nep-mon New Economics Papers
on Monetary Economics
Issue of 2006‒03‒11
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary Policy Transparency:Lessons from Germany and the Eurozone By Iris Biefang-Frisancho Mariscal; Peter Howells
  2. Revisiting the Delegation Problem in a Sticky Price and Wage Economy. By Gregory E. Givens
  3. A Microfoundation of Monetary Economics By Shouyong Shi
  4. "Monetary Policy Strategies of the European Central Bank and the Federal Reserve Bank of the U.S." By L. Randall Wray
  5. Are the Effects of Monetary Policy Asymmetric in Australia? By Phil Bodman
  6. Hot money inflows in China : How the people's bank of China took up the challenge. By Vincent Bouvatier
  7. "Are Long-run Price Stability and Short-run Output Stabilization All that Monetary Policy Can Aim For?" By Giuseppe Fontana; Alfonso Palacio-Vera
  8. Monetary Policy Regimes: a fragile consensus By Peter Howells; Iris Biefang-Frisancho Mariscal
  9. "Prolegomena to Realistic Monetary Macroeconomics: A Theory of Intelligible Sequences" By Wynne Godley; Marc Lavoie
  10. Can monetary policy be helped by domestic oil price stabilization?, By Eduardo Loyo; Luciano Vereda
  11. Testing for Rate-Dependence and Asymmetry in Inflation Uncertainty: Evidence from the G7 Economies By Sandy Suardi; O.T.Henry; N. Olekalns
  12. The Endogeneity of Money: Empirical Evidence By Peter Howells
  13. "Bad for Euroland, Worse for Germany: The ECB's Record" By Joerg Bibow
  14. Monetary and Fiscal Theories of the Price Level: The Irreconcilable Differences By Bennett T. McCallum; Edward Nelson
  15. "Speculation, Liquidity Preference, and Monetary Circulation" By Korkut A. Erturk
  16. Methodological Triangulation at the Bank of England:An Investigation By Paul Downward; Andrew Mearman
  17. How tight should one's hands be tied? Fear of floating and credibility of exchange regimes. By Jesús Rodríguez López; Hugo Rodríguez Mendizábal
  18. "Keynes's Approach To Money: An Assessment After 70 Years" By L. Randall Wray
  19. Welfare Improvement from Restricting the Liquidity of Nominal Bonds By Shouyong Shi
  20. Information in the Term Structure – The Indian Evidence (I): Modeling the Term Structure and Information at the Short End for Future Inflation By Virmani Vineet
  21. "Micro-aspects of Monetary Policy in Pre-war Japan: Lender of Last Resort and Selection of Banks" By Tetsuji Okazaki

  1. By: Iris Biefang-Frisancho Mariscal (School of Economics, University of the West of England); Peter Howells (School of Economics, University of the West of England)
    Abstract: The conduct of monetary policy emphasises institutional arrangements which make monetary policy decision-making more ‘transparent’. Judged by these institutional features neither the Bundesbank, nor the ECB, score very highly. We test for (i) agents’ average ability to anticipate policy rate changes under the Bundesbank and the ECB and (ii) and agents’ forecasting unanimity of money market rates. Rising forecasting uncertainty may either be due to a lack of ECB transparency or to larger inflation and growth forecasting errors. Our results indicate that inflation forecast spreads widened amongst private agents and that inflation forecasting uncertainty increased the forecasting spread of money market rates
    Keywords: transparency, yield curve, forecasting uncertainty, Bundesbank, ECB
    JEL: E58
    Date: 2004–12
  2. By: Gregory E. Givens
    Abstract: In a stylized economy with price and wage stickiness, this paper argues that delegating a nominal wage target to a central bank operating under discretion generally delivers better social outcomes than delegating price level or inflation targets. Although both policies impart inertia into central bank actions, wage targeting dominates price level targeting because the former delivers a more favorable tradeoff between the stabilization goals appearing in the social welfare function, namely, price inflation, wage inflation, and the output gap. Delegation of a dual policy featuring both price level and nominal wage targets, however, nearly replicates the efficient outcome accompanying the precommitment policy from a timeless perspective.
