nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒11‒19
53 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The Exchange Rate and Canadian Inflation Targeting By Christopher Ragan
  2. Uncertainty about the Persistence of Periods with Large Price Shocks and the Optimal Reaction of the Monetary Authority By Gonzalez F.; Rodriguez A.; Gonzalez-Garcia J.R.
  3. The natural real interest rate and the output gap in the euro area - a joint estimation By Julien Garnier; Bjørn-Roger Wilhelmsen
  4. Monetary Policy and Fiscal Rules By Giancarlo Marini; Alessandro Piergallini
  5. What do robust policies look like for open economy inflation targeters? By Kirdan Lees
  6. Estimating the Revealed Inflation Target: An Application to U.S. Monetary Policy By Daniel Leigh
  7. On the Sources of the Inflation Bias and Output Variability By Gustavo Piga
  8. The Optimal Inflation Buffer with a Zero Bound on Nominal Interest Rates By Roberto M. Billi
  9. Does Financial Structure Matter for the Information Content of Financial Indicators? By Ramdane Djoudad; Jack Selody; Carolyn Wilkins
  10. Monetary Concequences of Alternative Fiscal Policy Rules By Jukka Railavo
  11. Income Inequality, Monetary Policy, and the Business Cycle By Stuart J. Fowler
  12. Monetary and Fiscal Interactions without Commitment and the Value of Monetary Conservatism By Roberto Billi; Klaus Adam
  13. Interbank market under the currency board: Case of Lithuania By Marius Jurgilas
  14. Insurance Policies for Monetary Policy in the Euro Area By Volker Wieland; Keith Kuester
  15. Optimal Interest Rate Rules, Asset Prices and Credit Frictions By Tommaso Monacelli; Ester Faia
  16. Measuring Inflation Persistence: A Structural Time Series Approach By Maarten Dossche; Gerdie Everaert
  17. Monetary Policy Shifts, Indeterminacy and Inflation Dynamics By Paolo Surico
  18. Speculation, Liquidity Preference and Monetary Circulation By Korkut Erturk
  19. Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious? By Carlos Capistrán-Carmona
  20. Optimal Inflation Persistence: Ramsey Taxation with Capital and Habits By Sanjay K. Chugh
  21. Changing Effects of Monetary Policy in the U.S. –Evidence from a Time-Varying Coefficient VAR By Christian Melzer; Thorsten Neumann
  22. TIPS: Taking Inflation Premium Seriously By Min Wei; Stefania D'Amico; Don H. Kim
  24. The Fed and the Stock Market By Paolo Surico; Antonello D'Agostino; Luca Sala
  25. Dynamic Limited Dependent Variable Modeling and US Monetary Policy By George Monokroussos
  26. Monetary Policy under Adaptive Learning By Vitor Gaspar; Frank Smets
  27. Simple Pricing Rules, the Phillips Curve and the Microfoundations of Inflation Persistence By Richard Mash
  28. Parallel Monies, Parallel Debt: Lessons from the EMU and Options for the New EU By Giorgio Basevi; Lorenzo Pecchi
  29. Learning about which measure of inflation to target By Luis-Felipe Zanna; Marco Airaudo
  30. How (Not) to Sell Money By Arup Daripa
  31. A dynamic model of a monetary production economy under the disequilibrium economics approach By Marco Raberto; Andrea Teglio
  32. Bad for Euroland, Worse for Germany-The ECB's Record By Jorg Bibow
  33. Distributional Effects of Monetary Policies in a New Neoclassical Model with Progressive Income Taxation By Burkhard Heer; Alfred Maussner
  34. A BVAR Forecasting Model For Peruvian Inflation By Gonzalo Llosa; Vicente Tuesta; Marco Vega
  35. Capital controls, two-tiered exchange rate systems and exchange rate policy : the South African experience By Schaling,Eric
  36. The link between interest rates and exchange rates - do contractionary depreciations make a difference? By Marcelo Sánchez
  37. Inflation Bias after the Euro: Evidence from the UK and Italy By Giancarlo Marini; Alessandro Piergallini
  38. Gains from International Monetary Policy Coordination: Does It Pay to Be Different? By Evi Pappa; Zheng Liu
  39. Computational Efficiency and Macroeconomic Stability under Centralized Exchange: Evidence from Swiss and US Exchange Data By James Stodder
  40. Time Consistent Policy in Markov Switching Models By Fabrizio Zampolli; Andrew P. Blake
  41. Money, Inventories and Underemployment in Deflationary Recessions By Gerd Weinrich; Luca Colombo
  42. Real-time data for Norway: Output gap revisions and challenges for monetary policy By TOM BERNHARDSEN; ØYVIND EITRHEIM
  43. A Rational Expectations Model of Optimal Inflation Inertia By Michael Kumhof; Douglas Laxton
  44. The Term Structure of Interest Rates and the Public Debt Issuance Policy: A Note By Gustavo Piga; Giorgio Valente
  45. Performance of Interest Rate Rules under Credit Market Imperfections By Beatriz de-Blas-Pérez;
  46. The Recent Shift in Term Structure Behavior from a No-Arbitrage Macro-Finance Perspective By Tao Wu; Glenn Rudebusch
  48. Term structure estimation without using latent factors By Greg Duffee
  49. Interest Rates, Exchange Rates and International Adjustment By Michael P. Dooley; David Folkerts-Landau; Peter M. Garber
  50. Resurrecting the Expectations Hypothesis: How to Extract Additional Information From the Term Structure of Interest Rates By Andrea Carriero
  51. Measuring the Effects of Real and Monetary Shocks in a Structural New-Keynesian Model By Andreas Beyer; Roger E.A. Farmer
  52. Has Trade any Importance in the Transmission of Currency Shocks? By Roberta De Santis
  53. Monetary Policy in an Estimated DSGE Model with a Financial Accelerator By Ali Dib; Ian Christensen

  1. By: Christopher Ragan
    Abstract: The author provides a non-technical explanation of the role played by the exchange rate in Canada's inflation-targeting monetary policy. He reviews the motivation for inflation targeting and describes the monetary transmission mechanism. Though the exchange rate is an integral component of the transmission mechanism, the author explains why it is not a target for monetary policy. He provides a simple taxonomy for exchange rate movements, distinguishing between movements associated with direct shocks to aggregate demand and those unrelated to such direct shocks. He explains the importance to monetary policy of determining the cause of any given movement in the exchange rate, and of determining the net effect on aggregate demand. The author also describes Canadian monetary policy during the 2003–04 period, a time when the Canadian dollar appreciated sharply against the U.S. dollar.
