nep-mon New Economics Papers
on Monetary Economics
Issue of 2006‒09‒30
25 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Financial Structure and its Impact on the Convergence of Interest Rate Pass-through in Europe. A Time-varying Interest Rate Pass-through Model By Schwarzbauer, Wolfgang
  2. Foreign exchange market interventions as monetary policy By Post, Erik
  3. Why are federal central banks more activist? By Hein Roelfsema
  4. Real and Nominal UK Interest Rates, ERM Membership and Inflation Targeting By Reschreiter, Andreas
  5. Monetary Cooperation in the North American Economy By David Laidler
  6. The price puzzle: fact or artefact? By Efrem Castelnuovo; Paolo Surico
  7. The danger of inflating expectations of macroeconomic stability: heuristic switching in an overlapping generations monetary model By Alex Brazier; Richard Harrison; Mervyn King; Tony Yates
  8. Monetary policy and private sector misperceptions about the natural level of output By Jarkko J""skel"; Jack McKeown
  9. Finland`s Experiences and Challenges in the Euro Zone By Markku Kotilainen
  10. Misperceptions and monetary policy in a New Keynesian model By Jarkko J""skel"; Jack McKeown
  11. UK monetary regimes and macroeconomic stylised facts By Luca Benati
  12. Bank capital, asset prices and monetary policy By David Aikman; Matthias Paustian
  13. Determinants of long-term interest rates in the Scandinavian countries By Suzan Hol
  14. Panel Cointegration and the Neutrality of Money By Westerlund, Joakim; Costantini, Mauro
  15. Monetary reform in times of Charles II (1679-1686): Aspects concerning the issued dispositions. By Cecilia Font de Villanueva
  16. Supply shocks and currency crises : the policy dilemma reconsidered By García-Fronti, Javier; Miller, Marcus; Zhang, Lei
  17. Pricing-to-market, sectoral shocks and gains from monetary cooperation By Bastiaan Verhoef
  18. Monetary policy and data uncertainty By Jarkko J""skel"; Tony Yates
  19. A model of bank capital, lending and the macroeconomy: Basel I versus Basel II By Lea Zicchino
  20. Will it float? The New Keynesian Phillips curve tested on OECD panel data By Roger Bjørnstad and Ragnar Nymoen
  21. The Euro Changeover and its Effects on Price Transparency and Inflation. By Giovanni Mastrobuoni; Wioletta Dziuda
  22. A Comparison of Five Federal Reserve Chairmen: Was Greenspan the Best? By Ray C. Fair
  23. The New Keynesian Phillips Curve in the United States and the euro area: aggregation bias, stability and robustness By Bergljot Barkbu; Vincenzo Cassino; Aileen Gosselin-Lotz; Laura Piscitelli
  24. Empirical Phillips Curves in OECD Countries: Has There Been A Common Breakdown? By Doyle, Matthew
  25. The welfare benefits of stable and efficient payment systems By Stephen Millard; Matthew Willison

  1. By: Schwarzbauer, Wolfgang (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)
    Abstract: So far studies concerned with the interest pass-through of monetary policy have not taken into account one central issue that arose in Europe in the late 1990s: the importance of financial structure for the convergence of monetary transmission. This study addresses this shortcoming. We estimate a time varying interest pass-through allowing us to test for the importance of financial structure and its impact on the convergence of the effects of monetary policy. We find convergence in banks' reaction to money market movements, which is additionally reduced in groups of countries with similar financial structure. Furthermore, there is a significant impact of financial structure on the extent of transmission of monetary policy impulses within the same month. Thus, differences in financial structure between countries must not be ignored when considering convergence of monetary transmission in Europe.
    Keywords: Convergence, Interest rate pass-through, EMU, Financial structure, Money and bank interest rates, Transmission mechanism
    JEL: E43 G21 E52
    Date: 2006–09
  2. By: Post, Erik (Department of Economics)
    Abstract: This paper sets up a simple model for interventions and interest rate setting assuming that the policy maker cares about deviations in inflation from a target level. Under a quadratic cost of interest rate adjustments and interventions the policy maker should use a combination of interest rate adjustment and interventions. According to the model interventions (purchases of foreign currency) will be negatively correlated with interest rate deviations from the steady state level but positively correlated with interest rate deviations pertaining to non-stabilizing motives or a binding zero lower bound. The model also predicts that interventions will be decreasing in inflation expectations and in the real exchange rate but increasing the expected interventions. Interventions are shown to be positively serially correlated if the policy maker cares about the future. Following the theoretical model closely two sets of regression results are presented using both Two Stage Least Squares and an Ordered Probit model. The empirical analysis uses daily intervention data for Australia, Japan and Sweden. Overall, the predictions of the model is supported in most dimensions indicating that interventions have been used in a way that is consistent with monetary policy considerations.
