nep-mon New Economics Papers
on Monetary Economics
Issue of 2006‒01‒24
fifty-five papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Forecasting the central bank’s inflation objective is a good rule of thumb By Marie Diron; Benoît Mojon
  2. Discretionary Policy, Multiple Equilibria, and Monetary Instruments By Andreas Schabert
  3. The timing of central bank communication By Michael Ehrmann; Marcel Fratzscher
  4. A better way to account for fiat money at the Central Bank By Thomas Colignatus
  5. Discretionary Policy, Multiple Equilibria, and Monetary Instruments By Schabert, Andreas
  6. Attila Csajbók - András Rezessy : Hungary's euro zone entry date: what do the markets think and what if they change their minds? By Attila Csajbók; András Rezessy
  7. Pitfalls of monetary policy under incomplete information: imprecise indicators and real indeterminacy By Eugenio Gaiotti
  8. Establishing Credibility: Evolving Perceptions of the European Central Bank By Linda S. Goldberg; Michael W. Klein
  9. Do ECB's Statements Steer Short-Term and Long-Term Interest Rates in the Euro Zone ? By Marie Musard-Gies
  10. Optimal Monetary and Fiscal Policy in a Currency Union By Galí, Jordi; Monacelli, Tommaso
  11. Forecasting ECB monetary policy - accuracy is (still) a matter of geography By Helge Berger; Michael Ehrmann; Marcel Fratzscher
  12. Inflation convergence and divergence within the European Monetary Union By Fabio Busetti; Lorenzo Forni; Andrew Harvey; Fabrizio Venditti
  13. Information variables for monetary policy in a small structural model of the euro area By Francesco Lippi; Stefano Neri
  14. Robust Optimal Policy in a Forward-Looking Model with Parameter and Shock Uncertainty By Marc Giannoni
  15. An Unobserved Components Model of the Monetary Transmission Mechanism in a Small Open Economy By Francis Vitek
  16. The 1975-78 Anti-Inflation Program in Retrospect By John Sargent
  17. Endogenous monetary policy with unobserved potential output By Alex Cukierman; Francesco Lippi
  18. Estimating the immediate impact of monetary policy shocks on the exchange rate and other asset prices in Hungary By András Rezessy
  19. Monetary policy and stock prices: theory and evidence By Stefano Neri
  20. Is time ripe for a currency union in emerging East Asia? The role of monetary stabilisation By Marcelo Sánchez
  22. Estimating the Effect of Hungarian Monetary Policy within a Structural VAR Framework By Balázs Vonnák
  23. Monetary policy with heterogenous agents and credit constraints. By Yann Algan; Xavier Ragot
  24. The Impact of Central Bank FX Interventions on Currency Components By Michel Beine; Charles S. Bos; Sebastian Laurent
  25. Driving factors behind O/N interbank interest rates – the Hungarian experiences By Szilárd Erhart
  26. Interest rate rules, inflation and the Taylor principle: An analytical exploration. By Jean-Pascal Bénassy
  27. Forecasting Core Inflation in Canada: Should We Forecast the Aggregate or the Components? By Frédérick Demers; Annie De Champlain
  28. Towards European monetary integration - the evolution of currency risk premium as a measure for monetary convergence prior to the implementation of currency unions By Fernando González; Simo Launonen
  29. An Unobserved Components Model of the Monetary Transmission Mechanism in a Closed Economy By Francis Vitek
  30. Is there a cost channel of monetary policy transmission? An investigation into the pricing behaviour of 2,000 firms By Eugenio Gaiotti; Alessandro Secchi
  31. The Impact of Labor Markets on the Transmission of Monetary Policy in an Estimated DSGE Model By Kai Christoffel; Keith Kuester; Tobias Linzert
  32. What does the Bank of Japan do to East Asia? By Bartosz Mackowiak
  33. Endogeneities of Optimum Currency Areas: What brings Countries Sharing a Single Currency Closer together? By Paul de Grauwe; Francesco Paolo Mongelli
  34. Monetary union with voluntary participation By William Fuchs; Francesco Lippi
  35. Exchange Rate Smoothing in Hungary By Péter Karádi
  36. Estimation and Evaluation of a Segmented Markets Monetary Model By John Landon-Lane; Filippo Occhino
  37. Money, Interest Rate and Stock Prices: New Evidence from Singapore and The United States By Wong Keung-Wing; Habibullah Khan; Jun Du
  38. Pareto Efficiency vs. the Ad Hoc Standard Monetary Objective An Analysis of Inflation Targeting By David Eagle
  39. The real effect of inflation with credit constraints. By Xavier Ragot
  40. Bi-Polar Disorder: Exchange Rate Regimes, Economic Crises and the IMF By Graham Bird; Dane Rowlands
  41. The Impact of Monetary Union on EU-15 Sovereign Debt Yield Spreads By Marta Gómez-Puig
  42. Robust Inflation-Forecast-Based Rules to Shield against Indeterminacy By Nicoletta Batini; Alejandro Justiniano; Paul Levine; Joseph Pearlman
  43. International Transmission Effects of Monetary Policy Shocks: Can Asymmetric Price Setting Explain the Stylized Facts? By Caroline Schmidt
  44. Money Pumps in the Market By Ariel Rubinstein; Rani Spiegler
  45. The Distribution of Money Balances and the Non-Neutrality of Money By Aleksander Berentsen; Gabriele Camera; Christopher Waller
  46. AMU Deviation Indicator for Coordinated Exchange Rate Policies in East Asia and its Relation with Effective Exchange Rates By Eiji Ogawa; Junko Shimizu
  47. Financial structure and the transmission of monetary shocks: preliminary evidence for the Czech Republic, Hungary and Poland By Alessio Anzuini; Aviram Levy
  48. Consensus Formation in Monetary Policy Committees By Christopher Spencer
  49. The 'Sense and Nonsense of Maastricht' Revisited: What Have We Learnt About Stabilization In EMU? By Buiter, Willem H
  50. Liquidity effects in non Ricardian economies. By Jean-Pascal Bénassy
  51. Bank interest rate pass-through in the euro area: a cross country comparison By Christoffer Kok Sorensen; Thomas Werner
  52. The Taylor principle and global determinacy in a non Ricardian world. By Jean-Pascal Bénassy; Michel Guillard
  53. How the Eurosystem’s Treatment of Collateral in its Open Market Operations Weakens Fiscal Discipline in the Eurozone (and what to do about it) By Buiter, Willem H; Sibert, Anne
  54. On Prosperity and Posterity: The Need for Fiscal Discipline in a Monetary Union By Carsten Detken; Vítor Gaspar; Bernhard Winkler
  55. Are emerging market currency crises predictable? A test By Tuomas A. Peltonen

  1. By: Marie Diron (Brevan Howard Asset Management); Benoît Mojon (Corresponding author: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper first shows that the forecast error incurred when assuming that future inflation will be equal to the inflation target announced by the central bank is typically at least as small and often smaller than forecast errors of model-based and published inflation forecasts. It then shows that there are substantial benefits in having rule-of-thumb agents who simply trust that the central bank will deliver its pre-announced inflation objective.
    Keywords: Monetary policy, credibility, inflation targeting, inflation forecast.
