nep-mon New Economics Papers
on Monetary Economics
Issue of 2006‒05‒06
24 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Quantitative goals for monetary policy By Antonio Fatás; Ilian Mihov; Andrew K. Rose
  2. How does information affect the comovement between interest rates and exchange rates? By Marcelo Sánchez
  3. Is Central Bank Transparency Desirable? By Sibert, Anne
  4. A speed limit monetary policy rule for the euro area By Livio Stracca
  5. Do Bank-Based Financial Systems Reduce Macroeconomic Volatility by Smoothing Interest Rates? By Johann Scharler
  6. Monetary policy, determinacy, and learnability in the open economy By James Bullard; Eric Schaling
  7. Monetary Policy, Corporate Financial Composition and Real Activity By Paul Mizen; Cihan Yalcin
  8. Optimal fiscal and monetary policy in a medium-scale macroeconomic model By Stephanie Schmitt-Grohé; Martín Uribe
  9. Interest Rate Pass-Through, Monetary Policy Rules and Macroeconomic Stability By Claudia Kwapil; Johann Scharler
  10. Price setting and inflation persistence: did EMU matter? By Ignazio Angeloni; Luc Aucremanne; Matteo Ciccarelli
  11. Regime Shifts and the Stability of Backward Looking Phillips Curves in Open Economies By Efrem Castelnuovo
  12. What effects is EMU having on the euro area and its member countries? An overview By Francesco Paolo Mongelli; Juan Luis Vega
  13. A Hands-off Central Banker? Marriner S. Eccles and the Federal Reserve Policy, 1934-1951 By Matias Vernengo
  14. Financial Systems and the Cost Channel Transmission of Monetary Policy Shocks By Sylvia Kaufmann; Johann Scharler
  15. Global financial transmission of monetary policy shocks By Michael Ehrmann; Marcel Fratzscher
  16. Expenditure switching versus real exchange rate stabilization - competing objectives for exchange rate policy By Michael B. Devereux; Charles Engel
  17. A Methodological approach to estimating the Money Demand in Pre-Industrial Economies: Probate Inventories and Spain in the 18th century By Esteban A. Nicolini; Fernando Ramos
  18. Central Banking by Committee By Sibert, Anne
  19. Real-time model uncertainty in the United States - the Fed from 1996-2003 By Robert J. Tetlow; Brian Ironside
  20. Increasing Returns and the Design of Interest Rate Rules By Xiao, Wei
  21. The accumulation of foreign reserves By Georges Pineau; Ettore Dorrucci
  22. The impact of the euro on financial markets By Lorenzo Cappiello; Peter Hördahl; Arjan Kadareja; Simone Manganelli
  23. The microstructure approach to exchange rates: a survey from a central bank’s viewpoint By Áron Gereben; György Gyomai; Norbert Kiss M.
  24. Deflationary Bubbles By Buiter, Willem H; Sibert, Anne

  1. By: Antonio Fatás (INSEAD, Boulevard de Constance, 77305 Fontainebleau, France.); Ilian Mihov (INSEAD, Boulevard de Constance, 77305 Fontainebleau, France.); Andrew K. Rose (Haas School of Business, University of California, Berkeley, CA 94720-1900, USA.)
    Abstract: We study empirically the macroeconomic effects of an explicit de jure quantitative goal for monetary policy. Quantitative goals take three forms: exchange rates, money growth rates, and inflation targets. We analyze the effects on inflation of both having a quantitative target, and of hitting a declared target; we also consider effects on output volatility. Our empirical work uses an annual data set covering 42 countries between 1960 and 2000, and takes account of other determinants of inflation (such as fiscal policy, the business cycle, and openness to international trade), and the endogeneity of the monetary policy regime. We find that both having and hitting quantitative targets for monetary policy is systematically and robustly associated with lower inflation. The exact form of the monetary target matters somewhat (especially for the sustainability of the monetary regime), but is less important than having some quantitative target. Successfully achieving a quantitative monetary goal is also associated with less volatile output.
    Keywords: Transparency; exchange; rate; money; growth; inflation; target; business cycle.
