balance sheets and avoiding inflation, others have argued that from an ex ante perspective such a policy leads to private sector underinsurance against sudden stops. A commitment to floating during potential crises would increase the incentives of the private sector to conserve international liquidity. This paper develops a model of the optimal exchange rate regime when both ex ante and ex post concerns are present. Since it is only “fear of floating” during potential sudden stops which undermines insurance, we reexamine the data on exchange rate regimes for evidence that exchange rate flexibility is state-contingent. We find most emerging markets exhibit non-contingent policies with a uniformly low level of flexibility, which together with an absence of substituteinsurance policies supports the claim that greater exchange rate flexibility during sudden stops would be desirable for such countries. However, more recent floats with intermediate levels of credibility exhibit little state contingency because of a uniformly high degree of flexibility. More established floats with high credibility exhibit statecontingent regimes, retaining a capacity for discretionary intervention, but floating during potential crises. Exchange rate flexibility is associated with increased private sector hoarding of dollar assets and reduced incidence of sudden stops. Together the evidence suggests that the insurance benefits to floating for emerging markets can be substantial and that the credibility of the monetary policy framework is central to successful implementation of this policy.
    Date: 2005–09
  13. By: Qiang Dai; Thomas Philippon
    Abstract: Macroeconomists want to understand the effects of fiscal policy on interest rates, while financial economists look for the factors that drive the dynamics of the yield curve. To shed light on both issues, we present an empirical macro-finance model that combines a no-arbitrage affine term structure model with a set of structural restrictions that allow us to identify fiscal policy shocks, and trace the effects of these shocks on the prices of bonds of different maturities. Compared to a standard VAR, this approach has the advantage of incorporating the information embedded in a large cross-section of bond prices. Moreover, the pricing equations provide new ways to assess the model's ability to capture risk preferences and expectations. Our results suggest that (i) government deficits affect long term interest rates: a one percentage point increase in the deficit to GDP ratio, lasting for 3 years, will eventually increase the 10-year rate by 40--50 basis points; (ii) this increase is partly due to higher expected spot rates, and partly due to higher risk premia on long term bonds; and (iii) the fiscal policy shocks account for up to 12% of the variance of forecast errors in bond yields.
    JEL: E0 G0
    Date: 2005–08
  14. By: Jerome Creel (Observatoire Français des Conjonctures Économiques); Paola Monperrus-Veroni (Observatoire Français des Conjonctures Économiques); Francesco Saraceno (Observatoire Français des Conjonctures Économiques)
    Abstract: We estimate a SVAR model of the French economy. The econometric method originates in Blanchard and Perotti [Quarterly Journal of Economics, 2002] but owes also extensively to the fiscal theory of the price level (FTPL) that investigates the interactions between government surplus, debt accumulation and price dynamics. We have the objective, on the one hand, of assessing the effects of fiscal and monetary policy shocks on the economy; and, on the other, of studying the strategic interactions between fiscal and monetary authorities. As a consequence, the theoretical restrictions to identify our model are derived from a FTPL framework. Our estimations reveal so-called Keynesian features of fiscal and monetary shocks; meanwhile, they are consistent with the prediction of the FTPL as regards price dynamics. Although the first part of our findings agrees with most of the recent literature on the subject, the non-rejection of the FTPL is an originality.
    Keywords: Fiscal policy, Monetary policy, Fiscal theory of the price level, Structural VAR, France
    JEL: C32 E60 E63 H60
    Date: 2005
  15. By: Rangan Gupta (University of Connecticut and University of Pretoria)
    Abstract: The paper analyzes the effects of financial liberalization on inflation. We develop a monetary and endogenous growth, dynamic general equilibrium model of a small open semi-industrialized economy, with financial intermediaries subjected to obligatory "high" reserve ratio, serving as the source of financial repression. When calibrated to four Southern European semi-industrialized countries, namely Greece, Italy, Spain and Portugal, that typically had high reserve requirements, the model indicates a positive inflation-financial repression relationship irrespective of the the specification of preferences. But the strength of the relationship obtained from the model is found to be much smaller in size than the corresponding empirical estimates.
