nep-mon New Economics Papers
on Monetary Economics
Issue of 2006‒12‒16
27 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. In noise we trust? Optimal monetary policy with random targets By Ethan Cohen-Cole; Bogdan Cosmaciuc
  2. Does Model Uncertainty Lead to Less Central Bank Transparency? By Li Qin; Elefterios Spyromitros; Moïse Sidiropoulos
  3. The impact of monetary policy signals on the intradaily euro-dollar volatility By Darmoul Mokhtar
  4. Monetary Policy in a Small Open Economy with a Preference for Robustness By Richard Dennis, Kai Leitemo and Ulf Soderstrom
  5. New Findings on Firm Investment and Monetary Policy Transmission in the Euro Area By Jean-Bernard Chatelain; Andrea Generale; Ignacio Hernando; Philip Vermeulen; Ulf Von Kalckreuth
  6. Monetary policy transmission in the euro area:<br />New evidence from micro data on firms and banks By Jean-Bernard Chatelain; Andrea Generale; Philip Vermeulen; Michael Ehrmann; Jorge Martínez-Pagés; Andreas Worms
  7. Monetary policy and rejections of the expectations hypothesis By Ravenna , Federico; Seppälä , Juha
  8. An estimate of the inflation risk premium using a three-factor affine term structure model By J. Benson Durham
  9. Deflationary shocks and monetary rules: an open-economy scenario analysis By Douglas Laxton; Papa N'Diaye; Paolo Pesenti
  10. The Effect of Monetary Policy on Real Commodity Prices By Jeffrey A. Frankel
  11. Trend inflation and inflation persistence in the New Keynesian Phillips curve By Timothy Cogley; Argia M. Sbordone
  12. Managing uncertainty through robust-satisficing monetary policy By Q. Farooq Akram; Yakov Ben-Haim; Øyvind Eitrheim
  13. PROPERTIES OF TWO U.S. INFLATION MEASURES (1985-2005) By Eva Vicente Martinez
  14. Silvio Gesell's Theory and Accelerated Money Experiments By Jérôme Blanc
  15. Indeterminacy in a forward-looking regime-switching model By Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
  16. Incorporating judgement in fan charts By Pär Österholm
  17. The conquest of South American inflation By Thomas Sargent; Noah Williams; Tao Zha
  18. The Importance of Stock Market Returns in Estimated Monetary Policy Rules. By Jesus Vazquez
  19. The Nature of Exchange Rate Regimes By Michael W. Klein; Jay C. Shambaugh
  20. Panel Cointegration Tests of the Fisher Effect By Westerlund Joakim
  21. Inflation measurement By David E. Lebow; Jeremy B. Rudd
  22. Financial Versus Monetary Mercantilism-Long-run View of Large International Reserves Hoarding By Joshua Aizenman; Jaewoo Lee
  23. A model in which outside and inside money are essential By David C. Mills, Jr.
  25. Chronicles of a deflation unforetold By François R. Velde
  26. Monetary and financial forces in the Great Depression By Satyajit Chatterjee; Dean Corbae
  27. Government Spending and the Taylor Principle By Gisle James Natvik

  1. By: Ethan Cohen-Cole; Bogdan Cosmaciuc
    Abstract: We show that a monetary policy in which the central bank commits to a randomized inflation target allows for potentially faster-expectations convergence than with a fixed target. The randomized target achieves faster convergence in particular in transition environments: those demonstrating either particularly high or low inflation.
    Keywords: Monetary policy
    Date: 2006
  2. By: Li Qin; Elefterios Spyromitros; Moïse Sidiropoulos
    Abstract: This paper discusses the problem of monetary policy transparency in a simple static robust control framework. In this framework, we identify two sources of monetary policy uncertainty. First, we identify the uncertainty about the central bank’s inflation stabilization preferences, which affects the private sector’s inflation expectations and therefore the realized inflation and output. On the other hand, uncertainty means that central bank is unsure about its model, in the sense that there is a group of approximate models that it also considers as possibly true and its objective is to choose a rule that will work under a range of different model specifications. We find that robustness reveals the emergence of a precautionary behaviour of the central bank in the case of unstructured model uncertainty, reducing thus central bank’s willingness to choice a high degree of monetary policy transparency.
