nep-mon New Economics Papers
on Monetary Economics
Issue of 2005‒12‒20
25 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary policy and exchange rate interactions in a small open economy By Hilde C. Bjørnland
  2. A Comparison of Exchange Economies withina Monetary Business Cycle By Benk, Szilárd; Gillman, Max; Kejak, Michal
  3. Monetary Policy News and Exchange Rate Responses: Do Only Surprises Matter? By Rasmus Fatum; Barry Scholnick
  4. Money and Inflation: A Taxonomy By Matias Vernengo
  5. Inflation Targeting in India: Issues and Prospects By Raghbendra Jha
  6. International Observations of Monetary Policy Periods By Yamin Ahmad
  7. Optimal Monetary and Fiscal Policy in a Currency Union By Jordi Galí; Tommaso Monacelli
  9. Would price-level targeting destabilise the economy? By Minford, Patrick; Nowell, Eric; Webb, Bruce
  10. Should Private Expectations Concern Central Bankers? By Martin Fukac
  11. Optimal Inflation Stabilization in a Medium-Scale Macroeconomic Model By Stephanie Schmitt-Grohe; Martin Uribe
  12. Money, Credit and Banking By Aleksander Berentsen; Gabriele Camera; Christopher Waller
  13. Opportunistic Monetary Policy: an Alternative Rationalization By Minford, Patrick; Srinivasan, Naveen
  14. Is Monetary Policy in the Eurozone less Effective than in the US? By Paul De Grauwe; Cláudia Costa Storti
  15. The Role of the Housing Market in Monetary Transmission By Gabor Vadas; Gergely Kiss
  16. Reconciling the Effects of Monetary Policy Actions on Consumption Within a Heterogeneous Agent Framework By Yamin Ahmad
  18. Inflation and Balanced-Path Growth with Alternative Payment Mechanisms By Gillman, Max; Kejak, Michal
  19. New Evidence on Inflation Persistence and Price Stickiness in the Euro Area: Implications for Macro Modelling By Ignazio Angelloni; Luc Aucremanne; Michael Ehrmann; Jordi Galí; Andrew Levin; Frank Smets
  20. Technology, Preference Structure, and the Growth Effect of Money Supply By Jun-ichi Itaya
  21. Credit Shocks in the Financial Deregulatory Era: Not the Usual Suspects By Benk, Szilárd; Gillman, Max; Kejak, Michal
  22. Trade union density and inflation performance: evidence from OECD panel data By Christopher Bowdler; Luca Nunziata
  23. Does a free trade area favors an optimum currency area? The Case of Morocco and the European Union By Lahcen ACHY; Juliette Milgram
  24. The inflation-productivity trade-off revisited By George C. Bitros; Epameinondas E. Panas
  25. Monetary Policy in a Changing International Environment: The Role of Global Capital Flows By Martin Feldstein

  1. By: Hilde C. Bjørnland (University of Oslo and Norges Bank (Central Bank of Norway))
    Abstract: This paper analyses the transmission mechanisms of monetary policy in a small open economy like Norway through structural VARs, paying particular attention to the interdependence between the monetary policy stance and exchange rate movements in the inflation-targeting period. Previous studies of the effects of monetary policy in open economies have typically found small or puzzling effects on the exchange rate; puzzles that may arise due to the recursive restrictions imposed on the contemporaneous interaction between monetary policy and the exchange rate. By instead imposing a long-run neutrality restriction on the real exchange rate, thereby allowing the interest rate and the exchange rate to react simultaneously to any news, the interdependence increases considerably. In particular, following a contractionary monetary policy shock, the real exchange rate appreciates immediately and thereafter depreciates back to baseline. Furthermore, output and consumer price inflation fall gradually as expected; thereby also ruling out any price puzzle that has commonly been found in the literature. Results are compared and found to be consistent with among other the findings from an “event study” that focuses on immediate responses in asset prices following a surprise monetary policy decision.
