nep-mon New Economics Papers
on Monetary Economics
Issue of 2006‒12‒01
nineteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Modelling Central Bank Intervention Activity under Inflation Targeting By Horvath, Roman
  2. The yield curve as a predictor and emerging economies By Arnaud Mehl
  3. Fear of Floating and the External Effects of Currency Unions By Thomas Plümper; Vera E. Troeger
  4. Optimal monetary policy rules with labor market frictions By Ester Faia
  5. Informal central bank independence: an analysis for three European countries By DAVID COBHAM; STEFANIA COSCI; MATTESINI FABRIZIO
  6. A Deliberative Independent Central Bank By Erwin Jericha; Martin Schürz
  7. Equilibrium of incomplete markets with money and intermediate banking system By Monique Florenzano; Stella Kanellopoulou; Yannis Vailakis
  8. Optimal currency shares in international reserves - the impact of the euro and the prospects for the dollar By Elias Papaioannou; Richard Portes; Gregorios Siourounis
  9. Credibility of Exchange Rate Policies in Selected EU New Members: Evidence from High Frequency Data By Jarko Fidrmuc; Roman Horváth
  10. Hot Money Inflows in China : How the People's Bank of China Took up the Challenge By Vincent Bouvatier
  11. Geography or skills - What explains Fed watchers’ forecast accuracy of US monetary policy? By Helge Berger; Michael Ehrmann; Marcel Fratzscher
  12. Structural Breaks and Optimal Monetary Policy By MATTESINI FABRIZIO; NISTICO' SALVATORE
  13. FIRM INVESTMENT AND MONETARY POLICY<br />TRANSMISSION IN THE EURO AREA By Jean-Bernard Chatelain; Andrea Generale; Ignacio Hernando; Ulf Von Kalckreuth; Philip Vermeulen
  14. Okun's Law, Creation of Money and the Decomposition of the Rate of Unemployment By Mussard, Stéphane; Philippe, Bernard
  15. Fundamental inflation uncertainty By Charlotta Groth; Jarkko Jääskelä; Paolo Surico
  16. On Prices in Myrdal's Monetary Theory By Alexander Tobon
  17. What is global excess liquidity, and does it matter? By Rasmus Rüffer; Livio Stracca
  18. Heterogeneity of Central Bankers and Inflationary Pressure By Bugarin, Mauricio; Carvalho. Fabia A.

  1. By: Horvath, Roman
    Abstract: Using daily data from the Czech Republic in 1/1/1998-31/12/2002, we find that foreign exchange intervention activity is determined by the degree of exchange rate misalignment and lagged intervention. Additionally, inflation targeting regime is a binding constraint of intervention activity.
    Keywords: Foreign exchange intervention; central bank; inflation targeting
    JEL: E58 E52 F31 F33
    Date: 2006–05–10
  2. By: Arnaud Mehl (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper investigates the extent to which the slope of the yield curve in emerging economies predicts domestic inflation and growth. It also examines international financial linkages and how the US and the euro area yield curves help to predict. It finds that the domestic yield curve in emerging economies has in-sample information content even after controlling for inflation and growth persistence, at both short and long forecast horizons, and that it often improves out-of-sample forecasting performance. Differences across countries are seemingly linked to market liquidity. The paper further finds that the US and the euro area yield curves also have in- and out-of-sample information content for future inflation and growth in emerging economies. In particular, for emerging economies that have an exchange rate peg to the US dollar, the US yield curve is often found to be a better predictor than these economies’ own domestic curve and to causally explain their movements. This suggests that monetary policy changes and short-term interest rate pass-through are key drivers of international financial linkages through movements from the low end of the yield curve. JEL Classification: E44, F3, C5.
    Keywords: emerging economies, yield curve, forecasting, international linkages.