    JEL: E52
    Date: 2006–04
  2. By: Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper compares the link between exchange rates and interest rates under full information and two alternative asymmetric information approaches. It also distinguishes between cases of expansionary and contractionary depreciations. Full information results are not robust to the presence of informational frictions. For economies exhibiting expansionary or strongly contractionary depreciations, such frictions lead to two optimal deviations from full information outcomes: i) under asymmetric information with signal extraction, the realisation of a relatively less frequent shock leads the central bank to behave as if a more likely disturbance had instead taken place; and ii) under asymmetric information without signal extraction, the monetary authority does not react on impact to shocks. Finally, in the case of mildly contractionary depreciations, both asymmetric information models predict a lack of response of the central bank to aggregate demand shocks, as opposed to an offsetting movement in interest rates under full information.
    Keywords: Transmission mechanism, Emerging market economies, Exchange rate, Monetary policy, Imperfect information.
    JEL: E52 E58 F31 F41
    Date: 2006–04
  3. By: Sibert, Anne
    Abstract: I analyse central bank transparency when the central bank's objective function is its private information. Non-transparency exists when the public does not observe the action of the central bank and an unobservable component of the inflation-control error keeps the public from using its observation of inflation to infer perfectly the central bank's action, and hence, the central bank's objective. The degree of transparency is defined as the fraction of the inflation-control error that is observable. This notion is similar to that of Cukierman and Meltzer [9], Faust and Svensson [15], [16] and others. I find a number of results; some are different than what previous authors have found and others are novel. I demonstrate that non-transparent central banks with private information inflate less than central banks in a regime with perfect information. Moreover, in contrast to transparent central banks with private information, non-transparent banks with private information respond optimally to shocks; lower inflation is not at the expense of flexibility. Increased transparency lowers planned inflation, but surprisingly, it can worsen the public's ability to infer the central bank's objective function. I find that, no matter what their preferences, central banks and societies are made better off by more transparency. I further demonstrate that the transparent regime is not the same as the non-transparent regime when non-transparency goes to zero. I show that planned inflation is not necessarily lower in the transparent regime than in the non-transparent regime. However, numerical results suggest that all central banks and societies are better off in the transparent regime.
    Keywords: monetary policy; signalling; transparency
    JEL: E58
    Date: 2006–04
  4. By: Livio Stracca (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper estimates a hybrid New Keynesian model on euro area data and evaluates the performance of different simple policy rules and of the optimal unconstrained rule under commitment. The study reaches two main conclusions. First, inflation is found to be mainly forward-looking in the euro area, which implies the optimal policy reaction to cost push shocks is a muted one. Second, a "speed limit" rule of the type recently proposed by Walsh (2003) is able to closely approximate the performance of the optimal rule under commitment. The optimal speed limit rule is also characterised by super-inertia, making it a first difference rule similar to those recently proposed as a possible solution to measurement problems in the level of the natural interest rate and of potential output.
    Keywords: Euro area, hybrid New Keynesian model, monetary policy rules, commitment, speed limit policies.
    JEL: E52 E58
    Date: 2006–04
  5. By: Johann Scharler (Oesterreichische Nationalbank, Economic Analysis Division)
    Abstract: This paper investigates the business cycle implications of limited pass-through to retail interest rates based on a calibrated sticky price model. Although limited interest rate pass-through can in principle reduce output and inflation volatility at the same time, large reductions in output volatility are likely to be accompanied by a more volatile inflation rate. Limited pass-through gives rise to two counteracting effects: It partially insulates the economy from adverse liquidity shocks and thereby leads to lower output volatility. However, it also reduces the stabilizing effect of monetary policy which implies higher inflation volatility.
    Keywords: Financial Systems, Interest Rate Pass-Through, Business Cycle
    JEL: E32 E44 E52
    Date: 2006–03–17
  6. By: James Bullard (Research Division, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166-0442, United States.); Eric Schaling (Department of Economics University of Johannesburg, and CentER for Economic Research, Tilburg University. Address: P.O. Box 524, 2006, Auckland Park, Johannesburg, Republic of South Africa.)
    Abstract: We study how determinacy and learnability of global rational expectations equilibrium may be affected by monetary policy in a simple, two country, New Keynesian framework. The two blocks may be viewed as the U.S. and Europe, or as regions within the euro zone. We seek to understand how monetary policy choices may interact across borders to help or hinder the creation of a unique rational expectations equilibrium worldwide which can be learned by market participants. We study cases in which optimal policies are being pursued country by country as well as some forms of cooperation. We find that open economy considerations may alter conditions for determinacy and learnability relative to closed economy analyses, and that new concerns can arise in the analysis of classic topics such as the desirability of exchange rate targeting and monetary policy cooperation.