    Keywords: foreign exchange interventions; monetary policy; central banks
    JEL: E52 E58 F31
    Date: 2006–09–26
  3. By: Hein Roelfsema
    Abstract: This paper analyzes monetary policy making by a committee of regional representatives in a currency union with asymmetric shocks. By considering strategic delegation of monetary policy making, we show that regional representatives in a federal policy making committee may be more activist than the average citizen in their district. Hence, in our model federal central banks such as the ECB and the FED respond more aggressively to output shocks when compared to individual central banks.
    Keywords: Central Banking, Asymmetric Shocks, Federations, Strategic Delegation
    JEL: F33 F53 E58
    Date: 2006–09
  4. By: Reschreiter, Andreas (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)
    Abstract: This paper models the time-varying mean of the UK real and nominal short-term interest rate. Both rates mean revert to a time-varying central tendency in continuous-time interest rate models. Before and during British membership in the ERM, the mean of the real and nominal short rate have a strong negative correlation. Afterwards, when the UK implemented an inflation targeting policy, the mean of the real and nominal short rate are no longer negatively correlated, but instead have a strong positive correlation. The paper also reports empirical evidence of a relationship between the mean of the real and nominal short rate and inflation in the period before the departure from the ERM.
    Keywords: ERM, Inflation targeting, Nominal and real rates, Term structure model, UK
    JEL: E52 F33 G12
    Date: 2006–09
  5. By: David Laidler (University of Western Ontario)
    Abstract: The economic integration of North America, unlike that of Europe, has no parallels on the political front, and U.S. economic and political interests are world-wide, while those of Canada and Mexico are predominantly regional. These facts have important implications for the degree of policy integration, not least in monetary matters, that is feasible within NAFTA. Each member has an interest in the monetary stability of the others, but a common currency -- even a pegged exchange rate system -- is not desirable without a significantly greater degree of labour market integration than currently exists, and without a willingness on the part of the U.S. authorities to subordinate national to regional interests in their policy making. Absent these preconditions, monetary stability within NAFTA is best achieved by each country pursuing its own domestic stability, while maintaining the current high degree of formal and informal communications about economic conditions and policy intentions implicit in current arrangements.
    Keywords: NAFTA; economic integration; currency unions; exchange rate regimes; monetary policy; inflation targets
    JEL: E41 E58 E61 F15 F33 F42
    Date: 2006
  6. By: Efrem Castelnuovo; Paolo Surico
    Abstract: This paper re-examines the empirical evidence on the price puzzle and proposes a new theoretical interpretation. Using structural VARs and two different identification strategies based on zero restrictions and sign restrictions, we find that the positive response of prices to a monetary policy shock is historically limited to the subsamples associated with a weak central bank response to inflation. These subsamples correspond to the pre-Volcker period for the United States and the period prior to the introduction of the inflation targeting framework for the United Kingdom. Using a micro-founded New Keynesian monetary policy model for the US economy, we then show that the structural VARs are capable of reproducing the price puzzle from artificial data only when monetary policy is passive and hence multiple equilibria arise. In contrast, this model never generates on impact a positive inflation response to a policy shock. The omission in the VARs of a variable capturing the high persistence of expected inflation under indeterminacy is found to account for the price puzzle observed in actual data.
  7. By: Alex Brazier; Richard Harrison; Mervyn King; Tony Yates
    Abstract: The volatility of inflation and output has fallen in most advanced economies in the 1990s and 2000s. We use a monetary overlapping generations model to discuss the cause and durability of this macroeconomic change. In that model, agents' decision rules require them to make forecasts of future inflation, which, because of shocks to productivity, is uncertain. Agents make forecasts of inflation using two rules of thumb or 'heuristics'. One is based on lagged inflation, the other on an inflation target announced by the central bank. They switch between those heuristics based on an imperfect assessment of how each has performed in the past. The way the economy propagates productivity shocks into inflation depends on the proportion of agents using each. Movements in that proportion generate fluctuations in small sample measures of economic volatility. We use this simple model of heuristic switching to contrast the performance of monetary policy rules. We find that, relative to the rule that would be optimal under rational expectations, a rule that responds to both productivity shocks and inflation expectations better stabilises the economy but does not prevent agents switching between heuristics. Finally, we study the impact of introducing an explicit inflation target, which can be used by agents as a simple heuristic, into an economy that did not previously have one. Depending on the heuristics agents have access to before the introduction of the target, this can result in reduced inflation volatility.