    Date: 2006–11
  3. By: Thomas Plümper; Vera E. Troeger
    Abstract: The introduction of the Euro has considerably affected the de facto monetary policy autonomy – defined as statistical independence from monetary policy in the key currency areas – in countries outside the European Currency Union. Using a standard open economy framework we argue that de facto monetary policy autonomy has significantly declined for countries that dominantly trade with the ECU and slightly increased that dominantly trade with the Dollar-Zone. The predictions of our model find support in the data. We estimate the influence of the Bundesbank/ECB’s and the Fed’s monetary policies on various country groups. The de facto monetary policy autonomy of both non-Euro EU-members and EFTA countries declined with the introduction of Euro. This effect was slightly stronger for the EU member countries than for EFTA countries as our theory predicts. At the same time, the de facto monetary policy autonomy of Australia and New Zealand vis-à-vis the US Dollar has (moderately) increased. This finding also supports our theoretical model.
    Date: 2006–11–16
  4. By: Ester Faia (Department of Economics, Universitat Pompeu Fabra, Ramon Trias Fargas 25-27, 08005, Barcelona, Spain.)
    Abstract: This paper studies optimal monetary policy rules in a framework with sticky prices, matching frictions and real wage rigidities. Optimal monetary policy is given by a constrained Ramsey plan in which the monetary authority maximizes the agents’ welfare subject to the competitive economy relations and the assumed monetary policy rule. I find that optimal policy should deviate from the strict inflation targeting since the policy maker faces a typical unemployment/inflation trade-off. In this context and unlike a standard New Keynesian model stabilizing inflation is not sufficient to stabilize the marginal cost (hence the output gap) since the latter also depends on the evolution of unemployment. The matching frictions add a congestion externality since the number of unemployed in the market and their bargaining power reduce the probability of forming matches. Hence optimal monetary policy features unemployment targeting along with inflation targeting. JEL Classification: E52, E24.
    Keywords: Optimal monetary policy rules, matching frictions, wage rigidity.
    Date: 2006–11
    Abstract: Changes in formal and informal central bank independence (CBI) in France, Italy and the UK in the period from the mid-1970s to the 1990s are examined; the major changes occurred in the 1990s, after the disinflations of the 1980s. Broad trends in the informal independence of central banks, defined as the ability to pursue price stability regardless of the government’s preferences, are identified on the basis of a monetary policy narrative and an analysis of a set of qualitative determinants of informal independence. The most important determinants are the social/political acceptance that monetary policy is the sphere of the central bank, the existence of anti-inflationary commitments in the form of intermediate targets for monetary policy, the degree of social consensus on the means and ends of macroeconomic policy, and the relative technical expertise of the central bank. These broad trends help to explain some of the inflation experience of the 1980s and 1990s which cannot be understood in terms of changes to formal CBI.
    Date: 2005–09
  6. By: Erwin Jericha (Vienna University of Technology); Martin Schürz (Oesterreichische Nationalbank, Economic Analysis Division)
    Abstract: The paper develops a communication game that is applied to the question of central bank policy and independence. The game is about the preferred degree of conservatism of monetary policy and the game setting consists of a principal (politics), an agent (central bank) and an observer (financial market participants). The extent of the welfare losses depends on the degree of knowledge, the endogenized signaling of financial market participants and the probability whether the degree of conservatism in monetary policy is adequate to nature. Consequently, a mechanism to minimize welfare losses of the principal has to be implemented. It is shown how the introduction of an institutional control mechanism with a countervailing goal function will improve the utilities for the principal.
    Keywords: accountability, agency losses, principal agent model
    JEL: E58 E59 E61 C79
    Date: 2006–06–11
  7. By: Monique Florenzano (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I]); Stella Kanellopoulou (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I]); Yannis Vailakis (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I])
    Abstract: This paper studies a simple stochastic two-period general equilibrium exchange model with money, an incomplete market of nominal assets, and a competitive banking system, intermediate between consumers and a Central Bank. There is a finite number of agents, consumers and banks. Default is not permitted. The public policy instruments are, besides real taxes implicit in the model, public debt and creation of money both implemented at the first period. The equilibrium existence is established under a Gains to trade hypothesis and the assumption that banks have a non zero endowment of money at each date-event of the model.
