nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒11‒12
fourteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Discretionary policy, multiple equilibria, and monetary instruments By Andreas Schabert
  2. Money and Monetary Policy in Stochastic General Equilibrium Models By Arnab Bhattacharjee; Christoph Thoenissen
  3. Monetary policy and the illusionary exchange rate puzzle By Hilde C. Bjørnland
  4. Global inflation By Matteo Ciccarelli; Benoît Mojon
  5. The Theory of Monetary Aggregation (book front matter) By William Barnett; Apostolos Serletis; W. Erwin Diewert
  6. Monetary Policy with Model Uncertainty: Distribution Forecast Targeting By Lars Svensson; Noah Williams
  7. How successful are exchange rate communication and interventions? Evidence from time-series and event-study approaches By Marcel Fratzscher
  8. Influential Price and Wage Setters, Monetary Policy and Real Effects By G J Bratsiotis
  9. "Refocusing the ECB on Output Stabilization and Growth through Inflation Targeting?" By Joerg Bibow
  10. " Can Fiscal Stimulus Overcome the Zero Interest-Rate Bound?: A Quantitative Assessment" By Kenneth Lewis; Laurence Seidman
  11. "Liquidity Preference Theory Revisited: To Ditch or to Build on It?" By Joerg Bibow
  12. "Europe's Quest for Monetary Stability: Central Banking Gone Astray" By Joerg Bibow
  13. Cape Verde's exchange rate policy and its alternatives By Romain Weber
  14. Cross-dynamics of volatility term structures implied by foreign exchange options By Elizaveta Krylova; Jussi Nikkinen; Sami Vähämaa

  1. By: Andreas Schabert (University of Amsterdam, Department of Economics, Roeterstraat 11, 1018 WB Amsterdam,The Netherlands.)
    Abstract: This paper examines monetary policy implementation in a ticky price model. The central bank’s plan under discretionary optimization is entirely forward-looking and exhibits multiple equilibrium solutions if transactions frictions are not negligibly small. The central bank can then implement stable history dependent equilibrium sequences that are consistent with its plan by inertial interest rate adjustments or by money injections. These equilibria are associated with lower welfare losses than a forward-looking solution implemented by interest rate adjustments. The welfare gain from a history dependent implementation is found to rise with the strength of transactions frictions and the degree of price flexibility. It is further shown that the central bank’s plan can uniquely be implemented in a history dependent way by money injections, whereas inertial interest rate adjustments cannot avoid equilibrium multiplicity.
    Keywords: Monetary policy implementation; optimal discretionary policy; history dependence; equilibrium indeterminacy; money growth policy.
    JEL: E52 E51 E32
    Date: 2005–10
  2. By: Arnab Bhattacharjee; Christoph Thoenissen
    Abstract: We compare three methods of motivating money in New Keynesian DSGE Models: Money-in-the-utility function, shopping time and cash-in-advance constraint, as well as two ways of modelling monetary policy, interest rate feedback rule and money growth rules. We use impulse response analysis, and a set of econometric measures of the distance between model and data variance-covariance matrices to compare the different models. We find that the models closed by an estimated interest rate feedback rule imply counter-cyclical policy and inflation rates, which is at odds with the data. This problem is robust to the introduction of demand side shocks, but is not a feature of models closed by an estimated money growth rule. Drawing on our econometric analysis, we argue that the cash-in-advance model, closed by a money growth rule, comes closest to the data.
    Keywords: Intertemporal macroeconomics, role of money, monetary policy, model selection, moment matching.
    JEL: C13 E32 E52
    Date: 2005–10
  3. By: Hilde C. Bjørnland (Department of Economics, University of Oslo and Norges Bank (Central Bank of Norway))
    Abstract: Dornbusch’s exchange rate overshooting hypothesis is a central building block in international macroeconomics. Yet, empirical studies of monetary policy have typically found exchange rate effects that are inconsistent with overshooting. This puzzling result has developed into a “styled facts” to be reckoned with in policy modelling. However, many of these studies, in particular those using VARs, have disregarded the strong contemporaneous interaction between monetary policy and exchange rate movements by placing zero restriction on them. By instead imposing a long-run neutrality restriction on the real exchange, thereby allowing the interest rate and the exchange rate to react simultaneously to any news, I find that the puzzles disappear. In particular, a contractionary monetary policy shock has a strong effect on the exchange rate that appreciates on impact. The maximum effect occurs immediately, and the exchange rate thereafter gradually depreciates to baseline, consistent with the Dornbusch overshooting hypothesis and with few exceptions consistent with UIP.
