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on Monetary Economics |
| By: | Jinhui H. Bai; Ingolf Schwarz (Department of Economics, Georgetown University) |
| Abstract: | The general equilibrium model with incomplete financial markets (GEI) is extended by adding fiat money, fiscal and monetary policy and a cash-in-advance constraint. The central bank either pegs the interest rate or money supply while the fiscal authority sets a Ricardian or a non-Ricardian fiscal plan. We prove the existence of equilibria in all four scenarios. In Ricardian economies, the conditions required for existence are not more restrictive than in standard GEI. In non-Ricardian economies, the sufficient conditions for existence are more demanding. In the Ricardian economy, neither the price level nor the equivalent martingale measure is determinate. Classification-JEL Codes: D52; E40; E50 |
| Keywords: | Money; Incomplete Markets; Fiscal Policy; Indeterminacy |
| URL: | http://d.repec.org/n?u=RePEc:geo:guwopa:gueconwpa~06-06-05&r=mon |
| By: | Gábor Orbán (Magyar Nemzeti Bank); Zoltán Szalai (Magyar Nemzeti Bank) |
| Abstract: | The most important mechanism through which monetary policy affects the real economy in Hungary is the exchange rate channel. With euro adoption, this mechanism will largely disappear and the impact of monetary policy will be transmitted via the interest rate channel, presently seen as rather weak. This has raised concerns that the influence of monetary policy on the real economy in Hungary could be very limited after euro adoption. On top of this, other concerns have been voiced as regards potential asymmetries in the wage-setting behaviour, the exchange rate and credit channels. Based on the experience of today’s euro area participating countries and the structural characteristics of the Hungarian economy, this paper argues that after euro adoption 1) we may expect a broadening of the scope of the interest rate channel of monetary policy after euro adoption, 2) there are no institutional obstacles in the way of the effective functioning of the expectations channel in Hungary 3) substantially different monetary conditions from that in the euro area as a result of a different trade orientation are unlikely, and, finally 4) some asymmetries in the balance sheet channel may continue to exist for some time between Hungary and the core euro area countries but its effect will be significantly smaller after euro zone entry. |
| Keywords: | monetary transmission mechanism, transmission channels, EMU participation. |
| JEL: | E52 E58 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:mnb:backgr:2005/4&r=mon |
| By: | Peter Bofinger (University of Wuerzburg) |
| Abstract: | The paper provides an analysis of the first three years of the European Monetary Union. It discusses the changeover to Euro notes, the performance of monetary policy in terms of price stability and real growth, the establishment of credibility for the ECB, and the two pillar strategy. The weakness of the euro's exchange value during the first three years is explained. Some aspects of the eastern enlargement of the eurozone are examined especially the problems that may be associated with the lack of real convergence. Other issues such as the importance of a Balassa-Samuelson effect and the need for appropriate fiscal policies are discussed. |
| Keywords: | European Monetary Union, European Central Bank, Euro, monetary policy |
| JEL: | E42 E58 E60 |
| URL: | http://d.repec.org/n?u=RePEc:ece:dispap:3&r=mon |
| By: | Allen Head (Queen's University); Alok Kumar (University of Victoria); Beverly Lapham (Queen's University) |
| Abstract: | We study the responses of real and nominal prices to random flutuations in costs and money growth using a monetary search economy in which there are no costs or temporal restrictions on sellers' ability to change prices. The economy exhibits a form of price stickiness in that the price level may react incompletely to either type of shock as a result of endogenous changes in the average mark-up driven by movements in consumers' search intensity. The average mark-up falls as inflation rises, a finding consistent with emprical observations. As a result of this reduction in market power, prices become more responsive to shocks as inflation rises. Our results are consistent with empirical findings that the degree of price adjustment in response to both cost and money growth shocks is increasing in the average rate of inflation, that the variance of inflation increases with its average level, and that positive and negative shocks to money growth have asymmetric effects. |
| Keywords: | Search, Mark-up, Inflation, Price Dispersion, Pass-through |
| JEL: | E31 D43 E42 |
| Date: | 2006–01 |
| URL: | http://d.repec.org/n?u=RePEc:qed:wpaper:1089&r=mon |
| By: | Ricardo Lagos; Guillaume Rocheteau |
| Abstract: | We construct a model in which capital competes with fiat money as a medium of exchange, and establish conditions on fundamentals under which fiat money can be both valued and socially beneficial. When the socially efficient stock of capital is too low to provide the liquidity agents need, they overaccumulate productive assets to use as media of exchange. When this is the case, there exists a monetary equilibrium that dominates the nonmonetary one in terms of welfare. Under the Friedman rule, fiat money provides just enough liquidity so that agents choose to accumulate the same capital stock a social planner would. |
| Keywords: | Money |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0608&r=mon |
| By: | Stephanie Schmitt-Grohé; Martín Uribe |