    Keywords: central bank transparency, min-max policies, model uncertainty, robust control.
    JEL: E50 E52 E58
    Date: 2006
  3. By: Darmoul Mokhtar (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I])
    Abstract: In this paper, we investigate the impact of monetary policy signals stemming from the ECB Council and the FOMC on the intradaily Euro-dollar volatility, using high-frequency data (five minutes frequency). For that, we estimate an AR(1)-GARCH(1,1) model, which integrates a polynomials structure depending on signal variables, starting from the deseasonalized exchange rate returns series. This structure allows us to test the signals persistence one hour after their occurence and to reveal a dissymmetry between the effect of the ECB and Federal Reserve signals on the exchange rate volatility.
    Keywords: Exchange rates, official interventions, monetary policy, GARCH models.
    Date: 2006–12–06
  4. By: Richard Dennis, Kai Leitemo and Ulf Soderstrom
    Abstract: We use robust control techniques to study the effects of model uncertainty on monetary policy in an estimated, semi-structural, small-open-economy model of the U.K. Compared to the closed economy, the presence of an exchange rate channel for monetary policy not only produces new trade-offs for monetary policy, but it also introduces an additional source of specification errors. We find that exchange rate shocks are an important contributor to volatility in the model, and that the exchange rate equation is particularly vulnerable to model misspecification, along with the equation for domestic inflation. However, when policy is set with discretion, the cost of insuring against model misspecification appears reasonably small.
  5. By: Jean-Bernard Chatelain (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], EconomiX - [CNRS : UMR7166] - [Université de Paris X - Nanterre]); Andrea Generale (Banca d´Italia - [Banca d´Italia]); Ignacio Hernando (Bank of Spain - [Bank of Spain]); Philip Vermeulen (ECB - European Central Bank - [European Central Bank]); Ulf Von Kalckreuth (Bundesbank - [Bundesbank])
    Abstract: In this paper we present comparable results on the determinants of firms' investment and their link to monetary policy. The results have been obtained by the Eurosystem Monetary Transmission Network. This network has produced a series of papers in which the use of micro data permits estimating and quantifying the relevance of two channels of monetary policy transmission: the nterest rate and the broad credit channel. The research findings provide evidence of an operative interest rate channel in all countries examined. Moreover, the results indicate that variables which proxy firms' financial conditions play a role. Firms characterised by weaker balance sheets<br />show higher liquidity sensitivity.
    Keywords: investment, monetary transmission, user cost of capital
    Date: 2006–12–11
  6. By: Jean-Bernard Chatelain (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], EconomiX - [CNRS : UMR7166] - [Université de Paris X - Nanterre]); Andrea Generale (Banca d´Italia - [Banca d´Italia]); Philip Vermeulen (ECB - European Central Bank - [European Central Bank]); Michael Ehrmann (ECB - European Central Bank - [European Central Bank]); Jorge Martínez-Pagés (Bank of Spain - [Bank of Spain]); Andreas Worms (Bundesbank - [Bundesbank])
    Abstract: This paper presents an overview of the results of a research project on monetary transmission pursued by the Eurosystem, which has analysed micro data on firms and banks in several countries of the euro area in great detail. There is strong empirical support for an interest rate channel working through firm investment. Furthermore, a credit channel can be identified with firm micro data. On the bank side, there is evidence that lending reacts differently to monetary policy according to bank balance sheet characteristics. In particular, banks that have a less liquid asset composition show a stronger loan supply response. This finding may be due to banks drawing on their liquid assets to cushion the effects of monetary policy on their loan portfolio, which is in line with the existence of close relationships between banks and their loan customers.