    Keywords: VAR, monetary policy, open economy, identification, event study
    JEL: C32 E52 F31 F41
    Date: 2005–05–15
  2. By: Benk, Szilárd; Gillman, Max (Cardiff Business School); Kejak, Michal
    Abstract: The paper sets out a monetary business cycle model with three alternative exchange technologies, the cash-only, shopping time, and credit production models. The goods productivity and money shocks affect all three models, while the credit model has in addition a credit productivity shock. The paper compares the performance of the models in explaining the puzzles of the monetary business cycle theory. The credit model improves the ability to explain the procyclic movement of monetary aggregates, inflation and the nominal interest rate.
    Keywords: Cash-in-advance; credit production; cycle; inflation
    JEL: E13 E32 E44
    Date: 2005–12
  3. By: Rasmus Fatum (School of Business, University of Alberta); Barry Scholnick (School of Business, University of Alberta)
    Abstract: This paper shows that exchange rates respond to only the surprise component of an actual US monetary policy change and that failure to disentangle the surprise component from the actual monetary policy change can lead to an underestimation of the impact of monetary policy, or even to a false acceptance of the hypothesis that monetary policy has no impact on exchange rates. This finding implies that there is a need for reexamining the empirical analyses of asset price responses to macro news that do not isolate the unexpected component of news from the expected element. In addition, we add to the debate on how quickly exchange rates respond to news by showing that the exchange rates under study absorb monetary policy surprises within the same day as the news are announced.
    Keywords: expectations; monetary policy; federal funds futures; exchange rates
    JEL: E52 F31 G14
    Date: 2005–11
  4. By: Matias Vernengo
    Abstract: This paper reviews the various explanations for inflation and the relation between inflation and money aggregates. Two analytical distinctions are useful to understand different explanations of inflationary processes of all types. First, and more importantly, theories can be seen as cost-push or demand-pull theories of inflation. Second, the distinction between exogenous and endogenous money supply is important for a proper taxonomy of inflation theories. This second analytical cut results from the fact that there is a clear empirical connection between inflation and monetary stock measures. A tentative taxonomy is presented at the end, allowing an evaluation of the dominant view on money and inflation and the main counter points from a heterodox perspective.
    Keywords: Inflation, Macroeconomic Schools
    JEL: E11 E12 E13 E31
    Date: 2005
  5. By: Raghbendra Jha
    Abstract: Inflation targeting (henceforth IT) has emerged as a significant monetary policy framework in both developed and transition economies. It has been in place for a decade or more in a number of countries - with around 20 central banks adopting it as their basic monetary policy framework. Some authors have argued that for transition economies undergoing sustained financial liberalization and integration in world financial markets IT is an attractive monetary policy framework. Consequently there is some pressure for such economies to adopt IT as a core element in their monetary policy frameworks. The present paper evaluates the case for IT in India. It begins with stating, almost from first principles, the objectives of monetary policy in India. I argue that inflation control cannot be an exclusive concern of monetary policy in a country such as India with a substantial poverty problem. The rationales for IT is then spelt out as are some nuances of the practical implementation of IT. The paper provides some evidence on the effects of IT in developed and transition economies and argues that although IT may have been responsible for maintaining a low inflation regime it has not brought down the inflation rate itself substantially. Further, the volatility of exchange rate and output movements in transition countries adopting IT has been higher than in developed market economies. The paper then discusses India’s experience with using rules-based policy measures (nominal targets) and elaborates on the reasons (as espoused in the extant literature) why India is not ready for IT. It is further shown that even if the Reserve Bank of India wanted to, it could not pursue IT since the short-term interest rate (the principal policy tool used to affect inflation in countries working with IT) does not have significant effects on the rate of inflation. The paper concludes by listing monetary policy options for India at the current time.
    Date: 2005
  6. By: Yamin Ahmad (Department of Economics, University of Wisconsin - Whitewater)
    Abstract: I identify twenty observations of monetary policy periods within six of the G7 countries, following the spirit of the Narrative Approach used by Romer and Romer (1989). Statistics are used to characterize the state of these economies from the 1970's until 2001. Major historical events and narrative evidence are then used as a guide to identify these monetary policy periods, which re?ect the stance of monetary policy at central banks during those events. The significance of these monetary policy periods are then assessed using an instrumental variables approach. The results find the policy periods to be significant in the majority of the countries.