| Abstract: | This paper computes welfare-maximizing monetary and fiscal policy rules in a real business cycle model augmented with sticky prices, a demand for money, taxation, and stochastic government consumption. We consider simple feedback rules whereby the nominal interest rate is set as a function of output and inflation, and taxes are set as a function of total government liabilities. We implement a second-order accurate solution to the model. Our main findings are: First, the size of the inflation coefficient in the interest-rate rule plays a minor role for welfare. It matters only insofar as it affects the determinacy of equilibrium. Second, optimal monetary policy features a muted response to output. More importantly, interest rate rules that feature a positive response to output can lead to significant welfare losses. Third, the welfare gains from interest-rate smoothing are negligible. Fourth, optimal fiscal policy is passive. Finally, the optimal monetary and fiscal rule combination attains virtually the same level of welfare as the Ramsey optimal policy. |
| JEL: | E52 E61 E63 |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12402&r=mon |
| By: | Gergely Kiss (Magyar Nemzeti Bank); Gábor Vadas (Magyar Nemzeti Bank) |
| Abstract: | As part of the monetary transmission studies of the Magyar Nemzeti Bank, this paper attempts to analyse the role of the housing market in the monetary transmission mechanism of Hungary. The housing market can influence monetary transmission through three channels, namely, the nature of the interest burden of mortgage loans, asset (house) prices, and the credit channel. The study first summarises the experiences of developed countries, paying special attention to issues arising from the monetary union. It then examines the developments in the Hungarian housing and mortgage markets in the last 15 years, as well as the expected developments and changes attendant to the adoption of the euro. Using panel econometric techniques, the study investigates the link between macroeconomic variables and house prices in Hungary, and the effect of monetary policy on housing investment and consumption through the wealth effect and house equity withdrawal. |
| Keywords: | Housing, Monetary transmission, Mortgage market, Panel econometrics. |
| JEL: | E52 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:mnb:backgr:2005/3&r=mon |
| By: | Roberto Frenkel; Lance Taylor |
| Abstract: | The exchange rate affects the economy through many channels and, consequently, has diverse macroeconomic and development impacts. Five are analysed in this paper: resource allocation, economic development, finance, external balance and inflation. The use of the exchange rate as a developmental tool in conjunction with its other uses (often in coordination with monetary policy) is at the focus of the discussion. |
| Keywords: | exchange rate, development policy |
| JEL: | F3 F4 O2 |
| Date: | 2006–02 |
| URL: | http://d.repec.org/n?u=RePEc:une:wpaper:19&r=mon |
| By: | Valadkhani, Abbas (University of Wollongong) |
| Abstract: | This paper examines the long- and short-run determinants of the demand for money in six countries in the Asian-Pacific region using panel data (1975-2002). Various country-specific coefficients are allowed to capture inter-country heterogeneities. Consistent with theoretical postulates, it is found that (a) the demand for money in the long-run positively responds to real income and inversely to the interest rate spread, inflation, the real effective exchange rate, and the US real interest rate; (b) the long-run income elasticity is greater than unity; and (c) both the currency substitution and capital mobility hypotheses hold only in the long run. |
| Keywords: | Demand for Money; Money and Interest Rate Spread; Panel Data |
| JEL: | E41 E52 C33 O11 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:uow:depec1:wp06-11&r=mon |
| By: | Pablo A. Guerron (Department of Economics, North Carolina State University) |
| Abstract: | I provide new empirical and theoretical evidence about the effectiveness of sterilized interventions on exchange rates. These new developments are particularly important to understand why central bankers from developing countries tend to intervene during periods of financial distress. In the first half of the paper, I apply a VAR formulation to measure the effects of sterilized interventions on the U.S. bilateral exchange rate. Information from the Exchange Stabilization Fund in the U.S. for the period 1974 -- 2000 is used to identify a shock that is orthogonal to the U.S. money supply and therefore mimics the role of sterilized interventions. According to my identification strategy, a sterilized intervention shock in favor of the U.S. dollar would appreciate it against a trade-weighted currency index by roughly 1 percent. This appreciation is statistically significant, lasts for about 1 year, and is robust to alternative identification strategies. Then, I devote the second part of the paper to rationalize the results from the empirical section by studying sterilized interventions within a two-country general equilibrium model. I find that if trading bonds is costly worldwide and asset markets are incomplete, a domestic government purchase of domestic bonds accompanied by a sale of foreign bonds, a sterilized intervention, appreciates the domestic currency. Accordingly, a calibrated version of the model renders similar results to those from the VAR formulation. |
| Keywords: | Exchange Rate, Sterilized Intervention, VAR, Open Economy |
| JEL: | C32 F3 E58 |
| Date: | 2006–01 |
