nep-mon New Economics Papers
on Monetary Economics
Issue of 2006‒09‒16
twenty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Modelling the Duration of Interest Rate Spells Under Inflation Targeting in Canada By Ruby Shih; David E. A. Giles
  2. Monetary policy with model uncertainty: distribution forecast targeting By Svensson, Lars E.O.; Williams, Noah
  3. Turkish Experience With Implicit Inflation Targeting By Ali Hakan Kara
  4. The long-run Fisher effect: can it be tested? By Mark J. Jensen
  5. Slow Money Dissemination By Zeno Enders
  6. Changes in the Federal Reserve's Inflation Target: Causes and Consequences By Peter N. Ireland
  7. Assessing Different Drivers of the GreatModeration in the U.S. By Efrem Castelnuovo
  8. Is there a bank lending channel in Hungary? Evidence from bank panel data By Csilla Horváth; Judit Krekó; Anna Naszódi
  9. A Companion to "The Origin and Diffusion of Shocks to Regional Interest Rates in the United States, 1880-2002." By Hugh Rockoff; John Landon-Lane
  10. Futures prices as risk-adjusted forecasts of monetary policy By Monika Piazzesi; Eric T. Swanson
  11. Phillips Curves and Unemployment Dynamics: A Critique and a Holistic Perspective By Marika Karanassou; Hector Sala; Dennis J. Snower
  12. International Financial Instability in a World of Currencies Hierarchy By Andrea Terzi
  13. Are Monetary Rules and Reforms Complements or Substitutes? A Panel Analysis for the World versus OECD Countries By Ansgar Belke; Bernhard Herz; Lukas Vogel
  14. A factor analysis of volatility across the term structure: the Spanish case By Sonia Benito; Alfonso Novales
  15. U.S. wage and price dynamics: a limited information approach By Argia M. Sbordone
  16. Swiss Exchange Rate Policy in the 1930s. Was the Delay in Devaluation Too High a Price to Pay for Conservatism? By Michael Bordo; Thomas Helbling; Harold James
  17. A Worldwide System of Reference Rates By John Williamson
  18. The adaptive markets hypothesis: evidence from the foreign exchange market By Christopher J. Neely; Paul A. Weller; Joshua M. Ulrich
  19. The Forward Market in Emerging Currencies: Less Biased Than in Major Currencies By Jeffrey Frankel; Jumana Poonawala
  20. The Returns to Currency Speculation By Craig Burnside; Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo
  21. The Credibility of Cabo Verde’s Currency Peg By Macedo, Jorge Braga de; Pereira, Luis Brites
  22. Trade First and Trade Fast: A Duration Analysis of Recovery from Currency Crisis By Saubhik Deb

  1. By: Ruby Shih (Department of Economics, University of Victoria); David E. A. Giles (Department of Economics, University of Victoria)
    Abstract: We use survival models to analyze the duration of the spells associated with the interest rate used by the Bank of Canada as its monetary policy instrument. Both non-parametric and parametric models are estimated, allowing for right-censoring of the data, and time-varying covariates. We find that the data are explained well by an accelerated failure time Weibull model, with the annual rate of inflation and the quarterly rate of growth in GDP as covariates. The model indicates that there is positive duration dependence in the interest rate spells, and that unemployment and exchange rate effects are insignificant.
    Keywords: Inflation target, survival analysis, monetary policy
    JEL: C14 C42 E43
    Date: 2006–09–08
  2. By: Svensson, Lars E.O.; Williams, Noah
    Abstract: We examine optimal and other monetary policies in a linear-quadratic setup with a relatively general form of model uncertainty, so-called Markov jump-linear-quadratic systems extended to include forward-looking variables. The form of model uncertainty our framework encompasses includes : simple i.i.d. model deviations; serially correlated model deviations; estimable regimeswitching models; more complex structural uncertainty about very different models, for instance, backward- and forward-looking models; time-varying central-bank judgment about the state of model uncertainty; and so forth. We provide an algorithm for finding the optimal policy as well as solutions for arbitrary policy functions. This allows us to compute and plot consistent distribution forecasts–fan charts–of target variables and instruments. Our methods hence extend certainty equivalence and “mean forecast targeting” to more general certainty non-equivalence and “distribution forecast targeting.”
