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on Monetary Economics |
| By: | Iris Biefang-Frisancho Mariscal; Peter Howells (School of Economics, University of the West of England) |
| Abstract: | There is a widespread belief that the transparency of UK monetary policy has increased substantially as a result of the introduction of inflation targeting in 1992 and a number of procedural and institutional reforms which accompanied and followed it. In this paper, we use money market responses (and other data) to test the possibility that improved anticipation of policy moves may be the result of developments other than the institutional reforms popularly cited. We find overwhelming evidence that the switch to inflation targeting itself significantly reduced monetary policy surprises, while subsequent reforms have contributed little. Where we advance substantially on earlier work is to look at the cross-sectional dispersion of agents’ anticipation. If the benefit of transparency is the elimination of policy surprise, there is little benefit if the averagely correct anticipations of agents conceal a wide dispersion of view. The most striking feature is the general decline in cross-sectional one year-ahead forecast uncertainty of the interbank rate. So, even though we do not find that agents on average have improved monetary policy anticipation since 1997, we do find that they have become more unanimous about forecasting future money market rates. However, further testing reveals that it is a simultaneous fall in the dispersion of inflation rate forecasts that explains the increased consensus on interest rates, rather than institutional reforms in 1997 and later. |
| Keywords: | Monetary Policy; transparency; independence; inflation targeting |
| JEL: | E58 |
| Date: | 2006–01 |
| URL: | http://d.repec.org/n?u=RePEc:uwe:wpaper:0601&r=mon |
| By: | Ivo J. M. Arnold; Jan J.G. Lemmen |
| Abstract: | This paper uses the European Commission’s Consumer Survey to assess whether inflation expectations have converged and whether inflation uncertainty has diminished following the introduction of the Euro in Europe. Consumers’ responses to the survey suggest that inflation expectations depend more on past national inflation rates than on the ECB’s anchor for price stability. The convergence in inflation expectations does not appear to be faster than the convergence in actual inflation rates. Regarding inflation uncertainty, the data indicate a relationship with country size, suggesting that within EMU, inflation uncertainty may increase in countries that have a smaller influence on ECB policy. |
| Keywords: | monetary union, inflation differentials, consumer survey |
| JEL: | D84 E31 E58 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_1667&r=mon |
| By: | Helge Berger; Jakob de Haan; Jan-Egbert Sturm |
| Abstract: | We examine the role of money in the policies of the ECB, using introductory statements of the ECB President at the monthly press conferences during 1999-2004. Over time, the relative amount of words devoted to the monetary analysis has decreased. Our analysis of indicators of the monetary policy stance suggests that developments in the monetary sector, while somewhat more important in the later half of the sample, only played a minor role most of the time. Our estimates of ECB interest rate decisions suggest that the ECB’s words (monetary-sector based policy intensions) are not an important determinant of its actions. |
| Keywords: | ECB, communication, monetary policy |
| JEL: | E43 E52 E58 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_1652&r=mon |
| By: | Eijffinger, Sylvester C W; Geraats, Petra M; van der Cruijsen, Carin A B |
| Abstract: | Central banks have become increasingly transparent during the last decade. One of the main benefits of transparency predicted by theoretical models is that it enhances the credibility, reputation, and flexibility of monetary policy, which suggests that increased transparency should result in lower nominal interest rates. This paper exploits a detailed transparency data set to investigate this relationship for eight major central banks. It appears that for all central banks, the level of interest rates is affected by the degree of central bank transparency. In particular, the majority of the improvements in transparency are associated with significant effects on interest rates, controlling for economic conditions. In most of these cases, interest rates are lower, often by around 50 basis points, although in some instances transparency appears to have had a detrimental effect on interest rates. |
| Keywords: | central bank transparency; interest rates; monetary policy |
| JEL: | E52 E58 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5526&r=mon |
| By: | Helge Berger |
| Abstract: | The paper discusses key elements of optimal central bank design and applies its findings to the Eurosystem. A particular focus is on the size of monetary policy committees, the degree of centralization, and the representation of relative economic size in the voting rights of regional (or sectoral) interests. Broad benchmarks for the optimal design of monetary policy committees are derived, combining relevant theoretical arguments with available empirical evidence. A new indicator compares the mismatch of relative regional economic size and voting rights in the monetary policy committees of the US Fed, the pre-1999 German Bundesbank, and the ECB over time. Based on these benchmarks, there seems to be room to improve the organization of the ECB Governing Board and current plans for reform. |