| URL: | http://d.repec.org/n?u=RePEc:ncs:wpaper:007&r=mon |
| By: | Troy Davig; Eric M. Leeper |
| Abstract: | This paper makes changes in monetary policy rules (or regimes) endogenous. Changes are triggered when certain endogenous variables cross specified thresholds. Rational expectations equilibria are examined in three models of threshold switching to illustrate that (i) expectations formation effects generated by the possibility of regime change can be quantitatively important; (ii) symmetric shocks can have asymmetric effects; (iii) endogenous switching is a natural way to formally model preemptive policy actions. In a conventional calibrated model, preemptive policy shifts agents' expectations, enhancing the ability of policy to offset demand shocks; this yields a quantitatively significant "preemption dividend." |
| JEL: | E31 E32 E52 E58 |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12405&r=mon |
| By: | Kenneth Kuttner |
| Abstract: | This paper addresses the possible role of bond prices as operating or intermediate targets for monetary policy. The paper begins with a brief review of the mechanisms through which a central bank could, in theory, influence long-term interest rates, and continues with a brief narrative overview of debt management policies in the U.S., tracing their effects on the maturity distribution of outstanding publicly-held Treasury debt and the composition of the assets held by the Federal Reserve System. The empirical section presents new econometric evidence on the effects of these policies on expected excess holding returns (“term premia”), demonstrating that changes in the Fed’s holdings of long-term securities have had statistically significant and economically meaningful effects on the term premia associated with Treasury securities with maturities in the two- to five-year range. |
| JEL: | E43 E58 E63 |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12454&r=mon |
| By: | Stanley Fischer |
| Abstract: | In this paper I reflect on my first year as Governor of the Bank of Israel, which I joined in May 2005. I start by describing the current state of the Israeli economy and monetary policy and economic developments during the past year. I then review a series of issues that have arisen during the past year. Among them are: the monetary mechanism, which is unusual because exchange rate changes have a very rapid impact on prices; the role of inflation and interest rate expectations in policy decisions; the role of the interest rate gap with the US; the role of the Governor as chief economic adviser to the Government; banking supervision; and management and political issues. |
| JEL: | E50 E65 |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12426&r=mon |
| By: | Pablo A. Guerron (Department of Economics, North Carolina State University) |
| Abstract: | The interest semi-elasticity of money demand has been a long standing puzzle in the monetary economics literature. Researchers consistently have estimated low short-run semi-elasticities, usually around 1, and high long-run semi-elasticities of 10. Given the crucial role of interest semi-elasticity in determining the welfare costs of inflation and the effectiviness of tax cuts, we must understand why these short- and long-run estimates are so different. To explore this issue, I formulate and estimate a model of the demand for money that simultaneously accounts for low short- and high long-run semi-elasticities. In my formulation, re-balancing money holdings between money for purchases and money for financial investment is costly. I model this re-balancing cost by assuming that households re-optimize their money holdings subject to an exogenous probability. In the log-linearized version of my model, velocity depends on both its own past value and households' present and future expectations of the interest rate. I use this equilibrium condition to estimate my model's parameters by employing generalized method of moments. My estimates for the short-run and long-run interest semi-elasticities are 0.96 and 12.62, respectively. When I apply my model of money demand to explain the increase in the volatility of real balances after 1980, my model indicates that the late-1970s financial innovations, which facilitated portfolio re-balancing, lie behind this rise. |
| Keywords: | Interest Semi-Elasticity of Money Demand, Time-Dependent Portfolio Adjustment, Volatility, GMM. |
| JEL: | C32 E41 E47 |
| Date: | 2006–01 |
| URL: | http://d.repec.org/n?u=RePEc:ncs:wpaper:006&r=mon |
| By: | Alessandro Prati; Thierry Tressel |
| Abstract: | This paper analyses how monetary policy can enhance the effectiveness of volatile aid fl ows. We find that monetary policy is effective in reducing trade balance volatility. We propose the following taxonomy, excluding the case of emergency assistance. Monetary policy should slow down consumption growth and build up international reserves when aid is abundant and deplete them to finance imports and support consumption when aid is scarce. If foreign aid also affects productivity growth, monetary policy should take this productivity effect into account in responding to aid flows. |
| Keywords: | Aid effectiveness, monetary policy, real exchange rate, Dutch disease |
| JEL: | O11 O4 O23 E5 F35 |
| Date: | 2006–02 |
| URL: | http://d.repec.org/n?u=RePEc:une:wpaper:12&r=mon |
| By: | Sabina Pogorelec (European Investment Bank, 100 boulevard Konrad Adenauer, L-2950 Luxembourg, Luxembourg.) |
