nep-mon New Economics Papers
on Monetary Economics
Issue of 2006‒04‒22
29 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Money Rules By Cees Ullersma; Jan Marc Berk; Bryan Chapple
  2. Dissent and Disagreement on the Fed's FOMC: Understanding Regional Affiliations and limits to Transparency By Ellen Meade
  3. The Relationship Between Exchange Rates and Inflation Targeting Revisited By Sebastian Edwards
  4. Central Bank Instruments, Fiscal Policy Regimes, and the Requirements for Equilibrium Determinacy By Andreas Schabert
  5. Optimal Monetary Policy When Agents Are Learning By Krisztina Molnár; Sergio Santoro
  6. House Prices and Monetary Policy in Colombia By Martha Misas A.
  7. Optimal Inflation Targeting under Alternative Fiscal Regimes By Pierpaolo Benigno; Michael Woodford
  8. Exchange Rate Changes and Inflation in Post-Crisis Asian Economies: VAR Analysis of the Exchange Rate Pass-Through By Takatoshi Ito; Kiyotaka Sato
  9. Following the yellow brick road? The Euro, the Czech Republic, Hungary and Poland. By Jesús Rodríguez López; José Luis Torres Chacón
  10. Macroeconomic Regime Switches and Speculative Attacks By Bartosz Mackowiak
  11. Pareto Improving Monetary Policy in Incomplete Markets By Sergio Turner; Norovsambuu Tumennasan
  12. External Shocks, U.S. Monetary Policy and Macroeconomic Fluctuations in Emerging Markets By Bartosz Mackowiak
  13. The Real Effects of EMU By Philip R. Lane;
  14. Joining the European Monetary Union - Comparing First and Second Generation Open Economy Models By Le, Vo Phuong Mai; Minford, Patrick
  15. A Pressure-Augmented Taylor Rule for Italy By Chiara Dalle Nogare; Matilde Vassalli
  16. Currency Areas and Monetary Coordination By Qing Liu; Shouyong Shi
  17. Monetary policy regime shifts: new evidence from time-varying interest rate rules By Carmine Trecroci; Matilde Vassalli
  18. Openness and the Case for Flexible Exchange Rates By Corsetti, Giancarlo
  19. Back to Wicksell? In search of the foundations of practical monetary policy By Roberto Tamborini
  20. On Determinants of the Yen Weight in the Implicit Basket System in East Asia By Takatoshi Ito; Keisuke Orii
  21. The Chinese Yuan after the Chinese Exchange Rate System Reform By Eiji Ogawa; Michiru Sakane
  22. The Persistence of Inflation in OECDCountries: a Fractionally Integrated Approach By Laura Mayoral
  23. The Impact of Foreign Interest Rates on the Economy: The Role of the Exchange Rate Regime By Jay C. Shambaugh; Julian di Giovanni
  24. Dynamic equilibrium correction modelling of yen Eurobond credit spreads By Seppo Pynnönen; Warren P. Hogan; Jonathan A. Batten
  25. Arbitrage, Covered Interest Parity and Long-Term Dependence between the US Dollar and the Yen By Peter G. Szilagyi; Jonathan A. Batten
  27. Managing Exchange Rate Volatility: A Comparative Counterfactual Analysis of Singapore 1994 to 2003 By Peter Wilson; Henry Ng Shang Ren
  28. Monetary and fiscal policy interactions in a New Keynesian model with capital accumulation and non-Ricardian consumers By Campbell Leith and Leopold von Thadden
  29. The Forward Exchange Rate Bias Puzzle: Evidence from New Cointegration Tests By Raj Aggarwal; Brian M. Lucey; Sunil K. Mohanty

  1. By: Cees Ullersma; Jan Marc Berk; Bryan Chapple
    Abstract: We assess a New Keynesian macro-economic model that is supplemented with a micro-founded role for money in determining aggregate demand and supply in order to better describe monetary policy transmission. In this model welfare is higher if the monetary authority takes money growth explicitly into account when setting interest rates.