    Keywords: Optimal policy, multiplicative uncertainty
    JEL: E42 E52 E58
    Date: 2005
  3. By: Ali Hakan Kara
    Date: 2006
  4. By: Mark J. Jensen
    Abstract: Empirical support for the long-run Fisher effect, a hypothesis that a permanent change in inflation leads to an equal change in the nominal interest rate, has been hard to come by. This paper provides a plausible explanation of why past studies have been unable to find support for the long-run Fisher effect. This paper argues that the necessary permanent change to the inflation rate following a monetary shock has not occurred in the industrialized countries of Australia, Austria, Belgium, Canada, Denmark, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Norway, Sweden, Switzerland, the United Kingdom, and the United States. Instead, this paper shows that inflation in these countries follows a mean-reverting, fractionally integrated, long-memory process, not the nonstationary inflation process that is integrated of order one or larger found in previous studies of the Fisher effect. Applying a bivariate maximum likelihood estimator to a fractionally integrated model of inflation and the nominal interest rate, the inflation rate in all seventeen countries is found to be a highly persistent, fractionally integrated process with a positive differencing parameter significantly less than one. Hence, in the long run, inflation in these countries will be unaffected by a monetary shock, and a test of the long-run Fisher effect will be invalid and uninformative as to the truthfulness of the long-run Fisher effect hypothesis.
    Date: 2006
  5. By: Zeno Enders
    Abstract: A model of limited participation in the asset market is developed, in which varieties of consumption bundles are purchased sequentially. By this, heterogeneity in money holdings and in the effective elasticity of substitution of consumers arises, which affects optimal markups chosen by oligopolistic firms. The model generates a short-term inflation-output trade off, although all firms can set their optimal price each period and no informational problems exist. The responses are persistent even after a one-time monetary shock due to an internal propagation mechanism that stems from the slow dissemination of newly injected money. Furthermore, a liquidity effect, countercyclical markups, procyclical profits and marginal costs after monetary shocks are obtained. The model is simple and tractable, such that analytical results for the linearized model can be derived.
    Keywords: Limited Participation, Countercyclical Markups, Liquidity Effect Phillips Curve, Oligopolistic Competition
    JEL: E31 E32 E51
    Date: 2006
  6. By: Peter N. Ireland
    Abstract: This paper estimates a New Keynesian model to draw inferences about the behavior of the Federal Reserve's unobserved inflation target. The results indicate that the target rose from 1 1/4 percent in 1959 to over 8 percent in the mid-to-late 1970s before falling back below 2 1/2 percent in 2004. The results also provide some support for the hypothesis that over the entire postwar period, Federal Reserve policy has systematically translated short-run price pressures set off by supply-side shocks into more persistent movements in inflation itself, although considerable uncertainty remains about the true source of shifts in the inflation target.
    JEL: E31 E32 E52
    Date: 2006–08
  7. By: Efrem Castelnuovo (University of Padua)
    Abstract: This paper employs a calibrated new-Keynesian DSGE model to assess the relative importance of two different, potentially important drivers of the Great Moderation in the U.S., namely 'good policy' vs. 'good luck'. The calibrated model is capable to replicate the actual standard deviations of inflation and output. Factual and counterfactual simulations are run in order to gauge the relative importance of the systematic monetary policy vs. the stochastic shocks hitting the economic system in shaping some macroeconomic volatilities. Importantly, under the bad policy scenario sunspots may influence the equilibrium values of the macroeconomic variables of interest, and distortions in the transmission mechanism going from the structural shocks to the variables of interest are allowed for. Our findings support the relevance of both drivers in causing inflation volatility. By contrast, output volatility can hardly be explained by a monetary policy switch like the one occurred in the U.S. at the end of the '70s.