    JEL: E5
    Date: 2005–12
  2. By: Andreas Schabert (Faculty of Economics and Econometrics, Universiteit van Amsterdam)
    Abstract: This paper examines monetary policy implementation in a sticky price model. The central bank's plan under discretionary optimization is entirely forward-looking and exhibits multiple equilibrium solutions if transactions frictions are not negligibly small. The central bank can then implement stable history dependent equilibrium sequences that are consistent with its plan by inertial interest rate adjustments or by money injections. These equilibria are associated with lower welfare losses than a forward-looking solution implemented by interest rate adjustments. The welfare gain from a history dependent implementation is found to rise with the strength of transactions frictions and the degree of price flexibility. It is further shown that the central bank's plan can uniquely be implemented in a history dependent way by money injections, whereas inertial interest rate adjustments cannot avoid equilibrium multiplicity.
    Keywords: Monetary policy implementation; optimal discretionary policy; history dependence; equilibrium indeterminacy; money growth policy
    JEL: E52 E51 E32
    Date: 2005–10–21
  3. By: Michael Ehrmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper explores whether there are systematic patterns as to when members of the decision-making committees of the Federal Reserve, the Bank of England and the European Central Bank communicate with the public, and under what circumstances such communication has the ability to move financial markets. The findings suggest that communication is generally seen as a tool to prepare markets for upcoming decisions, as it becomes more intense before committee meetings, and particularly so prior to interest rate changes. At the same time, markets react more strongly to communication prior to policy changes. Other instances where communication becomes more intense, or where financial markets become more responsive are also identified; even though these are more specific to the individual central banks, they are consistent with differences in the central banks’ monetary policy strategies and communication policies.
    Keywords: Communication; central bank; monetary policy; timing.
    JEL: E43 E52 E58 G12
    Date: 2005–12
  4. By: Thomas Colignatus (Thomas Cool Consultancy & Econometrics)
    Abstract: Proper monetary accounting rules are: (1) Central Banks should conform to the practice of the US Federal Reserve to distinguish its Balance Sheet from its Statement of Conditions. (2) Fiat money should not appear as a liability in a Balance Sheet. (3) The Central Bank should not record more government bonds than required for open market operations. Surplus bonds should be accounted as being void (on loan from the government who should destroy them). If these rules are not observed, a wrong measure of government debt arises, distorting the requirements for policy making.
    Keywords: Fiat Money, Money, Central Bank, Government Debt, Seigniorage, Inflation Tax, Gold Standard, Accounting
    JEL: A00
    Date: 2005–12–31
  5. By: Schabert, Andreas
    Abstract: This paper examines monetary policy implementation in a sticky price model. The central bank’s plan under discretionary optimization is entirely forward-looking and exhibits multiple equilibrium solutions if transactions frictions are not negligibly small. The central bank can then implement stable history dependent equilibrium sequences that are consistent with its plan by inertial interest rate adjustments or by money transfers. These equilibria can be associated with lower welfare losses than a forward-looking solution implemented by interest rate adjustments. The welfare gain from a history dependent implementation tends to rise with the strength of transactions frictions and the degree of price flexibility. It is further shown that the central bank’s plan can uniquely be implemented in a history dependent way by money transfers, whereas inertial interest rate adjustments cannot avoid equilibrium multiplicity.
    Keywords: equilibrium indeterminacy; history dependence; Monetary policy implementation; money growth policy; optimal discretionary policy
    JEL: E32 E51 E52
    Date: 2005–12
  6. By: Attila Csajbók (Magyar Nemzeti Bank); András Rezessy (Magyar Nemzeti Bank)
    Abstract: This article investigates the potential impact of a shift in market expectations about a country’s eurozone entry date on long-term yields and the spot exchange rate in a simple uncovered interest parity (UIP) framework. The results suggest that the size of the reactions depend on how far the entry date is postponed, how far current inflation is from the Maastricht-satisfying level, and whether the credibility of the central bank’s target inflation path is sensitive to changes in the expected entry date. In the empirical part, the authors apply the framework for Hungary and draw some policy conclusions for the timing of ERM II entry.
    Keywords: monetary policy, monetary union, expectations, euro zone entry, uncovered interest parity.
    JEL: E42 E52 F33 F42
    Date: 2005
  7. By: Eugenio Gaiotti (Banca d'Italia)
    Abstract: The paper examines the link between the precision of the available monetary policy indicators and the determinacy of equilibrium in a forward-looking macroeconomic model with partial information and an optimizing central bank. When the information on endogenous variables is not precise enough, the central bank acts too timidly; there is a possibility of self-fulfilling fluctuations in inflation and output. It is argued that, unless they are very precise, projections of output or inflation over the relevant horizon cannot be the only criterion for determining monetary policy actions. Rules which include a sufficient reaction to nominal variables may be necessary to supply an anchor for prices, even when the policymaker intends to consider all relevant information. Appointing a “conservative” central banker may also induce a less timid response to signs of inflation or deflation, even when their interpretation is difficult. In contrast, relying too much on measures of exogenous variables, such as potential output, can be counter-productive, because it could induce an attitude that is not responsive enough to inflation or deflation.
    Keywords: Monetary policy, information variables, incomplete information
    JEL: E52 E58
    Date: 2004–03
  8. By: Linda S. Goldberg; Michael W. Klein
    Abstract: The credibility of a central bank’s anti-inflation stance, a key determinant of its success, may reflect institutional structure or, more dynamically, the history of policy decisions. The first years of the European Central Bank (ECB) provide a natural experiment for considering whether, and how, central bank credibility evolves. In this paper, we present a model demonstrating how the high-frequency response of asset prices to news reflects market perceptions of the anti-inflation stance of a central bank. Empirical tests of this model on high frequency data, regressing both the change in the slope of the German yield curve and the change in the euro/dollar exchange rate on the surprise component of price news, suggest significant instability in the market’s perception of the policy stance of the ECB during its first five years of operation. Estimated smoothed paths of the coefficients linking news to asset prices show that these coefficients change with policies undertaken by the ECB. In contrast, there is no evidence of parameter instability for the response of the slope of the United States yield curve to price news during this period, suggesting no comparable evolution in the market perceptions of the commitment to inflation fighting by the Federal Reserve.
    Keywords: Central Banking, European Central Bank, Federal Reserve, inflation, exchange rate, credibility, yield curve
    JEL: F3 E5 E6
    Date: 2005–12–15
  9. By: Marie Musard-Gies (LEO - Laboratoire d'économie d'Orleans - - CNRS : FRE2783 - Université d'Orléans)
    Abstract: In this paper, we aim at testing whether press conferences held after the meeting of the ECB's monetary policy council steer market short- and long-term interest rates in the euro zone. To meet this goal, we "codify" the statements according to whether they are neutral, hawkish, or dovish. We show, using a principal components analysis of euro-zone (short- and long-term) interest rates that the euro-zone's market rates, react significantly to the bias in statements, and more particularly to changes in statements from one meeting to the next. If we study separately the reaction of short- and long-term interest rates to change in statements, the short end of the yield curve reacts more sharply to statements than the long segment. We show that the effect of statements peaks on interest rates with a maturity of six or twelve months and is smaller for the longer maturities. Using non-parametric tests confirms our previous results.
    Keywords: Communication ; Transparency ; Monetary Policy ; European Central Bank.
    Date: 2006–01–06
  10. By: Galí, Jordi; Monacelli, Tommaso
    Abstract: We lay out a tractable model for fiscal and monetary policy analysis in a currency union, and analyse 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 efficient 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 offers some insights on two aspects of policy design in currency unions: (i) the conditions for equilibrium determinacy and (ii) the effects of exogenous government spending variations.