    Keywords: Price Level Targeting, Wage Targeting, Delegation, Timeless Perspective
    JEL: E42 E50 E52 E58
    Date: 2006–02
  3. By: Shouyong Shi
    Abstract: In this lecture, I explain what the microfoundations of money are about and why they are necessary for monetary economics. Then, I review recent developments of a particular microfoundation of money, commonly known as the search theory of money. Finally, I outline some unresolved issues.
    JEL: E40 E50 E31
  4. By: L. Randall Wray
    Abstract: In the debate on monetary policy strategies on both sides of the Atlantic, it is now almost a commonplace to contrast the Fed and the ECB by pointing out the formerÕs flexibility and capacity to adjust rigidity, and the latterÕs extreme caution, and obsession with low inflation. In looking at the foundations of the two banksÕ strategies, however, we do not find differences that can provide a simple explanation for their divergent behavior, nor for the very different economic performance in the U.S. and Euroland in recent years. Not surprisingly, both central banks share the same conviction that money is neutral in the long period, and even their short-term policies are based on similar fundamental principles. The two policy approaches really differ only in terms of implementation, timing, competence, etc., but not in terms of the underlying theoretical orientation. We then draw the conclusion that monetary policy cannot represent a significant variable in the explanation of the different economic performances of Euroland and U.S. The two economic areasÕ differences must be explained by considering other factors among which the most important is fiscal policy.
    Date: 2005–11
  5. By: Phil Bodman (MRG - School of Economics, The University of Queensland)
    Abstract: This paper examines whether monetary policy shocks have asymmetric effects on output in Australia. Using methods similar to Cover (1992) together with some other simple threshold models, evidence is found of certain types of asymmetries when comparing monetary contractions to monetary policy expansions. Unanticipated decreases in interest rates appear to significantly raise GDP growth rates, whilst unexpected increases in rates do not appear to significantly lower growth. These findings are also found in a brief examination of the investment and consumption channels within the monetary policy transmission process. Economic growth is also significantly higher in a low interest rate regime (when interest rates are below a certain threshold, such as the sample average or average over some longer time period) than in a high interest rate environment. These results appear to refute the idea that monetary policy is like `pushing on a string', at least for Australian data over the period 1973:1-2005:1.
  6. By: Vincent Bouvatier (CES-TEAM)
    Abstract: This paper investigates hot money inflows in China. The financial liberalization comes into effect and the effectiveness of capital controls tends to diminish over time. As a result, China is fuelled by hot money inflows. The US interest rate cut since 2001 and expectations of exchange rate adjustments are the main factors explaining these capital inflows. This study use the Bernanke and Blinder (1988) model extended to an open economy to examine implications of hot money inflows for the Chinese economy. A Vector Error Correction Model (VECM) on monthly data from March 1995 to March 2005 is estimated to investigate the recent upsurge in foreign reserves and shows that the interaction between domestic credit and foreign reserves was stable and consistent with monetary stability. Granger causality tests are implemented to show how the People's Bank of China (PBC) achieved this result.
    Keywords: Hot money inflows, domestic credit, VECM, Granger causality.
    JEL: C32 E5 F32 F33
    Date: 2006–02
  7. By: Giuseppe Fontana; Alfonso Palacio-Vera
    Abstract: A central tenet of the so-called new consensus view in macroeconomics is that there is no long-run trade-off between inflation and unemployment. The main policy implication of this principle is that all monetary policy can aim for is (modest) short-run output stabilization and long-run price stabilityÑi.e., monetary policy is neutral with respect to output and employment in the long run. However, research on the different sources of path dependency in the economy suggests that persistent but nevertheless transitory changes in aggregate demand may have a permanent effect on output and employment. If this is the case, then, the way monetary policy is run does have long-run effects on real variables. This paper provides an overview of this research and explores how monetary policy should be implemented once these long-run effects are acknowledged.
