nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒10‒08
thirteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary Policy and its Theoretical Foundations By David Laidler
  2. Demand for Money in India: 1953-2003 By B Bhaskara Rao; Singh Rup
  3. Fear of Floating: An optimal discretionary monetary policy analysis By Madhavi Bokil
  4. Credit and Monetary Policy: An Australian SVAR By Leon Berkelmans
  6. Monetary policy and asset prices: To respond or not? By Q. Farook Akram; Gunnar Bårdsen; Øyvind Eitrheim
  7. The Calculus of Dollarization, Central Banking (U.K.), Vol.XI, No. 2, (November 2000), 45-58. By Zeljko Bogetic
  8. Pegged Exchange Rate Regimes %u2013 A Trap? By Joshua Aizenman; Reuven Glick
  9. Full Dollarization: Fad or Future? Challenge (March 2000). By Zeljko Bogetic
  10. Official Dollarization: Current Experiences and Issues, Cato Journal, Vol. 20, No. 2 (Fall 2000), 179-213. By Zeljko Bogetic
  11. Seignirage Sharing and Dollarization, Central Banking (U.K.), Vol. X, No.4, 77-88. By Zeljko Bogetic
  12. Monetary-Fiscal Policy Interactions and the Price Level: Background and Beyond By Eric M. Leeper; Tack Yun
  13. Financial Dollarization and the Size of the Fear By Juan F. Castro; Eduardo Morón

  1. By: David Laidler (University of Western Ontario)
    Abstract: This paper briefly discusses why a monetary policy framework that emphasises interest rates has become standard in recent years, and why so many economists have been persuaded simultaneously to downgrade the importance of monetary aggregates. Then it describes Michael Woodford's particular contribution to these developments, and contrasts it with a more traditional approach to the theory of money that stresses its means of exchange role. It suggests that, though there are difficulties aplenty with the latter, Woodford's cashless simplification of the monetary economy presents problems of its own, both for monetary theory per se, and for the discussion of currently relevant monetary policy questions. It concludes that the theoretical basis for monetary policy should embrace wary eclecticism.
    Keywords: money; interest rates; inflation; monetarism; cashless economy; open-market operations rates; unemployment; multiplier
    JEL: E10 E31 E42 E44 E52 E58
    Date: 2005
  2. By: B Bhaskara Rao (University of the South Pacific); Singh Rup (University of the South Pacific)
    Abstract: The demand for money, especially in the developing countries, is an important relationship for formulating appropriate monetary policy and targeting monetary variables. In this paper we estimate the demand for narrow money in India and evaluate its robustness. It is found that there is a stable demand for money for almost half a century from 1953 to 2003. There is no evidence for any significant effects of the $1991$ financial reforms.
    Keywords: Demand for money, Developing countries, Income and interest rate elasticities, Cointegration, Financial reforms.
    JEL: C1 C5 C8
    Date: 2005–10–02
  3. By: Madhavi Bokil (Clark University)
    Abstract: This paper explores the idea that “Fear of Floating” and accompanying pro-cyclical interest rate policies observed in the case of some emerging market economies may be justified as an optimal discretionary monetary policy response to shocks. The paper also examines how the differences in monetary policies may lead to different degrees of this fear. These questions are addressed with a small open economy, new- Keynesian model with endogenous capital accumulation and sticky prices. The economy consists of two sectors- traded and non-traded. International credit markets are assumed to be imperfect, so that only the traded sector enjoys the ability to borrow internationally in foreign currency. The firms in the traded sector could potentially hold a large proportion of their debt in foreign currency, while the liabilities of the non-traded sector firms are entirely denominated in the domestic currency. Domestic exchange rate volatility adversely affects the balance sheets of the traded sector firms, while interest rate volatility creates problems for the firms in the non-traded sector. In such a situation, the monetary authorities face a dilemma when reacting to shocks. The numerical solution of the model indicates that the central bank’s reaction to shocks depends not only on the net effect of exchange rate movements on output gap and inflation, but also on the relative weight the central bank allocates to stabilizing output in the traded sector as against the non-traded sector. A central bank that assigns relatively higher importance to output stability in the traded goods sector also displays greater aversion for exchange rate volatility.