| Keywords: | central bank design, federal central banks, ECB, Eurosystem, ECB reform |
| JEL: | D72 E58 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_1697&r=mon |
| By: | Schabert, Andreas; van Wijnbergen, Sweder |
| Abstract: | Blanchard (2005) suggested that active interest rate policy might induce unstable dynamics in highly-indebted economies. We examine this in a dynamic general equilibrium model where Calvo-type price rigidities provide a rationale for inflation stabilization. Unstable dynamics can occur when the CB is aggressively raising the interest rate in response to higher expected inflation. The constraint on stabilizing interest rate policy is tighter the higher the primary deficit and the more open the economy is. If the government cannot borrow from abroad in its own currency, stability requires interest rate policy to be accommodating (passive). Inflation stabilization is nevertheless feasible if the CB uses an instrument not associated with default risk, e.g. money supply. |
| Keywords: | fiscal-monetary policy interactions; foreign debt; inflation targeting; policy implementation; sovereign default risk |
| JEL: | E52 E63 F41 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5590&r=mon |
| By: | K C Neanidis; C S Savva |
| Abstract: | MThis paper examines the effects of inflation and currency substitution volatility on the average rates of inflation and currency substitution for twelve emerging market economies. Using a bivariate GARCH-in-Mean model, which accommodates for asymmetric and spillover effects of inflation and currency substitution innovations on their volatilities, we find that for the majority of the countries in the sample the variability of inflation exerts a positive influence on both the average rates of inflation and currency substitution. Similarly, higher uncertainty in currency substitution displays enhancing effects on inflation and currency substitution. These results indicate an alternative avenue that stresses the importance of currency substitution for the conduct of monetary policy in terms of price stability, and provide an additional explanation to the phenomenon of dollarization hysteresis. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:71&r=mon |
| By: | Günter W. Beck (University of Frankfurt and CFS); Axel A. Weber (Deutsche Bundesbank) |
| Abstract: | Using a set of regional inflation rates we examine the dynamics of inflation dispersion within the U.S.A., Japan and across U.S. and Canadian regions. We find that inflation rate dispersion is significant throughout the sample period in all three samples. Based on methods applied in the empirical growth literature, we provide evidence in favor of significant mean reversion (ß- convergence) in inflation rates in all considered samples. The evidence on s-convergence is mixed, however. Observed declines in dispersion are usually associated with decreasing overall inflation levels which indicates a positive relationship between mean inflation and overall inflation rate dispersion. Our findings for the within-distribution dynamics of regional inflation rates show that dynamics are largest for Japanese prefectures, followed by U.S. metropolitan areas. For the combined U.S.-Canadian sample, we find a pattern of withindistribution dynamics that is comparable to that found for regions within the European Monetary Union (EMU). In line with findings in the so-called ‘border literature’ these results suggest that frictions across European markets are at least as large as they are, e.g., across North American markets. |
| Keywords: | Inflation Convergence, Deflation, ECB Monetary Policy, EMU, Regional Diversity |
| JEL: | E31 E52 E58 |
| Date: | 2005–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:cfs:cfswop:wp200531&r=mon |
| By: | Axel A. Weber (Deutsche Bundesbank); Günter W. Beck (University of Frankfurt and CFS) |
| Abstract: | Using a unique data set of regional inflation rates we are examining the extent and dynamics of inflation dispersion in major EMU countries before and after the introduction of the euro. For both periods, we find strong evidence in favor of mean reversion (ß-convergence) in inflation rates. However, half-lives to convergence are considerable and seem to have increased after 1999. The results indicate that the convergence process is nonlinear in the sense that its speed becomes smaller the further convergence has proceeded. An examination of the dynamics of overall inflation dispersion (s-convergence) shows that there has been a decline in dispersion in the first half of the 1990s. For the second half of the 1990s, no further decline can be observed. At the end of the sample period, dispersion has even increased. The existence of large persistence in European inflation rates is confirmed when distribution dynamics methodology is applied. At the end of the paper we present evidence for the sustainability of the ECB’s inflation target of an EMU-wide average inflation rate of less than but close to 2%. |
| Keywords: | Convergence, Deflation, ECB Monetary Policy, EMU, Regional Diversity |
| JEL: | E31 E52 E58 |
| Date: | 2005–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:cfs:cfswop:wp200530&r=mon |
| By: | John C. Bluedorn (Nuffield College, Oxford University); Christopher Bowdler (Nuffield College, Oxford University) |
