nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒01‒02
eighteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary Policy Challenges in Emerging Markets: Sudden Stop, Liability Dollarization, and Lender of Last Resort By Guillermo A. Calvo
  2. Monetary policy, oil shocks, and TFP: accounting for the decline in U.S. volatility By Sylvain Leduc; Keith Sill
  3. The transmission of monetary policy shocks from the US to the euro area By Andrea Nobili; Stefano Neri
  4. Central Bank Interventions, Communication and Interest Rate Policy in Emerging European Economies By Balázs Égert
  5. Deflationary Shocks and Monetary Rules: An Open-Economy Scenario Analysis By Laxton, Doug; N'Diaye, Papa; Pesenti, Paolo
  6. The Evolution of the East Asian Currency Baskets – Still Undisclosed and Changing By Gunther Schnabl
  7. A bivariate model of Fed and ECB main policy rates By Chiara Scotti
  8. Model selection for monetary policy analysis – Importance of empirical validity By Q. Farooq Akram; Ragnar Nymoen
  9. Monetary and budgetary-fiscal policy interactions in a Keynesian heterogeneous monetary union By Angel Asensio
  10. Global integration of India's Money Market : Interest rate parity in India By Vipul Bhatt; Arvind Virmani
  11. Monetary Policy and Staggered Wage Bargaining when Prices are Sticky By Carlsson, Mikael; Westermark, Andreas
  12. Welfare Effects of the Euro Cash Changeover By Christoph Wunder; Johannes Schwarze; Gerhard Krug; Bodo Herzog
  13. Bank imputed interest rates: unbiased estimates of offered rates? By Evren Örs; Tara Rice
  14. How to be Well Shod to Absorb Shocks? Shock Synchronization and Joining the Euro Zone By Natacha Gilson
  15. The monetary origins of asymmetric information in international equity markets By Gregory H. Bauer; Clara Vega
  16. When Is It Optimal to Abandon a Fixed Exchange Rate? By Sergio Rebelo; Carlos A. Vegh
  17. The expectation hypothesis of the term structure of very short-term rates: statistical tests and economic value By Pasquale Della Corte; Lucio Sarno; Daniel L. Thornton
  18. Counterfeit or genuine: can you tell the difference? By Nicole Jonkera; Bram Scholten; Marco Wind (DNB); Martijn van Emmerik; Marieke van der Hoeven (TNO Human Factors)

  1. By: Guillermo A. Calvo
    Abstract: The paper argues that Emerging Market economies (EMs) face financial vulnerabilities that weaken the effectiveness of a domestic Lender of Last Resort (LOLR). As a result, monetary policy is inextricably linked to the state of the credit market. In particular, the central bank should be ready to operate as LOLR during Sudden Stop (of capital inflows) by releasing international reserves in an effective manner. These conditions also impact on optimal monetary policy in normal but high-volatility periods. The paper further argues that during those periods interest rate rules may engender excessive volatility of exchange rates and, thus, that it may be advisable to temporarily supplement those rules by foreign exchange market intervention or outright exchange rate pegging. At a fundamental level, the analysis suggests that the state-of-the-art literature summarized by Woodford (2003) or even more heterodox approaches exemplified by Stiglitz and Greenwald (2003) are likely fall short of providing a satisfactory guide for monetary policy in EMs.
    JEL: E52 E58 F32
    Date: 2006–12
  2. By: Sylvain Leduc; Keith Sill
    Abstract: An equilibrium model is used to assess the quantitative importance of monetary policy for the post-1984 decline in U.S. inflation and output volatility. The principal finding is that monetary policy played a substantial role in reducing inflation volatility, but a small role in reducing real output volatility. The model attributes much of the decline in real output volatility to smaller TFP shocks. We also investigate the pattern of output and inflation volatility under an optimal monetary policy counterfactual. We find that real output volatility would have been somewhat lower, and inflation volatility substantially lower, had monetary policy been set optimally.