    Keywords: money; monetary policy; monetary transmission
    JEL: E52 E58
    Date: 2006–04
  2. By: Ellen Meade
    Abstract: This paper addresses two important, but distinct, issues in monetary policy. The first issue concerns regional influences on voting within a monetary policy committee. In a committee that includes representatives from different regions or countries, is there a regional element to the monetary policy decision or to the votes cast by monetary policymakers? The second issue concerns possible limits to transparency. In an independent central bank that strives to be accountable and to communicate its policy effectively, are there circumstances under which increasing transparency could be harmful? The answer to both of these questions with respect to the Federal Reserve is "maybe".
    Keywords: central banking; Federal Reserve; FOMC; voting
    JEL: E58 F33 E42 E65
    Date: 2006–03
  3. By: Sebastian Edwards
    Abstract: This paper deals with the relationship between inflation targeting and exchange rates. I address three specific issues: first, I analyze the effectiveness of nominal exchange rates as shock absorbers in countries with inflation targeting. This issue is closely related to the magnitude of the "pass-through" coefficient. Second, I investigate whether exchange rate volatility is different in countries with an inflation targeting regime than in countries with alternative monetary policy arrangements. And third, I discuss whether the exchange rate should play a role in determining the monetary policy stance under inflation targeting. An alternative way of posing this question is whether the exchange rate should have an independent role in an open economy Taylor rule.
    JEL: F02 F43
    Date: 2006–04
  4. By: Andreas Schabert (Universiteit van Amsterdam)
    Abstract: This paper examines the role of the monetary instrument choice for local equilibrium determinacy under sticky prices and different fiscal policy regimes. Corresponding to Benhabib et al.'s (2001) results for interest rate feedback rules, the money growth rate should not rise by more than one for one with inflation when the primary surplus is raised with public debt. Under an exogenous primary surplus, money supply should be accommodating -- such that real balances grow with inflation -- to ensure local equilibrium determinacy. When the central bank links the supply of money to government bonds by controlling the bond-to-money ratio, an inflation stabilizing policy can be implemented for both fiscal policy regimes. Local determinacy is then ensured when the bond-to-money ratio is not extremely sensitive to inflation, or when interest payments on public debt are entirely tax financed, i.e., the budget is balanced.
    Keywords: Fiscal-Monetary Policy Interaction; Money Growth; Bond-to-Money Ratio; Local Equilibrium Determinancy
    JEL: E52 E63 E32
    Date: 2006–03–08
  5. By: Krisztina Molnár; Sergio Santoro
    Abstract: Most studies of optimal monetary policy under learning rely on optimality conditions derived for the case when agents have rational expectations. In this paper, we derive optimal monetary policy in an economy where the Central Bank knows, and makes active use of, the learning algorithm agents follow in forming their expectations. In this setup, monetary policy can influence future expectations through its e ect on learning dynamics, introducing an additional tradeo between inflation and output gap stabilization. Specifically, the optimal interest rate rule reacts more aggressively to out-of-equilibrium inflation expectations and noisy cost-push shocks than would be optimal under rational expectations: the Central Bank exploits its ability to "drive" future expectations closer to equilibrium. This optimal policy closely resembles optimal policy when the Central Bank can commit and agents have rational expectations. Monetary policy should be more aggressive in containing inflationary expectations when private agents pay more attention to recent data. In particular, when beliefs are updated according to recursive least squares, the optimal policy is time-varying: after a structural break the Central Bank should be more aggressive and relax the degree of aggressiveness in subsequent periods. The policy recommendation is robust: under our policy the welfare loss if the private sector actually has rational expectations is much smaller than if the Central Bank mistakenly assumes rational expectations whereas in fact agents are learning.
    Keywords: Optimal Monetary Policy, Learning, Rational Expectations
    JEL: C62 D83 D84 E0 E5
    Date: 2006–03–15
  6. By: Martha Misas A.
    Abstract: This paper investigates the possible responses of an inflation-targeting monetary policy in the face of asset price deviations from fundamental values. Focusing on the housing sector of the Colombian economy, we consider a general equilibrium model with frictions in credit market and bubbles in housing prices. We show that monetary policy is less efficient when it responds directly to asset price of housing than a policy that reacts only to deviations of expected inflation (CPI) from target. Some prudential regulation may provide a better outcome in terms of output and inflation variability.