    Date: 2005–11
  8. By: Peter Howells (School of Economics, University of the West of England); Iris Biefang-Frisancho Mariscal (School of Economics, University of the West of England)
    Abstract: The last fifteen years have seen the emergence of widespread consensus that optimum monetary policy is designed on the basis of three pillars: a short-term official rate of interest as the sole policy instrument and the placing of that instrument in the hands of a central bank which is (a) independent of government and (b) transparent in its decision-making. We take a critical look at each of these. In the first case, we focus attention on the failure of mainstream economics to recognise the choice of instrument and the implications of its adoption. In the case of independence we argue that he theoretical case for independence has been misunderstood and that it is not an essential requirement for successful policy. We also show that ‘independence’ is not best measured against a checklist of statutory characteristics. As regards ‘transparency’ our argument is slightly different, though we come to a similar conclusion. Unlike independence, ‘transparency’ does address a real problem for central banks. However, the evidence suggests that transparency is not the only, or even the best, solution. A variety of evidence tells us that agents can understand and anticipate the actions of the most secretive institutions.
    Keywords: Monetary policy; central banks; independence; transparency
    JEL: E31 E42
    Date: 2005–12
  9. By: Wynne Godley; Marc Lavoie
    Abstract: This paper sets out a rigorous basis for the integration of Keynes-Kaleckian macroeconomics (with constant or increasing returns to labor, multipliers, mark-up pricing, etc.) with a model of the financial system (comprising banks, loans, credit money, equities, etc.), together with a model of inflation. Central contentions of the paper are that, with trivial exceptions, there are no equilibria outside financial markets, and the role of prices is to distribute the national income, with inflation sometimes playing a key role in determining the outcome. The model deployed here describes a growing economy that does not spontaneously find a steady state even in the long run, but which requires active management of fiscal and monetary policy if full employment without inflation is to be achieved. The paper outlines a radical alternative to the standard narrative method used by post-Keynesians as well as by Keynes himself.
    Date: 2006–02
  10. By: Eduardo Loyo (Department of Economics PUC-Rio); Luciano Vereda (Department of Economics PUC-Rio)
    Date: 2005–05
  11. By: Sandy Suardi (MRG - School of Economics, The University of Queensland); O.T.Henry; N. Olekalns
    Abstract: The Friedman-Ball hypothesis implies a link between the inflation rate and inflation uncertainty. In this paper we employ a new test for the joint null hypothesis of no dependence effects and no asymmetry in the G7 inflation volatility. The results show that higher inflation rates operate additively via the conditional variance of inflation to induce greater inflation uncertainty in the U.S., U.K. and Canada. In addition, positive inflationary shocks are found to generate greater inflation uncertainty than negative shocks of a similar magnitude in the U.K. and Canada.
  12. By: Peter Howells (School of Economics, University of the West of England)
    Abstract: For many years, the endogenous nature of the money supply has been a cornerstone of post-Keynesian economics. In this paper we survey the empirical work which has been done on both the ‘core’ thesis – that loans create deposits – and on peripheral questions such as the origin of the demand for loans, the reconciliation of the demand for money with the loan-created supply and the accommodationist/structuralist debate. The originality of the paper lies in its demonstration that while post-Keynesians may have thought they were fighting in heroic isolation, most economists involved with the real world of monetary policy-making in practice took much the same view. The consequence is that we can find empirical investigations of issues relating to the endogeneity in a wide range of locations.
    Keywords: Money; endogeneity;
    JEL: E50
    Date: 2005
  13. By: Joerg Bibow
    Abstract: This paper assesses the contribution of the European Central Bank (ECB) to GermanyÕs ongoing economic crisis, a vicious circle of decline in which the country has become stuck since the early 1990s. It is argued that the ECB continues the Bundesbank tradition of asymmetric policymaking: the bank is quick to hike, but slow to ease. It thereby acts as a brake on growth. This approach has worked for the Bundesbank in the past because other banks behaved differently. Exporting the Bundesbank Òsuccess storyÓ to Euroland has undermined its working, however; given its sheer size, Euroland simply cannot freeload on external stimuli forever. While Euroland cannot do without proper demand management, the Maastricht regime and especially the ECB are firmly geared against it. The ECBÕs monetary policies have been biased against growth and have thus proved bad for Euroland as a whole. Meanwhile, the German disease of protracted domestic demand weakness has spread across much of Euroland. Yet, by pursuing its peculiar traditions of wage restraint and procyclical public thrift, the ECBÕs policies have had even worse results for Germany. Fragility and divergence undermine the euroÕs long-term survival.