    JEL: E30 E52
    Date: 2006–08
  8. By: Csilla Horváth; Judit Krekó (Magyar Nemzeti Bank); Anna Naszódi (Magyar Nemzeti Bank)
    Abstract: In this paper we analyze the bank lending channel in Hungary. We provide a brief overview of the theory and the empirical approaches used to investigate the existence of bank lending channel. From the possible methods we use the generally applied approach suggested by Kahsyap and Stein (1995) which relies on discovering asymmetries in changes in the amount of loans to monetary actions in order to isolate supply and demand effects. We estimate an ARDL model where the asymmetric effects are captured by interaction-terms. We find significant asymmetric adjustment of loan quantities along certain bank characteristics. The existence of bank lending channel, and therefore loan supply decisions of banks, can explain these asymmetries. In addition, we do not find any sign for asymmetric loan demand adjustment along these variables. According to these findings, we cannot rule out the existence of the bank lending channel in Hungary.
    Keywords: monetary transmission, credit channel, bank lending channel, ARDL model.
    JEL: C23 E44 E52 G21
    Date: 2006
  9. By: Hugh Rockoff (Rutgers); John Landon-Lane (Rutgers)
    Abstract: This paper contains all of the statistical results underlying our paper "The Origin and Diffusion of Shocks to Regional Interest Rates in the United States, 1880-2002." It also contains a table of the underlying data, and a discussion of how the data was constructed.
    Keywords: interest rates, monetary unions
    JEL: N22
    Date: 2006–07–31
  10. By: Monika Piazzesi; Eric T. Swanson
    Abstract: Many researchers have used federal funds futures rates as measures of financial markets' expectations of future monetary policy. However, to the extent that federal funds futures reflect risk premia, these measures require some adjustment. In this paper, we document that excess returns on federal funds futures have been positive on average and strongly countercyclical. In particular, excess returns are surprisingly well predicted by macroeconomic indicators such as employment growth and financial business-cycle indicators such as Treasury yield spreads and corporate bond spreads. Excess returns on eurodollar futures display similar patterns. We document that simply ignoring these risk premia significantly biases forecasts of the future path of monetary policy. We also show that risk premia matter for some futures-based measures of monetary policy shocks used in the literature.
    Keywords: Federal funds rate ; Federal funds market (United States) ; Monetary policy
    Date: 2006
  11. By: Marika Karanassou (Queen Mary, University of London and IZA Bonn); Hector Sala (Universitat Autònoma de Barcelona and IZA Bonn); Dennis J. Snower (Kiel Institute for World Economics, University of Kiel, CEPR and IZA Bonn)
    Abstract: The conventional wisdom that inflation and unemployment are unrelated in the long-run implies that these phenomena can be analysed by separate branches of economics. The macro literature tries to explain inflation dynamics and estimates the NAIRU. The labour macro literature tries to explain unemployment dynamics and determine the real economic factors that drive the natural rate of unemployment. We show that the orthodox view that the New Keynesian Phillips curve is vertical in the long-run and that it cannot generate substantial inflation persistence relies on the implausible assumption of a zero interest rate. In the light of these results, we argue that a holistic framework is needed to jointly explain the evolution of inflation and unemployment.
    Keywords: natural rate of unemployment, NAIRU, New Keynesian Phillips Curve, inflation-unemployment tradeoff, inflation dynamics, unemployment dynamics
    JEL: E24 E31
    Date: 2006–08
  12. By: Andrea Terzi
    Abstract: The 1990s witnessed an increase in international financial turbulence. In fact, financial crises have become a global policy issue, due to their frequency, size, geographic extension, and social costs, while an array of policy actions have been advocated to prevent crises from happening again. One significant, yet controversial question is whether efforts should be directed towards national reforms in emerging markets or, rather, towards a new international design of international payments. After a critical review of the standing proposals, this paper contends that this debate has not yet fully explored one of the problems of international instability, that is to say, the problem raised by international payments in a world where currencies are of diverse quality. As Keynes firmly contended, the monetary side of the (global) economy is not a neutral factor. In fact, it may be that some of the fundamental factors behind any model of international financial instability, are the problems posed by the different degrees of “international moneyness” that make currencies unequal. Viewed in this light, a major re-design of international payments systems is warranted, and options seem limited to either world dollarization or the ‘bancor’ solution. Recent reformulations of Keynes’s original ‘bancor’ proposal seem to be a more viable alternative to either the status quo or world dollarization.