    Keywords: Dornbusch overshooting, VAR, monetary policy, exchange rate puzzle, identification
    JEL: C32 E52 F31 F41
    Date: 2005–11–09
  4. By: Matteo Ciccarelli (Corresponding author: European Central Bank, DG Research, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Benoît Mojon (Université de la Méditerranée and European Central Bank, DG Research, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper shows that inflation in industrialized countries is largely a global phenomenon. First, inflations of (22) OECD countries have a common factor that alone account for nearly 70% of their variance. This large variance share that is associated to Global Inflation is not only due to the trend components of inflation (up from 1960 to 1980 and down thereafter) but also to fluctuations at business cycle frequencies. Second, Global Inflation is, consistently with standard models of inflation, a function of real developments at short horizons and monetary developments at longer horizons. Third, there is a very robust "error correction mechanism" that brings national inflation rates back to Global Inflation. This model consistently beats the previous benchmarks used to forecast inflation 1 to 8 quarters ahead across samples and countries.
    Keywords: Inflation; common factor; international business cycle; OECD countries.
    JEL: E31 E37 F42
    Date: 2005–10
  5. By: William Barnett (University of Kansas); Apostolos Serletis (University of Calgary); W. Erwin Diewert (University of British Columbia)
    Abstract: This is the front matter from the book, William A. Barnett and Apostolos Serletis (eds.), The Theory of Monetary Aggregation, published in 2000 by Elsevier in its Contributions to Economic Anaysis mongraph series. The front matter includes the Table of Contents and the Introduction by Barnett and Serletis and the Preface by W. Erwin Diewert. The volume contains a unified collection and discussion of W. A. Barnett's most important published papers on financial aggregation theory and monetary economics.
    Keywords: monetary aggregation, money demand, Divisia, Divisia monetary aggregates, index number theory, aggregation theory
    JEL: E41 G12 C43 C22
    Date: 2005–11–07
  6. By: Lars Svensson; Noah Williams
    Abstract: We examine optimal and other monetary policies in a linear-quadratic setup with a relatively general form of model uncertainty, so-called Markov jump-linear-quadratic systems extended to include forward-looking variables. The form of model uncertainty our framework encompasses includes: simple i.i.d. model deviations; serially correlated model deviations; estimable regime-switching models; more complex structural uncertainty about very different models, for instance, backward- and forward-looking models; time-varying central-bank judgment about the state of model uncertainty; and so forth. We provide an algorithm for finding the optimal policy as well as solutions for arbitrary policy functions. This allows us to compute and plot consistent distribution forecasts---fan charts---of target variables and instruments. Our methods hence extend certainty equivalence and "mean forecast targeting" to more general certainty non-equivalence and "distribution forecast targeting."
    JEL: E42 E52 E58
    Date: 2005–11
  7. By: Marcel Fratzscher (European Central Bank, DG-Research, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: The paper analyses whether communication and actual interventions in FX markets are successful in moving exchange rates over the medium- to long-run. It compares empirical evidence based on time-series analysis with that obtained from an eventstudy approach. Both the time-series approach based on option contracts and the event-study methodology yield compelling evidence that communication and actual interventions tend to be successful in moving exchange rates in the desired direction contemporaneously as well as over the medium- to long-term. This finding is consistent with recent work on microstructure models that emphasises the importance of dynamic effects of news and fundamentals on exchange rates.
    Keywords: Communication; exchange rate; intervention; policy; time-series analysis; event-study methodology; United States; euro area; Japan.
    JEL: E61 E58 F31
    Date: 2005–09
  8. By: G J Bratsiotis
    Abstract: Using a general equilibrium model this paper shows that when large monopolistic firms or unions perceive even a small influence on aggregate nominal variables, price targeting results in a higher equilibrium output than monetary accommodation. This is because price targeting increases, whereas monetary accommodation decreases, (i) the price elasticity of demand, (ii) the labour elasticity of demand and (iii) the elasticity of the wage with respect to households’ total real income (i.e. wage, money transfers and profits). Within this framework, price targeting is shown to reduce the macroeconomic inefficiencies associated with monopolistic competition. The paper also shows that the standard approximation, that no single price or wage setter can affect nominal aggregates, is a good approximation provided, (a) at least a few hundreds of such large firms exist and more significantly (b) labour markets are decentralized or wage centralization is very low.
    Date: 2005
  9. By: Joerg Bibow
    Abstract: Challenging the conventional wisdom that structural problems are to blame for the euro areaÕs protracted domestic demand stagnation, this paper sets out to shed some fresh light on the role of the ECB in the ongoing EMU crisis. Contrary to the widely held interpretation of the ECB as an inflation targeterÑand a rather soft one, too -- it is argued that the key characteristic of the ECB is the pronounced asymmetry in its policy approach and mindset. Curiously, this asymmetry has not only given rise to an antigrowth bias, but to upward price pressures and distortions as well. There is a link between stagnation and inflation persistence that owes to the ECBÕs failure to internalize the euro areaÕs fiscal regime. This raises the question as to whether inflation targeting would have led to better results, or could do so in future.