    Keywords: monetary policy transmission, interest rate channel, credit channel, euro area
    Date: 2006–12–11
  7. By: Ravenna , Federico (Department of Economics, University of California); Seppälä , Juha (Department of Economics, University of Illinois)
    Abstract: We study the rejection of the expectations hypothesis within a New Keynesian business cycle model. Earlier research has shown that the Lucas general equilibrium asset pricing model can account for neither sign nor magnitude of average risk premia in forward prices, and is unable to explain rejection of the expectations hypothesis. We show that a New Keynesian model with habit-formation preferences and a monetary policy feedback rule produces an upward-sloping average term structure of interest rates, procyclical interest rates, and countercyclical term spreads. In the model, as in U.S. data, inverted term structure predicts recessions. Most importantly, a New Keynesian model is able to account for rejections of the expectations hypothesis. Contrary to earlier work, we identify systematic monetary policy as a key factor behind this result. Rejection of the expectation hypothesis can be entirely explained by the volatility of just two real shocks which affect technology and preferences.
    Keywords: term structure of interest rates; monetary policy; sticky prices; habit formation; expectations hypothesis
    JEL: E43 E44 E52 G12
    Date: 2006–12–14
  8. By: J. Benson Durham
    Abstract: This paper decomposes nominal Treasury yields into expected real rates, expected inflation rates, real risk premiums, and inflation risk premiums by separately calibrating a three-factor affine term structure model to the nominal Treasury and TIPS yield curves. Although this particular application seems to produce expected real short rates and inflation rates that are somewhat static, there are theoretical advantages to calibrating the model to nominal and real yields separately. Moreover, the estimates correlate positively with back-of-the-envelope measures of the inflation risk premium. With respect to the current environment, monetary policy uncertainty does not seem to have contributed to the apparent increase in the inflation risk premium since the beginning of 2006. Also, in purely nominal terms, the increase in term premiums thus far this year might be just as much a global as a domestic phenomenon, given that nominal term premiums have also increased in Germany and the United Kingdom.
    Date: 2006
  9. By: Douglas Laxton; Papa N'Diaye; Paolo Pesenti
    Abstract: The paper considers the macroeconomic transmission of demand and supply shocks in an open economy under alternative assumptions about whether the zero interest rate floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy relative to the rest of the world. Negative demand shocks have more prolonged and conspicuous effects on the economy when the ZIF is binding than when it is not binding. Positive supply shocks can actually extend the period of time over which the ZIF may be expected to bind. Economies that are more open hit the ZIF for a shorter period of time, and with less harmful effects. The implications of deflationary supply shocks depend on whether the shocks are concentrated in the tradables or the nontradables sector. Price-level-path targeting rules are likely to provide better guidelines for monetary policy in a deflationary environment, and have desirable properties in normal times when the ZIF is not binding.
    Keywords: Economic forecasting ; Monetary policy ; Interest rates ; Macroeconomics
    Date: 2006
  10. By: Jeffrey A. Frankel
    Abstract: Commodity prices are back. This paper looks at connections between monetary policy, and agricultural and mineral commodities. We begin with the monetary influences on commodity prices, first for a large country such as the United States, then smaller countries. The claim is that low real interest rates lead to high real commodity prices. The theory is an analogy with Dornbusch overshooting. The relationship between real interest rates and real commodity prices is also supported empirically. One channel through which this effect is accomplished is a negative effect of interest rates on the desire to carry commodity inventories. The paper concludes with a consideration of implications for monetary policy.
    JEL: E4 E5 F3 Q0
    Date: 2006–12
  11. By: Timothy Cogley; Argia M. Sbordone
    Abstract: The New Keynesian Phillips curve (NKPC) asserts that inflation depends on expectations of real marginal costs, but empirical research has shown that purely forward-looking versions of the model generate too little inflation persistence. In this paper, we offer a resolution of the persistence problem. We hypothesize that inflation is highly persistent because of drift in trend inflation, a feature that many versions of the NKPC neglect. We derive a version of the NKPC as a log-linear approximation around a time-varying inflation trend and examine whether it explains deviations of inflation from that trend. We estimate the NKPC parameters jointly with those that define the inflation trend by estimating a vector autoregression with drifting coefficients and volatilities; the autoregressive parameters are constrained to satisfy the restrictions imposed by the NKPC. Our results suggest that trend inflation has been historically quite volatile and that a purely forward-looking model that takes these fluctuations into account approximates well the short-run dynamics of inflation.