    Keywords: Exchange rates; Inflation targets; Monetary policy implementation
    JEL: E50 E52 F41
    Date: 2005
  2. By: Gonzalez F.; Rodriguez A. (Economic Studies Division Bank of Mexico); Gonzalez-Garcia J.R.
    Abstract: Uncertainty about the persistence of periods characterized by large price shocks is an important aspect of monetary policy. This type of uncertainty posed some difficulties for central banks in 2004. This paper formalizes the treatment of this type of uncertainty by solving an optimal control problem in which the economy randomly alternates between two regimes characterized by different magnitudes of price shocks. By using an open economy model, we find that the optimal policy rule is both regime-contingent and robust. In particular, we find that: a) the optimal reaction of the interest rate is dependent on both the current regime and on the difference in the magnitude of the shocks between regimes; b) the alternation between regimes leads to more aggressive policy reactions with respect to inflation and the second lag of the real exchange rate; and c) after a robust selection of transition probabilities, the min-max probability of switching to the regime with large price shocks increases when such regime is more harmful. In general, cautious behavior renders smaller losses than recklessness for the central bank. This result argues in favor of caution over recklessness in the formulation of monetary policy when there is uncertainty about the persistence of periods with large price shocks
    Keywords: monetary policy, Markov regime-switching, optimal control, robustness, model uncertainty, inflation targeting
    JEL: C6 E5
    Date: 2005–11–11
  3. By: Julien Garnier (European University Institute and University of Parix X-Nanterre); Bjørn-Roger Wilhelmsen (Central Bank of Norway, Economics Department, Oslo, Norway)
    Abstract: The notion of a natural real rate of interest, due to Wicksell (1936), is widely used in current central bank research. The idea is that there exists a level at which the real interest rate would be compatible with output being at its potential and stationary inflation. This paper applies the method recently suggested by Laubach and Williams to jointly estimate the natural real interest rate and the output gap in the euro area over the past 40 years. Our results suggest that the natural rate of interest has declined gradually over the past 40 years. They also indicate that monetary policy in the euro area was on average stimulative during the 1960s and the 1970s, while it contributed to dampen the output gap and inflation in the 1980s and the 1990s.
    Keywords: Real interest rate gap; output gap; Kalman filter; euro area.
    JEL: C32 E43 E52 O40
    Date: 2005–11
  4. By: Giancarlo Marini (University of Rome II - Faculty of Economics); Alessandro Piergallini (University of Rome II; University of Bristol - Department of Economics)
    Abstract: This paper studies the performance of monetary policy under alternative fiscal regimes in a dynamic New Keynesian optimizing general equilibrium model with wealth effects. The interactions between fiscal policy and interest rate rules are shown to have relevant implications for the existence of a unique rational expectations equilibrium. When calibrated to Euro Area quarterly data, the model simulation results show that the preferred monetary-fiscal regime for inflation stabilization consists of a generalized Taylor rule with a low degree of inertia coupled with a public debt-GDP ratio targeting rule.
    Keywords: Fiscal Policy Rules, Monetary Policy, Wealth Effects
    JEL: E52 E58 E63
  5. By: Kirdan Lees (Economics Reserve Bank of New Zealand)
    Abstract: For policymakers, thinking about best practice monetary policy means thinking about uncertainty. Open economy monetary policymakers face an additional source of uncertainty – exchange rate dynamics. This paper identifies policy rules robust to the open economy inflation targeters face in practice. For Knight (1921), uncertainty differs from risk because the policymaker does not know the nature of the uncertainty and is unable to form a probability distribution or risk statement, over different possible models. Hansen and Sargent (2004) apply Knight’s (1921) philosophy to the linear-quadratic control framework, recognizing that policy-makers work with models which are approximations to some true, unknown model and seek a rule that is robust to models close to the policymaker’s best approximation. While there exist some open economy robust control policy experiments (Leitemo and Söderström (2004) obtain analytical robust control solutions for a purely forward-looking new Keynesian model) the majority of the literature focuses on the closed economy. This paper calibrates a single open economy model to capture the key open economy dynamics for Australia, Canada and New Zealand, three of the earliest inflation targeters that form a useful dataset for identifying robust monetary policy rules in practice. Robust policies are found to respond more aggressively to not only inflation and the output gap, but also the exchange rate and its associated shock. This result generalizes to the context of a flexible inflation targeting central bank that cares about the volatility of the real exchange rate. However, when the central bank places only a small weight on interest rate smoothing and fears misspecification in only exchange rate determination, a more aggressive response to the lag of the exchange rate is not warranted. It is shown that the benefits of an exchange rate channel far outweigh the concomitant costs of uncertain exchange rate determination.
    Keywords: uncertainty; open economy; robust control
    JEL: E52 E58 F41
    Date: 2005–11–11
  6. By: Daniel Leigh (European International Monetary Fund)
    Abstract: This paper proposes a new method of estimating the Taylor rule with a time-varying implicit inflation target and a time-varying natural rate of interest. The inflation target and the natural rate are modelled as random walks and are estimated using maximum likelihood and the Kalman filter. I apply this method to U.S. monetary policy over the last 25 years to understand how the Federal Reserve’s target has varied during this broadly successful period. Stability tests indicate significant time variation in the implicit target. In the early 1980s, during the Volcker disinflation, the inflation target is near 3%. In the late 1980s and early 1990s, the target is close to actual inflation of 3-4% and only declines once the 1990-91 recession reduces inflation to 1-2%, corroborating historical evidence of an “opportunistic approach to disinflation.†Finally, over 2001-2004, the target rises to 2-3%, behaviour that can be interpreted as a response the risks of hitting the zero bound on nominal interest rates
    Keywords: Taylor rule, time-varying parameters, Kalman filter
    JEL: C22 E31 E52
    Date: 2005–11–11
  7. By: Gustavo Piga (University of Rome II)
    Abstract: Why do dynamic inconsistencies in monetary policy exist? In this paper a traditional model without put inefficiencies is introduced, but monetary policy is allowed to be influenced by the various constituencies in the economy, that pressure Congress in turn to pressure the central bank to adopt a particular policy stance. The paper shows that in this economy an inflation bias arises due to the lobbying pressures of outsiders. Furthermore, it shows that if lobbying pressures are high enough, an inflation bias cannot be avoided for any finite level of central bank independence. It also shows that introducing the realistic feature of lobbying pressures has an impact on the stabilization properties of monetary policy. When a supply shock occurs, the shock is totally absorbed by a non myopic trade union which has no lobbying costs. This is independent of any finite degree of conservativeness of the central banker, who has to accept an extreme increase in price instability. It is shown that monetary policy delegation is therefore sub-optimal in achieving price-stability compared to labor-market reforms meant to remove monopsonistic elements. However, the same structural policies will induce greater output instability by strengthening the power of conservative central bankers
    JEL: E52 E58 E31
    Date: 2005–02–04
  8. By: Roberto M. Billi (- Center for Financial Studies)
    Abstract: This paper characterizes the optimal inflation buffer consistent with a zero lower bound on nominal interest rates in a New Keynesian sticky-price model. It is shown that a purely forward-looking version of the model that abstracts from inflation inertia would significantly underestimate the inflation buffer. If the central bank follows the prescriptions of a welfare-theoretic objective, a larger buffer appears optimal than would be the case employing a traditional loss function. Taking also into account potential downward nominal rigidities in the price-setting behavior of firms appears not to impose significant further distortions on the economy
    Keywords: inflation inertia, downward nominal rigidity, nonlinear policy, liquidity trap
    JEL: C63 E31 E52
    Date: 2005–11–11
  9. By: Ramdane Djoudad; Jack Selody; Carolyn Wilkins
    Abstract: Of particular concern to monetary policy-makers is the considerable unreliability of financial variables for predicting GDP growth and inflation. As Stock and Watson (2003) find, some financial variables work well in some countries or over some time periods and forecast horizons, but the results do not show any clear pattern. This may be caused by the changing nature of financial structures within countries across time, or the differing types of financial structures across countries. The authors assess the extent to which financial structure across countries influences the information content of financial variables for predicting real GDP growth and inflation. Their assumption is that financial asset prices will dominate financial quantities in economies with highly developed market-based financial systems. The authors use standard methods to determine the predictive content of common financial asset prices and quantities for 29 countries. They find no systematic pattern between financial structure and whether financial asset prices or quantities are the best financial indicators for monetary policy. Importantly, financial quantities are sometimes the best financial indicator, even in economies with highly developed market-based financial systems. The authors conclude that it would be difficult to tell, a priori, whether a financial asset price or quantity would be the best indicator for monetary policy for a particular country at a particular point in time.