    Keywords: countercyclical policy; inflation differentials; monetary union; sticky prices
    JEL: E52 E62 F41
    Date: 2005–12
  11. By: Helge Berger (Free University Berlin, Department of Economics, Boltzmannstr. 20, 12161 Berlin, Germany & CESifo.); Michael Ehrmann (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank,Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: Monetary policy in the euro area is conducted within a multi-country, multicultural, and multi-lingual context involving multiple central banking traditions. How does this heterogeneity affect the ability of economic agents to understand and to anticipate monetary policy by the ECB? Using a database of surveys of professional ECB policy forecasters in 24 countries, we find remarkable differences in forecast accuracy, and show that they are partly related to geography and clustering around informational hubs, as well as to country-specific economic conditions and traditions of independent central banking in the past. In large part this heterogeneity can be traced to differences in forecasting models. While some systematic differences between analysts have been transitional and are indicative of learning, others are more persistent.
    Keywords: monetary policy; ECB; forecast; geography; history; heterogeneity; Taylor rule; learning; transmission; survey data; communication.
    JEL: E52 E58 G14
    Date: 2006–01
  12. By: Fabio Busetti (Bank of Italy, Research Department, Via Nazionale 91, 00184 Rome, Italy); Lorenzo Forni (Bank of Italy, Research Department, Via Nazionale 91, 00184 Rome, Italy); Andrew Harvey (University of Cambridge, Department of Applied Economics, Sidgwick Avenue, Cambridge CB3 9DE, United Kingdom); Fabrizio Venditti (Bank of Italy, Research Department, Via Nazionale 91, 00184 Rome, Italy)
    Abstract: We study the convergence properties of inflation rates among the countries of the European Monetary Union over the period 1980-2004. Given the Maastricht agreements and the adoption of the single currency, the sample can be naturally split into two parts, before and after the birth of the euro. We study convergence in the first sub-sample by means of univariate and multivariate unit root tests on inflation differentials, arguing that the power of the tests is considerably increased if the Dickey-Fuller regressions are run without an intercept term. Overall, we are able to accept the convergence hypothesis over the period 1980-1997. We then investigate whether the second sub-sample is characterized by stable inflation rates across the European countries. Using stationarity tests on inflation differentials, we find evidence of diverging behaviour. In particular, we can statistically detect two separate clusters, or convergence clubs: a lower inflation group that comprises Germany, France, Belgium, Austria, Finland and a higher inflation one with Spain, Netherlands, Greece, Portugal and Ireland. Italy appears to form a cluster of its own, standing in between the other two.
    Keywords: Absolute Convergence, Inflation Differentials, Stability, Unit Root Tests.
    JEL: C12 C22 C32 E31
    Date: 2006–01
  13. By: Francesco Lippi (Banca d'Italia); Stefano Neri (Banca d'Italia)
    Abstract: This paper estimates a small New-Keynesian model with imperfect information and optimal discretionary policy using data for the euro area. The model is used to assess the usefulness of monetary aggregates and unit labour costs as information variables for monetary policy. The estimates reveal that the information content of the M3 monetary aggregate is limited. A more useful role emerges for the unit labour cost indicator, which contains information on potential output that helps to reduce the volatility of the output gap. Finally, the estimated weights for the objectives of monetary policy show that considerable importance is attributed to interest-rate smoothing, greater than to output gap stabilization. This finding indicates that the welfare gains of commitment may be smaller than suggested by typical parametrizations of New-Keynesian models.
    Keywords: monetary policy, Kalman filter, inflation, output gap
    JEL: E5
    Date: 2004–07
  14. By: Marc Giannoni
    Abstract: This paper characterizes a robust optimal policy rule in a simple forward-looking model, when the policymaker faces uncertainty about model parameters and shock processes. We show that the robust optimal policy rule is likely to involve a stronger response of the interest rate to fluctuations in inflation and the output gap than is the case in the absence of uncertainty. Thus parameter uncertainty alone does not necessarily justify a small response of monetary policy to perturbations. However uncertainty may amplify the degree of "super-inertia" required by optimal monetary policy. We finally discuss the sensitivity of the results to alternative assumptions.
    JEL: C61 D81 E42 E52
    Date: 2006–01
  15. By: Francis Vitek (University of British Columbia)
    Abstract: This paper develops and estimates an unobserved components model for purposes of monetary policy analysis and inflation targeting in a small open economy. Cyclical components are modeled as a multivariate linear rational expectations model of the monetary transmission mechanism, while trend components are modeled as unobserved components while ensuring the existence of a well defined balanced growth path. Full information maximum likelihood estimation of this unobserved components model, conditional on prior information concerning the values of trend components, provides a quantitative description of the monetary transmission mechanism in a small open economy, yields a mutually consistent set of indicators of inflationary pressure together with confidence intervals, and facilitates the generation of relatively accurate forecasts.
    Keywords: Monetary policy analysis; Inflation targeting; Small open economy; Unobserved components model; Indicators of inflationary pressure; Monetary transmission mechanism; Forecast performance evaluation
    JEL: E52 F41 F47
    Date: 2005–12–27
  16. By: John Sargent
    Abstract: The author provides an overview of the 1975–78 Anti-Inflation Program (AIP), in a background document prepared for a seminar organized by the Bank of Canada to mark the AIP's 30th anniversary. After reviewing Canada's experience with, and policy response to, inflation in the decade preceding the introduction of the AIP, the author sets out the elements of the AIP's monetary and fiscal policy, and prices and incomes controls. He then compares the program's inflation objectives with the actual course of inflation and aggregate demand during, and immediately after, the AIP. Drawing on existing analyses of the program's monetary and fiscal policy and controls elements, the author discusses why the program's specific targets and general objectives were not met. He concludes, with the benefit of hindsight, that-while external factors contributed to the failure to meet objectives-monetary and fiscal policy were not suc h as to give the AIP a strong chance of fully succeeding. The program's controls element has generally been assessed more favourably, although certain specifics of the controls design can be questioned. The author briefly considers parallels with recent retrospective considerations of monetary and fiscal policy over the same period in the United States. He also attempts to draw some general lessons from the AIP experience and, more generally, from the 1970s experience. Given that the AIP was an early attempt at a form of inflation targeting, these include lessons that may be relevant to current policy with respect to inflation.
    Keywords: Credibility; Fiscal policy; Inflation and prices; Inflation targets; Monetary policy framework; Monetary policy implementation
    JEL: E31 E52 E63 E64 E65
    Date: 2005
  17. By: Alex Cukierman (Tel-Aviv University and Center, Tilburg University); Francesco Lippi (Banca d'Italia)
    Abstract: This paper characterizes endogenous monetary policy when policymakers are uncertain about the extent to which movements in output and inflation are due to changes in potential output or to cyclical demand and cost shocks. We refer to this informational limitation as the “information problem” (IP). Main results of the paper are: 1. Policy is likely to be excessively loose (restrictive) for some time when there is a large decrease (increase) in potential output in comparison with a full information benchmark. 2. Errors in forecasting potential output and the output gap are generally serially correlated. These ndings provide a partial explanation for the inflation of the seventies and the price stability of the nineties. 3. A quantitative assessment, based on an empirical model of the US economy developed by Rudebusch and Svensson (1999), indicates that during and following periods of large changes in potential output the IP significantly affects the dynamics of inflation and output. 4. The increase in the Fed’s conservativeness between the seventies and the nineties, and a more realistic appreciation of the uncertainties surrounding potential output in the second period, imply that the IP problem had a stronger impact in the seventies than in the nineties.