    Date: 2006–03–01
  7. By: Pierpaolo Benigno; Michael Woodford
    Abstract: Standard discussions of flexible inflation targeting as an optimal monetary policy abstract completely from the consequences of monetary policy for the government budget. But at least some of the countries now adopting inflation targeting have substantial difficulty in controlling fiscal imbalances, so that the additional strains resulting from strict control of inflation are of substantial concern, and some (notably Sims 2005) have argued that inflation targeting can even be counterproductive under some fiscal regimes. Here, therefore, we analyze welfare-maximizing monetary policy taking explicit account of the consequences of monetary policy for the government budget, and under a variety of assumptions about the nature of the fiscal regime. The paper contrasts the optimal monetary policies under three alternative assumptions about fiscal policy: (i) the case in which little distortion is required to raise additional government revenue, and the fiscal authority can be relied upon to ensure intertemporal government solvency [the implicit assumption in standard analyses]; (ii) the case in which only distorting sources of revenue exist, but distorting taxes are adjusted optimally; and (iii) the case in which tax rates cannot be expected to change in response to a change in monetary policy [the problematic case emphasized by Sims]. In both of cases (ii) and (iii), it is optimal for monetary policy to allow the inflation rate to respond to fiscal developments (and the optimal responses to other shocks are somewhat different than in the classic analysis, which assumes case (I)). Nonetheless, optimal monetary policy can still be implemented through a form of flexible inflation targeting, and it remains critical, even in the most pessimistic case (case (iii)), that inflation expectations (beyond some very short horizon) not be allowed to vary in response to shocks.
    JEL: E52 E63
    Date: 2006–04
  8. By: Takatoshi Ito; Kiyotaka Sato
    Abstract: The pass-through effects of exchange rate changes on the domestic prices in the East Asian countries are examined using a VAR analysis including several price indices and domestic macroeconomic variables as well as the exchange rate. Results from the VAR analysis show that (1) the degree of exchange rate pass-through to import prices was quite high in the crisis-hit countries; (2) the pass-through to CPI was generally low, with a notable exception of Indonesia: and (3) in Indonesia, both the impulse response of monetary policy variables to exchange rate shocks and that of CPI to monetary policy shocks are positive, large and statistically significant. Thus, Indonesia's accommodative monetary policy as well as the high degree of the CPI responsiveness to exchange rate changes was important factors that resulted in the spiraling effects of domestic price inflation and sharp nominal exchange rate depreciation in the post-crisis period.
    Date: 2006–04
  9. By: Jesús Rodríguez López (Department of Economics, Universidad Pablo de Olavide); José Luis Torres Chacón (Departamento de Teoría e Historia Económica, Universidad de Málaga)
    Abstract: This paper uses a combination of VAR and bootstrapping techniques to analyze whether the exchange rates of some New Member States of the EU have been used as output stabilizers (those of the Czech Republic, Hungary and Poland), during 1993-2004. This question is important because it provides a prior evaluation on the costs and benefits involved in entering the European Monetary Union (EMU). Joining the EMU is not optional for these countries but mandatory, although there is no definite deadline. Therefore, if the exchange rate works as a shock absorber, monetary independence could be retained for a longer period. Our main finding is that the exchange rate could be a stabilizing tool in Poland and the Czech Republic, although in Hungary it appears to act as a propagator of shocks. In addition, in these three countries, demand and monetary shocks account for most of the variability in both nominal and real exchange rates.
    Keywords: EMU, exchange rate, Structural VAR, stationary bootstraps.
    JEL: C31 F31 F33
    Date: 2006–04
  10. By: Bartosz Mackowiak
    Abstract: This paper explains a currency crisis as an outcome of a switch in how monetary policy and fiscal policy are coordinated. The paper develops a model of an open economy in which monetary policy starts active, fiscal policy starts passive and, in a particular state of nature, monetary policy switches to passive and fiscal policy switches to active. The probability of the regime switch is endogenous and changes over time together with the state of the economy. The regime switch is preceded by a sharp increase in interest rates and causes a jump in the exchange rate. The model predicts that currency composition of public debt affects dynamics of macroeconomic variables. Furthermore, the model is consistent with evidence from recent currency crises, in particular small seigniorage revenues.