    Keywords: Currency hierarchy, Currency crises, Banking crises, Capital flows, International monetary arrangements and institutions
    JEL: F02 F33 F34 G15
    Date: 2005–10
  13. By: Ansgar Belke (University of Hohenheim); Bernhard Herz (University of Bayreuth); Lukas Vogel (University of Bayreuth)
    Abstract: This paper investigates the relationship between the exchange rate regime and the degree of structural reforms using panel data techniques. We look at a broad sample of countries (the “world sample”) and also an OECD sample. Our main findings suggest that adopting a fixed exchange rate rule is positively correlated with the degree of overall structural reforms and the trade component. The paper also highlights the fact that considering a heterogeneous panel of countries as opposed to a limited does not matter for this results.
    Date: 2006–06–07
  14. By: Sonia Benito (Universidad Complutense de Madrid. Facultad de CC. Económicas y Empresariales. Dpto. de Economía Cuantitativa.); Alfonso Novales (Universidad Complutense de Madrid. Facultad de CC. Económicas y Empresariales. Dpto. de Economía Cuantitativa.)
    Abstract: We show how the term structure of volatilities for zero-cupon interest rates from the Spanish secondary debt market can be explained by a reduced number of factors. This factor representation can be used to produce time series volatilities across the whole term structure. As an alternative, volatilities can also be derived from a factor model for interest rates themselves. We find evidence contrary to the hypothesis that these two procedures lead to statistically equivalent time series, so that choosing the right model to estimate volatility is far from trivial. The volatility factor model fits univariate EGARCH volatility time series much better than the interest rate factor model does. However, observed differences seem to be of little consequence for VaR estimation on zero coupon bonds.
    Date: 2005
  15. By: Argia M. Sbordone
    Abstract: This paper analyzes the dynamics of prices and wages using a limited information approach to estimation. I estimate a two-equation model for the determination of prices and wages derived from an optimization-based dynamic model in which both goods and labor markets are monopolistically competitive; prices and wages can be reoptimized only at random intervals; and, when prices and wages are not reoptimized, they can be partially adjusted to previous-period aggregate inflation. The estimation procedure is a two-step minimum distance estimation that exploits the restrictions imposed by the model on a time-series representation of the data. In the first step, I estimate an unrestricted autoregressive representation of the variables of interest. In the second, I express the model solution as a constrained autoregressive representation of the data and define the distance between unconstrained and constrained representations as a function of the structural parameters that characterize the joint dynamics of inflation and labor share. This function summarizes the cross-equation restrictions between the model and the time-series representations of the data. I then estimate the parameters of interest by minimizing a quadratic function of that distance. I find that the estimated dynamics of prices and wages track actual dynamics quite well and that the estimated parameters are consistent with the observed length of nominal contracts.
    Keywords: Prices ; Wages ; Estimation theory ; Inflation (Finance)
    Date: 2006
  16. By: Michael Bordo; Thomas Helbling; Harold James
    Abstract: In this paper we examine the experience of Switzerland’s devaluation in 1936. The Swiss case is of interest because Switzerland was a key member of the gold bloc, and much of the modern academic literature on the Great Depression tries to explain why Switzerland and the other gold bloc countries, France, and the Netherlands, remained on the gold standard until the bitter end. We ask the following questions: what were the issues at stake in the political debate? What was the cost to Switzerland of the delay in the franc devaluation? What would have been the costs and benefits of an earlier exchange rate policy? More specifically, what would have happened if Switzerland had either joined the British and devalued in September 1931, or followed the United States in April 1933? To answer these questions we construct a simple open economy macro model of the interwar Swiss economy. On the basis of this model we then posit counterfactual scenarios of alternative exchange rate pegs in 1931 and 1933. Our simulations clearly show a significant and large increase in real economic activity. If Switzerland had devalued with Britain in 1931, the output level in 1935 would have been some 18 per cent higher than it actually was in that year. If Switzerland had waited until 1933 to devalue, the improvement would have been about 15 per cent higher. The reasons Switzerland did not devalue earlier reflected in part a conservatism in policy making as a result of the difficulty of making exchange rate policy in a democratic setting and in part the consequence of a political economy which favored the fractionalization of different interest groups.