    Keywords: monetary policy, potential output, filtering, inflation, output gap
    JEL: E5
    Date: 2004–06
  18. By: András Rezessy (Magyar Nemzeti Bank)
    Abstract: The paper estimates the immediate impact of Hungarian monetary policy on three classes of asset prices: the exchange rate of the forint vis-à-vis the euro, spot and forward government bond yields and the index of the Budapest Stock Exchange. The endogeneity problem is treated with the method of identification through heteroskedasticity as described by Rigobon and Sack (2004). The results suggest a significant impact on the exchange rate in one day i.e. an increase in the policy rate leads to an appreciation of the domestic currency, which is in line with the classic intuition. The effect increases markedly when the estimation is carried out with a two-day window suggesting the inefficiency of markets in incorporating monetary policy decisions in asset prices in a short period of time. Monetary policy affects spot yields positively, but the effect gradually dies out as the horizon gets longer. This can be explained with the impact on forward yields, as the results suggest a positive impact on short-term and a negative impact on long-term forward yields meaning that a surprise change in the policy rate leads to a rotation of the forward curve. The method does not provide interpretable and significant results for the stock exchange index.
    Keywords: Monetary transmission mechanism, Asset prices, Exchange rate, Yield curve, Stock market, Identification, Heteroskedasticity.
    JEL: E44 E52
    Date: 2005
  19. By: Stefano Neri (Banca d'Italia)
    Abstract: The objective of this paper is to evaluate the effects of monetary policy shocks on stock market indices in the G-7 countries and Spain using the methodology of structural VARs. A model is estimated for each country and the effects of monetary policy shocks are evaluated by means of impulse responses. A contractionary shock has a negative and temporary effect on stock market indices. There is evidence of a significant cross-country heterogeneity in the persistence, magnitude and timing of the responses. A limited participation model with households trading in stocks is set up and the responses of stock prices to a monetary policy shock under different rules are evaluated. The model is able to account for the empirical response of stock prices to monetary policy shocks under different policy rules.
    Keywords: monetary policy; stock prices; structural VAR; limited participation model
    JEL: C32 E52 G12
    Date: 2004–07
  20. By: Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper assesses the prospects for monetary integration between Emerging East Asian (EEA) economies. Our empirical analysis is based on a simple analytical framework for currency unions of small open economies, with a focus on the conduct of monetary policy in the presence of different types of shocks. Our empirical analysis looks at a number of supply-side characteristics of EEA countries, distinguishing between aggregate and tradable sector structural features. Moreover, we discuss the evidence on the cross-country variation of disturbances hitting the region. Our study indicates that, at present, EEA economies exhibit a high degree of cross-country supply diversity, while there is no compelling evidence that shocks are highly correlated across the region.
    Keywords: East Asia, emerging economies, currency union, stabilisation.
    JEL: E52 E58 F33 F40
    Date: 2005–12
  21. By: Martin Menner
    Abstract: Search-theory has become the main paradigm for the micro-foundation of money. But no comprehensive business cycle analysis has been undertaken yet with a search-based monetary model. We extend the model with divisible goods and divisible money of Shi (JET, 1998) to allow for capital formation, analyze the monetary propagation mechanism and contrast the model .s implications with US business cycle stylized facts. With empirically plausible adjustment costs the model features a persistent propagation of monetary shocks and is able to replicate fairly well the volatility and cross-correlation with output of key US time series, including sales and inventory investment. We find that monetary policy shocks are unlikely to be an important source of business cycle fluctuations but discover another dimension where money matters: the very frictions that make money essential shape also the responses of variables to real shocks.
    Date: 2005–10
  22. By: Balázs Vonnák (Magyar Nemzeti Bank)
    Abstract: A standard approach in measuring the effect of monetary policy on output and prices is to estimate a VAR model, characterise somehow the monetary policy shock and then plot impulse responses. In this paper I attempt to do this exercise with Hungarian data. I compare two identification approaches. One of them involves the ‘sign restrictions on impulse responses’ strategy applied recently by several authors. I also propose another approach, namely, imposing restrictions on implied shock history. My argument is that in certain cases, especially in the case of the Hungarian economy, the latter identification scheme may be more credible. In order to obtain robust results I use two datasets. To tackle possible structural breaks I make alternative estimates on a shorter sample as well. The main conclusions are the followings: (1) although the two identification approaches produced very similar results, imposing restrictions on history may help to dampen counterintuitive reaction of prices; (2) after 1995 a typical unanticipated monetary policy contraction (a roughly 25 basis points rate hike) resulted in an immediate 1 per cent appreciation of the nominal exchange rate (3) followed by a 0.3% lower output and 0.1-0.15% lower consumer prices; (4) the impact on prices is slower than on output; it reaches its bottom 4-6 years after the shock, resembling the intuitive choreography of sticky-price models; (5) using additional observations prior to 1995 makes identification more difficult indicating the presence of a marked structural break.
    Keywords: structural VAR, monetary transmission mechanism, identification, sign restriction, monetary policy shocks
    JEL: C11 C32 E52
    Date: 2005
  23. By: Yann Algan; Xavier Ragot
    Abstract: This paper analyzes the long-run effect of monetary policy when credit constraints are taken into account. This analysis is carried on in a heterogeneous agents framework in which infinitely lived agents can partially self-insure against income risks by using both financial assets and real balences. First we show theoretically that financial borrowing constraints give rise to an heterogeneity in money demand, leading to a real effect of inflation. Secondly, we show that inflation has a quantitative positive impact on output and consumption in economies which closely match the wealth distribution of the United States. Thirdly, we find that the average welfare cost of inflation is much smaller compared to a complete market economy, and that inflation induces important redistributive effects across households.
    Date: 2005
  24. By: Michel Beine (University of Luxemburg, and Free University of Brussels); Charles S. Bos (Vrije Universiteit Amsterdam); Sebastian Laurent (University of Namur, and CORE)
    Abstract: This paper is the first attempt to assess the impact of official FOREX interventions of the three major central banks in terms of the dynamics of the currency components of the major exchange rates (EUR/USD and YEN/USD) over the period 1989-2003. We identify the currency components of the mean and the volatility processes of exchange rates using the recent Bayesian framework developed by Bos and Shephard (2004). Our results show that in general, the concerted interventions tend to affect the dynamics of both currency components of the exchange rate. In contrast, unilateral interventions are found to primarily affect the currency of the central bank present in the market. Our findings also emphasize a role for interventions conducted by these central banks on other related FOREX markets.