    Date: 2006
  3. By: Andrea Nobili (Bank of Italy); Stefano Neri (Bank of Italy)
    Abstract: This paper studies the transmission of monetary policy shocks from the US to the euro-area using a two-country structural VAR with no exogeneity assumption. The analysis reveals the following results. First, in response to an unexpected increase in the Federal funds rate, the euro immediately depreciates with respect to the dollar and then appreciates in line with the prediction of the uncovered interest parity condition. Second, there is evidence of a temporary positive spillover to euro-area output in the short run, while a negative effect emerges in the medium run. Third, the contribution of the trade balance channel to the transmission of monetary shocks is negligible. Finally, the degree of pass-through of the exchange rate changes onto euro-area consumer prices is incomplete and small in the short run, while it is close to zero in the medium run.
    Keywords: VAR, Monetary Policy, International transmission
    JEL: C32 E52 F42
    Date: 2006–12
  4. By: Balázs Égert
    Abstract: This paper analyses the effectiveness of foreign exchange interventions in Croatia, the Czech Republic, Hungary, Romania, Slovakia and Turkey using the event study approach. Interventions are found to be effective only in the short run when they ease appreciation pressures. Central bank communication and interest rate steps considerably enhance their effectiveness. The observed effect of interventions on the exchange rate corresponds to the declared objectives of the central banks of Croatia, the Czech Republic, Hungary and perhaps also Romania, whereas this is only partially true for Slovakia and Turkey. Finally, interventions are mostly sterilized in all countries except Croatia. Interventions are not much more effective in Croatia than in the other countries studied. This suggests that unsterilized interventions do not automatically influence the exchange rate.
    Keywords: central bank intervention, foreign exchange intervention, verbal intervention, central bank communication, Central and Eastern Europe, Turkey
    JEL: F31
    Date: 2006
  5. By: Laxton, Doug; N'Diaye, Papa; Pesenti, Paolo
    Abstract: The paper considers the macroeconomic transmission of demand and supply shocks in an open economy under alternative assumptions on whether the zero interest floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy vis-à-vis the rest of the world. Negative demand shocks have more prolonged and startling 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. More open economies hit the ZIF for a shorter period of time, and with less harmful effects. Deflationary supply shocks have different implications according to whether they are concentrated in the tradables rather than 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: deflation; monetary policy rules; zero interest rate floor
    JEL: E17 E52 F41
    Date: 2006–12
  6. By: Gunther Schnabl
    Abstract: Both before and after the Asian crisis, the dollar has been the dominant anchor and reserve currency in East Asia. Due to underdeveloped capital markets and the limited international role of their domestic currencies, the East Asian countries (except Japan) are likely to continue to stabilize exchange rates and to accumulate international reserves. Yet expectations of further dollar depreciation may trigger a re-orientation of exchange rate policies based on basket strategies. Rolling econometric estimations of the basket structures in East Asia suggest growing weights for the Japanese yen in most East Asian currency baskets. The role of the euro as a reserve currency in East Asia remains uncertain.
    Keywords: East Asia, currency basket, exchange rate policies, international role of the euro
    JEL: E58 F31 G15
    Date: 2006
  7. By: Chiara Scotti
    Abstract: This paper studies when and by how much the Fed and the ECB change their target interest rates. I develop a new nonlinear bivariate framework, which allows for elaborate dynamics and potential interdependence between the two countries, as opposed to linear feedback rules, such as a Taylor rule, and I use a novel real-time data set. A Bayesian estimation approach is particularly well suited to the small data sample. Empirical results support synchronization between the central banks and non-zero correlation between mag- nitude shocks, but they do not support follower behavior. Institutional factors and inflation represent relevant variables for timing decisions of both banks. Inflation rates are important factors for magnitude decisions, while output plays a major role in US magnitude decisions.
    Date: 2006
  8. By: Q. Farooq Akram (Norges Bank (Central Bank of Norway)); Ragnar Nymoen (Department of Economics, University of Oslo)
    Abstract: We investigate the importance of employing a valid model for monetary policy analysis. Specifically, we investigate the economic significance of differences in specification and empirical validity of models. We consider three alternative econometric models of wage and price inflation in Norway. We find that differences in model specification as well as in parameter estimates across models can lead to widely different policy recommendations. We also find that the potential loss from basing monetary policy on a model that may be invalid, or on a suite of models, even when it contains the valid model, can be substantial, also when gradualism is exercised as a concession to model uncertainty. Furthermore, possible losses from such a practice appear to be greater than possible losses from failing to choose the optimal policy horizon to a shock within the framework of a valid model. Our results substantiate the view that a model for policy analysis should necessarily be empirically valid and caution against compromising this property for other desirable model properties, including robustness.