    Keywords: Monetary Policy Shocks, Identification, Narrative Approach
    JEL: E00 E52 E58
    Date: 2002–05
  7. By: Jordi Galí; Tommaso Monacelli
    Abstract: We lay out a tractable model for fiscal and monetary policy analysis in a currency union, and analyze its implications for the optimal design of such policies. Monetary policy is conducted by a common central bank, which sets the interest rate for the union as a whole. Fiscal policy is implemented at the country level, through the choice of government spending level. The model incorporates country-specific shocks and nominal rigidities. Under our assumptions, the optimal monetary policy requires that inflation be stabilized at the union level. On the other hand, the relinquishment of an independent monetary policy, coupled with nominal price rigidities, generates a stabilization role for fiscal policy, one beyond the e¢ cient provision of public goods. Interestingly, the stabilizing role for fiscal policy is shown to be desirable not only from the viewpoint of each individual country, but also from that of the union as a whole. In addition, our paper o¤ers some insights on two aspects of policy design in currency unions: (i) the conditions for equilibrium determinacy and(ii) the e¤ects of exogenous government spending variations.
    Keywords: Monetary union, sticky prices, countercyclical policy, inflation differentials
    JEL: E52 F41 E62
    Date: 2005–10
  8. By: Zavkidjon Zavkiev
    Abstract: This paper attempts to estimate a model of inflation in Tajikistan using the Johanson cointegration approach and single equation error correction model. It also develops a methodology for creating monthly real output series. The paper investigates both the short run dynamic behaviour of inflation and the long run relationship of prices with their determinants. There is evidence that in the long run prices are determined by exchange rate, money, real output and interest rates, and in the short run by values of money growth and inflation, and current and past values of output growth and interest rate changes. The speed of adjustment of prices to their long run equilibria is determined. The results suggest controlling excessive money growth and stabilizing excessive exchange rate fluctuations should be the key ingredients of monetary policy in controlling inflation of the country.
    JEL: E31 C32 O53
    Date: 2005–12
  9. By: Minford, Patrick (Cardiff Business School); Nowell, Eric; Webb, Bruce (Cardiff Business School)
    Abstract: When indexation is endogenous price level targeting slightly adds to economic stability, contrary to widespread fears to the contrary. The aggregate supply curve flattens and the aggregate demand curve steepens, increasing stability in the face of supply shocks.
    Keywords: Inflation; targeting; price-level rule; Price level target; indexation; monetary regime; endogenous contracts; stationarity; stability
    JEL: E31 E42 E52
    Date: 2005–12
  10. By: Martin Fukac
    Abstract: We analyze the standard New Keynesian economy adjusted by a financial intermediation sector, heterogenous, imperfect knowledge, and adaptive learning. We consider two groups of agents (i) private agents (households, firms, private banks) and (ii) the central bank who differ in their knowledge and expectations. The monetary-policy transmission is non-trivial in this environment. The interest rate directly affecting the decisions of households and firms is influenced by the private banks expectations, and the monetary policy may get distorted. The basic finding suggests the higher knowledge heterogeneity, the less active monetary policy should be in order to stabilize the economy. This contrasts the standard literature with homogenous knowledge and expectations.
    Keywords: Imperfect and heterogeneous knowledge, adaptive learning, monetary policy.
    JEL: E52
    Date: 2005–10
  11. By: Stephanie Schmitt-Grohe; Martin Uribe
    Abstract: This paper characterizes Ramsey-optimal monetary policy in a medium-scale macroeconomic model that has been estimated to fit well postwar U.S.\ business cycles. We find that mild deflation is Ramsey optimal in the long run. However, the optimal inflation rate appears to be highly sensitive to the assumed degree of price stickiness. Within the window of available estimates of price stickiness (between 2 and 5 quarters) the optimal rate of inflation ranges from -4.2 percent per year (close to the Friedman rule) to -0.4 percent per year (close to price stability). This sensitivity disappears when one assumes that lump-sum taxes are unavailable and fiscal instruments take the form of distortionary income taxes. In this case, mild deflation emerges as a robust Ramsey prediction. In light of the finding that the Ramsey-optimal inflation rate is negative, it is puzzling that most inflation-targeting countries pursue positive inflation goals. We show that the zero bound on the nominal interest rate, which is often cited as a rationale for setting positive inflation targets, is of no quantitative relevance in the present model. Finally, the paper characterizes operational interest-rate feedback rules that best implement Ramsey-optimal stabilization policy. We find that the optimal interest-rate rule is active in price and wage inflation, mute in output growth, and moderately inertial.