    JEL: N1 N13
    Date: 2006–08
  17. By: John Williamson (Institute for International Economics)
    Date: 2006–06–31
  18. By: Christopher J. Neely; Paul A. Weller; Joshua M. Ulrich
    Abstract: We analyze the intertemporal stability of returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously published rules. The excess returns of the 1970s and 1980s were genuine and not just the result of data mining. But these profit opportunities had disappeared by the mid-1990s for filter and moving average (MA) rules. Returns to less-studied rules, such as channel, ARIMA, genetic programming and Markov rules, also have declined, but have probably not completely disappeared. The volatility of returns makes it difficult to estimate mean returns precisely. The most likely time for a structural break in the MA and filter rule returns is the early 1990s. These regularities are consistent with the Adaptive Markets Hypothesis (Lo, 2004), but not with the Efficient Markets Hypothesis.
    Keywords: Foreign exchange market ; Foreign exchange
    Date: 2006
  19. By: Jeffrey Frankel; Jumana Poonawala
    Abstract: Many studies have replicated the finding that the forward rate is a biased predictor of the future change in the spot exchange rate. Usually the forward discount actually points in the wrong direction. But virtually all those studies apply to advanced economies and major currencies. We apply the same tests to a sample of 14 emerging market currencies. We find a smaller bias than for advanced country currencies. The coefficient is on average positive, i.e., the forward discount at least points in the right direction. It is never significantly less than zero. To us this suggests that a time-varying exchange risk premium may not be the explanation for traditional findings of bias. The reasoning is that emerging markets are probably riskier; yet we find that the bias in their forward rates is smaller. Emerging market currencies probably have more easily-identified trends of depreciation than currencies of advanced countries.
    JEL: F0 F15 F31
    Date: 2006–08
  20. By: Craig Burnside; Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo
    Abstract: Currencies that are at a forward premium tend to depreciate. This `forward-premium puzzle' represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. The first strategy, known as the carry trade, is widely used by practitioners. This strategy involves selling currencies forward that are at a forward premium and buying currencies forward that are at a forward discount. The second strategy relies on a particular regression to forecast the payoff to selling currencies forward. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. However, these Sharpe ratios do not represent unexploited profit opportunities. In the presence of microstructure frictions, spot and forward exchange rates move against traders as they increase their positions. The resulting `price pressure' drives a wedge between average and marginal Sharpe ratios. We argue that marginal Sharpe ratios are zero even though average Sharpe ratios are positive.
    JEL: E24 F31 G15
    Date: 2006–08
  21. By: Macedo, Jorge Braga de; Pereira, Luis Brites
    Abstract: This paper studies the credibility of the currency peg of Cape Verde (CV) by assessing the impact of economic fundamentals, our explanatory variables, on the stochastic properties of Exchange Market Pressure (EMP), the dependent variable, using EGARCH-M models. Our EMP descriptive analysis finds a substantial reduction in the number of crisis episodes and of (unconditional) volatility after the peg’s adoption. Moreover, our estimation results suggest that mean EMP is driven by fundamentals and that conditional variability is more sensitive to negative shocks. We also find evidence that the expected return from holding CV’s assets is lower under the currency peg for the same increase in monthly volatility. The reason is that the return’s composition is “more virtuous”, as it results from the strengthening of CV’s foreign reserve position and is not due to either a larger risk premium or favourable exchange rate movements. We take this to be a sign of the credibility of the peg, which apparently reflects the intertemporal credibility of CV’s economic policy and so has successfully withstood international markets’ scrutiny.
    Date: 2006
  22. By: Saubhik Deb (Department of Economics)
    Abstract: Over the last three decades, durations of recovery of output from contractionary currency crises have shown much variation both within and across countries. Using a dataset comprising of both developing and industrial countries, this paper examines the importance of economic fundamentals, international trade and liberalized capital account in determining the speed of recovery from such crises. We found that poor macroeconomic fundamentals and capital account liberalization have no significant effect on duration of recovery. However, all trade related variables were found to be significant. Our results indicate the preeminence of export led recovery.
    Keywords: Currency Crisis, Output Recovery, Duration Analysis
    JEL: F30 F41 C41
    Date: 2006–04–06

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