    Keywords: Model uncertainty; Econometric modelling; Economic significance; Robust monetary policy.
    JEL: C52 E31 E52
    Date: 2006–12–20
  9. By: Angel Asensio
    Abstract: The paper studies the effects of heterogeneity upon the monetary and fiscal-budgetary policy interactions in a Keynesian monetary union. As a result of interactions, some of our results contrast sharply with the ones in studies that consider separately monetary, fiscal and budgetary policies. Other non-conventional mechanisms are identified in connection with the supply-side effects of fiscal taxes variations. As concerns policy responses to inherited unemployment, the central bank profile proves notably to be crucial in determining the magnitude of the instrument moves that are required to achieve the objectives. Simulations suggest that heterogeneity is likely to introduce more sources of non conventional effects and to enforce adverse interactions, especially in contexts of high unemployment. However, provided authorities are able to control the distributive conflict and its inflationary consequences, it is beneficial for the union that monetary policy specializes in countering the common effects of shocks, because that pushes governments to concentrate in countering the idiosyncratic effects. Employment targets require then lower instruments responses, as a result of efficiency gains.
    Keywords: Monetary policy;Fiscal policy;Monetary union;Macroeconomic governance;Post-Keynesian
    Date: 2006–12–14
  10. By: Vipul Bhatt (Indian Council for Research on International Economic Relations); Arvind Virmani (Indian Council for Research on International Economic Relations)
    Date: 2005–07
  11. By: Carlsson, Mikael (Research Department, Central Bank of Sweden); Westermark, Andreas (Department of Economics, Uppsala University)
    Abstract: In this paper, we outline a baseline DSGE model which enables a straightforward analysis of wage bargaining between firms and households/unions in a model with both staggered prices and wages. Relying on empirical evidence, we assume that prices can be changed whenever wages are changed. This feature of the model greatly reduces the complexity of the price and wage setting decisions; specifically it removes complicated interdependencies between current and future price and wage decisions. In an application of the model we study the interaction between labor-market institutions and monetary policy choices, and the consequences for welfare outcomes. Specifically, we focus on the relative bargaining power of unions. We find that, for a standard specification of the monetary policy rule, welfare is substantially affected by the degree of relative bargaining power, but that this effect can be neutralized by optimal discretionary policy.
    Keywords: Monetary Policy; Labor Market; Bargaining
    JEL: E52 E58 J41
    Date: 2006–12–01
  12. By: Christoph Wunder (University of Bamberg); Johannes Schwarze (University of Bamberg, DIW Berlin and IZA Bonn); Gerhard Krug (Institute for Employment Research (IAB)); Bodo Herzog (German Council of Economic Experts)
    Abstract: Using merged data from the British Household Panel Survey (BHPS) and the German Socio- Economic Panel (SOEP), this paper applies a parametric difference-in-differences approach to assess the real effects of the introduction of the euro on subjective well-being. A complementary nonparametric approach is also used to analyze the impact of difficulties with the new currency on well-being. The results indicate a severe loss in well-being associated with the introduction of the new currency, with the predicted probability that a person is contented with his/her household income diminishing by 9.7 percentage points. We calculate a compensating income variation of approximately one-third. That is, an increase in postgovernment household income of more than 30% is needed to compensate for the rather drastic decline in well-being. The reasons for the negative impact are threefold. First, perceived inflation overestimates the real increase in prices resulting in suboptimal consumption decisions. Second, money illusion causes a false assessment of the budget constraint. Third, individuals have to bear the costs from the conversion and the adjustment to the new currency. Moreover, it is thought that losses are smaller when financial ability is higher. However, the impact of difficulties in using and converting the new currency is rather small, and the initial problems were overcome within one year of the introduction of euro cash.
    Keywords: subjective well-being, euro cash changeover, perceived inflation, difference-in-differences
    JEL: E31 I31
    Date: 2006–12
  13. By: Evren Örs; Tara Rice
    Abstract: We examine whether “imputed” interest rates obtained from bank financial statements are unbiased estimates of “offered” interest rates that the same banks report in surveys. We find evidence of a statistically significant amount of bias. However, the statistical bias that we document does not appear to be economically significant. When used as dependent variables in regression analysis, imputed rates and offered rates lead to the same policy conclusions. Our work has important methodological implications for empirical research that examines the product market competition among depository institutions.
