nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒01‒14
twenty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. How Important is Money in the Conduct of Monetary Policy? By Michael Woodford
  2. The Eventual Failure and Price Indeterminacy of Inflation Targeting By Eagle, David
  3. The Major Functions of the Central Bank By Govori, Fadil
  4. Exchange rate uncertainty and monetary transmission in the Philippines By Bayangos, V.B.
  5. The Single Global Currency: Common Cents for the World By Bonpasse, Morrison
  6. Productivity shocks and Optimal Monetary Policy in a Unionized Labor Market Economy By Mattesini, Fabrizio; Rossi, Lorenza
  7. The effect of the MNB’s communication on financial markets By Péter Gábriel; Klára Pintér
  8. Comovements in volatility in the euro money market By Nuno Cassola; Claudio Morana
  9. An econometric specification of monetary policy dark art By Ielpo, Florian; Guégan, Dominique
  10. Estimating demand for money in Jamaica By Canova, Luciano
  11. Coping with People’s Inflation Perceptions During a Currency Changeover By Thomas A. Eife; W. Timothy Coombs
  12. The macroeconomic effects of monetary policy and financial crisis By Douch, Mohamed
  13. Monetary Policy under Rule-of-Thumb Consumers and External Habits: An International Empirical Comparison By Dibartolomeo, Giovanni; Rossi, Lorenza; Tancioni, Massimiliano
  14. The effectiveness of official intervention in foreign exchange market in Malawi By Simwaka, Kisu
  15. Are money and consumption additively separable in the euro area? A non-parametric approach By Barry E. Jones; Livio Stracca
  16. Can Panel Data Really Improve the Predictability of the Monetary Exchange Rate Model? By Westerlund, Joakim; Basher, Syed A.
  17. Inflation and Supply Shocks in Spain: A Regional Approach By Maria A. Caraballo; Carlos Usabiaga
  18. An Interpretation of An Affine Term Structure Model for Chile By Juan Marcelo, Ochoa
  19. Forecasting Inflation in Developing Nations: The Case of Pakistan By Feridun, Mete
  20. On the optimality of a GCC Monetary Union: Structural VAR, Common Trends and Common Cycles Evidence By abu-qarn, aamer; abu-bader, suleiman
  21. Domestic and Global Determinants of the U.S. Inflation Expectations By Efrem Castelnuovo
  22. The Basic Dynamics of the Stock of Money and Capital By Sánchez, Julián

  1. By: Michael Woodford (Columbia University)
    Abstract: This paper was presented as the 2006 W.A. Mackintosh Lecture at Queen's University. I consider some of the leading arguments for assigning an important role to tracking the growth of monetary aggregates when making decisions about monetary policy. First, I consider whether ignoring money means returning to the conceptual framework that allowed the high inflation of the 1970s. Second, I consider whether models of inflation determination with no role for money are incomplete, or inconsistent with elementary economic principles. Third, I consider the implications for monetary policy strategy of the empirical evidence for a long­run relationship between money growth and inflation. (Here I give particular attention to the implications of "two-­pillar Phillips curves" of the kind proposed by Gerlach (2003).) And fourth, I consider reasons why a monetary policy strategy based solely on short-­run inflation forecasts derived from a Phillips curve may not be a reliable way of controlling inflation. I argue that none of these considerations provide a compelling reason to assign a prominent role to monetary aggregates in the conduct of monetary policy.
    Keywords: inflation, Phillips curve, monetary policy
    JEL: E50 E52 E58
    Date: 2006–10
  2. By: Eagle, David
    Abstract: In stark contrast to the previous literature, we find that IT leads to price indeterminacy even when the central bank uses a Taylor-like feedback rule to peg the nominal interest rate. We also find that there is no mechanism with IT to determine the current inflation rate or price level. We conclude that the previous literature has either committed mathematical errors involving infinity or misused the non-explosive criterion for ruling out speculative bubbles. To avoid making errors involving infinity, we analyze inflation targeting (IT) in a typical rational-expectations, pure-exchange, general-equilibrium model where the time horizon is arbitrarily large, but finite.