    Keywords: Competitive banking system, incomplete markets, nominal assets, money, monetary equilibrium, cash-in-advance constraints, public debt.
    Date: 2006–11–07
  8. By: Elias Papaioannou (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Richard Portes (London Business School, Sussex Place, Regent's Park, London NW1 4SA, United Kingdom); Gregorios Siourounis (London Business School, Sussex Place, Regent's Park, London NW1 4SA, United Kingdom)
    Abstract: Foreign exchange reserve accumulation has risen dramatically in recent years. The introduction of the euro, greater liquidity in other major currencies, and the rising current account deficits and external debt of the United States have increased the pressure on central banks to diversify away from the US dollar. A major portfolio shift would significantly affect exchange rates and the status of the dollar as the dominant international currency. We develop a dynamic mean-variance optimization framework with portfolio rebalancing costs to estimate optimal portfolio weights among the main international currencies. Making various assumptions on expected currency returns and the variance-covariance structure, we assess how the euro has changed this allocation. We then perform simulations for the optimal currency allocations of four large emerging market countries (Brazil, Russia, India and China), adding constraints that reflect a central bank’s desire to hold a sizable portion of its portfolio in the currencies of its peg, its foreign debt and its international trade. Our main results are: (i) The optimizer can match the large share of the US dollar in reserves, when the dollar is the reference (risk-free) currency. (ii) The optimum portfolios show a much lower weight for the euro than is observed. This suggests that the euro may already enjoy an enhanced role as an international reserve currency ("punching above its weight"). (iii) Growth in issuance of euro-denominated securities, a rise in euro zone trade with key emerging markets, and increased use of the euro as a currency peg, would all work towards raising the optimal euro shares, with the last factor being quantitatively the most important. JEL Classification: F02, F30, G11, G15.
    Keywords: Currency optimizer, euro, foreign reserves, international currencies.
    Date: 2006–11
  9. By: Jarko Fidrmuc (Department of Economics, University of Munich; CESifo; Faculty of Mathematics, Physics and Informatics, Comenius University Bratislava); Roman Horváth (Czech National Bank, Prague, Czech Republic; Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: We examine the daily exchange rate dynamics in selected EU new member states (Czech Republic, Poland, Romania, and Slovakia) using GARCH and TARCH models between 1999 and 2004. We show that these countries tried to reduce volatility of the spot exchange rate despite their official policy of free floating and inflation targeting. However, we find that the low credibility of exchange rate policy implied higher volatility of exchange rates when it substantially deviated from the implicit target rates for all countries. Finally, we find significant asymmetric effects of the volatility of exchange rates in all new member states.
    Keywords: Exchange rates; target zones; ERM II; inflation targeting; GARCH
    JEL: F31 C22 C23
    Date: 2006–10
  10. By: Vincent Bouvatier (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I])
    Abstract: This paper investigates hot money inflows in China. The financial liberalization comes into effect and the effectiveness of capital controls tends to diminish over time. As a result, China is fuelled by hot money inflows. The US interest rate cut since 2001 and expectations of exchange rate adjustments are the main factors explaining these capital inflows. This study use the Bernanke and Blinder (1988) model extended to an open economy to examine implications of hot money inflows for the Chinese economy. A Vector Error Correction Model (VECM) on monthly data from March 1995 to March 2005 is estimated to investigate the recent upsurge in foreign reserves and shows that the interaction between domestic credit and foreign reserves was stable and consistent with monetary stability. Granger causality tests are implemented to show how the People's Bank of China (PBC) achieved this result.
    Keywords: Hot money inflows, domestic credit, VECM, Granger causality.