    Keywords: Inflation and prices; Business fluctuations and cycles; Credit and credit aggregates; Monetary aggregates; Interest rates
    JEL: E31 E32
    Date: 2005
  10. By: Jukka Railavo (Monetary Policy and Research Department Bank of Finland)
    Abstract: In this paper we analyse the monetary impact of alternative fiscal policy rules using the debt and deficit, both mentioned as measures of fiscal policy performance in the Stability and Growth Pact (SGP). We use a New Keynesian model, with distortionary taxation and an appropriately defined output gap. The economy is hit by two fundamental shocks: demand and supply shocks, which are orthogonal to each other. Monetary policy is conducted by an independent central bank that will optimise. Under discretionary monetary policy the size of the inflation bias depends on the fiscal policy regime. Using the timeless perspective approach to precommitment, output persistence increases compared to the discretionary case. The result holds with the alternative fiscal policy rules, and inflation and output persistence reflects the economic data. With the deficit rules, the autocorrelation of the tax rate is near unity irrespective of the monetary policy regime, and irrespective of the fiscal policy parameters and targets. Thus we revive Barro's (1979) random walk result with the deficit rules
    Keywords: Inflation, monetary policy, fiscal policy, policy coordination
    JEL: E52 E31 E61 E62
    Date: 2005–11–11
  11. By: Stuart J. Fowler
    Abstract: The effects of changes in monetary policy are studied in a general equilibrium model where money facilitates transactions. Because there are two types of agents, workers and capitalists, different elasticities of money demand exist, implying that monetary policy influences the distribution of income. Only when earnings inequality is incorporated into monetary policy rule is the model able to replicate cyclical fluctuations of both real and nominal aggregates as well as the inequality measure. Additionally, monetary policy becomes more countercyclical when the fraction of transfers received by the workers increases. These results can support a theory that the distribution of seigniorage revenues between the workers and capitalists changed in 1979
    Keywords: Inflation, Income Distribution, Heterogenous Agents, Perturbation
    JEL: E32 E42 E50
    Date: 2005–11–11
  12. By: Roberto Billi; Klaus Adam (Research Department CEPR and European Central Bank)
    Abstract: We study monetary and fiscal policy games in a dynamic sticky priceeconomy where monetary policy sets nominal interest rates and fiscal policy provides public goods financed with distortionary labor taxes. We compare the Ramsey outcome to non-cooperative policy regimes where one or both policymakers lack commitment power. Absence of fiscal commitment gives rise to a public spending bias, while lack of monetary commitment generates the well-known inflation bias. An appropriately conservative monetary authority can eliminate the steady state distortions generated by lack of monetary commitment and may even eliminate the distortions generated by lack of fiscal commitment. The costs associated with the central bank being overly conservative seem small, but insufficient conservatism may result in sizable welfare losses
    Keywords: optimal monetary and fiscal policy, lack of commitment, sequential policy, discretionary policy
    JEL: E52 E62 E63
    Date: 2005–11–11
  13. By: Marius Jurgilas (Economics University of Connecticut)
    Abstract: This paper studies the liquidity effect in the environment of a currency board. Under such an environment, the endogeneity issue common to other monetary regimes does not arise, thereby allowing for a straightforward analysis. Using daily data from the interbank market in Lithuania, we estimate the liquidity effect and show that, contrarily to the existent literature, overnight interest rates tend to fall at the end of reserve holding period while being higher at the beginning. Thus the martingale hypothesis of the interest rates is rejected. It is also shown that banks do not utilize aggregate liquidity information provided by the Central Bank of Lithuania due to the structural impediments of the market
    Keywords: interbank market, liquidity effect, currency board, Lithuania
    JEL: E52 E58
    Date: 2005–11–11
  14. By: Volker Wieland; Keith Kuester
    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: model uncertainty, robustness, monetary policy rules, minimax, euro area
    JEL: E52 E58 E61
    Date: 2005–11–11
  15. By: Tommaso Monacelli; Ester Faia
    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 behavior 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
    JEL: E52 F41
    Date: 2005–11–11
  16. By: Maarten Dossche (Research National Bank Belgium - Ghent University); Gerdie Everaert
    Abstract: Time series estimates of inflation persistence incur an upward bias if shifts in the inflation target of the central bank remain unaccounted for. Using a structural time series approach we measure different sorts of inflation persistence allowing for an unobserved time-varying inflation target. Unobserved components are identified using Kalman filtering and smoothing techniques. Posterior densities of the model parameters and the unobserved components are obtained in a Bayesian framework based on importance sampling. We find that inflation persistence, expressed by the half-life of a shock, can range from 1 quarter in case of a cost-push shock to several years for a shock to long-run inflation expectations or the output gap
    Keywords: Inflation persistence, Inflation target, Kalman filter
    JEL: C11 C13 C22
    Date: 2005–11–11
  17. By: Paolo Surico (Monetary Assessment & Strategy Division Bank of England)
    Abstract: The New-Keynesian Phillips curve plays a central role in modern macroeconomic theory. A vast empirical literature has estimated this structural relationship over various postwar full-samples. While it is well know that in a New-Keynesian model a `weak' central bank response to inflation generates sunspot fluctuations, the consequences of pooling observations from different monetary policy regimes for the estimates of the structural Phillips curve had not been investigated. Using Montecarlo simulations from a purely forward-looking model, this paper shows that indeterminacy can introduce a sizable persistence in the estimated process of inflation. This persistence however is not an intrinsic feature of the economy; rather it is endogenous to the policy regime and results from the self full-filling nature of inflation expectations. By neglecting indeterminacy the estimates of the forward-looking term of the structural Phillips curve are shown to be biased downward. The implications are in line with the empirical evidence for the U.K and U.S
    Keywords: indeterminacy, New-Keynesian Phillips curve, Montecarlo, bias, persistence
    JEL: E58 E31 E32
    Date: 2005–11–11
  18. By: Korkut Erturk
    Keywords: speculation, liquidity, monetary circulation
    Date: 2005–12
  19. By: Carlos Capistrán-Carmona
    Abstract: This paper documents that inflation forecasts of the Federal Reserve systematically under-predicted inflation before Volker's appointment as Chairman and systematically over-predicted it afterward. It also documents that, under quadratic loss, commercial forecasts have information not contained in the forecasts of the Federal Reserve. It demonstrates that this evidence leads to a rejection of the joint hypothesis that the Federal Reserve has rational expectations and quadratic loss. To investigate the causes of this failure, this paper uses moment conditions derived from a model of an inflation targeting central bank to back out the loss function implied by the forecasts of the Federal Reserve. It finds that the cost of having inflation above the target was larger than the cost of having inflation below it for the post-Volker Federal Reserve, and that the opposite was true for the pre-Volker era. Once these asymmetries are taken into account, the Federal Reserve is found to be rational and to efficiently incorporate the information contained in forecasts from the Survey of Professional Forecasters