    JEL: E52 E61 E63
    Date: 2005–12
  12. By: Aleksander Berentsen; Gabriele Camera; Christopher Waller
    Abstract: In monetary models in which agents are subject to trading shocks there is typically an ex-post inefficiency in that some agents are holding idle balances while others are cash constrained. This inefficiency creates a role for financial intermediaries, such as banks, who accept nominal deposits and make nominal loans. We show that in general financial intermediation improves the allocation and that the gains in welfare arise from paying interest on deposits and not from relaxing borrowers’ liquidity constraints. We also demonstrate that increasing the rate of inflation can be welfare improving when credit rationing occurs.
    Keywords: money, credit, rationing, banking
    JEL: D90 E40 E50
    Date: 2005
  13. By: Minford, Patrick (Cardiff Business School); Srinivasan, Naveen
    Abstract: This paper offers an alternative rationalization for opportunistic behaviour i.e., a gradual disinflation strategy where policymakers react asymmetrically to supply shocks, opting to disinflate only in recessionary period. Specifically, we show that adaptive expectations combined with asymmetry in the Phillips curve of a specific sort together provide an optimizing justification for opportunism. However, the empirical basis for these conditions to be satisfied in the current low-inflation context of most OECD countries remains however to be established.
    Keywords: Deliberate disinflation; Opportunistic disinflation
    JEL: E52 E58
    Date: 2005–12
  14. By: Paul De Grauwe; Cláudia Costa Storti
    Abstract: There is a wide consensus that the existence of structural rigidities in the Eurozone reduces the effectiveness of the ECB’s monetary policies. In order to test this “ECB-handicap” hypothesis, we perform a meta-analysis of the effects of monetary policies in the US and the Eurozone countries. This consists in collecting the estimated transmission coefficients obtained from published econometric studies. Meta-analysis then allows us to control for a number of factors that can affect these estimated coefficients. We conclude that there is no evidence for the hypothesis that the ECB is handicapped in using monetary policies for the purpose of stabilizing output compared to the US.
    JEL: E50 E52 E58
    Date: 2005
  15. By: Gabor Vadas (Magyar Nemzeti Bank); Gergely Kiss (Magyar Nemzeti Bank)
    Abstract: As part of the monetary transmission studies of the Magyar Nemzeti Bank, this paper attempts to analyse the role of the housing market in the monetary transmission mechanism of Hungary. The housing market can influence monetary transmission through three channels, namely, the nature of the interest burden of mortgage loans, asset (house) prices, and the credit channel. The study first summarises the experiences of developed countries, paying special attention to issues arising from the monetary union. It then examines the developments in the Hungarian housing and mortgage markets in the last 15 years, as well as the expected developments and changes attendant to the adoption of the euro. Using panel econometric techniques, the study investigates the link between macroeconomic variables and house prices in Hungary, and the effect of monetary policy on housing investment and consumption through the wealth effect and house equity withdrawal.
    Keywords: Housing, Monetary transmission, Mortgage market, Panel econometrics
    JEL: E52
    Date: 2005–12–15
  16. By: Yamin Ahmad (Department of Economics, University of Wisconsin - Whitewater)
    Abstract: This paper incorporates heterogeneous agents into a NNS model with nominal inertia. Heterogeneous households are introduced into NNS models to try and reconcile the movements in interest rates, consumption and inflation. The key findings here are that heterogeneity and wage inertia are needed to help reconcile these observations. Aggregate consumption and its expected growth rate responds much more to myopic households than compared to optimizing households when myopic households set wages one periods in advance. When myopic households set wages in the current period, aggregate consumption and its expected growth rate is found to respond much more to the respective profiles for optimizing households.