    Date: 2006–11–03
  11. By: Helge Berger (Free University Berlin, Department of Economics, Boltzmannstrasse 20, 12161 Berlin, Germany.); Michael Ehrmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The paper shows that there is a substantial degree of heterogeneity in forecast accuracy among Fed watchers. Based on a novel database for 268 professional forecasters since 1999, the average forecast error of FOMC decisions varies 5 to 10 basis points between the best and worst-performers across the sample. This heterogeneity is found to be related to both the skills of analysts – such as their educational and employment backgrounds – and to geography. In particular, there is evidence that forecasters located in regions which experience more idiosyncratic economic conditions perform worse in anticipating monetary policy. Moreover, systematic forecaster heterogeneity is economically important as it leads to greater financial market volatility after FOMC meetings. Finally, Fed communication may exert an influence on forecast accuracy. JEL Classification: E52, E58, G14.
    Keywords: monetary policy, forecast, Federal Reserve, FOMC, geography, skills, heterogeneity, survey data, communication, United States.
    Date: 2006–11
    Abstract: This paper analyzes the optimal behavior of the Central Bank in an economy characterized by balanced growth. Consistently with the view of Perron (1989) and di®erently from the standard approach in DNK literature, we model the dynamics of productivity as following a trend-stationary model subject to infrequent breaks; accordingly we characterize periods of productivity slowdown as structural breaks in trend-growth. We show that breaks in trend-growth a®ect the dynamics of in°ation, the preferences of a welfare-maximizing Cen- tral Bank and optimal monetary policy. We show that in periods of productivity slowdown, optimal monetary policy should not only guarantee the appropriate response to productivity shocks, but also take into consideration the change in trend-growth in responding to cost-push shocks. Moreover, we show that during productivity slow- downs the gains from commitment are higher than during phases of high productivity growth, while the consequences of a discretionary policy, albeit optimal, may be higher in°ation instability. JEL classification: E12, E44, E52
    Date: 2006–07
  13. By: Jean-Bernard Chatelain (EconomiX - [CNRS : UMR7166] - [Université de Paris X - Nanterre], PSE - Paris-Jourdan Sciences Economiques - [CNRS : UMR8545] - [Ecole des Hautes Etudes en Sciences Sociales][Ecole Nationale des Ponts et Chaussées][Ecole Normale Supérieure de Paris]); Andrea Generale (Banca d´Italia - [Banca d´Italia]); Ignacio Hernando (Bank of Spain - [Bank of Spain]); Ulf Von Kalckreuth (Bundesbank - [Bundesbank]); Philip Vermeulen (ECB - European Central Bank - [European Central Bank])
    Abstract: This paper presents a comparable set of results on the monetary transmission channels on firm<br />investment (the interest rate channel and the broad credit channel) for the four largest euro-area<br />countries (Germany, France, Italy and Spain), using particularly rich micro datasets for each<br />country containing over 215,000 observations from 1985 to 1999. For each of those countries,<br />investment relationships are estimated explaining investment by its user cost, sales and cash flow.<br />A first result is that investment is sensitive to user cost changes in all those four countries. This<br />implies an operative interest channel in these euro-area countries. A second result is that investment<br />in all countries is quite sensitive to cash flow movements. However, only in Italy do smaller firms<br />react more to cash flow movements than large firms, implying that a broad credit channel might not<br />be equally pervasive in all countries.
    Keywords: Investment, Monetary Transmission Channels, User Cost of Capital
    Date: 2006–11–08
  14. By: Mussard, Stéphane (CEPS/INSTEAD, GEREM, GREDI); Philippe, Bernard (GEREM Université de Perpignan)
    Abstract: In this paper, we show that the rate of unemployment in period t depends on GDP and inflation rate in period t-1. We then show that GDP is related to money creation, and subsequently that the rate of unemployment is a decreasing function of this creation.
