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

  1. The Mystique of Central Bank Speak By Petra Geraats
  2. The Federal Reserve's Dual Mandate: A Time-Varying Monetary Policy Priority Index for the United States By René Lalonde; Nicolas Parent
  3. The Open Economy Consequences of U.S. Monetary Policy By John Bluedorn; Christopher Bowdler
  4. The Welfare Implications of Inflation versus Price-Level Targeting in a Two-Sector, Small Open Economy By Eva Ortega; Nooman Rebei
  5. Why Do Countries Peg the Way They Peg? The Determinants of Anchor Currency Choice By Christopher M. Meissner; Nienke Oomes
  6. "GibsonÕs Paradox II" By Greg Hannsgen
  7. Bubbles, Collateral and Monetary Equilibrium By Aloisio Pessoa de Araújo; Mario R. Páscoa; Juan Pablo Torres-Martínez
  8. Implementing Optimal Monetary Policy in New-Keynesian Models with Inertia By George W. Evans; Bruce McGough
  9. Responses to Monetary Policy Shocks in the East and the West of Europe: A Comparison By Marek Jarocinski
  10. Exchange-Rate Arrangements and Financial Integration in East Asia: On a Collision Course? By Hans Genberg
  11. Optimal monetary policy in a regime-switching economy: the response to abrupt shifts in exchange rate dynamics By Fabrizio Zampolli
  12. Broad money vs. narrow money: A discussion following the Federal Reserve’s decision to discontinue publication of M3 data By Tim Congdon
  13. "Why Central Banks (and Money) ÒRule the RoostÓ" By C. Sardoni
  14. Optimal Time Consistent Monetary Policy By Tatiana Damjanovic; Vladislav Damjanovic; Charles Nolan
  15. Proposal for a Common Currency among Rich Democracies (Paper 1); One World Money, Then and Now (Paper 2) By Richard N. Cooper (Paper 1); Michael Bordo (Paper 2); Harold James (Paper 2)
  16. Regime Shifts in the Indicator Properties of Narrow Money in Canada By Tracy Chan; Ramdane Djoudad; Jackson Loi
  17. Optimal monetary policy in Markov-switching models with rational expectations agents By Andrew P Blake; Fabrizio Zampolli
  18. Are Currency Crises Low-State Equilibria? An Empirical, Three-Interest-Rate Model By Christopher M. Cornell; Raphael H. Solomon
  19. Money and Credit Factors By Paul D. Gilbert; Erik Meijer
  20. Monetary Union, External Shocks and Economic Performance: A Latin American Perspective By Sebastian Edwards
  21. "The Minskyan System, Part I: Properties of the Minskyan Analysis and How to Theorize and Model a Monetary Production Economy" By Eric Tymoigne
  22. Guarding Against Large Policy Errors under Model Uncertainty By Gino Cateau
  23. An Evaluation of Core Inflation Measures By Jamie Armour
  24. LVTS, the Overnight Market, and Monetary Policy By Nadja Kamhi
  25. "Asset Prices, Financial Fragility, and Central Banking" By Eric Tymoigne
  26. The euro and its perception in the German population By Bettina Isengard; Thorsten Schneider
  27. Europe’s Hard Fix: The Euro Area By Otmar Issing
  28. Regional Currency Arrangements in North America By Sven Arndt

  1. By: Petra Geraats (Faculty of Economics, University of Cambridge, Cambridge)
    Abstract: Despite the recent trend towards greater transparency of monetary policy, in many respects mystique still prevails in central bank speak. This paper shows that the resulting perception of ambiguity could be desirable. Under the plausible assumption of imperfect common knowledge about the degree of central bank transparency, economic outcomes are affected by both the actual and perceived degree of transparency. It is shown that actual transparency is beneficial while it may be useful to create the perception of opacity. The optimal communication strategy for the central bank is to provide clarity about the inflation target and to communicate information about the output target and supply shocks with perceived ambiguity. In this respect, the central bank benefits from sustaining transparency misperceptions, which helps to explain the mystique of central bank speak.
    Keywords: Transparency, monetary policy, communication
    JEL: E52 E58 D82
    Date: 2006–05–15
  2. By: René Lalonde; Nicolas Parent
    Abstract: In the United States, the Federal Reserve has a dual mandate of promoting stable inflation and maximum employment. Since the Fed directly controls only one instrument-the federal funds rate-the authors argue that the Fed's priorities continuously alternate between inflation and economic activity. In this paper, the authors assume that the effective weights put by the Fed on different indicators vary over time. To test this assumption, they estimate a monetary policy priority index by adding non-linear endogenous weights to a conventional Taylor-type rule.