    Keywords: Phillips curve ; Inflation (Finance)
    Date: 2006
  12. By: Q. Farooq Akram (Norges Bank (Central Bank of Norway)); Yakov Ben-Haim (Technion - Israel Institute of Technology); Øyvind Eitrheim (Norges Bank (Central Bank of Norway))
    Abstract: We employ information-gap decision theory to derive a robust monetary policy response to Knightian parameter uncertainty. This approach provides a quantitative answer to the question: For a specified policy, how much can our models and data err or vary, without rendering the outcome of that policy unacceptable to a policymaker? For a given acceptable level of performance, the policymaker selects the policy that delivers acceptable performance under the greatest range of uncertainty. We show that such information-gap robustness is a proxy for probability of policy success. Hence, policies that are likely to succeed can be identified without knowing the probability distribution. We adopt this approach to investigate empirically the robust monetary policy response to a supply shock with an uncertain degree of persistence.
    Keywords: Knightian uncertainty, Monetary policy, Info-gap decision theory.
    JEL: E31 E52 E58 E61
    Date: 2006–10–23
  13. By: Eva Vicente Martinez
    Abstract: Analyses are presented of 84 quarterly observations 1/85-4/05 on two U.S. index numbers of nominal prices often employed to measure inflation. Analyses are designed to answer two key questions of interest to macroeconomists. Is inflation stationary (I(0)) or stochastically non-stationary (I(1))? If it is I(1), is it scalar or multivariate? Both measures of inflation are found clearly to be I(1) and, for these measures, inflation is found clearly to be scalar. The paper also illustrates univariate analysis procedures (and report standards) considered to be more effective and convincing than those found in the existing literature on inflation measures.
    Date: 2006–12
  14. By: Jérôme Blanc (LEFI - Laboratoire d'économie de la firme et des institutions - [Université Lumière - Lyon II])
    Abstract: Silvio Gesell (1862-1930) proposed a system of stamped money in order to accelerate monetary circulation and to free money from interest. This was part of a global socialist system intended to free economy from rent and interest. In the 1930s, Irving Fisher, who proposed the system to President Roosevelt, and John Maynard Keynes rendered homage to Gesell's monetary proposals in the context of the economic depression. Among the experiments that took place, several were based on his ideas, notably in the Austrian town of Wörgl and in the United States. These experiments were always local and never lasted more than a few months. This article shows that trust is the main issue of this kind of monetary organization; and therefore, that such experiments can only take place successfully on a small scale.
    Keywords: Gesell. History of economic ideas, monetary utopia, local currencies.
    Date: 2006–12–08
  15. By: Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
    Abstract: This paper is about the properties of Markov-switching rational expectations (MSRE) models. We present a simple monetary policy model that switches between two regimes with known transition probabilities. The first regime, treated in isolation, has a unique determinate rational expectations equilibrium, and the second contains a set of indeterminate sunspot equilibria. We show that the Markov switching model, which randomizes between these two regimes, may contain a continuum of indeterminate equilibria. We provide examples of stationary sunspot equilibria and bounded sunspot equilibria, which exist even when the MSRE model satisfies a generalized Taylor principle. Our result suggests that it may be more difficult to rule out nonfundamental equilibria in MRSE models than in the single-regime case where the Taylor principle is known to guarantee local uniqueness.
    Date: 2006
  16. By: Pär Österholm
    Abstract: Within a decision-making group, such as the monetary-policy committee of a central bank, group members often hold differing views about the future of key economic variables. Such differences of opinion can be thought of as reflecting differing sets of judgement. This paper suggests modelling each agent's judgement as one scenario in a macroeconomic model. Each judgement set has a specific dynamic impact on the system, and accordingly, a particular predictive density - or fan chart - associated with it. A weighted linear combination of the predictive densities yields a final predictive density that correctly reflects the uncertainty perceived by the agents generating the forecast. In a model-based environment, this framework allows judgement to be incorporated into fan charts in a formalised manner.
