nep-mon New Economics Papers
on Monetary Economics
Issue of 2006‒03‒25
eighteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Maximising Seigniorage and Inflation Tax: The Case of Belarus By D r. (elect.) Julia Korosteleva
  2. Estonia’s Accession to the EMU By Mart Sõrg
  3. Wage Indexation, Inflation Inertia, and the Cost of Disinflation - New version By Javier Gómez
  4. Consistent Targets and Optimal Monetary Policy: A Note By Stephen M. Miller; Huiping Yuan
  5. Output and Inflation in Models of the Business Cycle with Nominal Rigidities: Some Counterfactual Evidence By Páez-Farrell, Juan
  6. The Dynamic (In)efficiency of Monetary Policy by Committee By RIBONI, Alessandro; RUGE-MURCIA, Francisco
  7. The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy By Huiping Yuan; Stephen M. Miller
  8. Monetary Policy and Financial Sector Reform For Employment Creation and Poverty Reduction in Ghana By Gerald Epstein; James Heintz
  9. Investigating M3 Money Demand in the Euro Area : New Evidence Based on Standard Models By Christian Dreger; Jürgen Wolters
  10. Rational inattention, inflation developments and perceptions after the euro cash changeover By Michael Ehrmann
  11. Sunspots and Monetary Policy By Jagjit S. Chadha; Luisa Corrado
  12. Measuring the Impact of Intervention on Exchange Market Pressure By Pierre L. Siklos; Diana N. Weymark
  13. The Making of Optimal and Consistent Policy: An Analytical Framework for Monetary Models By Huiping Yuan; Stephen M. Miller; Langnan Chen
  14. Macroeconomic Instability in the European Monetary System? By Amalia Morales Zumaquero; Simón Sosvilla Rivero
  15. Determinants of business cycle synchronisation across euro area countries By Uwe Böwer; Catherine Guillemineau
  16. Forecasting inflation with an uncertain output gap By Hilde C. Bjørnland; Leif Brubakk; Anne Sofie Jore
  17. Does Monetary Policy Help Least Those Who Need It Most? By Michael S. Hanson; Erik Hurst; Ki Young Park
  18. Non-linear dynamics in the euro area demand for M1 By Alessandro Calza; Andrea Zaghini

  1. By: D r. (elect.) Julia Korosteleva
    Abstract: While most Central European countries, realising the inflationary potential of money creation, had by the mid-1990s switched to market instruments based monetary policy, Belarus continued to use money emission, so gaining seigniorage and inflation tax. The productivity of the inflation tax can be analysed by comparing the revenue actually raised from inflation tax with the revenue that could be raised if the quantity of money had risen at a constant rate. The present paper, based on Cagan’s (1956) seminal work ‘Monetary Dynamics of Hyperinflation’, analyses the effect of inflation on seigniorage revenue in Belarus and draws conclusions about the effectiveness of monetary policy in 1995-2002, and about the consequences of inflationary financing.
    JEL: C12 C22 E42 E52 G28
  2. By: Mart Sõrg (Institute of Finance and Accounting, University of Tartu)
    Abstract: CEE countries have passed the process of transition to market economy and eight of them, including Estonia, joined the European Union in 2004. Estonia has been very successful in the transition process, mainly owing to the currency board-based monetary system, which serves as a signal of commitment to prudent monetary policy and as a guarantee of sound money during the transition period. The current paper discusses the thirteen years of experience in operating the currency board-based monetary system in Estonia. Estonia’s accession to the European Union will soon be accompanied by membership of the Economic and Monetary Union (EMU). Here it is also explained why Estonia wants to join the EMU as fast as possible and what the prospects are to do it on time, at the beginning of 2007.
    Keywords: monetary systems, monetary policy, Economic and Monetary Union
    JEL: E42 E5 F33
    Date: 2005
  3. By: Javier Gómez
    Abstract: A Statement of the Colombian Consitutional Court has mandated wage indexation on the basis of past inflation. A simple model with a wage price system, a real block, and an inflation targeting interest rule is calibrated to resemble price setting in the colombian economy and to analize the differing slope of the output inflation trade off for diferent specifications of wage indexation. The disinflation experiments show that backward looking indexation increases inflation inertia, decreases the effect of monetary policy, and increases the cost of disinflation. Shorter wage contracts and more frequent wage negotiations do not appear to have important effects on the cost of disinflation. Higher central bank credibility and the use of forward looking inflation expectations in wage negotiations decrease the cost of disinflation and may eventually lead to a boom.