    Keywords: Indeterminacy, monetary policy rules, new open economy macroeconomics, international policy coordination.
    JEL: E52 F33
    Date: 2006–04
  7. By: Paul Mizen; Cihan Yalcin
    Date: 2006
  8. By: Stephanie Schmitt-Grohé (Duke University, Durham, NC 27708, United States.); Martín Uribe (Duke University, Durham, NC 27708, United States.)
    Abstract: In this paper, we study Ramsey-optimal fiscal and monetary policy in a mediumscale model of the U.S. business cycle. The model features a rich array of real and nominal rigidities that have been identified in the recent empirical literature as salient in explaining observed aggregate fluctuations. The main result of the paper is that price stability appears to be a central goal of optimal monetary policy. The optimal rate of inflation under an income tax regime is half a percent per year with a volatility of 1.1 percent. This result is surprising given that the model features a number of frictions that in isolation would call for a volatile rate of inflation—particularly nonstate-contingent nominal public debt, no lump-sum taxes, and sticky wages. Under an income-tax regime, the optimal income tax rate is quite stable, with a mean of 30 percent and a standard deviation of 1.1 percent.
    Keywords: Ramsey Policy, Inflation Stabilization, Tax Smoothing, Time to Tax, Nominal and Real Rigidities.
    JEL: E52 E61 E63
    Date: 2006–04
  9. By: Claudia Kwapil (Oesterreichische Nationalbank, Economic Analysis Division); Johann Scharler (Oesterreichische Nationalbank, Economic Analysis Division)
    Abstract: In this paper we analyze equilibrium determinacy in a sticky price model in which the pass-through from policy rates to retail interest rates is sluggish and potentially incomplete. In addition, we empirically characterize and compare the interest rate pass-through process in the euro area and the U.S. We find that if the pass-through is incomplete in the long run, the standard Taylor principle is insufficient to guarantee equilibrium determinacy. Our empirical analysis indicates that this result might be particularly relevant for bank-based financial systems as for instance that in the euro area.
    Keywords: Interest Rate Pass-Through, Interest Rate Rules, Equilibrium Determinacy, Stability
    JEL: E32 E52 E58
    Date: 2006–03–20
  10. By: Ignazio Angeloni (The Department of the Treasury, Italian Ministry of Economy and Finance, Via XX Settembre, 97, 00187 Rome, Italy.); Luc Aucremanne (National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.); Matteo Ciccarelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Surprisingly it did not, or at least not directly. Using micro data on consumer prices and sectoral inflation rates from 6 euro area countries, spanning several years before and after the introduction of the euro, we look at whether EMU has altered the behaviour of retail price setting and/or inflation dynamics. We find no evidence that anything has changed around 1999 – if anything, persistence may have slightly increased. At the end of 2001 and in the beginning of 2002 (period surrounding the euro cash changeover) retail price adjustment frequencies, both up and down, increased substantially, while the magnitude of the price adjustment, also both up and down, was smaller than otherwise. However, both settled quickly back to the earlier patterns. On the contrary, we do find evidence of a decline in the persistence of the inflation process in the mid-1990s. This could be due to a structural change in private inflationary expectations due, at least in part, to policies linked to the preparation of EMU; however, this interpretation is weakened by the fact that a similar decline occurred also in the US.
    Keywords: Price setting, Inflation persistence, Aggregate and Sectoral Inflation, EMU.
    JEL: E31 E42 E52
    Date: 2006–03
  11. By: Efrem Castelnuovo (University of Padua)
    Abstract: We assess the stability of open economy backward-looking Phillips curves estimated over two different exchange rate regimes. We calibrate a new-Keynesian monetary policy model and employ it for producing artificial data. A monetary policy break replicating the move from a Target-Zone regime to a Free-Floating regime implemented in Sweden in 1992 is modeled. We employ two different, plausibly calibrated Taylor rules to describe the Swedish monetary policy conduct, and fit a reduced-form Phillips curve to the artificial data. While not rejecting the statistical relevance of the Lucas critique, we find that its economic importance does not seem to be overwhelming.