    Keywords: Central banks; interventions; exchange rates; stochastic volatility; state space
    JEL: C11 C32 E58 F31
    Date: 2005–11–10
  25. By: Szilárd Erhart (Magyar Nemzeti Bank)
    Abstract: This study examines overnight (O/N) interest rates which constitute the short end of the yield curve and the factors which have an impact on such rates. The MNB, unlike several other central banks, does not have a direct overnight interest rate target; it does, however, limit the divergence of O/N interest rates from its policy rate with the settings of its operational framework. First, the MNB’s regulations on compulsory reserves allow banks to apply averaging in the reserve maintenance period, which reduces overnight interest rate volatility. Second, the interest rate corridor – determined by MNB’s collateralised loan and deposit – limits the maximum fluctuation band of overnight interbank interest rates. The study finds that the role of reserve averaging to reduce yield fluctuations is imperfect, as a clear seasonal pattern is observed in the intra-maintenance period evolution of overnight rates. The frequency of cumulative front-loading and excess reserves is significantly higher than the frequency of reserve deficit. Therefore, the level of overnight interest rates tends to remain below the policy rate and drop towards the interest rates of overnight central bank deposits at the end of the maintenance period. Moreover, statistical analysis finds evidence that the impact of liquidity withdrawing shocks are typically greater – approximately twice as much – as of those injecting liquidity. This phenomenon could be explained by the volatility of autonomous liquidity factors, especially that of the government accounts, which is particularly high on VAT payment days. Institutional settings (credit limits, limitation of maximum deviation from reserve requirements, high interbank concentration) curtail the potential of the interbank market to efficiently distribute liquidity over the entire system, which may also explain the asymmetric liquidity management characteristics of Hungarian banks.
    Keywords: overnight rate, central bank instruments, operational framework, averaging, reserve requirements.
    JEL: G14 E42 E52
    Date: 2005
  26. By: Jean-Pascal Bénassy
    Abstract: The purpose of this article is to characterize optimal interest rate rules in the framework of a dynamic stochastic general equilibrium model, and notably to scrutinize the "Taylor principle", according to which the nominal interest rate should respond more than one for one to inflation. This model yields explicit solutions for the optimal rule. We find that the elasticity of response depends on numerous factors, such as the degree of price rigidity, the autocorrelation of the underlying shocks, or which measure of inflation is used. In general the optimal elasticity of the interest rate with respect to inflation needs not be greater than one.
    Date: 2005
  27. By: Frédérick Demers; Annie De Champlain
    Abstract: The authors investigate the behaviour of core inflation in Canada to analyze three key issues: (i) homogeneity in the response of various price indexes to demand or real exchange rate shocks relative to the response of aggregate core inflation; (ii) whether using disaggregate data helps to improve the forecast of core inflation; and (iii) whether using monthly data helps to improve quarterly forecasts. The authors show that the response of inflation to output-gap or real exchange rate shocks varies considerably across the components, although the average response remains low; they also show that the average response has decreased over time. To forecast monthly inflation, the use of disaggregate data is a significant improvement over the use of aggregate data. However, the improvements in forecasts of quarterly rates of inflation are only minor. Overall, it remains difficult to properly model and forecast monthly core inflation in Canada.
    Keywords: Econometric and statistical methods; Inflation and prices
    JEL: E37 C5
    Date: 2005
  28. By: Fernando González (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Simo Launonen (SEB Merchant Banking, Unioninkatu 30, P. O. Box 630, 00101 Helsinki, Finland)
    Abstract: We assess monetary convergence preceding the implementation of the EuropeanMonetary Union (EMU) through Kalman filtering estimates of the risk premium of eleven forward exchange rates of European and non-European currencies. Since all participating currencies are in effect identical from inception of a currency union, the convergence process to such an identical status should be reflected in the participating currencies' risk premiums prior to monetary union implementation. Starting from this assumption, we show the paths followed by the participating currencies towards monetary union. We find that the co-movements of risk premiums among the preceding European Monetary System (EMS) currencies differ across time periods but display a tendency to convergence to the German mark’s risk premium up to EMU implementation. The paper also shows a clear pattern of asymmetry of the participating currencies in relation to the German mark.
    Keywords: Currency unions, European Monetary Union, foreign exchange risk premium.
    JEL: F02 F31 F33 F36 G15 G18
    Date: 2005–12
  29. By: Francis Vitek (University of British Columbia)
    Abstract: This paper develops and estimates an unobserved components model for purposes of monetary policy analysis in a closed economy. Cyclical components are modeled as a multivariate linear rational expectations model of the monetary transmission mechanism, while trend components are modeled as unobserved components while ensuring the existence of a well defined balanced growth path. Full information maximum likelihood estimation of this unobserved components model, conditional on prior information concerning the values of trend components, provides a quantitative description of the monetary transmission mechanism in a closed economy, yields a mutually consistent set of indicators of inflationary pressure together with confidence intervals, and facilitates the generation of relatively accurate forecasts.
    Keywords: Monetary policy analysis; Unobserved components model; Indicators of inflationary pressure; Monetary transmission mechanism; Forecast performance evaluation
    JEL: E37 E52
    Date: 2005–12–27
  30. By: Eugenio Gaiotti (Banca d'Italia); Alessandro Secchi (Banca d'Italia)
    Abstract: The paper exploits a unique panel, covering some 2,000 Italian manufacturing firms and 14 years of data on individual prices and individual interest rates paid on several types of debt, to address the question of the existence of a channel of transmission of monetary policy operating through the effect of interest expenses on the marginal cost of production. It has been argued that this mechanism may explain the dimension of the real effects of monetary policy, give a rationale for the positive short-run response of prices to rate increases (the “price puzzle”) and call for a more gradual monetary policy response to shocks. We find robust evidence in favour of the presence of a cost channel of monetary policy transmission, proportional to the amount of working capital held by each firm. The channel is large enough to have non-trivial monetary policy implications.
    Keywords: monetary transmission, cost channel, working capital
    JEL: E52 E31
    Date: 2004–12
  31. By: Kai Christoffel (European Central Bank); Keith Kuester (Goethe University, Frankfurt); Tobias Linzert (European Central Bank and IZA Bonn)
    Abstract: Real wages are a key determinant of marginal costs. The latter themselves are a driving force of inflation. We ask how wages and labor market shocks feed into the inflation process. We model search and matching frictions in the labour market in an otherwise standard New- Keynesian closed economy DSGE model. We estimate the model using Bayesian techniques for German data from the mid 70s to present. In our framework, we find that labor market structure is important for the evolution of the business cycle, and for monetary policy in particular. Yet labor market shocks are not important information for the conduct of stabilization policy.
    Keywords: labor market, wage rigidity, bargaining, Bayesian estimation
    JEL: E52 E58 J64
    Date: 2005–12
  32. By: Bartosz Mackowiak
    Abstract: In recent policy debates some have argued that expansionary monetary policy in Japan can increase real output in Japan and in Japan´s neighbors, while others have warned that it is a beggar-thy-neighbor policy. In this paper we estimate structural vector autoregressions to assess the effects of Japanese monetary policy shocks. We find that the effects of Japanese monetary policy shocks on macroeconomic variation in East Asia have been modest and difficult to reconcile with the beggar-thy-neighbor view. We estimate that the Asian crisis was preceded by expansionary monetary policy shocks in Japan, but we fail to find support for the view that these shocks contributed to the crisis.