    JEL: E1 E17 E52 E27 J30
  4. By: Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas); Huiping Yuan (Xiamen University)
    Abstract: Kydland and Prescott (1977) develop a simple model of monetary policy making, where the central bank needs some commitment technique to achieve optimal monetary policy over time. Although not their main focus, they illustrate the difference between consistent and optimal policy in a sequential-decision one-period world. We employ the analytical method developed in Yuan and Miller (2005), whereby the government appoints a central bank with consistent targets or delegates consistent targets to the central bank. Thus, the central bank s welfare function differs from the social welfare function, which cause consistent policy to prove optimal.
    JEL: E42 E52 E58
    Date: 2005–12
  5. By: Páez-Farrell, Juan (Cardiff Business School)
    Abstract: This paper examines the relationship between cyclical output and inflation in models commonly used for monetary policy analysis. This includes models that incorporate the New Keynesian, Fuhrer-Moore and backward-looking Phillips curves. The main finding is that these models imply a strong negative relationship between inflation and output, a result that is at odds with the data. The fact that New Keynesian models yield counterfactual implications is not new; the novelty of the paper lies in the fact that the finding extends to the other variants, such as the backward-looking Phillips Curve, which has been put forward as displaying superior dynamics.
    Keywords: nominal rigidities; monetary policy; Phillips Curve; Output; Inflation; Correlation
    JEL: E20 E31 E32 E52 E61
    Date: 2006–03
  6. By: RIBONI, Alessandro; RUGE-MURCIA, Francisco
    Abstract: This paper develops a model where the value of the monetary policy instrument is selected by a heterogenous committee engaged in a dynamic voting game. Committee members differ in their institutional power and, in certain states of nature, they also differ in their preferred instrument value. Preference heterogeneity and concern for the future interact to generate decisions that are dynamically ineffcient and inertial around the previously-agreed instrument value. This model endogenously generates autocorrelation in the policy variable and provides an explanation for the empirical observation that the nominal interest rate under the central bank’s control is infrequently adjusted.
    Keywords: Committees, status-quo bias, interest-rate smoothing, dynamic voting
    JEL: E58
    Date: 2006
  7. By: Huiping Yuan (Xiamen University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the social loss function cannot serve as a direct loss function for the central bank. Accordingly, we employ implementation theory to design a central bank loss function (mechanism design) with consistent targets, while the social loss function serves as a social welfare criterion. That is, with the correct mechanism design for the central bank loss function, optimal policy and consistent policy become identical. In other words, optimal policy proves implementable (consistent).
    JEL: E42 E52 E58
    Date: 2006–02
  8. By: Gerald Epstein; James Heintz
    Abstract: This report summarizes the findings of a UNDP-sponsored study on the structure of the financial sector, central bank policy, and employment outcomes in Ghana. The financial sector is the primary conduit through which monetary policy affects real economic outcomes, and monetary policy determines the resources available to financial institutions. Therefore, monetary policy must be coordinated with financial sector reforms in order to improve employment opportunities, reduce poverty and support human development. The report develops a critique of financial programming and inflation targeting, presents a series of empirical estimates on the impact of monetary policy variables in Ghana, and describes the elements of an alternative monetary policy. In addition, the report documents the institutional and structural constraints currently operating in the financial system which prevent the sector from facilitating investment, growth, and improved employment opportunities. Econometric estimates of the determinants of investment explicitly link financial variables to real economic activity. The report summarizes a series of financial sector reforms that would improve the financial sector's capacity to move Ghana onto an employment-intensive growth path.