| Abstract: | We argue that endogenous and anticipated movements in interest rates lead to underestimates of the speed and magnitude of the exchange rate response to monetary policy. Employing the Romer and Romer (2004) exogenous monetary policy shock measure, we find that the effect of a one percentage point increase in the U.S. interest rate is up to twice as large and 3 times as fast as that obtained using the actual federal funds rate to identify monetary shocks. Moreover, new evidence from open economy VARs emphasises the adjustment role of the exchange rate. U.S. prices and output respond almost twice as quickly as they do in a closed economy VAR using the Romer and Romber shock measure. There is also evidence of stronger international transmission of U.S. monetary shocks. Overall, the estimated response speeds and magnitudes are more easily reconciled with existing models than previous empirical work. |
| Keywords: | monetary policy shocks, exchange rate dynamics, open economy VARs |
| JEL: | E52 F31 F41 |
| Date: | 2005–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:nuf:econwp:0518&r=mon |
| By: | Miquel Faig; Belén Jerez |
| Abstract: | We study the effects of inflation in a competitive search model where each buyer's utility is private information, and where money is essential in facilitating trade. The equilibrium is efficient at the Friedman rule, but inflation creates an inefficiency in the terms of trade. Buyers experience a preference shock after they are matched with a seller, and thus they have a precautionary motive for holding money. Sellers, who compete to attract buyers, post non-linear price schedules to screen out different types of buyers. As inflation rises, sellers post relatively flat price schedules which reduce the need for buyers to hold precautionary balances. These price schedules induce buyers with a low desire to consume to purchase inefficiently high quantities because of the low marginal cost of purchasing goods. In contrast, buyers with a high desire to consume purchase inefficiently low quantities as they face binding liquidity constraints. The reduction of precautionary balances as inflation rises allows the model to fit historical US data on velocity and interest rates. |
| Keywords: | inflation; precautionary money demand; competitive search; private information. |
| JEL: | E40 E52 D58 |
| URL: | http://d.repec.org/n?u=RePEc:tor:tecipa:tecipa-215&r=mon |
| By: | Minford, Patrick; Nowell, Eric; Sofat, Prakriti; Srinivasan, Naveen |
| Abstract: | A large econometric literature has found that post-war US inflation exhibits very high persistence, approaching that of a random walk process. Given similar evidence for other OECD countries, many macroeconomists have concluded that high inflation persistence is a 'stylized fact'. The objective of this paper is to show that degree of inflation persistence is not an inherent structural characteristic of an economy, but in fact a function of the stability and transparency of monetary policy regime in place. We begin by estimating univariate processes for inflation across different periods, allowing for structural breaks based on a priori knowledge of the UK economy. Then we examine whether, a rather straightforward model, easily micro-founded in a standard classical set-up can generate the facts such as we find them. We calibrate our structural model for each of the regimes and solve it analytically for the implied persistence in the inflation process. We compare this theoretical prediction with the estimated persistence for each regime. Finally we bootstrap our model to generate pseudo inflation series and check whether the actual persistence coefficients lie within the 95 percent confidence limits implied by the bootstraps. As a robustness exercise we do the same for the Liverpool model. |
| Keywords: | bootstraps; inflation |
| JEL: | E0 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5608&r=mon |
| By: | Matthews, Kent; Meenagh, David; Minford, Patrick; Webb, Bruce |
| Abstract: | Macro models generally assume away heterogeneous welfare in assessing policies. We investigate here within two aggregative models - one with a representative agent, the other a long-used forecasting model of the UK - whether allowing for differences in welfare functions (specifically between those in continuous employment and those with frequent unemployment spells) alters the rankings of monetary policies. We find that it does but that a set of policies (money supply targeting implemented by money supply control) can be found that are robust in the sense of avoiding very poor outcomes for either of the two groups. |
| Keywords: | heterogenous welfare; interest rate setting; money supply rules; price level targeting; robustness |
| JEL: | E52 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5609&r=mon |
| By: | Benjamin M. Friedman |
| Abstract: | What stands out in retrospect about U.S. monetary policy during the Greenspan Era is the ongoing movement away from mechanistic restrictions on the conduct of policy, together with a willingness on occasion to depart even from what more flexible guidelines dictated by contemporary conventional wisdom would imply, in the interest of carrying out the Federal Reserve System’s dual mandate to pursue both stable prices and maximum employment. Part of this change was procedural – for example, the elimination of money growth targets. The most substantive demonstration of policy flexibility came in the latter half of the 1990s, as unemployment fell below 6% (in 1994), then below 5% (in 1997), and then remained below 5% for more than four years, yet the Federal Reserve did not tighten monetary policy. This policy stance was consistent with a view of the economy, including faster productivity growth and increased exposure to international competition, that Chairman Greenspan had articulated nearly a decade before. |