    Keywords: Monetary policy framework; Monetary policy implementation; Econometric and statistical methods
    JEL: C22 C52 E52
    Date: 2006
  3. By: John Bluedorn; Christopher Bowdler
    Abstract: We characterize the channels by which a failure to distinguish intended/unintended and anticipated/unanticipated monetary policy may lead to attenuation bias in monetary policy`s open economy effects. Using a U.S. monetary policy measure which isolates the intended and unanticipated component of federal funds rate changes, we quantify the magnitude of the attenuation bias for the exchange rate and foreign variables, finding it to be substantial. The exchange rate appreciation following a monetary contraction is up to 4 times larger than a recursively-identified VAR estimate. There is stronger evidence of foreign interest rate pass-through. The expenditure-reducing effects of a U.S. monetary policy contraction dominate any expenditure-switching effects, leading to a positive conditional correlation of international outputs and prices.
    Keywords: Open economy monetary policy identification, Exchange rate adjustment, Interest rate pass-through
    JEL: E52 F31 F41
    Date: 2006
  4. By: Eva Ortega; Nooman Rebei
    Abstract: The authors analyze the welfare implications of simple monetary policy rules in the context of an estimated model of a small open economy for Canada with traded and non-traded goods, and with sticky prices and wages. They find statistically significant heterogeneity in the degree of price rigidity across sectors. They also find welfare gains in targeting only the non-traded-goods inflation, since prices are found to be more sticky in this production sector, but those gains come at the cost of substantially increased aggregate volatility. The authors look for the welfare-maximizing specification of an interest rate reaction function that allows for a specific price-level target. They find, however, that, overall, the higher welfare is achieved, given the estimated model for the Canadian economy, with a strict inflation-targeting rule where the central bank reacts to the next period's expected deviation from the inflation target and does not target the output gap.
    Keywords: Economic models; Exchange rates; Inflation targets
    JEL: E31 E32 E52
    Date: 2006
  5. By: Christopher M. Meissner; Nienke Oomes
    Abstract: Conditional on choosing a pegged exchange rate regime, what determines the currency to which countries peg or “anchor” their exchange rate? This paper aims to answer this question using a panel multinomial logit framework, covering more than 100 countries for the period 1980-1998. We find that trade network externalities are a key determinant of anchor currency choice, implying that there are multiple steady states for the distribution of anchor currencies in the international monetary system. Other factors found to be related to anchor currency choice include the symmetry of output co-movement, the currency denomination of debt, and legal or colonial origins.
    Keywords: exchange rate regime; anchor; network externalities; optimal currency area; international currency; de facto
    JEL: E42 F02 F33
    Date: 2006–06
  6. By: Greg Hannsgen
    Abstract: The Gibson paradox, long observed by economists and named by John Maynard Keynes (1936), is a positive relationship between the interest rate and the price level. This paper explains the relationship by means of interest-rate, cost-push inflation. In the model, spending is driven in part by changes in the rate of interest, and the central bank sets the interest rate using a policy rule based on the levels of output and inflation. The model shows that the cost-push effect of inflation, long known as GibsonÕs paradox, intensifies destabilizing forces and can be involved in the generation of cycles.
    Date: 2006–05
  7. By: Aloisio Pessoa de Araújo (EPGE/FGV); Mario R. Páscoa; Juan Pablo Torres-Martínez
    Date: 2006–04
  8. By: George W. Evans (University of Oregon Economics Department); Bruce McGough (Oregon State University)
    Abstract: We consider optimal monetary policy in New Keynesian models with inertia. First order conditions, which we call the MJB-alternative, are found to improve upon the timeless perspective. The MJB-alternative is shown to be the best possible in the sense that it minimizes policymakers' unconditional expected loss, and further, it is numerically found to offer significant improvement over the timeless perspective. Implementation of the MJB-alternative is considered via construction of interest-rate rules that are consistent with its associated unique equilibrium. Following Evans and Honkapohja (2004), an expectations based rule is derived that always yields a determinate model and an E-stable equilibrium. Further, the "policy manifold" of all interest-rate rules consistent with the MJB-alternative is classified, and open regions of this manifold are shown to correspond to indeterminate models and unstable equilibria.