  8. By: Jarkko J""skel"; Jack McKeown
    Abstract: In this paper we illustrate, using a simple model of monetary policy, the welfare costs of the private sector and/or the central bank being uncertain about the natural level of output. It turns out that monetary policy strategies that put less weight on output stabilisation can offset some of these welfare costs.
  9. By: Markku Kotilainen
    Keywords: Economic and Monetary Union, EMU, Finland
    JEL: E30 E32 E42 E52 F33 F41 F42
    Date: 2006–09–27
  10. By: Jarkko J""skel"; Jack McKeown
    Abstract: This paper studies the consequences for the monetary policy design of information shortages on the part of the private sector. We model these shortages as exogenous shocks to expected output, which through an IS curve, disturb demand and output themselves. We constrain policymakers to follow Taylor-like rules but allow them to optimise coefficients: we find that the presence of misperceptions makes the optimised Taylor rule respond more aggressively to inflation and the output gap. We also find that if the policymaker is uncertain about misperceptions, then it is less costly to assume they are pervasive when they are not than the reverse. In other words, setting policy on the basis that the private sector is subject to misperceptions is a 'robust' policy
  11. By: Luca Benati
    Abstract: We exploit the marked changes in UK monetary arrangements since the metallic standards era to investigate continuity and changes across monetary regimes in key macroeconomic stylised facts in the United Kingdom. We find that, historically, inflation persistence has been the exception, rather than the rule, with inflation estimated to have been highly persistent only during the period between the floating of the pound, in June 1972, and the introduction of inflation targeting, in October 1992. As a corollary, our results clearly reject Mishkin's explanation for time variation in the extent of the Fisher effect, favouring instead Barsky's theory. We document a remarkable stability across regimes in the correlation between inflation and the rates of growth of both narrow and broad monetary aggregates at the very low frequencies, thus countering the Whiteman-McCallum criticism of Lucas. The post-1992 inflation-targeting regime appears to have been characterised, to date, by the most stable macroeconomic environment in recorded UK history, with the volatilities of the business-cycle components of real GDP, national accounts aggregates, and inflation measures having been, post-1992, systematically lower than for any of the pre-1992 monetary regimes/historical periods, often markedly so, as in the case of inflation and real GDP. The Phillips correlation between inflation and unemployment was flattest under the gold standard, steepest between 1972 and 1992. In line with Ball, Mankiw and Romer, evidence points towards a positive correlation between mean inflation and the steepness of the trade-off. We show how Keynes, in his dispute with Dunlop and Tarshis on real wage cyclicality, was entirely right: during the inter-war period, real wages were strikingly countercyclical. By contrast, under inflation targeting they have been, so far, strongly procyclical.
  12. By: David Aikman; Matthias Paustian
    Abstract: We study a general equilibrium model in which informational frictions impede entrepreneurs' ability to borrow and banks' ability to intermediate funds. These financial market frictions are embedded in an otherwise-standard dynamic New Keynesian model. We find that exogenous shocks have an amplified and more persistent effect on output and investment, relative to the case of perfect capital markets. The chief contribution of the paper is to analyse how these financial sector imperfections - in particular, those relating to the banking sector - modify our understanding of optimal monetary policy. Our main finding is that optimal monetary policy tolerates only a very small amount of inflation volatility. Given that similar results have been reported for models that abstract from banks, we conclude that assigning a non-trivial role for banks need not materially affect the properties of optimal monetary policy.
  13. By: Suzan Hol (Statistics Norway)
    Abstract: The financial markets in a small open economy like the Scandinavian countries are influenced by international economic developments, especially in their major trading partners. This paper investigates to which degree nominal long-term interest rates in Norway, Sweden and Denmark are determined by fundamental domestic macroeconomic variables and by international economic conditions. Relating the level of interest rates to international macroeconomic variables also sheds some light on the degree of financial marketintegration. In Norway the currency risk, exchange rate regime, international debt and unemployment in Europe are significant in explaining the interest rate differential. In Sweden domestic and US inflation are important, while for Denmark domestic debt, domestic and US money stock, and less significantly US inflation are determinants of the interest rate differential. In these three countries with quite different economies the expectations hypothesis, the effect of domestic growth and unemployment and of international growth are not supported as determinants of long-term interest rate differentials.