| JEL: | E52 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12118&r=mon |
| By: | Faia, Ester; Monacelli, Tommaso |
| Abstract: | We analyze optimal monetary policy in a small open economy characterized by home bias in consumption. Peculiar to our framework is the application of a Ramsey-type analysis to a model of the recent open economy New Keynesian literature. We show that home bias in consumption is a sufficient condition for inducing monetary policy-makers of an open economy to deviate from a strategy of strict markup stabilization and contemplate some (optimal) degree of exchange rate stabilization. We focus on the optimal setting of policy both in the case in which firms set prices one period in advance as well as in the case in which firms set prices in a dynamic forward-looking fashion. While the first setup allows us to analytically highlight home bias as an independent source of equilibrium markup variability, the second setup allows us to study the effects of future expectations on the optimal policy problem and the effect of home bias on optimal inflation volatility. The latter, in particular, is shown to be related to the degree of trade openness in a U-shaped fashion, whereas exchange rate volatility is monotonically decreasing in openness. |
| Keywords: | home bias; optimal monetary policy; Ramsey planner; sticky prices |
| JEL: | E52 F41 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5522&r=mon |
| By: | Kirsanova, Tatiana; Vines, David; Wren-Lewis, Simon |
| Abstract: | We generalise the analysis of inflation bias with dynamic Phillips curves in three respects. First, we examine the discretionary (time consistent) solution in cases where the Phillips curve has both a backward looking and forward-looking component. Second, we show that the commitment (time inconsistent) solution does not normally involve zero inflation and output at its natural rate. Instead, with a purely forward-looking Phillips curve and positive discounting, it will involve a dynamic path for inflation in which steady state inflation is below its target. In this sense, we obtain negative inflation bias. Third, we show that the timeless perspective policy has the same steady state as the commitment case, but without any short-term output gains. |
| Keywords: | commitment; discretion; inflation bias; timeless perspective policy |
| JEL: | E52 E61 E63 F41 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5534&r=mon |
| By: | Lane, Philip R. |
| Abstract: | We explore the impact of European monetary union (EMU) on the economies of the member countries. While the annual dispersion in inflation rates have not been much different to the variation across US regions, inflation differentials in the euro area have been much more persistent, such that cumulative intra-EMU real exchange rate movements have been quite substantial. EMU has indeed contributed to greater economic integration - however, economic linkages with the rest of the world have also been growing strongly, such that the relative importance of intra-EMU trade has not dramatically increased. In terms of future risks, a severe economic downturn or financial crisis in a member country will be the proving ground for the political viability of EMU. |
| Keywords: | EMU; heterogeneity; integration |
| JEL: | F2 F4 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5536&r=mon |
| By: | Aoki, Kosuke |
| Abstract: | This paper considers the determination of aggregate price level under dispersed information. Central Bank sets policy in response to its noisy measure of the price level, and each agent makes its decisions by observing a subset of data. Information revealed to the agents and Bank is determined endogenously. It is shown that the aggregate state of the economy is not revealed perfectly to anybody but this economy behaves as if it is a representative-agent economy in which the representative agent has perfect information while the Bank has partial information. The Bank has information set affects fluctuations in the price level through its effect on policy. |
| Keywords: | monetary policy; uncertainty |
| JEL: | E52 E58 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5570&r=mon |
| By: | Kirsanova, Tatiana; Vines, David; Wren-Lewis, Simon |
| Abstract: | We analyse the stability of countries within a monetary union in the face of asymmetric shocks, using a simple but widely applicable model. We show that members of the union may be subject to severe, and possibly unstable, cycles following asymmetric shocks if there is a significant backward looking element in inflation behaviour, and if real interest rates influence the level of aggregate demand. This cyclical instability can be mitigated if fiscal policy in each member country reacts to inflation differences, but it can be aggravated if fiscal feedback on debt is too strong. |
| Keywords: | macroeconomic stability; monetary and fiscal policies; monetary union |
| JEL: | E52 E61 E63 F41 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5584&r=mon |