    Keywords: Structural vector autoregression, sign restrictions, monetary policy shocks, spillover effects, beggar-thy-neighbor, Japan, East Asia
    JEL: F41 E3 E52
    Date: 2005–12
  33. By: Paul de Grauwe (Leuven University); Francesco Paolo Mongelli (European Central Bank)
    Abstract: This paper brings together several strands of the literature on the endogenous effects of monetary integration: i.e., whether sharing a single currency may set in motion forces bringing countries closer together. The start of the European Economic and Monetary Union (EMU) has spurred a new interest in this debate. There are four areas that we analyse in this context: the endogeneity of economic integration, in which we look primarily at evidence on prices and trade; the endogeneity of financial integration or equivalently insurance schemes that can be provided by capital markets; the endogeneity of symmetry of shocks and (similarly) at synchronisation of outputs; and the endogeneity of product and labour market flexibility. The paper presents a conceptual framework within which to illustrate such endogeneities. We present diverse arguments and, where possible, explore the incipient empirical literature focussing on the euro area. On the whole, concerning EMU, our preliminary conclusion is one of moderate optimism. The different endogeneities that exist in the dynamics towards optimum currency areas are at work. How strong these endogeneities are and how quickly they do their work remains to be seen.
    Keywords: Optimum Currency Area, Economic and Monetary Integration and EMU
    JEL: E42 F13 F33 F42
    Date: 2005–12
  34. By: William Fuchs (Stanford University); Francesco Lippi (Banca d'Italia)
    Abstract: A Monetary Union is modeled as a technology that makes a surprise policy deviation impossible but requires voluntarily participating countries to follow the same monetary policy. Within a fully dynamic context, we identify conditions under which such arrangement may dominate a coordinated system with independent national currencies. Two new results are delivered by the voluntary participation assumption. First, optimal policy is shown to respond to the agents’ incentives to leave the union by tilting both current and future policy in their favor. This contrasts with the static nature of optimal policy when participation is exogenously assumed and implies that policy in the union is not exclusively guided by area-wide developments but does occasionally take account of member countries’ national developments. Second we show that there might exist states of the world in which the union breaks apart, as occurred in some historical episodes. The paper thus provides a first formal analysis of the incentives behind the formation, sustainability and disruption of a Monetary Union.
    Keywords: monetary union, limited commitment
    JEL: C7 E5 F33
    Date: 2004–07
  35. By: Péter Karádi (New York University, USA)
    Abstract: The paper proposes a structural empirical model capable of examining exchange rate smoothing in the small, open economy of Hungary. The framework assumes the existence of an unobserved and changing implicit exchange rate target. The central bank is assumed to use interest rate policy to obtain this preferred rate in the medium term, while market participants are assumed to form rational expectations about this target and influence exchange rates accordingly. The paper applies unobserved variable method – Kalman filtering – to estimate this implicit exchange rate target, and simultaneously estimate an interest rate rule and an exchange rate equation consistent with this target. The results provide evidence for exchange rate smoothing in Hungary by providing an estimated smooth implicit exchange rate target development and by showing significant interest rate response to the deviation of the exchange rate from this target. The method also provides estimates for the ceteris paribus exchange rate effects of expected and unexpected interest rate changes.
    Keywords: exchange rate smoothing, interest rate rules, Kalman filter
    JEL: E52 F31 F41
    Date: 2005
  36. By: John Landon-Lane (Rutgers University); Filippo Occhino (Rutgers University)
    Abstract: This paper develops a heterogeneous agents segmented markets model with endogenous production and a monetary authority that follows a Taylor-type interest rate rule. The model is estimated using Markov chain Monte Carlo techniques and is evaluated as a framework suitable for empirical monetary analysis. We find that the segmented markets friction significantly improves the statistical out-of-sample prediction performance of the model, and generates delayed and realistic impulse response functions to monetary policy shocks. In addition, we find that the estimates of the Taylor rule are stable across the pre-1979 and post-1982 periods in our sample, while the volatilities of the structural shocks faced in the pre-1979 period are substantially higher than in the post-1982 period.
    Keywords: Segmented Markets; Markov chain Monte Carlo; Taylor rule; Monetary policy shocks;
    JEL: C11 C52 E52
    Date: 2005–06–13
  37. By: Wong Keung-Wing (Department of Economics, National University of Singapore); Habibullah Khan (Graduate School of Business, Universitas21Global); Jun Du (Department of Economics, National University of Singapore)
    Abstract: This paper examines the long-term as well as short-term equilibrium relationships between the major stock indices and selected macroeconomic variables (such as money supply and interest rate) of Singapore and the United States by employing the advanced time series analysis techniques that include cointegration, Johansen multivariate cointegrated system, fractional cointegration and Granger causality. The cointegration results based on data covering the period January 1982 to December 2002 suggest that Singapore’s stock prices generally display a long- run equilibrium relationship with interest rate and money supply (M1) but a similar relationship does not hold for the United States. To capture the short-run dynamics of the relationship, we replicate the same experiments with different subsets of data representing shorter time periods. It is evident that stock markets in Singapore moved in tandem with interest rate and money supply before the Asian Crisis of 1997, but this pattern was not observed after the crisis. In the United States, stock prices were strongly cointegrated with macroeconomic variables before the 1987 equity crisis but the relationship gradually weakened and totally disappeared with the emergence of Asian Crisis that also indirectly affected the United States. The results of fractional cointegration and the Johansen multivariate system are consistent with the earlier cointegration result that both Singapore and US stock markets did possess equilibrium relationship with M1 and interest rate at the early days. However, the stability of the systems was disturbed by a series of well-known financial turbulence in the past two decades and eventually weakened for Singapore and completely disappeared for the U.S. This may imply that monetary authority may take action to respond to the asset price turbulence in order to maintain the stability of monetary economy and thus break the existing equilibrium between stock markets and macroeconomic variables like interest rate and M1. Another possible explanation is that the market became more efficient after 1997 Asian crisis. Finally, the results of Granger causality tests uncover some systematic causal relationships implying That stock market performance might be a good gauge for Central Bank’s monetary policy adjustment.
  38. By: David Eagle (Eastern Washington University)
    Abstract: The standard ad hoc monetary objective function creates a bias in favor of inflation targeting. Instead, this paper uses the Pareto criterion to assess inflation targeting (IT), price-level targeting (PLT), and nominal-income targeting (NIT). The effect that unanticipated inflation or deflation benefits one party to a nominal contract while hurting the other party is an effect that cannot be captured in a model with a representative consumer or identical consumers. To capture this effect, this paper analyses models with diverse consumers in a pure-exchange economy without storage. When nominal aggregate demand (NAD) is stochastic but real aggregate supply (RAS) is not, PLT Pareto dominates IT. This is because IT perpetuates price errors and hence nominal aggregate demand errors, while PLT tries to return to the original targeted price path. By perpetuating these errors, IT perpetuates the welfare losses, whereas PLT corrects so to help reduce these welfare losses in the future. When RAS is also stochastic, nominal contracts under NIT can lead to Pareto efficiency when consumers have average relative risk aversion, non-stochastic endowment-to-RAS ratios, and no utility shocks. Under the same assumptions IT and PLT lead to Pareto inefficiencies because they force the payers of nominal contracts to guarantee the real value of those payments to the receivers. In essence this transfers RAS risk from the receivers of the nominal obligations to payers of the nominal obligations. However, this transfer of risk would only be appropriate if all payers of nominal obligations had below average relative risk aversion and all receivers had above average relative risk aversion, a situation that rarely will hold.
    Keywords: Pareto efficiency, inflation targeting, price-level targeting, nominal-income targeting, monetary objective function
    JEL: E
    Date: 2005–12–29
  39. By: Xavier Ragot
    Abstract: The article presents a new channel through which inflation affects real variables. In a simple liquidity constraint model where money enters the utility function of infinitely living households, it is proven that credit constraints create heterogeneity in money demand. Because of this, long run inflation affects the real interest rate and wealth inequalities even when there is no redistributive effect, no distorting fiscal policy, and no substitution between leisure and working time. This result is proven for a general class of utility and production functions. In a simple calibration exercise, an increase in inflation from 2% to 3% increases the capital stock by 0.12% and raises wealth inequality.