    Keywords: Asymmetric loss function, Inflation forecasts, Forecast Evaluation
    JEL: C53 E52
    Date: 2005–11–11
  20. By: Sanjay K. Chugh
    Abstract: Ramsey models of fiscal and monetary policy with perfectly-competitive product markets and a fixed supply of capital predict highly volatile inflation with no serial correlation. In this paper, we show that an otherwise-standard Ramsey model that incorporates capital accumulation and habit persistence predicts highly persistent inflation. The result depends on increases in either the ability to smooth consumption or the preference for doing so. The effect operates through the Fisher relationship: a smoother profile of consumption implies a more persistent real interest rate, which in turn implies persistent optimal inflation. Our work complements a recent strand of the Ramsey literature based on models with nominal rigidities. In these models, inflation volatility is lower but continues to exhibit very little persistence. We quantify the effects of habit and capital on inflation persistence and also relate our findings to recent work on optimal fiscal policy with incomplete markets
    Keywords: Optimal fiscal and monetary policy, inflation persistence, Ramsey model, habit formation
    JEL: E50 E61 E63
    Date: 2005–11–11
  21. By: Christian Melzer; Thorsten Neumann
    Abstract: We estimate a time-varying coefficient VAR model for the U.S. economy to analyse (i) if the effect of monetary policy on output has been changing systematically over time, and (ii) if monetary policy has asymmetric effects over the business cycle. We find that the impact of monetary policy shocks has been gradually declining over the sample period (1962-2002), as some theories of the monetary transmission mechanism imply. In addition, our results indicate that the effects of monetary policy are greater in a recession than in a boom.
    JEL: E52 E32 C52
    Date: 2005–11–11
  22. By: Min Wei; Stefania D'Amico; Don H. Kim
    Abstract: This paper asks the question of whether the newly available TIPS yields data can help us achieve a better understanding of the real term structure and the inflation expectations. The yield differential between TIPS and comparable nominal coupon securities is not a direct measure of inflation expectations, because it contains inflation risk premium, and because the TIPS yield may depart from the true "real yield," due to low investor demand especially in the early years. Without using data from the (indexed) real bond market, we cannot fully identify the real interest rate from the inflation risk premium, unless we assume that all information affecting the real term structure is reflected in the nominal bond prices. Even with this assumption, empirical identification of the real term structure is hard to achieve because of the poor measurement and the frequent revisions of the price series. We develop a flexible multifactor term-structure model to allow for suitable specifications of liquidity premium on TIPS, as well as complications caused by lagged indexation. We estimate the model by the Kalman filter using TIPS yields, nominal bond yields, realized inflation and survey data on interest rates and inflation
    Keywords: TIPS, Inflation risk premium, term structure of interest rates
    JEL: E43 E44 G12
    Date: 2005–11–11
  23. By: B Bhaskara Rao (University of the South Pacific); Rup Singh (University of the South Pacific)
    Abstract: Demand for money is an important macroeconomic relationship. Its stability has implications for the choice of monetary policy targets. This paper estimates demand for narrow money in Fiji and evaluates its robustness and stability. It is found that there is a well determined stable demand for money in Fiji, for three decades, from 1971 to 2002 and its dynamics are adequately captured by the cointegration and error- correction models. Income and interest rate elasticities are found to be significant.
    Keywords: Demand for money, Monetary policy, Income and interest rate elasticities, Cointegration, Error correction, Unit roots, Stability.
    JEL: C1 C5
    Date: 2005–11–11
  24. By: Paolo Surico; Antonello D'Agostino; Luca Sala
    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: 2005–11–11
  25. By: George Monokroussos (Economics UCSD)
    Abstract: I estimate, using real-time data, a forward-looking monetary policy reaction function that is dynamic and that also accounts for the fact that there are substantial restrictions in the period-to-period changes of the Fed's policy instrument. I find a substantial contrast between the periods before and after Paul Volcker's appointment as Fed Chairman in 1979, both in terms of the Fed's response to expected inflation and in terms of its response to the (perceived) output gap: In the pre-Volcker era the Fed's response to inflation was substantially weaker than in the Volcker-Greenspan era; conversely, the Fed seems to have been more responsive to real activity in the pre-Volcker era than later
    JEL: C25 E52 E58
    Date: 2005–11–11
  26. By: Vitor Gaspar; Frank Smets
    Abstract: The paper studies the conduct of monetary policy, in a simple new Keynesian model, with adaptive learning on the part of the private sector. A key feature is that even though we start out with a linear “structural†model, the system and hence policy responses inherit the non-linear feature of the updating equations for the estimated parameters. In the paper, we contrast two different monetary policy regimes. In the first the central bank follows a simple rule, which comes from the first order conditions, for optimal policy under discretion in the case of rational expectations. In the second, the central bank has full information about the structure of the economy, including the adaptive learning mechanism. It takes the expectations formation mechanism explicitly into account when deriving optimal policy. This framework allows an explicit discussion of the importance of keeping inflation expectations under control. We illustrate with an application to a regime change, where we assume that the incumbent policymaker did not take the learning into account and allowed the expectation formation process to become unhinged. However, before inflation expectations (and actual inflation) spirals out of control, we assume that a sophisticated central banker, who does take the effect of learning into account, takes charge and study how the economy adjusts after the regime change. Under our assumptions the transition is slow. We claim that some features of the transition match important stylised facts associated with the Volcker disinflation in the US. In the end the fully optimal policy delivers less inflation and output gap volatility. It does so by anchoring inflation expectations thereby contributing to the overall stability of the economy. To achieve this result optimal policy is conditional on the degree of perceived persistence. As perceived persistence increases so does inertia in the policy response in the face of inflation shocks. We compare the contrast between the two policy regimes in the paper with the difference between the rational expectations under discretion and commitment.