    Keywords: Inflation; Financial Markets and the Macroeconomy
    JEL: E31 E44
    Date: 2005–07
  16. By: Rangan Gupta (University of Connecticut and University of Pretoria)
    Abstract: The paper analyzes the effects of financial liberalization on inflation. We develop a monetary and endogenous growth, dynamic general equilibrium model with financial intermediaries subjected to obligatory "high" cash reserves requirement, serving as the source of financial repression. When calibrated to four Southern European semi-industrialized countries, namely Greece, Italy, Spain and Portugal, that typically had high reserve requirements, the model indicates a positive inflation-financial repression relationship irrespective of the the specification of preferences. But the strength of the relationship obtained from the model is found to be much smaller in size than the corresponding empirical estimates.
    Keywords: Inflation; Financial Markets and the Macroeconomy
    JEL: E31 E44
    Date: 2005–07
  17. By: John B. Carlson; Ben R. Craig; William R. Melick
    Abstract: This paper demonstrates how options on federal funds futures, which began trading in March 2003, can be used to recover the implied probability density function (PDF) for future Federal Open Market Committee (FOMC) interest rate outcomes. The discrete nature of the choices made by the FOMC allows for a very straightforward recovery of the implied PDF using ordinary least squares (OLS) estimation. This simple recovery method stands in contrast to the relatively complicated PDF recovery techniques developed for options written on assets such as equities, foreign exchange, or commodity futures where the underlying prices are most appropriately modeled as being drawn from continuous distributions. The OLS estimation is used to recover PDFs for single FOMC meetings as well as PDFs for joint estimation of multiple FOMC meetings, and allows for the imposition of restrictions on the recovered probabilities, both within and across FOMC meetings. Finally, recovered probabilities are used to assess the impact of data releases and Fed communication on the perceived likelihood of actual policy outcomes.
    Keywords: Federal Open Market Committee ; Monetary policy ; Interest rate futures
    Date: 2005
  18. By: Andrew Ang; Geert Bekaert; Min Wei
    Abstract: Surveys do! We examine the forecasting power of four alternative methods of forecasting U.S. inflation out-of-sample: time series ARIMA models; regressions using real activity measures motivated from the Phillips curve; term structure models that include linear, non-linear, and arbitrage-free specifications; and survey-based measures. We also investigate several optimal methods of combining forecasts. Our results show that surveys outperform the other forecasting methods and that the term structure specifications perform relatively poorly. We find little evidence that combining forecasts using means or medians, or using optimal weights with prior information produces superior forecasts to survey information alone. When combining forecasts, the data consistently places the highest weights on survey information.
    JEL: E31 E37 E43 E44
    Date: 2005–08
  19. By: Pahlavani, Mosayeb (University of Wollongong); Valadkhani, Abbas (University of Wollongong); Worthington, Andrew (University of Wollongong)
    Abstract: This paper employs all quarterly time series currently available to endogenously determine the timing of structural breaks for various monetary aggregates and interest rates in Australia over the last thirty years. The Innovational Outlier model (IO) and the Additive Outlier model (AO) are then used to test for nonstationarity. After accounting for the single most significant structural break, the results from both models clearly indicate that the null of at least one unit root cannot be rejected for almost all series examined. The structural breaks found coincide with important policy changes during the period of financial deregulation starting in the 1980s.
    Keywords: Monetary aggregates, interest rates, Innovational Outlier Model, Additive Outlier Model
    Date: 2005
  20. By: Juan Manuel Julio; Norberto Rodríguez; Héctor Manuel Zárate
    Abstract: In this paper we estimated a volatility model for COP/US under two different samples, one containing the information before the “discretional interventions” started, and the other using the whole sample. We use a nonparametric approach to estimate the mean and “volatility smile” return functions using daily data. For the pre-interventions sample, we found a nonlinear expected return function and, surprisingly, a nonsymmetric “volatility smile”. These lack of linearity and symmetry are related to absolute returns above 1,5% and 1,0%, respectively. We also found that the “discretional interventions” did not shift the mean response function, but moved the expected returns along the line towards the required levels. In contrast, the “volatility smile” tends to increase in a non-symmetric way after accounting for “discretional interventions”. The Sep/29/2004 announcement does not seem to have had any effect on the expected conditional mean or variance functions, but the Dec/17/2004 announcement seems to be related to non-symmetric effects on the volatility smile. We concluded that the announcement of discretional intervention by the monetary authority was more efficient when time and amount were unannounced.