    Date: 2005
  40. By: Graham Bird (University of Surrey); Dane Rowlands (Carleton University)
    Abstract: Over the course of the 1990s economists appeared to favour exchange rate regimes that were either completely flexible or rigidly fixed through mechanisms such as currency boards. According to this "bipolar" view of exchange rates, intermediate regimes were deemed to be ineffective and prone to crisis. This paper examines the link between exchange rate regimes and International Monetary Fund (IMF) programme use and finds fairly strong evidence that countries with intermediate exchange rate regimes are less likely to go to the IMF than others. To the extent that International Monetary Fund (IMF) programmes are a proxy for balance of payments difficulties, this finding supports the more recent, nuanced, literature on exchange rate regime choice.
    JEL: F33
    Date: 2005–04
  41. By: Marta Gómez-Puig
    Abstract: With European Monetary Union (EMU), there was an increase in the adjusted spreads (corrected from the foreign exchange risk) of euro participating countries' sovereign securities over Germany and a decrease in those of non-euro countries. The objective of this paper is to study the reasons for this result, and in particular, whether the change in the price assigned by markets was due to domestic factors such as credit risk and/or market liquidity, or to international risk factors. The empirical evidence suggests that market size scale economies have increased since EMU for all European markets, so the effect of the various risk factors, even though it differs between euro and non-euro countries, is always dependent on the size of the market.
  42. By: Nicoletta Batini (International Monetary Fund); Alejandro Justiniano (International Monetary Fund); Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University)
    Abstract: This paper provides a first attempt to quantify and at the same time utilize estimated measures of uncertainty for the design of robust interest rate rules. We estimate several variants of a linearized form of a New Keynesian model using quarterly US data. Both our theoretical and numerical results indicate that Inflation-Forecast-Based (IFB) rules are increasingly prone to the problem of indeterminacy as the forward horizon increases. As a consequence the stabilization performance of optimized rules of this type worsens too. Robust IFB rules can be designed to avoid indeterminacy in an uncertain environment, but at an increasing utility loss as rules become more forward-looking.
    Keywords: robustness, Taylor rules, inflation-forecast-based rules, indeterminacy
    JEL: E52 E37 E58
    Date: 2004–09
  43. By: Caroline Schmidt (Swiss Institute for Business Cycle Research (KOF), Swiss Federal Institute of Technology Zurich (ETH))
    Abstract: How does an unexpected domestic monetary expansion a.ect the foreign economy? Does it induce an increase or a decline in foreign production? In the traditional two-country Mundell-Fleming model, monetary policy has «beggar-thy-neighbor» effects. Yet, empirical evidence from VARs indicates that U.S. monetary policy has positive international transmission effects on both foreign (non-U.S. G-7) output and aggregate demand. In this paper, I will show that a two-country dynamic general equilibrium model with sticky prices can account for these «stylized facts» if we allow for international asymmetries in the price-setting behavior of firms. If U.S. firms set export prices in their own currency only (producer-currency pricing), whereas producers in the rest of the world price their exports to the U.S. in the local currency of the export market (local-currency pricing), a U.S. monetary expansion is found to increase output and aggregate demand abroad.
    Keywords: Local-currency pricing, Producer-currency pricing, New Open Economy Macroeconomics, International transmission effects of monetary policy
    JEL: F41 E52
    Date: 2005–03
  44. By: Ariel Rubinstein; Rani Spiegler
    Date: 2005–12–31
  45. By: Aleksander Berentsen; Gabriele Camera; Christopher Waller
    Abstract: Recent monetary models with explicit microfoundations are made tractable by assuming that agents have access to centralized markets after one round of decentralized trade. Given quasi-linear preferences, this makes the distribution of money degenerate which keeps the models simple but precludes discussion of distributional effects of monetary policy. We generalize these models by assuming two rounds of trade before agents can readjust their money holdings to study a range of new distributional effects analytically. We show that unexpected, symmetric lump-sum money injections may increase short-run output and welfare, while asymmetric injections may increase long-run output and welfare.
    Keywords: distribution, no-neutrality, money balance
    JEL: A12
  46. By: Eiji Ogawa; Junko Shimizu
    Abstract: The monetary authorities in East Asian countries have been strengthening their regional monetary cooperation since the Asian Currency Crisis in 1997. In this paper, we propose a deviation measurement for coordinated exchange rate policies in East Asia to enhance the monetary authorities' surveillance process for their regional monetary cooperation. We calculate the AMU as a weighted average of East Asian currencies following the method used to calculate the European Currency Unit (ECU) and the AMU Deviation Indicators, which how the degree of deviation from the hypothetical benchmark rate for each of the East Asian currencies in terms of the AMU. Furthermore, we investigate the relationships between the AMU and its Deviation Indicators and the effective exchange rates of each East Asian currency. As a result, we found the strong relationships between the AMU or the AMU Deviation Indicators and the effective exchange rates except for some currencies. These results indicate that the AMU Deviation Indicators have positive relationship with their effective exchange rates. Accordingly, we should monitor both the AMU and the AMU Deviation Indicator for the monetary authorities' surveillance in order to stabilize effective exchange rate in terms of trader partners' currencies.
    Date: 2006–02
  47. By: Alessio Anzuini (Banca d'Italia); Aviram Levy (Banca d'Italia)
    Abstract: The paper analyses the financial structure of the private sector in the Czech Republic, Hungary and Poland and assesses its implications for the monetary transmission mechanism. The financial accounts of these countries provide a picture of a private sector which is predictably financially less mature than the EU average: the corporate sector relies significantly on non-market financial liabilities (such as trade credits and non-traded shares) and bears a substantial exchange rate risk; the household sector is less sophisticated both in terms of financial assets, whose composition is tilted towards bank deposits, and liabilities, the volume of which is still negligible. VAR system estimates conducted separately on each acceding country suggest that, despite the inferior financial development of these countries, the co-movement of macroeconomic variables conditional on a monetary policy shock is similar across countries and not dissimilar to what is found in the more advanced economies.
    Keywords: Financial structure, identified VAR, monetary policy shock, price puzzle.
    JEL: C30 E44 E52 F41
    Date: 2004–07
  48. By: Christopher Spencer (University of Surrey)
    Abstract: Building on Blinder and Wyplosz (2005) this paper presents a formal mechanism which potentially explains how autocratically collegiate, genuinely collegiate and individualistic monetary policy committees (MPCs) are able to reach a consensus. Drawing on the theory of Markov chains, I adopt a bounded-rational approach, and demonstrate how individuals are able to forge agreement, even when interest rate preferences are initially diverse. I show how consensus is reached when (i) career concerns are present and (ii) when members hold different opinions about the usefulness of others’ information. An overriding conclusion which emerges is that it is possible to populate MPCs with people who hold very different views about the economy and still reach an agreement. Further, although MPCs should be populated by people who are willing to listen to the opinions of others, the degree to which members are willing to listen to each other has ramifications for the type of decision which is reached.