    Keywords: monetary policy, adaptive learning, regime change
    JEL: E5 E52 E65
    Date: 2005–11–11
  27. By: Richard Mash
    Abstract: We analyze the microfoundations of the Phillips curve, a key relationship in general macroeconomics and models of monetary policy in particular. The form in current widespread use includes both forward looking expected inflation and lagged inflation. The presence of lagged inflation is necessary to generate predicted inflation persistence to match actual persistence in real world data but it has proved very difficult to microfound. Recent contributions from Christiano, Eichenbaum and Evans (JPE, 2005) and Gali and Gertler (JME, 1999) have attempted to provide such microfoundations through the assumption of indexing or rule of thumb behaviour. We question the nature of the indexing rules or rules of thumb assumed and re-derive these models for the case where firms choose constrained optimal simple pricing rules. We find that the models no longer convincingly predict inflation persistence
    Keywords: Monetary policy, Phillips curve, Inflation persistence, Microfoundations
    JEL: E52 E58 E22
    Date: 2005–11–11
  28. By: Giorgio Basevi (University of Bologna - Department of Economics); Lorenzo Pecchi (University of Rome II; University of Rome II)
    Abstract: In 1975 Niels Thygesen, together with eight other economists - one of us among them - published in The Economist a "manifesto" proposing a new common currency for Europe (Basevi et al., 1975). His co-operation on this subject was pursued within a smaller group, and resulted in the publication of two reports for the EU Commission (Optica Report '75, Optica Report 1976). The proposal in the "manifesto" was ironically re-titled, by The Economist, "The All Saints' day manifesto for European monetary union". In fact it had been published on 1st November, and the "Saints" should have been, according to The Economist, the European Governments if they had adopted and adhered to the proposal. This amounted to launching a new currency that should have circulated in parallel to the national ones, related to them by flexible exchange rates, due to the constraint that such new currency, the "Europa", had to be kept by an automatic formula at fixed purchasing power. In fact the Europa was to be indexed to the inflation rates in the participating countries, according to the weights of their national currencies in what at that time was called the European Unit of Account. As for the two other reports, Optica '75 proposed again a parallel currency, but less than fully inflation-proof, since its standing in terms of purchasing power would have been the same as that of the currency of the member country with the lowest inflation rate. In the Optica 1976 Report, while reiterating the proposal of a parallel currency along the lines of Optica '75, the focus was on designing a joint management of intra-European exchange rates on the basis of inflation differentials. The proposals contained in the three documents where premature, perhaps visionary. On 7 July 1978 the European Council met in Bremen and drew the lines of the European Monetary System, which started on 13 March 1979, on the basis, among other things, of a new quasi-currency - the European Currency Unit (ECU) - composed of a basket of national currencies. Since then, it took almost twenty years before the euro was introduced, replacing the ECU on 1st January 1999. Comparing the euro to such proposals, we note at least two differences. The euro (a) did not start as a parallel currency, but replaced with a pre-announced schedule the national currencies of the countries participating in the monetary union, and (b) it was not conceived as an automatically inflation-proof currency, but one issued by a Central Bank bound by a monetary policy aimed at price stability.
    Date: 2005–04–04
  29. By: Luis-Felipe Zanna; Marco Airaudo (International Finance Federal Reserve Board)
    Abstract: Using a closed economy model with a flexible-price good and a sticky-price good we study the conditions under which interest rate rules induce real determinacy and, more importantly, the MSV solution is learnable in the E-stability sense proposed by Evans and Honkapohja (2001). We show that these conditions depend not only on how aggressively the rule responds to inflation but also on the measure of inflation included in the rule and on whether the flexible-price good and the sticky-price good are Edgeworth complements, substitutes or utility separable. We consider three possible measures of inflation: the flexible-price inflation, the sticky price inflation and the core inflation; and we analyze three different types of rules: a forward-looking rule, a contemporaneous rule and a backward-looking rule. Our results suggest that in order to guarantee a unique equilibrium whose MSV representation is learnable, the government should implement a backward looking rule that responds exclusively to the sticky-price inflation. Forward-looking and contemporaneous rules that respond to either the flexible-price inflation or the core-inflation are more prone to induce multiple equilibria and E-instability of the MSV solution. More importantly backward-looking rules that react to either the flexible-price inflation or the core inflation may guarantee a unique equilibrium but in these cases the fundamental solution (MSV representation) is not learnable in the E-stability sense
    Keywords: Interest rate rules, Learning, E-stability, multiple equilibria, inflation
    JEL: E31 E52
    Date: 2005–11–11
  30. By: Arup Daripa (Birkbeck College)
    Abstract: A repo auction is a multi-unit common value auction in which bidders submit demand functions. Such auctions are used by the Bundesbank as well as the European Central Bank as the principal instrument for implementing monetary policy. In this paper, we analyze a repo auction with a uniform pricing rule. We show that under a uniform pricing rule, the usual intuition about the value of exclusive information can be violated, and implies free riding by uninformed bidders on the information of the informed bidders, lowering payoff of the latter. Further, free riding can distort the information content of auction prices, in turn distorting the policy signals, hindering the conduct of monetary policy. The results agree with evidence from repo auctions, and clarifies the reason behind the Bundesbank's decision to switch away from the uniform price format. Our results also shed some light on the rationale behind the contrasting switch to the uniform price format in US Treasury auctions.