    Keywords: Monetary Policy, Taylor Rules, Indeterminacy, E-stability
    JEL: E52 E32 D83 D84
    Date: 2006–06–03
  9. By: Marek Jarocinski (Universitat Pompeu Fabra, Barcelona and CASE - Center for Social and Economic Research, Warsaw)
    Abstract: This paper compares responses to monetary shocks in the EMU countries (in the pre-EMU sample) and in the New Member States (NMS) from Central Europe. The small-sample problem, especially acute for the NMS, is mitigated by using a Bayesian estimation procedure which combines information across countries. A novel identification scheme for small open economies is used. The estimated responses are quite similar across regions, but there is some evidence of more lagged, but ultimately stronger price responses in the NMS economies. This contradicts the common belief that monetary policy is less effective in post-transition economies, because of their lower financial development. NMS also have a probably lower sacrifice ratio, which is consistent with the predictions of both the imperfect information model of Lucas (1973) and the New-Keynesian model of Ball et al. (1988).
    Keywords: monetary policy transmission, Structural VAR, Bayesian estimation, exchangeable prior
    JEL: C11 C15 C33 E40 E52
    Date: 2006–05–17
  10. By: Hans Genberg (Executive Director (Research), Hong Kong Monetary Authority)
    Abstract: Financial integration in Ease Asia is actively being pursued and will in due course lead to substantial mobility of capital between economies in the region. Plans for monetary cooperation as a prelude to monetary integration and ultimately monetary unification are also proposed. These plans often suggest that central banks should adopt some form of common exchange rate policy in the transition period towards full monetary union. This paper argues that this is a dangerous path in the context of highly integrated financial markets. An alternative approach is proposed where independent central banks coordinate their monetary policies through the adoption of common objectives and by building an appropriate institutional framework. When this coordination process has progressed to the point where interest rate developments are similar across the region, and if in the meantime the required institutional infrastructure has been build, the next step towards monetary unification can be taken among those central banks that so desire. The claim is that this transition path is likely to be robust and will limit the risk of currency crises.
    Date: 2006–05–05
  11. By: Fabrizio Zampolli
    Abstract: This paper examines the trade-offs that a central bank faces when the exchange rate can experience sustained deviations from fundamentals and occasionally collapse. The economy is modelled as switching randomly between different regimes according to time-invariant transition probabilities. We compute both the optimal regime-switching control rule for this economy and optimised linear Taylor rules, in the two cases where the transition probabilities are known with certainty and where they are uncertain. The simple algorithms used in the computation are also of independent interest as tools for the study of monetary policy under general forms of (asymmetric) additive and multiplicative uncertainty. An interesting finding is that policies based on robust (minmax) values of the transition probabilities are usually more conservative.
  12. By: Tim Congdon
    Date: 2006–05
  13. By: C. Sardoni
    Abstract: Some have argued that a significant decrease in the demand for money, due to financial innovations, could imply that central banks are unable to implement effective monetary policies. This paper argues that central banks are always able to influence the economyÕs interest rates, because their liability is the economyÕs unit of account. In this sense, central banks Òrule the roost.Ó In the 1930s, starting from KeynesÕs ideas and referring to money in general, Kaldor had followed a similar line of analysis. In principle, a new unit of account could displace conventional money and, hence, central banks. But this process meets relevant obstacles, which essentially derive from the externalities and network effects that characterize money. Money is a Òsocial relation.Ó Money and central banks are the outcome of complex social and economic processes. Their displacement will occur through equally complex processes, rather than through mere innovation.
    Date: 2006–06
  14. By: Tatiana Damjanovic; Vladislav Damjanovic; Charles Nolan
    Abstract: We develop a simple and intuitive procedure to derive analytically the unconditionally optimal (UO) policy in a general linear-quadratic setup, a perspective stressed by Taylor (1979) and Whiteman (1986). We compare the UO perspective on optimal monetary policy with the timeless perspective and policy based on minimizing conditional discounted losses. We use our approach in simple backward and forward-looking models and conclude that the UO perspective is worthy of renewed interest.
    Keywords: Time consistency, unconditional expectation, timeless perspective, optimal policy.
    JEL: E20 E32 F32 F41
    Date: 2006–06
  15. By: Richard N. Cooper (Paper 1) (Harvard University); Michael Bordo (Paper 2) (Economics Department, Rutgers University and Harvard University); Harold James (Paper 2) (History Department and Woodrow Wilson School, Princeton University)
    Abstract: Paper 1: This paper suggests that some time in the not-too-distant future the governments of the industrialized democracies – concretely, the United States, the European Union, and Japan – should consider establishing a common currency for their collective use. A common currency would credibly eliminate exchange rate uncertainty and exchange rate movements among major currencies, both of which are significant sources of disturbance to important economies. One currency would of course entail one monetary policy for the currency area, and a political mechanism to assure accountability. This proposal is not realistic today, but is set as a vision for the second or third decade into the 21st century. Europeans, in creating EMU, have taken a major step in the direction indicated. Their idea could be taken further. Paper 2: In this paper, we look at the major arguments for monetary simplification and unification before explaining why the nineteenth century utopia is an idea whose time has gone, not come.