    Date: 2005–07
  10. By: Kenneth Lewis (Department of Economics,University of Delaware); Laurence Seidman
    Abstract: This paper provides a quantitative assessment of the use of fiscal stimulus to achieve full recovery from a severe recession when the potency of monetary policy weakens after hitting its zero interest-rate bound. By contrast, most of the numerous recent zero interest-rate bound papers have ignored the use of fiscal stimulus, preferring to examine whether monetary policy alone can revive the economy despite the zero bound. We obtain our estimates by adapting and simulating a macro-econometric model that has been recently econometrically estimated, updated, and statistically tested using U.S. times series data. By contrast, most of the recent zero bound papers do not use an econometrically-estimated model. If the U.S. economy were hit with a large negative demand shock that drives the unemployment rate up to 7.9%, we estimate that even aggressive monetary policy that drives long-term interest rates to near zero would reduce the unemployment rate only to 6.7%. Full recovery would be achieved, however, if the aggressive monetary policy were complemented by sufficient fiscal stimulus in the form of cash transfers or income tax cuts to households. We estimate that a quarterly transfer to households that peaks at 2.7% of quarterly GDP and phases out gradually as it is repeated over seven quarters (so that the cumulative transfer is roughly 12% of quarterly GDP) would reduce the unemployment rate in such a recession by nearly an additional percentage pointC from 6.7% to 5.9%.
    JEL: E62
  11. By: Joerg Bibow
    Abstract: This paper revisits KeynesÕs liquidity preference theory as it evolved from the Treatise on Money to The General Theory and after, with a view of assessing the theoryÕs ongoing relevance and applicability to issues of both monetary theory and policy. Contrary to the neoclassical Òspecial caseÓ interpretation, Keynes considered his liquidity preference theory of interest as a replacement for flawed saving or loanable funds theories of interest emphasizing the real forces of productivity and thrift. His point was that it is money, not saving, which is the necessary prerequisite for economic activity in monetary production economies. Accordingly, turning neoclassical wisdom on its head, it is the terms of finance as determined within the financial system that Òrule the roostÓ to which the real economy must adapt itself. The key practical matter is how deliberate monetary control can be applied to attain acceptable real performance. In this regard, it is argued that KeynesÕs analysis offers insights into practical issues, such as policy credibility and expectations management, that reach well beyond both heterodox endogenous money approaches and modern Wicksellian orthodoxy, which remains trapped in the illusion of money neutrality.
    Date: 2005–08
  12. By: Joerg Bibow
    Abstract: This paper provides an overview of central banking arrangements in those European countries that have adopted the euro. Issues addressed include the structure of the ÒEurosystemÓ and its central banking functions, the kind of independence granted to the system and the role of monetary policy that central bankers have adopted for themselves, the Òtwo-pillar policy framework,Ó operating procedures, and actual performance since the euroÕs launch in 1999. The analysis concludes that, given the current macroeconomic policy regime, trends, and practices, the euro is on track for failure.
    Date: 2005–08
  13. By: Romain Weber
    Abstract: This paper analyses Cape Verde's exchange rate policy and investigates whether viable alternatives exist. Cape Verde currently operates a fixed exchange rate regime which, since 1999, links the national currency to the euro. The fixed exchange rate has many benefits, but authorities have to leave interest rates high in order to attract foreign capital, which has inhibited private investment and economic growth; the appreciation of the euro in 2002 and 2003 put the fixed exchange rate under additional strain. This issue is addressed by contemplating whether interest rates can be reduced in the context of the current exchange rate regime, and what costs and benefits are associated with a regime change that enables a reduction in interest rates. The analysis strongly suggests that it is not so much the exchange rate regime that is to blame for high interest rates, but rather a structural problem in the banking sector. Consequently, the policy conclusion reached in this paper is that although changing the current exchange rate policy might reduce interest rates, structural reforms would be more appropriate to tackle the problem at hand.
    Date: 2005–10
  14. By: Elizaveta Krylova (European Central Bank, Market Operations, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Jussi Nikkinen (University of Vaasa, Department of Accounting and Finance, P.O. Box 700, 65101 Vaasa, Finland); Sami Vähämaa (University of Vaasa, Department of Accounting and Finance, P.O. Box 700, 65101 Vaasa, Finland)
    Abstract: This paper examines the cross-dynamics of volatility term structures implied by foreign exchange options. The data used in the empirical analysis consist of daily observations of implied volatilities for OTC options on the euro, Japanese yen, British pound, Swiss franc, and Canadian dollar, quoted against the U.S. dollar. The empirical findings demonstrate that two common factors can explain a vast proportion of the variation in volatility term structures across currencies. Furthermore, the results indicate that the euro is the dominant currency, as the implied volatility term structure of the euro is found to affect all the other volatility term structures, while the term structure of the euro appears to be virtually unaffected by the other currencies. Finally, our results reveal a rather deviant relation between the volatility term structures of the euro and Swiss franc by providing evidence of significant nonlinearities in the relationship between these two currencies.
    Keywords: Implied volatility; volatility term structure; foreign exchange options.
    JEL: F31 G13 G15
    Date: 2005–09

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