    Keywords: Repo auction, Informational Free Riding, Monetary Policy Signals
    JEL: D44 E50
    Date: 2005–11–17
  31. By: Marco Raberto; Andrea Teglio
    Abstract: This paper presents a model of a monetary production economy with non-Walrasian good, labor and money markets. In the non-Walrasian approach, transactions occur at non clearing prices and agents's demand and supply are affected by quantity constraints in the opposite side of the market. The model is characterized by a representative firm, which maximize profits subject to a production technology, a representative consumer, which maximize utility subject to a budget constraint, and by a central bank which provide liquidity. The consumer provides the labor force and owns all the equities of the firm. The main result of the model is the existence of non-Warlasian equilibria which are suboptimal with respect to Warlasian ones. Furthermore, non-Warlasian equilibria are characterized by money non-neutrality and proper monetary policies are found to be able to bring the system near to the Walrasian point
    Keywords: disequilibrium economics; economic dynamics, monetary policy
    JEL: D92 E12 E37 E5
    Date: 2005–11–11
  32. By: Jorg Bibow (The Levy Economics Institute)
    Abstract: This paper assesses the contribution of the European Central Bank (ECB) to Germany’s ongoing economic crisis, a vicious circle of decline in which the country has become stuck since the early 1990s. It is argued that the ECB continues the Bundesbank tradition of asymmetric policymaking: the bank is quick to hike, but slow to ease. It thereby acts as a brake on growth. This approach has worked for the Bundesbank in the past because other banks behaved differently. Exporting the Bundesbank “success story” to Euroland has undermined its working, however; given its sheer size, Euroland simply cannot freeload on external stimuli forever. While Euroland cannot do without proper demand management, the Maastricht regime and especially the ECB are firmly geared against it. The ECB’s monetary policies have been biased against growth and have thus proved bad for Euroland as a whole. Meanwhile, the German disease of protracted domestic demand weakness has spread across much of Euroland. Yet, by pursuing its peculiar traditions of wage restraint and procyclical public thrift, the ECB’s policies have had even worse results for Germany. Fragility and divergence undermine the euro’s long-term survival.
    Keywords: German unification, Bundesbank, policy inconsistency, stability culture, ECB, EMU
    JEL: E31 E42 E58 E61 E63 E65 E66 H62
    Date: 2005–11–17
  33. By: Burkhard Heer; Alfred Maussner (School of Economics and Management Free University of Bolzano-Bozen)
    Abstract: In our dynamic optimizing sticky price model, agents are heterogenous with regard to their assets and their income. Unanticipated inflation redistributes income and wealth. In order to model the wealth distribution, we study a 60-period OLG model with aggregate uncertainty. A positive technology shock increases the concentration of wealth as measured by the Gini coefficient considerably. In particular, a one percent increase of the technology level results in a one percent increase of the Gini coefficient. An unexpected expansionary monetary policy is found to reduce the inequality of the wealth distribution. In addition, we find that the business cycle dynamics in the OLG model in response to both a technology shock and a monetary shock are different from those in the corresponding representative-agent model
    Keywords: Distribution Effects, Unanticipated Inflation, Heterogeneous Agents
    JEL: E31 E32 E52
    Date: 2005–11–11
  34. By: Gonzalo Llosa (Interamerican Development Bank and Central bank of Peru); Vicente Tuesta (Central Bank of Peru); Marco Vega (Central Bank of Peru)
    Abstract: We build a simple non-structural BVAR forecasting framework to predict key Peruvian macroeconomic data, in particular, inflation and output. Unlike standard applications we build our Litterman prior specification based on the fact that the structure driving the dynamics of the economy might have shifted towards a state where a clear nominal anchor has become well grounded (Inflation Targeting). We compare different BVAR specifications with respect to a ”naive” random walk and we find that they outperform the random walk in terms of inflation forecasts at all horizons. However, our PBI forecasts are not accurate enough to beat a ”naive” random walk.
    Keywords: Bayesian VAR, Forecasting, Inflation Targeting
    JEL: E31 E37 E47 C11 C53
    Date: 2005–11
  35. By: Schaling,Eric (Tilburg University, Center for Economic Research)
    Abstract: South Africa's 40 years of experience with capital controls on residents and non-residents (1961-2001) reads like a collection of examples of perverse unanticipated effects of legislation and regulation. We show that the presence of capital controls on residents and non-residents, enabled the South African Reserve Bank (SARB) to target domestic interest rates (and or the exchange rate) via interventions in the (commercial) foreign exchange market. This provides an early rationale for anchoring SA monetary policy via the exchange rate, rather than via domestic interest rates. This suggests not only that the capital controls themselves exhibited substantial institutional inertia, but that this same institutional inertia also applied to the monetary policy regime. A plausible reason for this is that for most of the 20th century in South Africa (partial) capital controls and exchange rate based monetary policies were like Siamese twins; almost impossible to separate.
    Keywords: capital controls;exchange rate mechanism
    JEL: E42 E61 E65 F32 F33 F41
    Date: 2005
  36. By: Marcelo Sánchez (Correspondence to: European Central Bank, Postfach 160319, 60066 Frankfurt am Main, Germany)
    Abstract: The link between exchange rates and interest rates features prominently in the theoretical and empirical literature on small open economies. This paper revisits this relationship using a simple model that incorporates the role of exchange rate pass-through into domestic prices and distinguishes between cases of expansionary and contractionary depreciations. The model results show that the correlation between exchange rates and interest rates, conditional on an adverse risk premium shock, is negative for expansionary depreciations and positive for contractionary ones. For this type of shock, interest rates are found to be raised to prevent the contractionary effect of a depreciation regardless of whether the latter effect is strong or mild. Interest rates are predicted to also rise in response to an adverse net export shock in contractionary depreciation cases, and to be lowered in the case of expansionary ones.
    Keywords: Transmission mechanism; Emerging market economies; Exchange rate; Monetary policy.
    JEL: E52 E58 F31 F41
    Date: 2005–11
  37. By: Giancarlo Marini (University of Rome II - Faculty of Economics); Alessandro Piergallini (University of Rome II; University of Rome II - Faculty of Economics; University of London - School of Oriental and African Studies (SOAS))
    Abstract: This paper presents an indirect approach to investigate the possible existence of measurement error bias in the Harmonized Index of Consumer Prices for the UK and Italy. Our empirical results show that there is no significant evidence for a bias in the UK, nor for Italy prior to the introduction of the Euro. Since January 2002, however, the inflation rate in Italy has been underestimated by at least 6 percentage points.
    Keywords: Inflation, Measurement bias
    JEL: C22 C43 D14 E31
    Date: 2004–10–14
  38. By: Evi Pappa; Zheng Liu
    Abstract: This paper presents a new argument for international monetary policy coordination based on considerations of structural asymmetries across countries. In a two-country world with a traded and a non-traded sector in each country, optimal independent monetary policy cannot replicate the natural-rate allocations. There are potential welfare gains from coordination since the planner under a cooperating regime internalizes a terms-of-trade externality that independent central banks tend to overlook. Yet, with symmetric structures across countries, the gains are quantitatively small. If the size of the traded sector differs across countries, the gains can be sizable and increase with the degree of asymmetry. The planner's optimal policy not only internalizes the terms-of-trade externality, it also creates a terms-of-trade bias in favor the country with a larger traded sector. Further, the planner tries to balance the terms-of-trade bias against the need to stabilize fluctuations in the terms-of-trade gap.