    JEL: E17 E52 F41
    Date: 2006–04
  12. By: Francesco Paolo Mongelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Juan Luis Vega (Banco de España, Alcalá, 48, 28014 Madrid, Spain.)
    Abstract: This paper addresses the effects of the European Economic and Monetary Union (EMU) since the introduction of the euro - on economic and financial structures, institutions and performance. What type of changes is the euro fostering? What forces is it setting in motion that were not there before? Six years after the launch of the euro, was an appropriate time to start taking stock of these effects. For this purpose, in June 2005, the ECB held a workshop on “What effects is EMU having on the euro area and its member countries?” The workshop was organised in five areas: 1. trade integration, 2. business cycles synchronisation, economic specialisation and risk sharing, 3. financial integration, 4. structural reforms in product and labour markets, and 5. inflation persistence. This paper sets the workshop in the context of the current debate on the effects of EMU and brings together several of the issues raised by the leading presentations: i.e., this paper serves as an overview. Overall, the effects of the euro observed are beneficial. However, progress has been uneven in the above areas. Many potential concerns preceding the launch of the euro have been dispelled. Moreover, it will take more time for the full effects of the euro to unravel.
    Keywords: Optimum Currency Area, Economic and Monetary Integration, EMU.
    JEL: E42 F13 F33 F42
    Date: 2006–03
  13. By: Matias Vernengo
    Abstract: Marriner Eccles is often seen as an early defender of Keynesian ideas. In that respect, it is generally accepted that he considered monetary policy of secondary importance, and that as a result he allowed the Federal Reserve to be submitted to the interests of the Treasury. In this view, the Federal Reserve after 1935 acquired new instruments to command monetary policy, but it did not change its behavior significantly. Further, his defense of the Federal Reserve-Treasury accord in 1951 is sometimes seen as a reversal of his previous policy stances. This paper claims that proper understanding of Eccles’ views is necessary to appreciate the changes in monetary policy during the Great Depression and World War II. Rather than a hands-off central banker, that submitted the Fed to the Treasury, a more proper depiction of Eccles tenure at the Fed would be as a Main Street chairman.
    Keywords: History of Thought, Keynesians, Federal Reserve History
    JEL: B22 B31 E12 E58
    Date: 2006–04
  14. By: Sylvia Kaufmann (Oesterreichische Nationalbank, Economic Studies Division); Johann Scharler (Oesterreichische Nationalbank, Economic Analysis Division)
    Abstract: In this paper we study the role of financial systems for the cost channel transmission of monetary policy in a calibrated business cycle model. We analyze the different effects that monetary policy has on the economy, in particular on output and inflation, which are due to differences in country-specific financial systems. For a plausible calibration of the model, differences in financial systems have a rather limited effect on the transmission mechanism and do not appear to give rise to cross country differences in the strength of the cost channel.
    Keywords: Financial Systems, Cost Channel, Transmission Mechanism
    JEL: E40 E50
    Date: 2006–03–14
  15. By: Michael Ehrmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The paper shows that US monetary policy has been an important determinant of global equity markets. Analysing 50 equity markets worldwide, we find that returns fall on average around 3.8% in response to a 100 basis point tightening of US monetary policy, ranging from a zero response in some to a reaction of 10% or more in other countries, as well as significant cross-sector heterogeneity. Distinguishing different transmission channels, we find that in particular the transmission via US and foreign short-term interest rates and the exchange rate play an important role. As to the determinants of the strength of transmission to individual countries, we test the relevance of their macroeconomic policies and the degree of real and financial integration, thus linking the strength of asset price transmission to underlying trade and asset holdings, and find that in particular the degree of global integration of countries – and not a country’s bilateral integration with the United States – is a key determinant for the transmission process.
    Keywords: Global financial markets, monetary policy, transmission, financial integration, United States, advanced economies, emerging market economies.
    JEL: F36 F30 G15
    Date: 2006–04
  16. By: Michael B. Devereux (Department of Economics, University of British Columbia, 997-1873 East Mall, Vancouver, BC V6T 1Z1, Canada.); Charles Engel (University of Wisconsin, 1180 Observatory Drive, Madison, WI 53706-1393, USA.)