    Date: 2005–11
  14. By: Bennett T. McCallum; Edward Nelson
    Abstract: The fiscal theory of the price level (FTPL) has attracted much attention but disagreement remains concerning its defining characteristics. Some writers have emphasized implications regarding interest-rate pegging and determinacy of RE solutions, whereas others have stressed its capacity to generate equilibria in which price level trajectories mimic those of bonds and differ drastically from those of money supplies. We argue that the FTPL attained prominence precisely because it appeared to provide a theory whose implications differ greatly from conventional monetary analysis; accordingly we review monetarist writings to identify the primary distinctions. In addition, we review recent findings concerning learnability – and therefore plausibility – of competing RE equilibria. These indicate that when FTPL and monetarist equilibria differ, the latter are more plausible in the vast majority of cases. Under Ricardian assumptions, necessary for clear distinctions, theoretical analysis indicates that fiscal and monetary coordination is not necessary for macroeconomic stability.
    JEL: E5 E6 D8
    Date: 2006–03
  15. By: Korkut A. Erturk
    Abstract: The sharp exchanges that Keynes had with some of his critics on the loanable funds theory made it harder to appreciate the degree to which his thought was continuous with the tradition of monetary analysis that emanates from Wicksell, of which KeynesÕs A Treatise on Money was a part. In the aftermath of the General Theory (GT), many of KeynesÕs insights in the Treatise were lost or abandoned because they no longer fit easily in the truncated theoretical structure he adopted in his latter work. A part of KeynesÕs analysis in the Treatise which emphasized the importance of financial conditions and asset prices in determining firmsÕ investment decisions was later revived by Minsky, but another part, about the way self-sustained biases in asset price expectations in financial markets exerted their influence over the business cycle, was mainly forgotten. This paper highlights KeynesÕs early insights on asset price speculation and its link to monetary circulation, at the risk perhaps, of downplaying the importance of the GT.
    Date: 2006–01
  16. By: Paul Downward (Augusta State University); Andrew Mearman (School of Economics, University of the West of England)
    Abstract: This paper investigates the extent to which triangulation takes place within the Monetary Policy Committee (MPC) process at the Bank of England. Triangulation is at its most basic, the mixing of two or more methods, investigators, theories, methodologies or data in a single investigation. More specifically, we argue for triangulation as a commitment in research design to the mixing of methods in the act of inference. The paper argues that there are many motivations for triangulation as well as types of triangulation. It is argued that there is evidence of extensive triangulation of different types within the MPC process. However, there is very little theoretical triangulation present; raising concerns about pluralism. Also, it is argued that the triangulation which occurs is mainly undertaken for pragmatic reasons and does not reflect other, coherent ontological and epistemological positions.
    Date: 2005–08
  17. By: Jesús Rodríguez López (Department of Economics, Universidad Pablo de Olavide); Hugo Rodríguez Mendizábal (Department of Economics, Universidad Autónoma de Barcelona)
    Abstract: The literature on exchange regimes has recently observed that officially self-declared free floaters strongly intervene their nominal exchange rates to maintain them within some unannounced bands. In this paper, we provide an explanation for this behavior, labeled by Calvo and Reinhart (2002) as fear of floating. First, we analyze the linkages between the credibility of the exchange regime, the volatility of the exchange rate and the band width of fluctuation. Second, the model is used to understand the reduction in volatility experienced by most ERM countries after their target zones were widened on August 1993. Finally, solving the model for a subgame perfect equilibrium, fear of floating can be viewed as the credible choice of a finite non-zero band
    Keywords: Fear of floating, target zones, exchange rate arrangements, credibility
    JEL: E52 E58 F31 F33
    Date: 2006–03
  18. By: L. Randall Wray
    Abstract: This paper first examines two approaches to money adopted by Keynes in the General Theory (GT). The first is the more familiar Òsupply and demandÓ equilibrium approach of Chapter 13 incorporated within conventional macroeconomics textbooks. Indeed, even Post Keynesians utilizing KeynesÕs Òfinance motiveÓ or the ÒhorizontalÓ money supply curve adopt similar methodology. The second approach of the GT is presented in Chapter 17, where Keynes drops Òmoney supply and demandÓ in favor of a liquidity preference approach to asset prices that offers a more satisfactory treatment of moneyÕs role in constraining effective demand. In the penultimate section, I return to KeynesÕs earlier work in the Treatise on Money (TOM), as well as the early drafts of the GT, to obtain a better understanding of the nature of money. I conclude with policy implications.