    Keywords: Monetary Policy Committee, consensus formation, bounded-rationality
    Date: 2005–06
  49. By: Buiter, Willem H
    Abstract: This paper revisits the paper 'Excessive deficits: sense and nonsense in the Treaty of Maastricht', co-authored with Giancarlo Corsetti and Nouriel Roubini and published during 2003 in Economic Policy. The first section of the paper addresses the problem that the exchange rate and inflation criteria for EMU membership contained in the Treaty of Maastricht may well prevent two or more of the new EU members that now participate in ERM2 from becoming full EMU members as soon as they have spent the required two years in the ERM purgatory. This despite the fact that there are no fundamental economic obstacles to their successful participation in monetary union. I propose that, if an inflation convergence condition for EMU membership is deemed necessary, it be formulated in terms of the maximum permitted excess of a candidate country's inflation rate of traded goods prices over the average rate of price inflation of traded goods prices in the Eurozone. Revisiting the Excessive Deficit Procedure turns out to be attending a wake. The reforms of the Pact adopted in March 2005 effectively killed it. I argue that the death of this Pact is not a tragedy. While individual nation states are well-advised to adopt intelligent rules for their public debt and deficits to ensure fiscal-financial sustainability of the state and to enhance macroeconomic stability, the case for the supranational imposition, monitoring and enforcement of public debt and deficit rules is weak, except in one respect - one not addressed by the Pact. Effective demand spillovers in a world with nominal price and wage rigidities can lead to first-order welfare losses. The Pact, in its old or its new incarnation, does not address these issues as it prescribes or proscribes behaviour one country at a time, without reference to economic policy actions and other economic developments in the rest of the EMU or EU. The Pact is not designed to ensure coordinated fiscal policy in the E(M)U, let alone coordinated monetary and fiscal policy in the E(M)U. There is nothing in it that ensures that the E(M)U-wide fiscal stance and fiscal-monetary mix is appropriate given economic developments in the rest of the world and given the monetary-fiscal policy mix in the other key national and regional economies. From the perspective of the Principle of Subsidiarity, the Pact was therefore subject to both a Type 1 and a Type 2 error. It addressed (albeit ineffectively) matters of national fiscal sustainability and national macroeconomic stabilisation that ought to have been handled at the national level. It failed to address the appropriate Europe-wide fiscal stance and monetary-fiscal policy mix for which a supranational approach might have been desirable.
    Keywords: excessive deficit procedure; fiscal sustainability; macroeonomic stabilization; Stability and Growth Pact
    JEL: E52 E63 F33 F41 F42
    Date: 2005–12
  50. By: Jean-Pascal Bénassy
    Abstract: It has often been found difficult to generate a liquidity effect (i.e. a negative effect of monetary injections on the nominal interest rate) in the traditional "Ricardian" stochastic dynamic model with a single infinitely lived household. We show that moving to a non Ricardian environment where new agents enter the economy in each period allows to generate such a liquidity effect.
    Date: 2005
  51. By: Christoffer Kok Sorensen (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.); Thomas Werner (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: The present paper investigates the pass-through between market interest rates and bank interest rates in the euro area. Compared to the large interest rate pass-through literature the paper mainly improves upon two points. First, a novel data set, partially based on new harmonised ECB bank interest rate statistics is used. Moreover, the market rates are selected in a way to match the maturities of bank and market rates using information provided by the new statistics. Secondly, new panel-econometric methods are applied to test for heterogeneity in the pass-through process. The paper shows a large heterogeneity in the pass-through of market rates to bank rates between euro area countries and finally possible explanations of the heterogeneity are discussed.
    Keywords: Interest rate pass-through; euro area countries; panel cointegration
    JEL: E43 G21
    Date: 2006–01
  52. By: Jean-Pascal Bénassy; Michel Guillard
    Abstract: The Taylor principle is quite usually considered as a central condition for price determinacy. Recently, however, this has been questioned on several grounds, notably because (i) this condition is a condition for local determinacy, not global determinacy (ii) it has been derived in "Ricardian" economies, and it appears that going to a non-Ricardian framework makes a very big difference for the determinacy conditions. In this paper we scrutinize the two issues together, and we find that for non-Ricardian equilibria the Taylor principle is replaced by another "financial dominance" criterion.
    Date: 2005
  53. By: Buiter, Willem H; Sibert, Anne
    Abstract: Market interest rates on sovereign debt issued by the 12 Eurozone national governments differ very little from each other, despite the credit ratings of these governments ranging from triple A to single A, and despite significant differences among their objective indicators of fiscal-financial sustainability. We argue that this market failure is at least in part due to a policy failure: the operational practices of the European Central Bank and the rest of the Eurosystem in its collateralised open market operations convey the message that the Eurosystem views the debt of the 12 Eurozone sovereigns as equivalent. The euro-denominated debt instruments of all twelve Eurozone governments are deemed to be eligible for use as collateral in collateralised lending by the Eurosystem. They are in addition allocated to the same (highest) liquidity category (Tier One, Category 1) as the debt instruments of the Eurosystem itself and subject to the lowest 'valuation haircut' (discount on the market value). Haircuts also increase with the remaining time to maturity. This discourages the use as collateral of longer maturity debt which would be more likely to reveal differences in sovereign default risk. We propose that the size of the haircut on each debt instrument be related inversely to its credit rating. A further re-enforcement of the market’s ability to penalise and constrain unsustainable budgetary policies would be to declare the sovereign debt of nations that violate the conditions of the Stability and Growth Pact to be ineligible as collateral in Eurosystem Repos.
    Keywords: collateralised loans; Eurosystem; sovereign default risk
    JEL: E58 E63 G12
    Date: 2005–12
  54. By: Carsten Detken (European Central Bank); Vítor Gaspar (European Central Bank); Bernhard Winkler (European Central Bank)
    Abstract: We show how in a Blanchard-Yaari, overlapping generations framework, perfect substitutability of government bonds in Monetary Union tempts governments to exploit the enlarged common pool of savings. In Nash equilibrium all governments increase their bond financed transfers to current generations (prosperity effect) at the expense of future generations (posterity effect). The resulting deficit bias occurs even if one assumes that before Monetary Union countries had eliminated their deficit bias by designing appropriate domestic institutions. The paper provides a rationale for an increased focus on fiscal discipline in Monetary Union, without the need to assume imperfect credibility of existing Treaty provisions or to refer to extreme situations involving sovereign default. We draw on existing empirical evidence to argue that the degree of government bond substitutability within the European Monetary Union is an order of magnitude larger than in the global economy.
    Keywords: fiscal spillover effects, common pool, overlapping generations, bond market integration, fiscal discipline, fiscal rules, European Monetary Union
    JEL: D62 E61 E63
    Date: 2005–12
  55. By: Tuomas A. Peltonen (European Central Bank, Postfach 16 03 19, 60066 Frankfurt am Main, Germany)
    Abstract: This paper analyzes the predictability of emerging market currency crises by comparing the often used probit model to a new method, namely a multi-layer perceptron artificial neural network (ANN) model. According to the results, both models were able to signal currency crises reasonably well in-sample, but the forecasting power of these models out-ofsample was found to be rather poor. Only in the case of Russian (1998) crisis were both models able to signal the crisis well in advance. The results reinforced the view that developing a stable model that can predict or even explain currency crises is a challenging task.
    Keywords: Currency crises, emerging markets, artificial neural networks.
    JEL: F31 E44 C25 C23 C45
    Date: 2006–01

This nep-mon issue is ©2006 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.