    Abstract: This paper develops a view of exchange rate policy as a trade-off between the desire to smooth fluctuations in real exchange rates so as to reduce distortions in consumption allocations, and the need to allow flexibility in the nominal exchange rate so as to facilitate terms of trade adjustment. We show that optimal nominal exchange rate volatility will reflect these competing objectives. The key determinants of how much the exchange rate should respond to shocks will depend on the extent and source of price stickiness, as well as the elasticity of substitution between home and foreign goods. Quantitatively, we find the optimal exchange rate volatility should be significantly less than would be inferred based solely on terms of trade considerations. Moreover, we find that the relationship between price stickiness and optimal exchange rate volatility may be non-monotonic.
    Keywords: Exchange rates, monetary policy, expenditure switching.
    JEL: F41 E52
    Date: 2006–04
  17. By: Esteban A. Nicolini; Fernando Ramos
    Abstract: The study of monetary phenomena and the understanding of price determination in Modern Europe are too often limited by the scarcity of good-quality data sets on the evolution across time of variables like money holdings, income, or wealth. In this paper we show that the information contained in probate inventories can be extremely useful to circumvent that problem. In particular, combining a data set of 114 inventories from Palencia (North of Spain) between 1750 and 1770 with census information (Catastro de Ensenada) we make a cross-section estimation of a money demand which is the first one ever produced for any period before the 19th century. The results provide meaningful insights about the relation between money demand and wealth, urbanization and structural change in a pre-industrial economy and highlight the potential of probate inventories to improve our knowledge of the monetary history of Modern Europe.
    Date: 2006–03
  18. By: Sibert, Anne
    Abstract: There is a small, but growing, economics literature on the importance and effects of having monetary policy made by a committee, rather than by an individual. Complimenting this is an older and larger body of literature on groups in the other social sciences, particular in social psychology. This paper provides a review of some of this work, focussing on two important features of committees: the effect of their size on performance and whether or not they are more moderate than the members who make them up. The results of the literature on committee size and committee polarization suggest that the ideal monetary policy committee may not have many more than five members. It should have a well-defined objective and it should publish the votes of its members. It should be structured so that members do not act as part of a group, perhaps by having short terms in office and members from outside the central bank. External scrutiny of the decision-making process should be encouraged.
    Keywords: committee size; groupthink; social loafing
    JEL: E50 E58
    Date: 2006–04
  19. By: Robert J. Tetlow (Contact address: Federal Reserve Board, Division of Research and Statistics 20th and Constitution Avenue NW, Washington, D.C. 20551, United States.); Brian Ironside (Safeco Insurance Companies, Safeco Plaza, SPI Actuarial, T-14, Seattle, WA 98185-0001, United States.)
    Abstract: We study 30 vintages of FRB/US, the principal macro model used by the Federal Reserve Board staff for forecasting and policy analysis. To do this, we exploit archives of the model code, coefficients, baseline databases and stochastic shock sets stored after each FOMC meeting from the model’s inception in July 1996 until November 2003. The period of study was one of important changes in the U.S. economy with a productivity boom, a stock market boom and bust, a recession, the Asia crisis, the Russian debt default, and an abrupt change in fiscal policy. We document the surprisingly large and consequential changes in model properties that occurred during this period and compute optimal Taylor-type rules for each vintage. We compare these optimal rules against plausible alternatives. Model uncertainty is shown to be a substantial problem; the efficacy of purportedly optimal policy rules should not be taken on faith.
    Keywords: Monetary policy, uncertainty, real-time analysis.
    JEL: E37 E5 C5 C6
    Date: 2006–04
  20. By: Xiao, Wei (University of New Orleans)
    Abstract: We introduce increasing returns to scale into an otherwise standard New Keynesian model with capital, and study the determinacy and E-stability of Taylor-type interest rate rules. With very mild increasing returns supported by empirical research, the conventional wisdom regarding the design of interest rate rules can be overturned. In particular, the "Taylor principle" no longer guarantees either determinacy or E-stability of the rational expectations equilibrium.