    Date: 2006–01
  19. By: Shouyong Shi
    Abstract: In this paper I examine whether a society can improve welfare by imposing a legal restriction to forbid the use of nominal bonds as a means of payments for goods. To do so, I integrate a microfounded model of money with the framework of limited participation. While the asset market is Walrasian, the goods market is decentralized and the legal restriction is imposed only in a fraction of the trades. I show that the legal restriction can improve the society's welfare. In contrast to the literature, this essential role of the legal restriction persists even in the steady state and it does not rely on households' ability to trade unmatured bonds for money after observing the taste (or endowment) shocks.
    JEL: E40
  20. By: Virmani Vineet
    Abstract: This study is part of an on-going work on assessing the information content of the term structure in India for future inflation, future short rates and real interest rates. In this part, first the Indian term structure is modeled using three alternative specifications and changes in slope of the term structure at the short-end assessed for forecastability of inflation. Performance of two atheoretical (Nelson and Siegel, 1987 and Svensson, 1994) models is compared against empirical implications of a general equilibrium (Cox, Ingersoll and Ross, 1985) model. While Svensson is seen to offer no improvement over Nelson-Siegel, Cox-Ingersoll-Ross comes out as marginally superior to both on the criteria of mean absolute pricing and yield errors (both in-sample and out-of-sample), behaviour of the short and the long rates, stability of the parameters and behaviour of forward rates for maturities 1-8 years. This is encouraging because models like Nelson-Siegel and Svensson are designed to fit the observed yield curves, while Cox-Ingersoll-Ross is a theoretical model derived from intertemporal description of a competitive economy. On the information content of the term structure, in the sample under study, change in the slope of the term structure seems to have no information for inflation changes over the horizon 1 month to 2 years. Results could be sample and/or sampling-frequency specific. Results for the long end of the term structure (from a bigger sample) follows.
    Date: 2006–03–02
  21. By: Tetsuji Okazaki (Faculty of Economics, University of Tokyo)
    Abstract: The central bank as the Lender of Last Resort (LLR) is faced with a trade off between the stability of the financial system and the "moral hazard" of banks. In this paper we explore how this trade off was dealt with by the Bank of Japan (BOJ) in the pre-war period, and how LLR lending by the BOJ affected the financial system. In particular, this paper focuses on the following two stylized facts of Japanese financial history. First, the BOJ actively intervened in the market as the LLR under the unstable financial system in the 1920s. Second, in this period, the financial market worked well to sort out inefficient banks through failures. In providing an LLR loan, the BOJ adopted the policy of favoring those banks that had an already established transaction relationship with the BOJ. At the same time, the BOJ was selective about which banks it would enter into a transaction relationship with. That is, the BOJ chose the banks it would conduct transactions with based on criteria that included profitability, liquidity, quality of assets, and the personal assets of directors. Furthermore, the BOJ did not hesitate to suspend transaction relationships with those banks whose performance declined. This policy enabled the BOJ to act as the LLR without impairing the function of the market to sort out inefficient banks. Whereas the transaction relationship with the BOJ affected a bank's survivability, the effect was not across the board. That is, the transaction relationship did not increase the survivability of a bank directly, but it increased the influence of profitability and liquidity on survivability, especially in a period of financial crisis. This implies that the BOJ bailed out only those transaction counterparts that were profitable and prudent when the financial system was especially unstable. It is suggested that through concentrating LLR lending on its transaction counterparts, the BOJ could successfully bail out only those banks which were illiquid but solvent, and thereby avoided the moral hazard that the LLR policy might otherwise have incurred.
    Date: 2006–01

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