    Keywords: Consumption, Aggregation, Interest Rates, Heterogeneity, Monetary Policy
    JEL: E27 E47 E52
    Date: 2004–07
  17. By: Yifan Hu; Timothy Kam
    Abstract: We construct a monetary model where government bonds also provide liquidity service. Liquid government bonds affect equilibrium allocations, inflation and create an endogenous interest-rate spread. How this new feature alters optimal fiscal-monetary policy in a stochastic sticky-price environment is considered. The trade-off confronting a planner, shown in recent literature, between using inflation surprise and labor-income tax is eradicated by the existence of the liquid bond. We find that the more sticky prices become, the more the planner stabilizes prices, but the planner also creates less distortionary and less volatile income taxes by resorting to taxing the liquidity service of bonds.
    JEL: E42 E52 E63
    Date: 2005–12
  18. By: Gillman, Max (Cardiff Business School); Kejak, Michal
    Abstract: The paper shows that contrary to conventional wisdom an endogenous growth economy with human capital and alternative payment mechanisms can robustly explain major facets of the long run inflation experience. A negative inflation-growth relation is explained, including a striking non-linearity found repeatedly in empirical studies. A set of Tobin (1965) effects are also explained and, further, linked in magnitude to the growth effects through the interest elasticity of money demand. Undisclosed previously, this link helps fill out the intuition of how the inflation experience can be plausibly explained in a robust fashion with a model extended to include credit as a payment mechanism.
    Keywords: Human capital; cash-in-advance; interest-elasticity; credit production
    JEL: O42 E31 E22
    Date: 2005–12
  19. By: Ignazio Angelloni; Luc Aucremanne; Michael Ehrmann; Jordi Galí; Andrew Levin; Frank Smets
    Abstract: This paper evaluates new evidence on price setting practices and inflation persistence in the euro area with respect to its implications for macro modelling. It argues that several of the most commonly used assumptions in micro-founded macro models are seriously challenged by the new findings.
    Keywords: Price setting practices, macro modellling
    JEL: E31 E52
    Date: 2005–09
  20. By: Jun-ichi Itaya (Graduate School of Economics and Business Administration, Hokkaido UniversityAuthor-Name: Kazuo Mino; Graduate School of Economies, Osaka University)
    Abstract: This paper studies the growth effect of money supply in the presence of increasing returns and endogenous labor supply. By using a simple model of endogenous growth with a cash-in-advance constraint, it is shown that the growth effect of money supply depends on the specifications of preference structures as well as on the production technology. Either if the production technology exhibits strong non-convexity or if the utility function has a high elasticity of intertemporal substitution, then there may exist dual balanced-growth equilibria and the impact of a change in money growth depends on which steady state is realized in the long run. It is also shown that there is no systematic relationship between the growth effect of money supply and local determinacy of the balanced growth path.
    Keywords: monetary growth, indeterminacy, increasing returns, non-separable utility.
    JEL: E31 E52 O42
    Date: 2005–12
  21. By: Benk, Szilárd; Gillman, Max (Cardiff Business School); Kejak, Michal
    Abstract: The paper constructs credit shocks using data and the solution to a monetary business cycle model. The model extends the standard stochastic cash-in-advance economy by including the production of credit that serves as an alternative to money in exchange. Shocks to goods productivity, money, and credit productivity are constructed robustly using the solution to the model and quarterly US data on key variables. The contribution of the credit shock to US GDP movements is found, and this is interpreted in terms of changes in banking legislation during the US financial deregulation era. The results put forth the credit shock as a candidate shock that matters in determining GDP, including in the sense of Uhlig (2003).
    Keywords: Business cycle; credit shocks; financial deregulation
    JEL: E32 E44
    Date: 2005–12
  22. By: Christopher Bowdler (Nuffield college); Luca Nunziata (University of Padua)
    Abstract: This paper examines the impact of union membership rates on inflation in OECD countries. A positive effect of union density is estimated, even after controlling for fixed effects and time dummies. Additional institutional characteristics, for example union coordination, employment protection laws and central bank independence, do not affect inflation directly in a panel setting, but do influence the size of the unionisation coefficient via interaction terms. The results are robust to controlling for potential common causes such as oil price shocks and the political stance of the government, and to using GMM/IV techniques to handle possible endogeneity biases.