    Date: 2006–09–06
  16. By: Tracy Chan; Ramdane Djoudad; Jackson Loi
    Abstract: Financial innovations and the removal of the reserve requirements in the early 1990s have made the distinction between demand and notice deposits arbitrary. This classification issue has affected those narrow monetary aggregates (gross and net M1) that rely on a proper distinction for their definition, and may have eroded their value as indicators. The authors examine whether the indicator properties of various narrow aggregates for the growth of real output have changed over time. They find evidence of a regime shift in the relationship between real and narrow monetary aggregates and the growth of real output, which seems to have occurred in 1992. More specifically, their results show that real M1+, the definition of which is not based on the distinction between demand and notice deposits, has become a more useful indicator in predicting the growth of real output over the more recent period.
    Keywords: Monetary aggregates
    JEL: E40 E42 E50
    Date: 2006
  17. By: Andrew P Blake; Fabrizio Zampolli
    Abstract: In this paper we consider the optimal control problem of models with Markov regime shifts and forward-looking agents. These models are very general and flexible tools for modelling model uncertainty. An algorithm is devised to compute the solution of a linear rational expectations model with random parameters or regime shifts. This algorithm can also be applied in the optimisation of any arbitrary instrument rule. A second algorithm computes the time-consistent policy and the resulting Nash-Stackelberg equilibrium. Similar methods can be easily employed to compute the optimal policy under commitment. Furthermore, the algorithms can also handle the case in which the policymaker and the private sector hold different beliefs. We apply these methods to compute the optimal (non-linear) monetary policy in a small open economy subject to random structural breaks in some of its key parameters.
  18. By: Christopher M. Cornell; Raphael H. Solomon
    Abstract: Suppose that the dynamics of the macroeconomy were given by (partly) random fluctuations between two equilibria: "good" and "bad." One would interpret currency crises (or recessions) as a shift from the good equilibrium to the bad. In this paper, the authors specify a dynamic investment-savings-aggregate-supply (IS-AS) model, determine its closed-form solution, and examine numerically its comparative statics. The authors estimate the model via maximum likelihood, using data for Argentina, Canada, and Turkey. Since the data show no support for the multiple-equilibrium explanation of fluctuations, the authors cast doubt on the third-generation models of currency crisis.
    Keywords: Uncertainty and monetary policy
    JEL: C62 E59 F41
    Date: 2006
  19. By: Paul D. Gilbert; Erik Meijer
    Abstract: The authors introduce new measures of important underlying macroeconomic phenomena that affect the financial side of the economy. These measures are calculated using the time-series factor analysis (TSFA) methodology introduced in Gilbert and Meijer (2005). The measures appear to be both more interesting and more robust to the effects of financial innovations than traditional aggregates. The general ideas set out in Gilbert and Pichette (2003) are pursued, but the improved estimation methods of TSFA are used. Furthermore, four credit aggregates are added to the components of the monetary aggregates, resulting in the possibility of extracting more common factors.
    Keywords: Credit and credit aggregates; Monetary aggregates; Econometric and statistical methods
    JEL: E51 C43 C82
    Date: 2006
  20. By: Sebastian Edwards (University of California, Los Angeles and National Bureau of Economic Research)
    Abstract: During the last few years there has been a renewed analysis in currency unions as a form of monetary arrangement. This new interest has been largely triggered by the Euro experience. Scholars and policy makers have asked about the optimal number of currencies in the world economy. They have analyzed whether different countries satisfy the traditional “optimal currency area” criteria. These include: (a) the synchronization of the business cycle; (b) the degree of factor mobility; and (c) the extent of trade and financial integration. In this paper I analyze the desirability of a monetary union from a Latin American perspective. First, I review the existing literature on the subject. Second, I use a large data set to analyze the evidence on economic performance in currency union countries. I investigate these countries’ performance on four dimensions: (a) whether countries without a national currency have a lower occurrence of “sudden stop” episodes; (b) whether they have a lower occurrence of “current account reversal” episodes; (c) what is their ability to absorb international terms of trade shocks; and (d) what is their ability to absorb “sudden stops” and “current account reversals” shocks. I find that belonging to a currency union does not lower the probability of facing a sudden stop or a current account reversal. I also find that external shocks are amplified in currency union countries. The degree of amplification is particularly large when compared to flexible exchange rate countries.