    Keywords: Increasing returns, Indeterminacy, E-stability, Taylor principle
    JEL: E32 E52
    Date: 2005–02
  21. By: Georges Pineau (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Ettore Dorrucci (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: In a number of countries, especially emerging market economies, the public sector has in recent years been accumulating sizeable cross-border financial assets, mainly in the form of official foreign exchange reserves. World reserves have risen from USD 1.2 trillion in January 1995 to above USD 4 trillion in September 2005, growing particularly rapidly since 2002. This paper investigates the features, drivers, risks and costs of such recent reserve accumulation, as well as the other uses that certain countries have been making of their accumulated foreign assets. The main trends in central bank reserve management are also reviewed. Finally, the paper provides some evidence for the impact of reserve accumulation on yields and asset prices.
    Keywords: Foreign exchange reserves, exchange rates, emerging market economies.
    Date: 2006–03
  22. By: Lorenzo Cappiello (European Central Bank, DG Research, Financial Research Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Peter Hördahl (European Central Bank, DG Research, Financial Research Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Arjan Kadareja (European Central Bank, DG Research, Financial Research Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Simone Manganelli (European Central Bank, DG Research, Financial Research Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We assess whether the euro had an impact first on the degree of integration of European financial markets, and, second, on the euro area term structure. We propose two methodologies to measure integration - one relies on time-varying GARCH correlations, and the other one on a regression quantile-based codependence measure. We document an overall increase in co-movements in both equity and bond euro area markets, suggesting that integration has progressed since the introduction of the euro. However, while the correlations in bond markets reaches almost one for all euro area countries, co-movements in equity markets are much lower and the increase is limited to large euro area economies only. In the second part of the paper, we focus on the asset pricing implications of the euro. Specifically, we use a dynamic no-arbitrage term structure model to examine the risk ? return trade-off in the term structure of interest rates before and after the introduction of the euro. The analysis shows that while the average level of term premia seems little changed following the euro introduction, the variability of premia has been reduced as a result of smaller macro shocks during the euro period. Moreover, the macro factors that were found to be important in explaining the dynamics of premia before the introduction of the euro continue to play a key role in this respect also thereafter.
    Keywords: Financial markets, euro, financial integration, volatility, conditional correlation, term structure, fundamentals, risk premia.
    JEL: F36 G12 E43 E44 C22
    Date: 2006–03
  23. By: Áron Gereben (Magyar Nemzeti Bank); György Gyomai (Magyar Nemzeti Bank (at the time of writing this study)); Norbert Kiss M. (Magyar Nemzeti Bank)
    Abstract: The application of the market microstructure theory to foreign exchange markets in the last few years has introduced a new approach to the analysis of exchange rates. The most important variable of the microstructure analysis, the so-called order flow has proven to be suitable for explaining a significant part of exchange rate changes, not only for high frequency data, but also at longer time horizons that are relevant for macro-economic analysis. Microstructure theory is thus extremely successful from an empirical point of view, especially when compared to traditional exchange rate models. The aim of our study is to provide an introduction to the microstructure-based analysis of exchange rates, emphasising those aspects which may be the most relevant for central banks. In addition to an introduction to the theoretical background of the microstructure approach and the presentation of the key empirical results, we also intend to cast light upon the questions which are important for central banks and which can be tackled successfully using this framework. On the basis of the literature's findings, we present the answers given by the microstructure approach to, among others, questions concerning the efficiency of central bank intervention, the effects of economic news on exchange rates, and the role of different currency market participants in exchange rate developments.
    Keywords: exchange rate, order flow, microstructure.
    JEL: F31 G15
    Date: 2005
  24. By: Buiter, Willem H; Sibert, Anne
    Abstract: In an attempt to clean up an unruly literature, we specify the necessary and sufficient conditions for household optimality in a model where money is the only financial asset and provide the relevant proofs. We use our results to analyse when deflationary bubbles can and cannot exist. Our findings are in contrast to the results in several prominent contributions to the literature. We argue for particular specifications of the no-Ponzi-game restrictions on the household's and government's intertemporal budget constraints in a model with money and bonds. Using the restriction on the household we derive the necessary and sufficient conditions for household optimality. The resulting equilibrium terminal conditions are then used to demonstrate that the existence of bonds does not affect when deflationary bubbles can and cannot occur. This result differs from that in other recent works.
    Keywords: deflationary bubbles; transversatility conditions
    JEL: D91 E31 E40
    Date: 2006–04

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