    Keywords: Coordination of monetary policy and fiscal policy, policy regime switch, currency crisis, speculative attack, fiscal theory of the price level
    JEL: E52 E61 F33
    Date: 2006–04
  11. By: Sergio Turner; Norovsambuu Tumennasan
    Date: 2006
  12. By: Bartosz Mackowiak
    Abstract: Using structural VARs, I find that external shocks are an important source of macroeconomic fluctuations in emerging markets. Furthermore, U.S. monetary policy shocks affect quickly and strongly interest rates and the exchange rate in a typical emerging market. The price level and real output in a typical emerging market respond to U.S. monetary policy shocks by more than the price level and real output in the U.S. itself. These findings are consistent with the idea that “when the U.S. sneezes, emerging markets catch a cold.” At the same time, U.S. monetary policy shocks are not important for emerging markets relative to other kinds of external shocks.
    Keywords: Structural vector autoregression, monetary policy shocks, international spillover effects of monetary policy, external shocks, emerging markets
    JEL: F41 E3 O11
    Date: 2006–04
  13. By: Philip R. Lane;
    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.
    Date: 2006–04–05
  14. By: Le, Vo Phuong Mai; Minford, Patrick
    Abstract: We log-linearise the Dellas and Tavlas (DT) model of monetary union and solve it analytically. We find that the intuition of optimal currency analysis of DT's second generation open economy model is essentially the same as that of first generation models. Monetary union results in no welfare loss if its member states are symmetric. However, asymmetry causes loss in welfare both due to the failure of the union policy to deal suitably with a country's asymmetric shocks and due to an active monetary policy by union in pursuit of its distinct objectives. The asymmetry in DT is largely due to the differing wage rigidities across countries.
    Keywords: asymmetry; monetary union; multi-country model; representative agent model; wage rigidity
    JEL: E42 F41 F42
    Date: 2006–04
  15. By: Chiara Dalle Nogare; Matilde Vassalli
    Abstract: Following Havrilesky seminal work (1995) and its extension by Maier, Sturm and de Haan (2002) we construct a monthly index of external influences on Bank of Italy’s conduct for the period 1984-1998. This paper describes the index of overall pressure on Italian monetary policy and the five sub-indexes of which it is composed. We evaluate whether Bank of Italy responded to pressure by estimating Taylor rules augmented with the pressure indexes. We conclude that in most cases external pressures did affect Bank of Italy’s action.
  16. By: Qing Liu; Shouyong Shi
    Abstract: In this paper we integrate the recent development in monetary theory with international finance, in order to examine the coordination between two currency areas in setting long-run inflation. The model determines the value of each currency and the size of each currency area without requiring buyers to use a particular currency to buy a country's goods. We show that the two countries inflate above the Friedman rule in a non-cooperative game. Coordination between the two areas reduces inflation to the Friedman rule, increases consumption, and improves welfare of both countries. This gain from coordination increases as the two areas become more integrated in trade. These results arise from the new features of the model, such as the deviations from the law of one price and the extensive margin of trade. To illustrate these new features, we show that introducing a direct tax on foreign holdings of a currency does not eliminate a country's incentive to inflate, while it does in traditional models.
    Keywords: Exchange rates; Currency areas; Coordination
    JEL: F41 E40
  17. By: Carmine Trecroci; Matilde Vassalli
    Abstract: We estimate forward-looking interest-rate rules, for major advanced countries, allowing for time variation in their parameters. Traditional constant-parameter reaction functions likely blur the impact of i) model uncertainty, ii) conflicting objectives, iii) shifting preferences and iv) nonlinearities of policymakers choices. We find that monetary policies followed by the US, the UK, Germany, France and Italy, often described in terms of standard Taylor rules, are best summarized by feedback rules that allow for time variation in their parameters. Estimated rules point to sizeable differences in the actual conduct of monetary policies, even in the countries now belonging to the EMU. Also, our TVP specification outperforms the conventional Taylor rule in tracking the actual Fed funds rate.