    Keywords: Volatility Smile,
    JEL: C14
    Date: 2005–07–30
  21. By: Jean-Marie Dufour; Lynda Khalaf; Maral Kichian
    Abstract: In this paper, we use identification-robust methods to assess the empirical adequacy of a New Keynesian Phillips Curve (NKPC) equation. We focus on the Gali and Gertler’s (1999) specification, on both U.S. and Canadian data. Two variants of the model are studied: one based on a rationalexpectations assumption, and a modification to the latter which consists in using survey data on inflation expectations. The results based on these two specifications exhibit sharp differences concerning: (i) identification difficulties, (ii) backward-looking behavior, and (ii) the frequency of price adjustments. Overall, we find that there is some support for the hybrid NKPC for the U.S., whereas the model is not suited to Canada. Our findings underscore the need for employing identificationrobust inference methods in the estimation of expectations-based dynamic macroeconomic relations. <P>Dans cet article, nous employons des méthodes robustes aux problèmes d’identification afin d’évaluer la valeur empirique d’une nouvelle équation de courbe de Phillips keynésienne (NKPC). Nous concentrons notre analyse sur la spécification de Gali et Gertler (1999), en considérant des données américaines et canadiennes. Nous étudions deux variantes du modèle : une première fondée sur une hypothèse d’attentes rationnelles et une seconde où les attentes sont mesurées à partir de données d’enquête. Les résultats basés sur ces deux spécifications diffèrent de manière notable sur plusieurs points : (i) les problèmes liés à l’identification, (ii) les comportements rétrospectifs, (iii) la fréquence des ajustements. En fin de compte, nos résultats sont compatibles dans une faible mesure avec un modèle NKPC hybride, tandis que le modèle ne semble pas compatible avec les données canadiennes. Nos résultats soulignent l’importance d’utiliser des méthodes robustes à l’identification dans l’analyse empirique de relations macroéconomiques où interviennent des attentes.
    Keywords: identification robust inference, inflation dynamics, macroeconomics, New Keynesian Phillips Curve, optimal instruments, weak instruments, dynamique de l’inflation, inférence robuste à l’identification, instruments faibles, instruments optimaux, macroéconomie, nouvelle courbe de Phillips keynésienne
    JEL: C12 C13 C3 C52 E3 E31 E5
    Date: 2005–08–01
  22. By: Jeffrey A. Frankel
    Abstract: To update a famous old statistic: a political leader in a developing country is almost twice as likely to lose office in the 6 months following a currency crash as otherwise. This difference, which is highly significant statistically, holds regardless whether the devaluation takes place in the context of an IMF program. Why are devaluations so costly? Many of the currency crises of the last ten years have been associated with output loss. Is this, as alleged, because of excessive reliance on raising the interest rate as a policy response? More likely it is because of contractionary effects of devaluation. There are various possible contractionary effects of devaluation, but it is appropriate that the balance sheet effect receives the most emphasis. Passthrough from exchange rate changes to import prices in developing countries is not the problem: this coefficient fell in the 1990s, as a look at some narrowly defined products shows. Rather, balance sheets are the problem. How can countries mitigate the fall in output resulting from the balance sheet effect in crises? In the shorter term, adjusting promptly after inflows cease is better than procrastinating by shifting to short-term dollar debt, which raises the costliness of the devaluation when it finally comes. In the longer term, greater openness to trade reduces vulnerability to both sudden stops and currency crashes.
    Date: 2005–08

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