    Keywords: International Policy Coordination; Optimal Monetary Policy; Asymmetric Structures; Terms-of-Trade Bias
    JEL: E52 F41 F42
    Date: 2005–11–11
  39. By: James Stodder
    Abstract: Centralized exchange has a worst-case size-complexity many orders of magnitude lower than decentralized monetary exchange for the same number of agents and goods. A more rapid approach to competitive equilibrium may therefore be possible through centralized exchange. An additional benefit of centralized exchanges is macroeconomic stability: their volume of financial activity can be shown to vary inversely with the business cycle. This counter-cyclical tendency is shown by error-correction models, based on twenty-five years of data from a US exchange (the International Reciprocal Trade Association) and fifty-five years of data from a Swiss bank (WIR). This combination of computational efficiency and counter-cyclical activity suggests that the forms of exchange and credit enabled by these centralized exchanges may promote both microeconomic efficiency and macroeconomic stability. The financial activities of such exchanges, therefore, can complement a central bank’s monetary policy, although they do diminish its direct control of the money supply itself.
    Keywords: size-complexity, centralized exchange, countercyclical policy
    JEL: D83 E52 G14
    Date: 2005–11–11
  40. By: Fabrizio Zampolli; Andrew P. Blake (Monetary Assessment and Strategy Bank of England)
    Abstract: In this paper we consider the quadratic optimal control problem with regime shifts and forward-looking agents. This extends the results of Zampolli (2003) who considered models without forward-looking expectations. Two algorithms are presented: The first algorithm computes the solution of a rational expectation model with random parameters or regime shifts. The second algorithm computes the time-consistent policy and the resulting Nash-Stackelberg equilibrium. The formulation of the problem is of general form and allows for model uncertainty and incorporation of policymaker’s judgement. We apply these methods to compute the optimal (non-linear) monetary policy in a small open economy subject to (symmetric or asymmetric) risks of change in some of its key parameters such as inflation inertia, degree of exchange rate pass-through, elasticity of aggregate demand to interest rate, etc.. We normally find that the time-consistent response to risk is more cautious. Furthermore, the optimal response is in some cases non-monotonic as a function of uncertainty. We also simulate the model under assumptions that the policymaker and the private sector hold the same beliefs over the probabilities of the structural change and different beliefs (as well as different assumptions about the knowledge of each other’s reaction function).
    Keywords: monetary policy, regime switching, model uncertainty, time consistency
    JEL: E52 D81
    Date: 2005–11–11
  41. By: Gerd Weinrich; Luca Colombo
    Abstract: This paper investigates monetary shocks and the rôle of inventories with respect to the occurrence of deflationary recessions. We propose a non-tâtonnement approach involving temporary equilibria with rationing in each period and price adjustment between successive periods. By amplifying spillover effects inventories imply that, following a restrictive monetary shock, the economy may converge to a quasi-stationary Keynesian underemployment state, in which case money is persistently non-neutral. Contrary to conventional wisdom, this is favored by sufficient downward flexibility of the nominal wage. The model is applied to the current deflationary Japanese recession, and we propose an economic policy to overcome it
    Keywords: Inventories, non-tatonnement, price adjustment, non-neutrality of money, deflationary recession
    JEL: D45 D50 E32
    Date: 2005–11–11
  42. By: TOM BERNHARDSEN (Research Department Norges Bank (The Central Bank of Norway)); ØYVIND EITRHEIM
    Abstract: Monetary policy conducted in real time has to take into account the preliminary nature of recent national accounts data. Not only recent data, but also figures dating many years back are potentially subject to revisions. This means that there is a danger that an important part of the central bank's information set is flawed for a substantial period of time. In this paper we present results based on quarterly vintages of real-time data for Norway from 1993Q1 to 2003Q4. We describe the nature and causes of the data revisions and investigate whether the revisions are true martingale differences or whether they can be forecasted. In the spirit of Orphanides and van Norden (2002), we analyze how data revisions and model uncertainty affect the reliability of output gap estimates. We find that total revisions of output gap estimates are heavily influenced by uncertainty about the trend at the end of the sample and that data revisions are of less importance, i.e., they are of smaller magnitude and show less persistence than other sources of output gap revisions. Finally, we analyse the implications of output gap uncertainty for monetary policy using a small New Keynesian macroeconomic model
    Keywords: Monetary policy, output gap, real-time data, interest rate rules
    JEL: C53 E37 E52
    Date: 2005–11–11
  43. By: Michael Kumhof (Modeling Division, Research Department International Monetary Fund); Douglas Laxton
    Abstract: This paper presents a monetary model with nominal rigidities and maximizing, rational, forward-looking households, intermediaries and firms. It differs from conventional models in this class in two key respects. First, price (and wage) setters set pricing policies, including an updating rate for future prices, instead of price levels. Second, output fluctuations during the period of a pricing policy are costly to firms. The paper is motivated by some important shortcomings of conventional models, namely their inability to generate inflation inertia, inflation persistence and recessionary disinflations without introducing either an ad-hoc updating rule or learning. While learning is clearly important, we are interested in the contribution that structural rigidities can make in a forward-looking and optimizing model. The model does generate all of the above effects in response to monetary policy shocks. The channel for these effects in the model is the long-run or inflation updating component of firms' pricing policies. This is distinct from another frequently stressed reason for inflation inertia and persistence, a slow response of marginal cost to shocks, which is also present in our model because all components of marginal cost, not just wages, are sticky. In work in progress, we are estimating the model using Bayesian techniques.
    Keywords: Inflation inertia, price setting behavior, output volatility
    JEL: E31 E32
    Date: 2005–11–11
  44. By: Gustavo Piga (University of Rome II); Giorgio Valente (The Chinese University of Hong Kong)
    Abstract: We estimate, using a previously unexploited set of data for the Italian public debt, quarterly yield curves over the period 1970-1996 to test the main implications of the expectations hypothesis theory (EH). Our empirical results show that short-term interest rates move according to the prediction of the EH, though the same cannot be found for long-term interest rates. In addition, using a probit model, we investigate the public debt issuance policy. We find and interpret a significant relationship between the slope of the yield curve and the probability of an increase in the aggregate duration of the outstanding debt.
    Keywords: Term Structure of Interest Rates, Expectations Hypothesis, Public Debt Management
    JEL: H63 E44 E58 E61
    Date: 2004–04–30
  45. By: Beatriz de-Blas-Pérez (Facultad de Ciencias Económicas y Empresariales Universidad de Navarra);
    Abstract: The stabilization effects of Taylor rules are analyzed in a limited participation framework with and without credit market imperfections in capital goods production. Financial frictions substantially amplify the impact of shocks, and also reinforce the stabilizing or destabilizing effects of interest rate rules. However, these effects are reversed relative to New Keynesian models: under limited participation, interest rate rules are stabilizing for productivity shocks, but imply an output-inflation tradeoff for demand shocks. Moreover, because financial frictions imply excessive fluctuation, stabilization via an interest rate rule can be a welfare-improving response to productivity shocks.