    Keywords: long-term interst rates; expectation hypothesis; international macroeconomic influence; crowding out
    JEL: E43 E44
    Date: 2006–08
  14. By: Westerlund, Joakim (Department of Economics, Lund University); Costantini, Mauro (Department of Public Economics)
    Abstract: Most econometric methods for testing the proposition of long-run monetary neutrality rely on the assumption that money and real output do not cointegrate, a result that is usually supported by the data. This paper argues that these results can be attributed in part to the low power of univariate tests, and that a violation of the noncointegration assumption is likely to result in a nonrejection of the neutrality proposition. To alleviate this problem, two new and more powerful panel cointegration tests are proposed that can be used under very general conditions. The tests are then applied to a panel covering 10 countries between 1870 and 1986. The results suggest money and real output are cointegrated, and that the neutrality proposition therefore must be rejected.
    Keywords: Monetary Neutrality; Panel Cointegration Testing
    JEL: C12 C22 C23 E30 E50
    Date: 2006–08–09
  15. By: Cecilia Font de Villanueva
    Abstract: During the reign of Carlos II drastic monetary reform was carried out, which once and for all ended the tremendous monetary instability that took place in Castile throughout the whole Seventeenth century. Between 1680 and 1686, six monetary rules were adopted. The path chosen to attain the stability was not easy due to the state of the coinage. The reform tried to provide the Kingdom with a currency properly valued for which it was later decreed the devaluation and then the subsequent removal of the circulating copper coins. Simultaneously, along with the gathered metal, new purely copper made coins were ordered with adjusted value. Once the stability of the lesser value coinage was obtained, the reach of the reform was extended to the gold and silver pieces to equate them to the new monetary values.
    Date: 2006–09
  16. By: García-Fronti, Javier (University of Warwick and CSGR, University of Warwick); Miller, Marcus (University of Warwick, Centre for Economic Policy Research and CSGR, University of Warwick); Zhang, Lei (University of Warwick and CSGR, University of Warwick)
    Abstract: The stylised facts of currency crises in emerging markets include output contraction coming hard on the heels of devaluation, with a prominent role for the adverse balance-sheet effects of liability dollarisation. In the light of the South East Asian experience, we propose an eclectic blend of the supply-side account of Aghion, Bacchetta and Banerjee (2000) with a demand recession triggered by balance sheet effects (Krugman, 1999). This sharpens the dilemma facing the monetary authorities - how to defend the currency without depressing the economy. But, with credible commitment or complementary policy actions, excessive output losses can, in principle, be avoided.
    Keywords: Supply and demand shocks ; financial crises ; contractionary devaluation ; Keynesian recession
    JEL: E12 E4 E51 F34 G18
    Date: 2006
  17. By: Bastiaan Verhoef
    Abstract: Recent literature states that international monetary cooperation results in substantial welfare gains in an environment with imperfectly correlated sectoral shocks and with prices only set in firms (domestic) currency. However, empirical studies provide evidence that firms not only set their prices in their own currency, but in foreign currency as well. The question is whether the result of substantial welfare gains due to imperfectly correlated sector-specific shocks applies to the case where firms in the tradable sector apply pricing-to-market, i.e. prices are set in both domestic and foreign currency. This paper finds that this is not the case. For imperfectly correlated sectoral shocks and local currency pricing, welfare benefits of international monetary cooperation are fairly small.
    Keywords: nominal rigidities; international cooperation; local currency pricing
    JEL: E31 E52 F42
    Date: 2006–08
  18. By: Jarkko J""skel"; Tony Yates
    Abstract: One of the problems facing policymakers is that recent releases of data are liable to subsequent revisions. This paper discusses how to deal with this, and is in two parts. In the normative part of the paper, we study the design of monetary policy rules in a model that has the feature that data uncertainty varies according to the vintage. We show how coefficients on lagged variables in optimised simple rules for monetary policy increase as the relative measurement error in early vintages of data increases. We also explore scenarios when policymakers are uncertain by how much measurement error in new data exceeds that in old data. An optimal policy can then be one in which it is better to assume that the ratio of measurement error in new compared to old data is larger, rather than smaller. In the positive part of the paper, we show that the response of monetary policy to vintage varying data uncertainty may generate evidence of apparent interest rate smoothing in interest rate reaction functions: but we suggest that it may not generate enough to account for what has been observed in the data.
  19. By: Lea Zicchino
    Abstract: The revised framework for capital regulation of internationally active banks (known as Basel II) introduces risk-based capital requirements. This paper analyses the relationship between bank capital, lending and macroeconomic activity under the new capital adequacy regime. It extends a model of the bank-capital channel of monetary policy - developed by Chami and Cosimano - by introducing capital constraints . la Basel II. The results suggest that bank capital is likely to be less variable under the new capital adequacy regime than under the current one, which is characterised by invariant asset risk-weights. However, bank lending is likely to be more responsive to macroeconomic shocks.