| By: | Miquel Faig; Xiuhua Huangfu |
| Abstract: | This is a comment on the work of Rocheteau and Wright (2005) who have recently introduced competitive search into monetary economics. We extend their work by eliminating the restriction that the fees market makers charge to enter a submarket must be either non-negative or identical for buyers and sellers. Without this restriction, buyers pay a positive fee to enter the submarket they visit and nothing else when they meet a seller. Sellers are remunerated by the market makers from the entry fees collected from the buyers. This trading arrangement allows buyers to perfectly predict their expenses, so the opportunity cost of holding idle money balances is eliminated. |
| JEL: | E40 |
| URL: | http://d.repec.org/n?u=RePEc:tor:tecipa:tecipa-217&r=mon |
| By: | Michael Bleaney |
| Abstract: | This paper considers the currency composition of sovereign debt in the context of risk-sharing through excusable defaults. It is shown that monetary credibility is not a sufficient condition for borrowing in domestic currency. With real exchange rate risk, debt denominated in a borrowing country’s currency can be too state-contingent to support international lending on purely reputational considerations, even when debt denominated in the lending country’s currency is viable. The model can explain the geographical pattern of bond issuance, the phenomenon of “original sin”, and the concentration of defaults on foreign-currency debt. |
| URL: | http://d.repec.org/n?u=RePEc:not:notecp:06/02&r=mon |
| By: | Miquel Faig |
| Abstract: | This paper provides a tractable search model with divisible money that encompasses the two frameworks currently used in the literature. Individuals belong to many villages. Inside a village, individuals know each other so financial contracts are feasible. Money is essential to facilitate trade across villages. When financial markets inside a village are complete, the model generalizes the framework advanced by Lagos and Wright (2005) without having to assume quasi-linear preferences. Likewise, complete financial markets in each village substitutes for the representative household in the framework advanced by Shi (1997). The paper describes sets of financial arrangements that complete the markets inside the villages. In general, these financial arrangements include a combination of credit and insurance. However, if individuals choose period by period the trading role they play outside their village, then under some parametric restrictions either a lottery or a risk-free bond market are sufficient. |
| Keywords: | monetary search, divisible money |
| JEL: | E40 |
| URL: | http://d.repec.org/n?u=RePEc:tor:tecipa:tecipa-216&r=mon |
| By: | Flandreau, Marc; Jobst, Clemens |
| Abstract: | Using a new database for the late 19th century, when the pound sterling circulated all over the world, this paper provides the first review of critical empirical issues in the economics of international currencies. First, we report evidence in favor of the search-theoretic approach to international currencies. Second, we give empirical support to strategic externalities. Third, we provide strong confirmation of the existence of persistence. Finally, we reject the view that the international monetary system is subject to pure path dependency in that it cannot remain locked into some past equilibrium. Our conclusion is that, for the late 19th century at least, money and trade were complements. |
| Keywords: | dollar; international currencies; persistence; search theoretic approach to money; sterling; strategic externalities |
| JEL: | F31 N32 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5529&r=mon |
| By: | Christian Ahlin (Department of Economics Vanderbilt University); Mototsugu Shintani (Department of Economics, Vanderbilt University) |
| Abstract: | We revisit a foundational theoretical paper in the menu cost literature, Sheshinski and Weiss (1983), one of the few to treat stochastic inflation with persistent deviations from trend. In contrast to the original finding, we find that optimal pricing in this environment entails using different (s,S) bands in high-inflation and low-inflation states of the world. The low-inflation band is strictly contained within the high-inflation band. This revised solution has very different implications from the original one. Firms are generally risk-loving, not risk-averse, with respect to inflation. An increase in the variance of inflation increases price dispersion when inflation is high and decreases price dispersion when inflation is low. On an aggregate level, this optimal pricing would lead to bunching of prices and non-neutrality of money in the setting of Caplin and Spulber (1987). To test the main finding, we construct an establishment-level dataset from the months surrounding Mexico's Tequila crisis, in 1995. In the high-inflation state, price increases are larger and establishments allow their prices to vary more widely around their respective long-run mean relative prices. Cross-establishment price dispersion is lower, but this result seems due to decreased establishment heterogeneity rather than narrower (s,S) bands. Overall, the evidence suggests that establishments employ wider (s,S) bands in the high-inflation state. |
| Keywords: | (s,S) policy, neutrality of money, optimal pricing, regime switching |
| JEL: | D40 E31 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:van:wpaper:0610&r=mon |