    Keywords: fear of floating, exchange rates, exchnage rate volatility, monetary policy, emerging countries
    JEL: F3 F4
    Date: 2005–10–04
  4. By: Leon Berkelmans (Reserve Bank of Australia)
    Abstract: Credit is an important macroeconomic variable that helps to drive economic activity and is also dependent on economic activity. This paper estimates a small structural vector autoregression (SVAR) model for Australia to examine the intertwined relationships of credit with other key macroeconomic variables. At short horizons, shocks to the interest rate, the exchange rate, and past shocks to credit are found to be important for credit growth. Over longer horizons, shocks to output, inflation and commodity prices play a greater role. The response of credit to changes in monetary policy is found to be relatively slow, similar to that of inflation and slower than that of output. The model suggests that an unexpected 25 basis point increase in the interest rate results in the level of credit being almost half of a percentage point lower than it otherwise would have been after a bit over one year, and almost 1 per cent lower after four years. Estimates from the model indicate that in responding to the macroeconomic consequences of a credit shock, monetary policy appears to stabilise the economy effectively. As a result of monetary policy’s response, output and the exchange rate are barely affected by a credit shock. The credit shock results in higher inflation for about two years, but it would be higher still over this period in the absence of a monetary policy response. Changes in credit are also moderated as a result of monetary policy’s response.
    Keywords: credit; credit channel; monetary policy
    JEL: E51
    Date: 2005–09
  5. By: Viv B. Hall
    Abstract: Arguments for and against abandoning independent national currencies and monetary policies have varied considerably over time and by country. For New Zealand, it can be argued that a key driving force behind recent debates has been the conduct of monetary policy and the need for improved overall economic performance in the longer term, rather than major dissatisfaction with its floating exchange rate system. In that context, this paper initially considers some issues considered important by other countries, and factors specific to New Zealand. It then utilises deterministic and stochastic simulation results from the RBNZ's core FPS model, to illustrate what New Zealand's inflation, output and trade outcomes might have been, had it faced US or Australian interest rate and exchange rate movements of the 1990s. The paper concludes with some implications for future research, and some ways forward for New Zealand policy.
    JEL: E58 F36 E31 E37 E17
    Date: 2005–09
  6. By: Q. Farook Akram (Norges Bank (Central Bank of Norway)); Gunnar Bårdsen (Norges Bank (Central Bank of Norway)); Øyvind Eitrheim (Norges Bank (Central Bank of Norway))
    Abstract: We investigate whether there is a case for asset prices in interest rates rules within a small econometric model of the Norwegian economy, modeling the interdependence of the real economy, credit and three classes of assets prices: housing prices, equity prices and the nominal exchange rate. We compare the performance of simple and efficient interest rate rules that allow for response to movements in asset prices to the performance of more standard monetary policy rules. We find that including housing prices and equity prices in the policy rules can improve macroeconomic performance in terms of both nominal and real economic stability. In contrast, a response to nominal exchange rate fluctuations can induce excess volatility in general and prove detrimental to macroeconomic stability.
    Keywords: Monetary policy, asset prices, simple interest rate rules, econometric model
    JEL: C51 C52 C53 E47 E52
    Date: 2005–10–03
  7. By: Zeljko Bogetic (The World Bank)
    Abstract: The paper compares the costs and benefits of dollarization for the dollarizing country and the 'anchor' country.