    Date: 2006–05–06
  21. By: Eric Tymoigne
    Abstract: This is the first part of a three-part analysis of the Minskyan framework. Via an extensive review of the literature, this paper looks at 12 essential elements necessary to get a good understanding of Minsky's theory, and argues that those elements are central to comprehend how a monetary production economy works. This paper also shows how important these 12 elements are for the modeling of the Minskyan framework, and how the omission of one of them may be detrimental to an understanding of the essential dynamics that Minsky put forward: the Financial Instability Hypothesis.
    Date: 2006–06
  22. By: Gino Cateau
    Abstract: How can policy-makers avoid large policy errors when they are uncertain about the true model of the economy? The author discusses some recent approaches that can be used for that purpose under two alternative scenarios: (i) the policy-maker has one reference model for choosing policy but cannot take a stand as to how that model is misspecified, and (ii) the policy-maker, being uncertain about the economy's true structure, entertains multiple distinct models of the economy. The author shows how these approaches can be implemented in practice using as benchmark models simplified versions of Fuhrer and Moore (1995) and Christiano, Eichenbaum, and Evans (2005).
    Keywords: Uncertainty and monetary policy
    JEL: E5 E58 D8 D81
    Date: 2006
  23. By: Jamie Armour
    Abstract: The author provides a statistical evaluation of various measures of core inflation for Canada. The criteria used to evaluate the measures are lack of bias, low variability relative to total CPI inflation, and ability to forecast actual and trend total CPI inflation. The author uses the same methodology as Hogan, Johnson, and Laflèche (2001) and thus provides updated empirical results. The findings are that most traditional measures of core inflation are unbiased and all continue to be less volatile than total inflation. They nevertheless display some volatility and have limited predictive ability. Overall, CPIW seems to have a slight advantage over the other measures, but the differences across measures are not large. (CPIW uses all components of total CPI but adjusts the weight of each component by a factor that is inversely proportional to the component's variability.) Compared with the results of Hogan, Johnson, and Laflèche, CPIW's relative performance has improved. The distribution of price changes for 54 CPI subcomponents is also examined, and substantial increases in both the skewness and kurtosis of this distribution since 1998 are found.
    Keywords: Inflation and prices
    JEL: E31
    Date: 2006
  24. By: Nadja Kamhi
    Abstract: Operational events in the Large Value Transfer System (LVTS) almost always result in a disturbance of the regular flow of payments. The author explores the link between payment flows and the overnight interest rate. She also explores the way that payments system frictions affect the overnight interest rate. Payments system frictions arise because LVTS participants lack full information on their own payment flows and those of others. This uncertainty diminishes as the final end-of-day settlement nears. By borrowing earlier in the day in the overnight market, however, participants can insure against being short at the final end-of-day settlement. The author first develops a general framework describing the role that payment flows and payments system frictions have on the overnight rate and then empirically tests the implications of this model. She finds that LVTS payment flows are an important determinant of pressure on the overnight interest rate.
    Keywords: Payment, clearing, and settlement systems; Monetary policy implementation
    JEL: E5
    Date: 2006
  25. By: Eric Tymoigne
    Abstract: The paper reviews the current literature on the subject in both the New Consensus and the Post Keynesian framework. It shows that both approaches give to central banks a wrong goal (inflation, distribution, curbing speculation, etc.) and a wrong instrument (interest rate rule). The paper claims that central banks should focus their attention on maintaining financial stability and leave other problems to public institutions better suited for this task. In doing so they should develop new tools of intervention and leave policy interest rates unchanged, close to or at zero percent. Central banks have been created to deal with financial matters (government finance and financial stability) and should stick to this. Central banks, then, have a large amount of improvements to make, both as reformers and as guides for the financial community. Their main instrument should be an analysis of the financial fragility of the financial system and of the different economic sectors. In this context, it is shown that the notion of ÒbubbleÓ does not matter for policy purposes, and that the current regulatory system lacks an institution that is able to deal effectively with solvency crisis.
    Date: 2006–06
  26. By: Bettina Isengard (DIW Berlin, German Socio-Economic Panel Study); Thorsten Schneider (Otto-Friedrich-University Bamberg, Chair of Sociology I)
  27. By: Otmar Issing (European Central Bank)
    Date: 2006–04–26
  28. By: Sven Arndt (The Lowe Institute of Political Economy, Claremont McKenna College)
    Date: 2006–02–05

This nep-mon issue is ©2006 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.