    Date: 2006
  17. By: Thomas Sargent; Noah Williams; Tao Zha
    Abstract: We infer determinants of Latin American hyperinflations and stabilizations by using the method of maximum likelihood to estimate a hidden Markov model that potentially assigns roles both to fundamentals in the form of government deficits that are financed by money creation and to destabilizing expectations dynamics that can occasionally divorce inflation from fundamentals. Our maximum likelihood estimates allow us to interpret observed inflation rates in terms of variations in the deficits, sequences of shocks that trigger temporary episodes of expectations driven hyperinflations, and occasional superficial reforms that cut inflation without reforming deficits. Our estimates also allow us to infer the deficit adjustments that seem to have permanently stabilized inflation processes. Our results show how the available inflation, deficit, and other macroeconomic data had left informed economists like Rudiger Dornbusch and Stanley Fischer undecided about the ultimate sources of inflation dynamics.
    Date: 2006
  18. By: Jesus Vazquez (Universidad del Pais Vasco)
    Abstract: This paper estimates a standard version of the New Keynesian Monetary (NKM) model augmented with financial variables in order to analyze the relative importance of stock market returns and term spread in the estimated U.S. monetary policy rule. The estimation procedure implemented is a classical structural method based on the indirect inference principle. The empirical results show that the Fed seems to respond to the macroeconomic outlook and to the stock market return but does not seem to respond to the term spread. Moreover, policy inertia and persistent policy shocks are also significant features of the estimated policy rule.
    Keywords: NKM model, stock market returns, policy rule
    JEL: C32 E44 E52
    Date: 2006–01–01
  19. By: Michael W. Klein; Jay C. Shambaugh
    Abstract: The impermanence of fixed exchange rates has become a stylized fact in international finance. The combination of a view that pegs do not really peg with the "fear of floating" view that floats do not really float generates the conclusion that exchange rate regimes are, in practice, unimportant for the behavior of the exchange rate. This is consistent with evidence on the irrelevance of a country's choice of exchange rate regime for general macroeconomic performance. Recently, though, more studies have shown the exchange rate regime does matter in some contexts. In this paper, we attempt to reconcile the perception that fixed exchange rates are only a "mirage" with the recent research showing the effects of fixed exchange rates on trade, monetary autonomy, and growth. First we demonstrate that, while pegs frequently break, many do last and those that break tend to reform, so a fixed exchange rate today is a good predictor that one will exist in the future. Second, we study the exchange rate effect of fixed exchange rates. Fixed exchange rates exhibit greater bilateral exchange rate stability today and in the future. Pegs also display somewhat lower multilateral volatility.
    JEL: F33 F41
    Date: 2006–12
  20. By: Westerlund Joakim (METEOR)
    Abstract: Most empirical evidence suggest that the Fisher effect, stating that inflation and nominal interest rates should cointegrate with a unit slope on inflation, does not hold, a finding at odds with many theoretical models. This paper argues that these results can be attributed in part to the low power of univariate tests, and that the use of panel data can generate more powerful tests. For this purpose, we propose two new panel cointegration tests that can be applied under very general conditions, and that are shown by simulation to be more powerful than other existing tests. These tests are applied to a panel of quarterly data covering 20 OECD countries between 1980 and 2004. The evidence suggest that the Fisher effect cannot be rejected once the panel evidence on cointegration has been taken into account.
    Keywords: econometrics;
    Date: 2006
  21. By: David E. Lebow; Jeremy B. Rudd
    Abstract: Inflation measurement is the process through which changes in the prices of individual goods and services are combined to yield a measure of general price change. This paper discusses the conceptual framework for thinking about inflation measurement and considers practical issues associated with determining an inflation measure's scope; with measuring individual prices; and with combining these individual prices into a measure of aggregate inflation. We also discuss the concept of "core inflation," and summarize the implications of inflation measurement for economic theory and policy.