    Keywords: Monetary policy, financial programming, inflation-targeting, financial reform, Ghana, employment
    JEL: E22 E24 E52 E58 O11
    Date: 2006
  9. By: Christian Dreger; Jürgen Wolters
  10. By: Michael Ehrmann (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: This paper uses the euro cash changeover to test theories of finite informationprocessing capacities on the side of consumers. It argues that the denomination of prices in a new currency has increased the information-processing requirements for consumers by more than for sellers, a wedge that can lead to price increases. The size of the wedge should depend on the complexity of the currency conversion rates. In line with this theory, the paper finds that the evolution of prices for food products around the cash changeover varied across countries, depending on the complexity of conversion rates. These changeover effects are found in particular for goods with prices below one euro sold in mid-priced stores. The paper also finds that cross-country differences in the mismatch of perceived and actual inflation in the aftermath of the cash changeover are linked to differences in the complexity of conversion rates.
    Keywords: rational inattention; perceived inflation; euro cash changeover
    JEL: D84 E31 E58 L11
    Date: 2006–02
  11. By: Jagjit S. Chadha; Luisa Corrado
    Abstract: A monetary economy subject to expectational sunspots is prone to instability, in the sense of multiple rational expectations equilibria. We show how to modify the policy rule to guarantee stability in the presence of expectational sunspots. The policy-maker must co-ordinate inflation dynamics by targeting each of lagged, current and expected inflation. We show that this solution maps directly into the timeless perspective by Woodford. Finally, we trace the responses in an artificial sunspot economy to the adoption of our rule and illustrate the extent to which macroeconomic persistence is reduced.
    Keywords: Sunspots; Indeterminacy; Monetary Policy Rules; Expectation Based Timeless Perspective.
    JEL: C63 C62 E00
    Date: 2006–01
  12. By: Pierre L. Siklos (Department of Economics and Viessmann Research Centre, Wilfrid Laurier University); Diana N. Weymark (Department of Economics, Vanderbilt University)
    Abstract: In this article, we introduce an index of ex ante exchange market pressure (EMP) that can be used as a benchmark against which to measure the effectiveness of sterilized intervention. Ex ante EMP is the change in the exchange rate that would have been observed if the policy authority had refrained from intervening and this policy decision had been correctly anticipated by rational agents. Ex post EMP measures the exchange market pressure under the policy actually implemented by the policy authority. We use a ratio of these two EMP measures to assess the effectiveness of sterilized intervention in Canada and Australia.
    Keywords: Exchange market pressure, exchange rate policy, foreign exchange intervention, Bank of Canada policy, Reserve Bank of Australia policy
    JEL: F31
    Date: 2006–03
  13. By: Huiping Yuan (Xiamen University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas); Langnan Chen (Sun Yat-sen University)
    Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the central bank should adopt a loss function that differs from the social loss function. Carefully designing the central bank s loss function with consistent targets can harmonize optimal and consistent policy. This desirable result emerges from two observations. First, the social loss function reflects a normative process that does not necessarily prove consistent with the structure of the microeconomy. Thus, the social loss function cannot serve as a direct loss function for the central bank. Second, an optimal loss function for the central bank must depend on the structure of that microeconomy. In addition, this paper shows that control theory provides a benchmark for institution design in a game-theoretical framework.
    JEL: E42 E52 E58
    Date: 2006–02
  14. By: Amalia Morales Zumaquero (Universidad de Málaga); Simón Sosvilla Rivero (FEDEA, UCM)
    Abstract: This paper analyses the impact of the establishment of the European Monetary System (EMS) on a number of macroeconomic variables, such as exchange rates, money, interest rates and prices for member countries participating in the Exchange Rate Mechanism (ERM). We examine the instability in terms of multiple structural breaks in the variance of the series. To that end, we employ two procedures: the OLS-based tests to detect multiple structural breaks, proposed by Bai and Perron (1998, 2003) and several procedures based on Information Criterion joint with the so called sequential procedure suggested by Bai and Perron (2003). Results indicate that there is some evidence of structural breaks in volatility across investigated variables, playing the realignments in the ERM a significant role in the reduction of volatility in some countries and sub-periods. In this sense, the results tend to support the hypothesis that the EMS has contributed to reduce the macroeconomic volatility of the member countries.