    Keywords: financial frictions, Taylor rules, limited participation, stabilization policy.
    JEL: E13 E44 E5
    Date: 2005–11
  46. By: Tao Wu; Glenn Rudebusch
    Abstract: This paper examines a recent shift in the dynamics of the term structure and interest rate risk. We first use standard yield-spread regressions to document such a shift in the U.S. in the mid-1980s. Over the pre- and post-shift subsamples, we then estimate dynamic, affine, no-arbitrage models, which exhibit a significant difference in behavior that can be largely attributed to changes in the pricing of risk associated with a "level" factor. Finally, we suggest a link between the shift in term structure behavior and changes in the risk and dynamics of the inflation target as perceived by investors
    JEL: E43 E44 G12
    Date: 2005–11–11
  47. By: Ghulam Sorwar (Business School Nottingham University)
    Abstract: Recent empirical studies have demonstrated that behaviour of interest rate processes can be better explained if standard diffusion processes are augmented with jumps in the interest rate process. In this paper we examine the performance of both linear and non-linear one factor CKLS model in the presence of jumps. We conclude that empirical features of interest rates not captured by standard diffusion processes are captured by models with jumps and that the linear CKLS model provides sufficient explanation of the data.
    Keywords: term structure, jumps, Bayesian, MCMC
    JEL: C11 C13 C15
    Date: 2005–11–11
  48. By: Greg Duffee (Haas School of Business University of California at Berkeley)
    Abstract: A combination of observed and unobserved (latent) factors capture term structure dynamics. Information about these dynamics is extracted from observed factors without specifying or estimating any of the parameters associated with latent factors. Estimation is equivalent to fitting the moment conditions of a set of regressions, where no-arbitrage imposes cross equation restrictions on the coefficients. The methodology is applied to the dynamics of inflation and yields. Outside of the disinflationary period of 1979 through 1983, short-term rates move one for one with expected inflation, while bond risk premia are insensitive to inflation.
    JEL: G12
    Date: 2005–11–11
  49. By: Michael P. Dooley; David Folkerts-Landau; Peter M. Garber
    Abstract: In this paper we examine the behavior of interest rates and exchange rates following a variety of shocks to the international monetary system. Our analysis suggests that real interest rates in the US and Europe will remain low relative to historical experience for an extended period but converge slowly toward normal levels. During this adjustment interval, the US absorbs a disproportionate share of world savings. After a substantial initial appreciation of floating currencies relative to the dollar, the dollar and other floating currencies remain constant relative to each other. An improvement in the investment climate in Europe during the adjustment period would generate an immediate depreciation of the euro relative to the dollar. In real terms, the dollar and the floating currencies will eventually have to depreciate relative to the managed currencies. But most of the adjustment in the US trade account will come as US absorption responds to increases in real interest rates.
    JEL: F02 F32 F33
    Date: 2005–11
  50. By: Andrea Carriero (Universitá Bocconi)
    Abstract: In this paper we propose a new way of modelling the expectations Hypothesis(EH) of the term structure of interest rates and provide striking evidence validating it on both statistical and economic grounds. The idea is to model the EH as a noisy relation, allowing for temporary departures from it. We do so using a Bayesian framework in which the EH can be viewed as a prior on a gaussian VAR. Importantly, our approach is very general and comprises the traditional framework as a special case. Once the EH is modeled as a noisy relation it is strongly supported by the data and is entirely consistent with the behavior of the U.S. 10-year rate from the seventies onwards. Moreover, our evidence explains the common result of rejection and the anomaly found by Campbell and Shiller (1987). Finally, our approach allows to extract additional information from the term structure and then to significantly increase the accuracy of a Taylor-rule based model in predicting future short term rates.
    Keywords: Bayesian VARs, Expectations Theory, Term Structure, Uncertain Restrictions
    JEL: C11 E43 E44 E47
    Date: 2005–11–11
  51. By: Andreas Beyer; Roger E.A. Farmer
    Abstract: We develop a technique for analyzing the dynamics of shocks in structural linear rational expectations models. Our work differs from standard SVARs since we allow expectations of future variables to enter structural equations. We show how to estimate the variance-covariance matrix of fundamental and non-fundamental shocks and we construct point estimates and confidence bounds for impulse response functions. Our technique can handle both determinate and indeterminate equilibria. We provide an application to U.S. monetary policy under pre and post Volcker monetary policy rules
    Keywords: Identification, indeterminacy, rational expectations models.
    JEL: C39 C62 D51
    Date: 2005–11–11
  52. By: Roberta De Santis (ISAE, Instituto di Studi e Analisi Economica)
    Abstract: The object of this study is to assess the role of trade in the transmission of currency shocks across geographically close countries. The analysis will focus on identifying and comparing the degree of vulnerability of new EU member states from the Central and Eastern European countries (CEECs) to currency shocks. We interpret the interactions that a centre-periphery model identifies for periphery countries as a possible description of existing interdependencies among CEECs. According to the centre periphery model discussed by Corsetti et al. (1998b), “if there is no pass-through, then direct bilateral trade links may play a more important role than competition in the third market in determining the transmission of exchange rate shocks in the periphery. If there is full pass-through, a high share of bilateral trade within a region can actually limit the extent of beggar-thy-neighbour effects.” These effects are emphasised by a high degree of export similarity among the countries in the periphery. As a result of the heterogeneity in pass-through and trade structures, it is very difficult to derive a unitary policy implication on the potential sustainability of the exchange rate mechanism (ERM) II. Yet it is possible to single out the country pairs in which the likelihood of transmitting currency shocks is higher. Preliminary results point out that (other things being equal and given the contained intra-periphery trade) the transmission of currency disturbances is lower if the disturbance originates in countries with low a pass-through rate (the Slovak and Czech Republics, Estonia and Latvia) and higher if it originates in countries with a high pass-through rate (Poland, Hungary and Slovenia).
    Keywords: currency crises, trade and contagion
    JEL: F31 F32 F41
    Date: 2004–07
  53. By: Ali Dib; Ian Christensen
    Abstract: This paper estimates a sticky-price DSGE model with a financial accelerator to assess the importance of financial frictions in the amplification and propagation of the effects of transitory shocks. Structural parameters of two models, one with and one without a financial accelerator, are estimated using a maximum-likelihood procedure and post-war US data. The estimation and simulation results provide some quantitative evidence in favour of the financial accelerator model. The financial accelerator appears to play an important role in investment fluctuations, but its importance for output depends on the nature of the initial shock
    Keywords: Monetary policy, Financial accelerator, DSGE estimation
    JEL: E31 E44 E51
    Date: 2005–11–11

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