    Keywords: Creation of Money; Decomposition ; GDP ; Rate of Unemployement
    JEL: E24 E20
    Date: 2006–10
  15. By: Charlotta Groth; Jarkko Jääskelä; Paolo Surico
    Abstract: We develop a method of quantifying the uncertainty surrounding the estimates of the fundamental inflation implied by the New Keynesian Phillips Curve (NKPC). The uncertainty is represented as a band around the fundamental inflation, and encompasses the sampling uncertainty of both the estimates of the structural parameters and the estimates of the VAR used to form a projection of real marginal costs. An empirical application on UK and US data confirms that fundamental inflation tracks actual inflation reasonably well in both countries. For the United Kingdom the confidence band is sufficiently narrow, relative to the sample variance of inflation, to identify a number of periods where the predictions of the NKPC do not fully capture movements in actual inflation. In contrast, considerable uncertainty surrounds the estimates of fundamental inflation for the United States.
  16. By: Alexander Tobon (EconomiX - [CNRS : UMR7166] - [Université de Paris X - Nanterre])
    Abstract: The aim of this paper is to show how Myrdal monetary theory can contribute to the study of the behaviour of prices in disequilibrium. The analysis explains the existence of a cumulative process based on the capacity of the entrepreneur to anticipate price variations. The variation in prices explains the persistence of the cumulative process. This, we argue, represents an opposite view of the one contained in Wicksell's theory. Myrdal's theory leads to the rejection of the quantity theory of money based on Wicksell's approach. This comes as a surprising result knowing Wicksell believed his results confirmed this theory.
    Keywords: Myrdal; monetary equilibrium; cumulative process; prices; profit
    Date: 2006–10–19
  17. By: Rasmus Rüffer (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Livio Stracca (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper endeavours to provide a comprehensive analysis of the nature and the possible importance of “global excess liquidity”, a concept which has attracted considerable attention in recent years. The contribution of this paper is threefold. First, we present some conceptual discussion on the meaning of excess liquidity in advanced countries with developed financial markets. Second, we report some descriptive analysis on the degree of co-movement of several possible measures of excess liquidity and spill-overs between them for a relatively large sample of industrialised and developing countries. Third, we estimate a VAR model for an aggregate of the major industrialised countries and analyse the transmission of shocks to global excess liquidity to the global economy, including possible cross-border spill-over effects to a number of domestic variables in the world’s three largest economies (the US, the euro area and Japan). JEL Classification: E52, F42.
    Keywords: Global excess liquidity, monetary policy, open economy, international economics.
    Date: 2006–11
  18. By: Bugarin, Mauricio; Carvalho. Fabia A.
    Date: 2006–10
  19. By: Jean-Bernard Chatelain (EconomiX - [CNRS : UMR7166] - [Université de Paris X - Nanterre], PSE - Paris-Jourdan Sciences Economiques - [CNRS : UMR8545] - [Ecole des Hautes Etudes en Sciences Sociales][Ecole Nationale des Ponts et Chaussées][Ecole Normale Supérieure de Paris]); Andre Tiomo (CREST - Centre de Recherche en Économie et Statistique - [INSEE] - [ École Nationale de la Statistique et de l'Administration Économique])
    Abstract: Using a large panel of 6946 French manufacturing firms, this paper investigates the effect<br />of sales, of the cost of capital and of liquidity constraint variables (cash flow or cash<br />stock) on the stock of capital from 1990 to 1999. The user cost elasticity is at the most<br />0.26 in absolute terms for all the firms of the sample. Three groups of firms representing<br />around 20 per cent of the sample (firms facing a high risk of bankruptcy, firms belonging<br />to the capital goods sector, firms making extensive use of trade credit) are more sensitive<br />to cash flow. Risky firms are less sensitive to sales, when cash stock replaces cash flow.<br />Simulations following shocks of interest rate (related to monetary policy shocks), provides<br />short run contemporaneous elasticities of investment with respect to interest rate through<br />the user cost and through debt repayments taken into account in cash flow.
    Keywords: Investment, User Cost of Capital, Liquidity Constraints, Monetary Policy<br />Shocks.
    Date: 2006–11–08

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