    Keywords: European Monetary System, multiple structural breaks, volatility
    JEL: C12 C22 F31 F33
    Date: 2006
  15. By: Uwe Böwer (University of Munich, Munich Graduate School of Economics, Kaulbachstr. 45, 80539 Munich, Germany.); Catherine Guillemineau (The Conference Board, 845 Third Avenue, New York, NY 10022-6679, USA)
    Abstract: We investigate the key factors underlying business cycle synchronisation in the euro area applying the extreme-bounds analysis. We examine both traditional determinants and new, EMU-specific policy and structural indicators over the past 25 years. Our evidence seems to support the endogeneity hypothesis of the optimum currency area criteria. The implementation of the single market intensified bilateral trade across euro area countries and contributed to higher business cycle symmetry. The introduction of the single currency led to an intensification of intra-industry trade which has become the main driving force ensuring the coherence of business cycles. In addition, the set of robust determinants of business cycle synchronisation has varied over time, depending on the difference phases of the European construction, with fiscal policy, in addition to industrial and financial structures, playing a greater role during the completion of the Single Market, while short-term interest rate differentials and cyclical services have become more determinant since Economic and Monetary Union.
    Keywords: business cycle synchronisation; extreme-bounds analysis; Economic and Monetary Union; trade.
    JEL: C21 E32 F15
    Date: 2006–02
  16. By: Hilde C. Bjørnland (University of Oslo and Norges Bank (Central Bank of Norway)); Leif Brubakk (Norges Bank (Central Bank of Norway)); Anne Sofie Jore (Norges Bank (Central Bank of Norway))
    Abstract: The output gap (measuring the deviation of output from its potential) is a crucial concept in the monetary policy framework, indicating demand pressure that generates inflation. The output gap is also an important variable in itself, as a measure of economic fluctuations. However, its definition and estimation raise a number of theoretical and empirical questions. This paper evaluates a series of univariate and multivariate methods for extracting the output gap, and compares their value added in predicting inflation. The multivariate measures of the output gap have by far the best predictive power. This is in particular interesting, as they use information from data that are not revised in real time. We therefore compare the predictive power of alternative indicators that are less revised in real time, such as the unemployment rate and other business cycle indicators. Some of the alternative indicators do as well, or better, than the multivariate output gaps in predicting inflation. As uncertainties are particularly pronounced at the end of the calculation periods, assessment of pressures in the economy based on the uncertain output gap could benefit from being supplemented with alternative indicators that are less revised in real time.
    Keywords: Output gap, real time indicators, forecasting, Phillips curve
    JEL: C32 E31 E32 E37
    Date: 2006–03–17
  17. By: Michael S. Hanson (Economics Department, Wesleyan University); Erik Hurst (University of Chicago GSB, and NBER); Ki Young Park (University of Chicago)
    Abstract: We estimate the impact of U.S. monetary policy on the cross-sectional distribution of state economic activity for a 35-year panel. Our results indicate that the effects of policy have a significant history dependence, in that relatively slow growth regions contract more following contractionarymonetary shocks. Moreover, policy is asymmetric, in that expansionary shocks have less of a beneficial impact upon relatively slow growth areas. As a result, we conclude that monetary policy on average widens the dispersion of growth rates among U.S. states, and those locations initially at the low end of the cross-sectional distribution benefit least from any given change inmonetary policy.
    Keywords: Monetary policy, asymmetric effects, state dependence, regional business cycles
    JEL: E32 E59 R10
    Date: 2006–01
  18. By: Alessandro Calza (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.); Andrea Zaghini (Banca d’Italia, Servizio Studi, Via Nazionale 91, 00184 Rome, Italy.)
    Abstract: This paper investigates possible non-linearities in the dynamics of the euro area demand for the narrow aggregate M1. A long-run money demand relationship is firstly estimated over a sample period covering the last three decades. While the parameters of the relationship are jointly stable, there are indications of non-linearity in the residuals of the error-correction model. This non-linearity is explicitly modelled using a fairly general Markov switch- ing error-correction model with satisfactory results. The empirical findings of the paper are consistent with theoretical predictions stemming from "buffer stock" and "target-threshold" models and with analogous empirical evidence for European countries and the US.
    Keywords: Euro area; cointegration; non-linear error correction; demand for money.
    JEL: E41 C22
    Date: 2006–02

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