| Abstract: | I build a quantitative two-country DSGE model of the European Union (EU) and investigate whether there are welfare gains from fiscal policy cooperation between the new EU members and the euro area (EMU). Fiscal cooperation is defined in terms ofjoint maximization of the weighted average of households’ welfare. I find that fiscal policy cooperation is welfare-reducing for both groups of countries. This result depends on a realistic assumption about the presence of foreign ownership of firms in the new EU countries. When there is no foreign ownership in the new EU countries, the euro area is indifferent between cooperating and not cooperating, but the new EU members still prefer not to cooperate with EMU in terms of fiscal policy. JEL Classification: E63; F42. |
| Keywords: | Fiscal policy cooperation; Foreign ownership of firms; Fiscal-monetary interactions; Enlarged European Union; Central and eastern European countries. |
| Date: | 2006–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20060655&r=mon |
| By: | Roberto Rigobon; Brian Sack |
| Abstract: | The current literature has provided a number of important insights about the effects of macroeconomic data releases on monetary policy expectations and asset prices. However, one puzzling aspect of that literature is that the estimated responses are quite small. Indeed, these studies typically find that the major economic releases, taken together, account for only a small amount of the variation in asset prices—even those closely tied to near-term policy expectations. In this paper we argue that this apparent detachment arises in part from the difficulties associated with measuring macroeconomic news. We propose two new econometric approaches that allow us to account for the noise in measured data surprises. Using these estimators, we find that asset prices and monetary policy expectations are much more responsive to incoming news than previously believed. Our results also clarify the set of facts that should be captured by any model attempting to understand the interactions between economic data, monetary policy, and asset prices. |
| JEL: | E44 E47 E52 |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12420&r=mon |
| By: | Daniel Levy |
| Abstract: | The price system, the adjustment of prices to changes in market conditions, is the primary mechanism by which markets function and by which the three most basic questions get answered; what to produce, how much to produce and for whom to produce. To the behaviour of price and price system, therefore, have fundamental implications for many key issues in microeconomics and industrial organization, as well as in macroeconomics and monetary economics. In microeconomics, managerial economics, and industrial organization, economists focus on the price system efficiency. In macroeconomics and monetary economics, economists focus on the extent to which nominal prices fail to adjust to changes in market conditions. Nominal price rigidities play particularly important role in modern monetary economics and in the conduct of monetary policy because of their ability to explain short-run monetary non-neutrality. The behaviour of prices, and in particular the extent of their rigidity and flexibility, therefore, is of central importance in economics. |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:emo:wp2003:0608&r=mon |
| By: | Simon Gilchrist; Masashi Saito |
| Abstract: | This paper studies the implications of financial market imperfections represented by a countercyclical external finance premium and the gradual recognition of changes in the drift of technology growth for the design of an interest rate rule. Asset price movements induced by changes in trend growth influence balance-sheet conditions that determine the external finance premium. Such movements are magnified when the private sector is imperfectly informed regarding the trend growth rate of technology. The presence of financial market imperfections provides a motivation for responding to the gap between the observed asset prices and the potential level of asset prices in addition to responding strongly to inflation. This is because the asset price gap represents distortions in the resource allocation induced by financial market imperfections more distinctly than inflation. The policymaker's imperfect information about the drift of technology growth renders imprecise the calculation of the potential and thus reduces the benefit of responding to the asset price gap. A policy that responds to the level of asset prices which does not take into account changes in potential tends to be welfare reducing. |
| JEL: | E44 E52 O41 |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12442&r=mon |
| By: | Pablo A. Guerron (Department of Economics, North Carolina State University) |
| Abstract: | I study the effects of a monetary shock in an economy characterized by heterogenous labor schedules and non-separability between consumption and labor in the utility function. To that end, I develop a simple method to deal with household heterogeneity arising from wealth differentials. Compared to competing models in the literature, the estimated version of my model fits better the responses of output, consumption, and wages after a monetary shock. Notably, my model requires no adjustment cost in investment, and smaller degrees of habit formation preference for consumption, and wage stickiness than other standard models. Furthermore, I show that non-separability is an important source of amplification of the effects of a monetary shock on output and investment. |
| Keywords: | Heterogeneous Choices, Impulse Responses, Monetary Policy |
| JEL: | E3 E4 E5 |
| Date: | 2006–05 |
| URL: | http://d.repec.org/n?u=RePEc:ncs:wpaper:005&r=mon |