  18. By: Corsetti, Giancarlo
    Abstract: Models of stabilization in open economy traditionally emphasize the role of exchange rates as a substitute for nominal price flexibility in fostering relative price adjustment. This view has been recently criticized on the ground that, to the extent that prices are sticky in local currency, the exchange rate does not play the stabilizing role envisioned by the received wisdom. An important question is whether, for this very reason, stabilization policies should limit exchange rate movements, or even eliminate them altogether. In this paper, I re-assess this issue by extending the Corsetti and Pesenti (2001) model to allow for home bias in consumption | so that I can exploit the advantages of closed-form solutions. While this extension leaves most properties of the model unaffected, home bias implies that the real exchange rate in an efficient equilibrium is not constant, but fluctuates with the terms of trade. The weight that monetary authorities optimally place on stabilizing domestic marginal costs is increasing in Home bias: with asymmetric shocks, fixed exchange rates are incompatible with efficient monetary rules. Yet, the adverse welfare consequences of exchange rate movements constrain the optimal intensity of monetary responses to domestic shocks. Openness matters: in our specification each country produces an equal share of the world value added; the lower the import content of consumption, the higher the exchange rate volatility implied by optimal stabilization rules. In relatively closed economy, optimal monetary rules tend to converge, regardless of the nature of nominal rigidities in the exports market.
    Keywords: exchange rate pass-through; exchange rate regimes; international policy cooperation; nominal rigidities; optimal monetary policy
    JEL: E31 E52 F42
    Date: 2006–04
  19. By: Roberto Tamborini
    Abstract: It is now widely held that the New Neoclassical Synthesis (NSS) offers central banks a "user friendly", though rigorous, theoretical framework consistent with current practice of systematic stabilization policy based on interest rate rules (e.g. Woodford (2003)). Particular interest and curiosity have been aroused by Woodford's argument that the NNS theory of monetary policy is in its essence a modern restatement and refinement of Wicksell's interest-rate theory of prices (1898). This paper deals with two main issues prompted by Woodford's Neo-Wicksellian revival. The first questions the consistency between the NNS and Wicksell. The second concerns the value added for monetary policy of Wicksellian ideas in their own right. Section 2 clarifies some basic theoretical issues underlying the NNS and its inconsistency with a proper Wicksellian approach, which should be based on saving-investment imbalances that are precluded by the NNS theoretical framework. Section 3 presents a proper Neo-Wicksellian dynamic model whereby it is possible to assess, and hopefully clarify, some basic issues concerning the macroeconomics of saving-investment imbalances. Section 4 examines implications for monetary policy, in particular for Taylor rules, and section 5 concludes.
    Date: 2006
  20. By: Takatoshi Ito; Keisuke Orii
    Abstract: After the Asian currency crisis, most Asian economies have adopted managed float regimes, with notable exception of China, Hong Kong, and Malaysia. Various studies have examined the weights of the dollar, the yen, and the euro, regarding floating is loosely managed with reference to the basket currency system. However, results are mixed, in that in some periods, the yen weight seems to be higher in some countries, and in some other periods, the Asian currencies seem to have gone back to the dollar peg. This paper seeks the determinants of the yen weight in Asian currencies. It is found that the yen weight tends to increase when the yen depreciates and when the domestic interest rates rise. The yen weight tends to decrease when the US interest rate rises. Asymmetry is observed among coefficients of variables between the lower and higher yen periods. In addition, the yen weight is less susceptible to the overall position of the US dollar vis-a-vis major currencies. It should also be noted that the peculiarity among countries seems large in handling the currency weights in the basket.
    Date: 2006–04
  21. By: Eiji Ogawa; Michiru Sakane
    Abstract: In this paper, we investigate the actual exchange rate policy conducted by the Chinese government after the Chinese exchange rate system reform on July 21 2005. Also, we investigate long-run effect (Balassa-Samuelson effect) on the Chinese yuan. We found that the Chinese government had a statistically significant but small change in exchange rate policy during our sample period to January 25, 2006. It is not identified that the Chinese monetary authority is adopting the currency basket system because the change is too small in the economic sense. On one hand, higher growth rate of productivity will appreciate the Chinese yuan in terms of the US dollar and the Japanese yen while higher growth rates of productivity in Chinese tradable good sector tend to give the Balassa-Samuleson effect, that is undervaluation bias, to the Chinese yuan.