    JEL: E31 J51
    Date: 2005–12
  23. By: Lahcen ACHY (INSEA, Rabat, Morocco); Juliette Milgram (Grenade University, Spain)
    Abstract: The purpose of this paper is to investigate simultaneously the potential effects of European Union's Association Agreement with Morocco and the adoption of the Euro as a single currency on exchange rate regime of Moroccan Dirham. Since Morocco depends heavily on EU as a market for its exports and a source for its imports, limited variability of the DH against the Euro seems à priori, to be an appropriate policy option. This option may even be strengthened within the FTA. However, the nature and the composition of Moroccan exports are typical of North-South trade with little diversification and high concentration on textiles and agricultural products. From this perspective, the risk of asymmetric shocks is more likely, which reduces the expected gains from nominal anchorage. This paper aims at contributing to the future exchange rate regime in Morocco and focuses on three main issues. The first issue is to investigate the potential effects of the FTA on trade structure and industrial specialization in Morocco. To this end, a computable general equilibrium model is used to simulate macroeconomic and sectoral effects of the implementation of the FTA on industrial sector. The second issue is to estimate the real exchange rate equilibrium based on macroeconomic fundamentals and assess the degree of misalignment of the actual value of the Dirham. Finally, the question of exchange rate arrangement is examined by combining the expected effects of free trade area between Morocco and the European Union, the existing degree of misalignment of the Dirham, and considering the adoption of the Euro as a single currency in 12 European countries. Our results seem to suggest that the implementation of a FTA may lead to a reallocation of industrial production toward an even more specialization in labor-intensive products. Under such circumstances, the symmetry of shocks, as an important condition for anchoring the DH to the Euro, is not satisfied making this option non-desirable.
    Keywords: Free Trade Area, CGE Model, Exchange rate
    JEL: F1 F2
    Date: 2005–12–14
  24. By: George C. Bitros (Athens University of Economics & Business); Epameinondas E. Panas (Athens University of Economics & Business)
    Abstract: Our aim in this paper is threefold. First, to test the robustness of the relation between total factor productivity growth and inflation to the specification of the estimating model; second, to test the stability of their relationship in the short run and in the long run, and third, to investigate the direction of causality between these two variables. To accomplish the first objective, we esti-mate a generalized Box-Box cost function using data from the two-digit Standard Industrial Clas- sification of manufacturing industries in Greece during the period 1964- 1980. The results show that: a) the acceleration of inflation from 1964- 1972 to 1973-1980 reduced total factor productiv-ity growth in a way that was both statistically significant and sizeable, and b) even when the ef-fect of inflation is separated from the effects of technical change and economies of scale, the choice of functional form is most crucial. With respect to the second objective, somewhat to our surprise, we find that the inflation-productivity trade-off prevails even in the long run. And, fi-nally, regarding the third objective, it emerges that in the great majority of two-digit manufactur-ing industries the causality runs from inflation to productivity. On these grounds we conclude that for a precise estimation of the relationship under consideration it is imperative to sort out the three effects involved, do so by adopting the most general flexible functional form for the cost function, and run the appropriate stability and causality tests.
    Keywords: inflation; productivity; scale economies; technical change; generalized Box-Cox cost function; stability; causality
    JEL: E31 O47
    Date: 2005–12–16
  25. By: Martin Feldstein
    Abstract: The Feldstein-Horioka study of 1980 found that OECD countries with high saving rates had high investment rates and vice versa, contrary to the traditional theory of global capital market integration. This capital market segmentation view, which has been verified in various studies over the past several decades, has important implications for tax and monetary policy. More recently, Alan Greenspan and John Helliwell have shown that the link between domestic saving and domestic investment became substantially weaker after the mid-1990s. The research reported in the current paper suggests that this is true of the smaller OECD countries but not of the larger ones. When observations are weighted by each country's GDP, the savings-investment link (i.e., the savings retention coefficient) remains relatively high. This paper also examines the recent capital flows to the United States. The Treasury International Capital (TIC) reports are generally misunderstood. When they are properly interpreted, they do not indicate that they U.S. has an excess of capital flows to finance the current account deficit. The TIC data also cannot be relied on the distinguish private and government sources of the capital flow. The persistence of these flows is therefore uncertain. The paper discusses the implications for monetary and fiscal policy of the changes in capital flows that may be happening.
    JEL: E0 F0
    Date: 2005–12

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