  20. By: Roger Bjørnstad and Ragnar Nymoen (Statistics Norway)
    Abstract: Galí, Gertler and Lòpez-Salido (2005), GGL, assert that the hybrid New Keynesian Phillips curve, NPC, is robust to different choices of estimation procedure and so some forms of specification bias. Specifically, the dominance of forward-looking behavior is robust according to GGL. We assess the NPC on a panel data set from OECD countries and find that the forward rate of inflation dominates also on the panel data set. However, when variables consistent with alternative inflation models are introduced in the models, the forward term is no longer significant. Such an outcome is predicted by the incomplete competition model of inflation, ICM, meaning that the ICM encompasses the NPC. The opposite does not apply. The non-robustness of the OECD panel data NPC is in alignment with a previous encompassing test on euro-area data, as well as tests on data from the UK and from Norway. GGL on their part do not test the robustness of the NPC features with respect to existing inflation models.
    Keywords: New Keynesian Phillips Curve; forward looking price setting; panel data model; encompassing
    JEL: C23 C52 E12 E31
    Date: 2006–07
  21. By: Giovanni Mastrobuoni; Wioletta Dziuda
    Abstract: Despite the expectations of economists that the euro changeover would have no effect on prices, we show that European consumers perceived the contrary. The data indicate that consumers based their perceptions about inflation on goods that are cheaper and more frequently purchased. We use this insight to develop and estimate a model of imperfect information that explains why these goods were subject to higher price growth after the changeover. The data indicate that some retailers, aware of the consumers' diffculties in adopting the new currency, used the changeover to increase profits by increasing prices. We also propose an explanation of why this effect was smaller in more concentrated retail markets.
    Keywords: euro, currency changeover, imperfect information, search costs, price setting.
    JEL: D83 F33 L11
    Date: 2005
  22. By: Ray C. Fair
    Date: 2006–09–22
  23. By: Bergljot Barkbu; Vincenzo Cassino; Aileen Gosselin-Lotz; Laura Piscitelli
    Abstract: In the recent past, the empirical literature on the New Keynesian Phillips Curve (NKPC) has grown rapidly. The NKPC has been shown to describe satisfactorily the relationship between inflation and marginal cost both for the United States and the euro area. However, little attention has been given so far to the stability and robustness of the parameters in the estimated NKPC. In this paper, we aim to help fill this gap. After estimating hybrid NKPCs on US and euro-area data using the generalised method of moments and having found that our results are broadly in line with previous findings, we subject our estimated NKPCs to a thorough stability analysis. We find that the estimated coefficients for the United States are stable, whereas those for the euro area are considerably less stable. We then investigate the possible reasons for this instability. One explanation, explored using the Andrews' test, is the presence of structural breaks. Another possibility is the presence of an aggregation bias, which we investigate by estimating NKPCs for the three largest euro-area economies: Germany, France and Italy. At this disaggregated level, the fit of the NKPC improves, but the coefficients are still unstable. Furthermore, the disaggregated analysis indicates the presence of structural breaks in the three largest euro-area economies.
  24. By: Doyle, Matthew
    Abstract: Recent work on U.S. data calls into question the ability of simple Phillips curve models to forecast inflation. This paper asks whether there is similar evidence of a breakdown in the forecasting ability of Phillips curve models in other OECD countries. The results suggests that the ability of a Phillips curve to out-forecast simpler models has deteriorated in many OECD countries. The evidence is less clear as to whether this breakdown can be attributed to structural breaks in the parameters of the Phillips curve
    Keywords: Phillips curve, structural breaks, forecast breakdown
    JEL: E3
    Date: 2006–09–25
  25. By: Stephen Millard; Matthew Willison
    Abstract: The Bank of England's second core purpose is to maintain the stability of the financial system. Payment systems, by supporting transactions, are a key aspect of this. In this paper, we examine the importance of smoothly functioning payment systems to the economy by extending a recently developed theoretical model of banks. In the model the risk of theft implies a cost to using cash. This risk can be avoided by depositing cash in banks and transferring money through an interbank payment system. However, agents are then exposed to the risk that the payment system is unreliable. Agents will use a payment system (rather than cash) to make transactions if the system is sufficiently cheap to use and/or it is sufficiently reliable. We show that the introduction of a payment system that buyers and producers choose to use unambiguously increases social welfare if it expands the number of trades occurring in the economy. This is more likely the more reliable is the payment system. When the introduction of a payment system does not increase the number of trades, social welfare may increase or decrease depending on the trade-off between the risk of using cash and the risk that the payment system is unreliable. We again show that the more reliable is the payment system, the more likely welfare is increased by its introduction and we illustrate how this benefit might be quantified.

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