    Date: 2006
  14. By: Natacha Gilson
    Abstract: This paper examines the demand and supply shocks observed in the present Eurozone member states and those observed in some neighboring countries. The analysis is based on recent data and each Eurozone member country is compared with an aggregate series corresponding to an area made up of the entire Eurozone minus the country being compared. The results of the study confirm that, even when the series are corrected by removing the country being compared, the disturbances observed in large Eurozone countries are well correlated with the disturbances observed in other Eurozone member countries.
    Keywords: shocks, Eurozone, optimal currency area
    JEL: E42 F31 F33
    Date: 2006
  15. By: Gregory H. Bauer; Clara Vega
    Abstract: Existing studies using low-frequency data have found that macroeconomic shocks contribute little to international stock market covariation. However, these papers have not accounted for the presence of asymmetric information where sophisticated investors generate private information about the fundamentals that drive returns in many countries. In this paper, we use a new microstructure data set to better identify the effects of private and public information shocks about U.S. interest rates and equity returns. High-frequency private and public information shocks help forecast domestic money and equity returns over daily and weekly intervals. In addition, these shocks are components of factors that are priced in a model of the cross section of international returns. Linking private information to U.S. macroeconomic factors is useful for many domestic and international asset pricing tests.
    Date: 2006
  16. By: Sergio Rebelo; Carlos A. Vegh
    Abstract: The influential Krugman-Flood-Garber (KFG) model of balance of payment crises assumes that a fixed exchange rate is abandoned if and only if international reserves reach a critical threshold value. From a positive standpoint, the KFG rule is at odds with many episodes in which the central bank has plenty of international reserves at the time of abandonment. We study the optimal exit policy and show that, from a normative standpoint, the KFG rule is suboptimal. We consider a model in which the fixed exchange rate regime has become unsustainable due to an unexpected increase in government spending. We show that, when there are no exit costs, it is optimal to abandon immediately. When there are exit costs, the optimal abandonment time is a decreasing function of the size of the fiscal shock. For large fiscal shocks immediate abandonment is optimal. Our model is consistent with the evidence that many countries exit fixed exchange rate regimes with plenty of international reserves in the central bank's vault.
    JEL: F31
    Date: 2006–12
  17. By: Pasquale Della Corte; Lucio Sarno; Daniel L. Thornton
    Abstract: This paper re-examines the validity of the Expectation Hypothesis (EH) of the term structure of US repo rates ranging in maturity from overnight to three months. We extend the work of Longstaff (2000) in two directions: (i) we implement statistical tests designed to increase test power in this context; (ii) we assess the economic value of departures from the EH based on criteria of profitability and economic significance. The EH is rejected throughout the term structure examined on the basis of the statistical tests. The results of our economic analysis are less uniform and more favorable to the EH, suggesting that the statistical rejections of the EH are not economically significant for rates with maturities of one month and longer.
    Date: 2006
  18. By: Nicole Jonkera; Bram Scholten; Marco Wind (DNB); Martijn van Emmerik; Marieke van der Hoeven (TNO Human Factors)
    Abstract: In 2005, some 25,000 counterfeit euro banknotes were identified in the Netherlands, representing a fictitious amount of two million euro. In collaboration with the TNO research institute, DNB has investigated how accurately cash handlers and consumers with no cash handler experience can distinguish counterfeit euro notes from genuine ones. Also examined was the question whether the use of DNB's educational CD-ROM entitled ‘Genuine or Counterfeit?' led to improved performance and whether such aids as UV lights or IR cameras helped to identify notes correctly. The results show that the public is quite capable of recognising a counterfeit note: without practice, members of the general public correctly identified 88% of counterfeit notes they were given to examine, while after training they scored as high as 96%. Remarkable scores were recorded by cash handlers operating without aids: even without training they showed themselves expert at sifting the wheat from the chaff (98% correctly identified counterfeit notes). Recognising genuine euro notes proved slightly more challenging, but here technical aids provided useful services. Practice with the help of the CD-ROM turned out to benefit untrained consumers in particular. They soon managed to bring their performance up to the level of experienced cash handlers. 
    Keywords: banknotes; counterfeits; discrete choice model; experiment; training
    Date: 2006–12

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