    Date: 2006
  22. By: Joshua Aizenman; Jaewoo Lee
    Abstract: The sizable hoarding of international reserves by several East Asian countries has been frequently attributed to a modern version of monetary mercantilism -- hoarding international reserves in order to improve competitiveness. Taking a long-run perspective, we point out that manufacturing exporters in East Asia frequently used financial mercantilism -- subsidizing the cost of capital -- during decades of high growth. The switches to sizable hoarding of international reserves happened when growth floundered or deep crises erupted, exacerbating financial fragility as the legacy of past financial mercantilism. As financial fragility may lead to currency crises, the rise of non-performing loans provides impetus for the precautionary hoarding of international reserves, making it harder to disentangle the monetary mercantilism from precautionary response to the heritage of past financial mercantilism. Monetary mercantilism also raises the prospects of competitive hoarding -- exporters of competing manufacturing goods to third markets would adopt a similar hoarding policy, in order to mitigate their deteriorating competitiveness following the adoption of monetary mercantilism by a competitor. Competitive hoarding, owing to the negative externalities associated with it, can dissipate competitiveness gains and result in excess reserves. It may also encourage the formation of institutions like regional funds, in an attempt to curb these adverse externalities.
    JEL: F15 F31 F43 F51
    Date: 2006–12
  23. By: David C. Mills, Jr.
    Abstract: I present an environment for which both outside and inside money are essential as means of payment. The key model feature is that there is imperfect monitoring of issuers of inside money. I use a random matching model of money where some agents have private trading histories and others have trading histories that can be publicly observed only after a lag. I show via an example that for lags that are neither too long nor too short, there exist allocations that use both types of money that cannot be duplicated when only one type is used. Inside money provides liquidity that increases the frequency of trades, but incentive constraints restrict the amount of output that can be traded. Outside money is immune to such constraints and can trade for higher levels of output.
    Date: 2006
  24. By: Martin Menner
    Abstract: Shouyong Shi(1998) presents a general equilibrium model which shows a persistent monetary propagation mechanism. There the high persistence is obtained by a combination of search frictions in the goods and labor markets and the presence of final goods inventories. The present paper addresses the question of robustness of these results, especially, how sensitive are Shi's results to parameter changes and to different model specifications. Calibration of the parameters to intervals is used to perform a global sensitivity analysis. The calibration exercise reveals that the model is quite robust to changes in parameters. Comparing different model versions - including a CIA model which appears as a special case when buyers and sellers match always - we can disentangle and quantify the contributions of the various frictions in accounting for the persistent propagation. Search-frictions in the goods market and inventory holdings are necessary for persistent propagation of monetary shocks. Labor market frictions are not crucial but prolong the output responses and reduce their magnitude.
    Date: 2006–11
  25. By: François R. Velde
    Abstract: Suppose the nominal money supply could be cut literally overnight by, say, 20%. What would happen to prices, wages, output? The answer can be found in 1720s France, where just such an experiment was carried out, repeatedly. Prices adjusted instantaneously and fully on one market only, that for foreign exchange. Prices on other markets (such as commodities) as well as prices of manufactured goods and industrial wages fell slowly, over many months, and not by the full amount of the nominal reduction. Coincidentally or not, the industrial sector (as represented by manufacturing of woolen cloths) experienced a contraction of 30%. When the government changed course and increased the nominal money supply overnight by 20%, prices responded much more, and the woolen industry rebounded.
    Date: 2006
  26. By: Satyajit Chatterjee; Dean Corbae
    Abstract: What caused the worldwide collapse in output from 1929 to 1933? Why was the recovery from the trough of 1933 so protracted for the U.S.? How costly was the decline in terms of welfare? Was the decline preventable? These are some of the questions that have motivated economists to study the Great Depression. In this paper, the authors review some of the economic literature that attempts to answer these questions.
    Keywords: Depressions
    Date: 2006
  27. By: Gisle James Natvik (University of Oslo and Norges Bank (Central Bank of Norway))
    Abstract: This paper explores how government size affects the scope for equilibrium indeterminacy in a New Keynesian economy where part of the population live hand-to-mouth. I find that in this framework, a larger public sector may widen the scope for self-fulfilling prophecies to occur. This takes place even though taxes serve to reduce swings in current income. In general, government provision of goods that are Edgeworth substitutes for private consumption tend to narrow the scope for indeterminacy, while government goods that are Edgeworth complements for private consumption increase the problem of indeterminacy. Hence monetary policy should be conducted with an eye to the amount and composition of government consumption.
    Keywords: Public expenditures, Taylor principle, Fiscal policy rules, Rule- of-thumb consumers.
    JEL: E32 E52 E63
    Date: 2006–12–11

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