    Keywords: dollarization, dollarisation, costs and benefits, monetary unions
    JEL: F3 G E O P
    Date: 2005–10–05
  8. By: Joshua Aizenman; Reuven Glick
    Abstract: This paper studies the empirical and theoretical association between the duration of a pegged exchange rate and the cost experienced upon exiting the regime. We confirm empirically that exits from pegged exchange rate regimes during the past two decades have often been accompanied by crises, the cost of which increases with the duration of the peg before the crisis. We explain these observations in a framework in which the exchange rate peg is used as a commitment mechanism to achieve inflation stability, but multiple equilibria are possible. We show that there are ex ante large gains from choosing a more conservative not only in order to mitigate the inflation bias from the well-known time inconsistency problem, but also to steer the economy away from the high inflation equilibria. These gains, however, come at a cost in the form of the monetary authority’s lesser responsiveness to output shocks. In these circumstances, using a pegged exchange rate as an anti-inflation commitment device can create a “trap” whereby the regime initially confers gains in anti-inflation credibility, but ultimately results in an exit occasioned by a big enough adverse real shock that creates large welfare losses to the economy. We also show that the more conservative is the regime in place and the larger is the cost of regime change, the longer will be the average spell of the fixed exchange rate regime, and the greater the output contraction at the time of a regime change.
    JEL: F15 F31 F43
    Date: 2005–10
  9. By: Zeljko Bogetic (The World Bank)
    Abstract: As more nations in the Western Hemisphere consider adopting the U.S. dollar as their own major currency, this IMF economist separates fact from fiction concerning dollarization. How will the dollarized nations react to U.S. monetary policy over which they will have no say?
    Keywords: dollarization seigniorage spreads Latin America
    JEL: F3 E O P
    Date: 2005–10–05
  10. By: Zeljko Bogetic (The World Bank)
    Abstract: The paper reviews the salient features of officially dollarized economies (with particular reference to Panama) and discusses costs and benefits of official dollarization. Also, the paper reviews existing and some potential seigniorage sharing arrangements and discusses conditions that are conducive to official dollarization, especially in Latin America.
    Keywords: dollarization monetary unions seigniorage Panama Latin America
    JEL: F3 E O P
    Date: 2005–10–05
  11. By: Zeljko Bogetic (The World Bank)
    Abstract: Dollarization is becoming a viable option for a number of countries, but the loss of seigniorage is a major obstacle. The paper looks at the major seigniorage sharing arrangements available and issues that arise in the design of the new arrangements.
    Keywords: dollarization, dollarisation, seigniorage, monetary unions
    JEL: F3 G O P
    Date: 2005–10–05
  12. By: Eric M. Leeper; Tack Yun
    Abstract: The paper presents the fiscal theory of the price level in a variety of models, including endowment economies with lump-sum taxes and production economies with proportional income taxes. We offer a microeconomic perspective on the fiscal theory by computing a Slutsky-Hicks decomposition of the effects of tax changes into substitution, wealth, and revaluation effects. Revaluation effects arise whenever tax changes alter the value of outstanding nominal government liabilities by changing the price level. Under certain assumptions on monetary and fiscal behavior, the revaluation effect reflects the fiscal theory mechanism. When taxes distort, two Laffer curves arise, implying that a tax increase can lower or raise the price level and the revaluation effect can be positive or negative, depending on which side of a particular Laffer curve the economy resides.
    JEL: E31 E52 E62
    Date: 2005–10
  13. By: Juan F. Castro (Universidad del Pacífico); Eduardo Morón (Universidad del Pacífico)
    Abstract: Based on the significance of a Minimum Variance Portfolio (MVP) for the understanding of dollarization equilibria, a significant strand of the debate concerned with the driving forces behind this phenomenon has focused on analyzing the determinants of the relative volatility of inflation vis-à-vis real depreciation. This analysis contributes in the identification of those factors by extending the basic CAPM formulation via the introduction of credit risk that is directly linked to the shock that determines real returns for dollar denominated assets: unanticipated shifts in the real exchange rate. We show this ingredient can end up altering the perceived relative volatility of peso and dollar assets in a way that fuels financial dollarization (by increasing the relative hedging opportunities offered by the latter). We calibrate our model using Peruvian data for the period 1998-2004, and its predictions show a better fit with observed financial dollarization ratios than those of the basic CAPM model.
    Keywords: Financial dollarization, Minimum Variance Portfolio, Peru
    JEL: E44 E58 C34
    Date: 2005–09–30

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