    Date: 2006–04
  22. By: Laura Mayoral
    Abstract: The statistical properties of inflation and, in particular, its degree of persistence and stability over time is a subject of intense debate and no consensus has been achieved yet. The goal of this paper is to analyze this controversy using a general approach, with the aim of providing a plausible explanation for the existing contradictory results. We consider the inflation rates of 21 OECD countries which are modelled as fractionally integrated (FI) processes. First, we show analytically that FI can appear in inflation rates after aggregating individual prices from firms that face different costs of adjusting their prices. Then, we provide robust empirical evidence supporting the FI hypothesis using both classical and Bayesian techniques. Next, we estimate impulse response functions and other scalar measures of persistence, achieving an accurate picture of this property and its variation across countries. It is shown that the application of some popular tools for measuring persistence, such as the sum of the AR coefficients, could lead to erroneous conclusions if fractional integration is present. Finally, we explore the existence of changes in inflation inertia using a novel approach. We conclude that the persistence of inflation is very high (although non-permanent) in most post-industrial countries and that it has remained basically unchanged over the last four decades.
    Keywords: Inflation persistence, persistence stability, ARFIMA models, long memory, structural breaks, bayesian estimations
    JEL: C22 E31
    Date: 2005–02
  23. By: Jay C. Shambaugh; Julian di Giovanni
    Abstract: It is often argued that small economies are affected by conditions in large countries. This paper explores the connection between interest rates in major industrial countries and annual real output growth in other countries. The results show that high large-country interest rates have a contractionary effect on annual real GDP growth in the domestic economy, but that this effect is centered on countries with fixed exchange rates. The paper then examines the potential channels through which large-country interest rates affect small economies. The direct monetary policy channel is the most likely channel when compared with other possibilities, such as a general capital market effect or a trade effect.
    JEL: F3 F4
    Date: 2006–04–05
  24. By: Seppo Pynnönen; Warren P. Hogan; Jonathan A. Batten
    Abstract: Understanding the long term relationship between the yields of risky and riskless bonds is a critical task for portfolio managers and policy makers. This study specifies an equilibrium correction model of the credit spreads between Japanese Government bonds (JGBs) and Japanese yen Eurobonds with high quality credit ratings. The empirical results indicate that the corporate bond yields are cointegrated with the otherwise equivalent JGB yields, with the spread defining the cointegration relation. In addition the results indicate that the equilibrium correction term is highly statistically significant in modelling credit spread changes. Another important factor is the risk-free interest rate with the negative sign, while there is little evidence of the contribution of the asset return to the behaviour of spreads.
    Date: 2006–04–05
  25. By: Peter G. Szilagyi; Jonathan A. Batten
    Abstract: Using a daily time series from 1983 to 2005 of currency prices in spot and forward USD/Yen markets and matching equivalent maturity short term US and Japanese interest rates, we investigate the sensitivity over the sample period of the difference between actual prices in forward markets to those calculated from short term interest rates. According to a fundamental theorem in financial economics termed covered interest parity (CIP) the actual and estimated prices should be identical once transaction and other costs are accommodated. The paper presents four important findings: First, we find evidence of considerable variation in CIP deviations from equilibrium that tends to be one way and favours those market participants with the ability to borrow US dollars (and subsequently lend yen). Second, these deviations have diminished significantly and by 2000 have been almost eliminated. We attribute this to the effects of electronic trading and pricing systems. Third, regression analysis reveals that interday negative changes in spot exchange rates, positive changes in US interest rates and negative changes in yen interest rates generally affect the deviation from CIP more than changes in interday volatility. Finally, the presence of long-term dependence in the CIP deviations over time is investigated to provide an insight into the equilibrium dynamics. Using a local Hurst exponent – a statistic used in fractal geometry - we find episodes of both positive and negative dependence over the various sample periods, which appear to be linked to episodes of dollar decline/yen appreciation, or vice versa. The presence of negative dependence is consistent with the actions of arbitrageurs successfully maintaining the long-term CIP equilibrium. Given the time varying nature of the deviations from equilibrium the sample period under investigation remains a critical issue when investigating the presence of longterm dependence.
    Keywords: Hurst exponent; Efficient market hypothesis; covered interest parity, arbitrage
    JEL: C22 C32 E31 F31
    Date: 2006–04–05
  26. By: Peter Rowland
    Abstract: The 90-day DTF rate is the main benchmark interest rate in Colombia. Since mid-July 2002 this rate has remained more or less constant at around 7.8 percent. More importantly, it did not react to any of two 100-basis-point increases in the overnight repo rate, the main tool of monetary policy that Banco de la República has to influence domestic interest rates, which has rendered the repo rate rather inefficient as a monetary policy tool. This paper studies the DTF rate and its development over time. It shows that a significant pass-through from the overnight interest rates to the DTF rate that was present before July 2002 thereafter seems to have vanished. It also provides a number of explanations to why the DTF rate has remained constant: Overnight rates have in real terms been negative and might, therefore, have been more out of the market than the DTF rate; due to heavy government borrowing, the yield curve has been too steep to allow a further lowering of the DTF rate; competition in the financial system is low, leading to sticky interest rates; the DTF rate is not a free-market auction rate but an offer rate set by the banks; and the DTF rate is a very dominant benchmark.
    Date: 2006–02–01
  27. By: Peter Wilson (Department of Economics, National University of Singapore 1 Arts Link, Singapore); Henry Ng Shang Ren
    Abstract: The objective of this paper is see how well Singapore’s exchange rate regime has coped with exchange rate volatility before and after the Asian financial crisis by comparing the performance of Singapore’s actual regime in minimising the volatility of the nominal effective exchange rate (NEER) and the bilateral rate against the US$ against some counterfactual regimes and the corresponding performance of eight other East Asian countries. In contrast to previous counterfactual exercises, such as Williamson (1998a) and Ohno (1999) which compute the weights for effective exchange rates on the basis of simple bloc aggregates, we apply a more disaggregated methodology using a larger number of trade partners. We also utilize ARCH/GARCH techniques to obtain estimates of heteroskedastic variances to better capture the time-varying characteristics of volatility for the actual and simulated exchange rate regimes. Our findings confirm that Singapore’s managed floating exchange rate system has delivered relatively low currency volatility. Although there are gains in volatility reduction for all countries in the sample from the adoption of either a unilateral or common basket peg, particularly post-crisis, these gains are relatively low for Singapore, largely because low actual volatility. Finally, there are additional gains for nondollar peggers from stabilizing intra-EA exchange rates against the dollar if they were to adopt a basket peg, especially post-crisis, but the gains for Singapore are again relatively modest.
    Keywords: East Asia, exchange rates, counterfactuals.
    JEL: F31 F33 F36
  28. By: Campbell Leith and Leopold von Thadden
    Abstract: This paper develops a small New Keynesian model with capital accumulation and government debt dynamics. The paper discusses the design of simple monetary and fiscal policy rules consistent with determinate equilibrium dynamics in the absence of Ricardian equivalence. Under this assumption, government debt turns into a relevant state variable which needs to be accounted for in the analysis of equilibrium dynamics. The key analytical finding is that without explicit reference to the level of government debt it is not possible to infer how strongly the monetary and fiscal instruments should be used to ensure determinate equilibrium dynamics. Specifically, we identify in our model discontinuities associated with threshold values of steady-state debt, leading to qualitative changes in the local determinacy requirements. These features extend the logic of Leeper (1991) to an environment in which fiscal policy is non-neutral and requires us to pay equal attention to to monetary and fiscal policy in designing policy rules consistent with determinate dynamics.
    JEL: E52 E63
  29. By: Raj Aggarwal; Brian M. Lucey; Sunil K. Mohanty
    Abstract: An important puzzle in international finance is the failure of the forward exchange rate to be a rational forecast of the future spot rate. It has often been suggested that this puzzle may be resolved by using better statistical procedures that correct for both non-stationarity and nonnormality in the data. We document that even after accounting for non-stationarity, nonnormality, and heteroscedasticity using parametric and non-parametric tests on data for over a quarter century, US dollar forward rates for horizons ranging from one to twelve months for the major currencies, the British pound, Japanese yen, Swiss franc, and the German mark, are generally not rational forecasts of future spot rates. These findings of non-rationality in forward exchange rates for the major currencies continue to be puzzling especially as these foreign exchange markets are some of the most liquid asset markets with very low trading costs.
    Keywords: flight-to-quality, contagion, multivariate GARCH
    JEL: F31 G14 F47 G15
    Date: 2006–04–05

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