    Keywords: inflation targeting; price determinacy; monetary policy; pegging interest rates; errors of infinity
    JEL: E42 E52 E58
    Date: 2006–11–22
  3. By: Govori, Fadil
    Abstract: The major functions of the Central Bank are to set and administer monetary policy, by controlling the money supply and interest rates; to act as a lender of last resort to banks through the discount window; to assist in the payments and collections systems, through the check clearing process and the electronic wire transfer of funds; and to regulate commercial banks.
    Keywords: Banking; Central Banking
    JEL: E58 E51 E52
    Date: 2006–11–30
  4. By: Bayangos, V.B.
    Keywords: exchange rate; monetary transfers; Philippines;
    Date: 2006
  5. By: Bonpasse, Morrison
    Abstract: This is the only book in print in the world about the single global currency, and is the only book in the world priced in 147 currencies. It describes the origins of the current worldwide foreign exchange system, and tells how to change it; and save the world - trillions. The multicurrency foreign exchange trading system was developed about 2,500 years ago to enable people of different currency areas to trade. That system has become far more sophisticated in the meantime and handles $2.5 trillion per day; but it is very expensive and risky. It is now time to replace that system with a single global currency. In a 3-G world with a single global currency managed by a global central bank within a global monetary union: - Annual transaction costs of $400 billion will be eliminated. - Worldwide asset values will increase by about $36 trillion. - Worldwide GDP will increase by about $9 trillion. - Global currency imbalances will be eliminated. - All Balance of Payments problems will be eliminated. - Currency crises will be prevented. - Currency speculation will be eliminated. - The need for foreign exchange reserves, with a current annual opportunity cost of approximately $470 billion, will be eliminated. Such gains are realistic and attainable if the world decides to pursue them. The monetary unions of Europe, the Caribbean, Africa and Brunei/Singapore have shown the way. What the people of the world want is sound, stable money and the end to the obsolete multicurrency foreign exchange system. A single global currency is no longer a utopian dream, but a realistic projection of what has been learned from current monetary unions, especially the euro. Each successive annual edition of this book will be priced in the remaining number of currencies until we reach, in the words of Nobel Prize winner, Robert Mundell, that odd number, preferably less than three: one The world needs to set the goal of a single global currency, to be managed by a global central bank, within a global monetary union, and begin planning - now.
    Keywords: single global currency; money; currency; monetary union; global monetary union; global central bank; global imbalances; current account; balance of payments; transaction charges; foreign exchange; foreign exchange reserves; monetary reserves; gold; international monetary fund; SDR; special drawing rights; optimal currency area; OCA; Robert Mundell; John Stuart Mill; dollar; European Monetary Union; euro; European Central Bank; Single Global Currency Association; Bretton Woods; John Maynard Keynes; bancor; dollarization; euroization; exchange rate; exchange rate regime; peg; float;
    JEL: F33 F02 F31
    Date: 2006–04–24
  6. By: Mattesini, Fabrizio; Rossi, Lorenza
    Abstract: In this paper we analyze a general equilibrium DSNK model characterized by labor indivisibilities, unemployment and a unionized labor market. The presence of monopoly unions introduces real wage rigidities in the model. We show that as in Blanchard Galì (2005) the so called "divine coincidence" does not hold and a trade-off between inflation stabilization and the output stabilization arises. In particular, a productivity shock has a negative effect on inflation, while a reservation-wage shock has an effect of the same size but with the opposite sign. We derive a welfare-based objective function for the Central Bank as a second order Taylor approximation of the expected utility of the economy's representative household, and we analyze optimal monetary policy under discretion and under commitment. Under discretion a negative productivity shock and a positive exogenous wage shock will require an increase in the nominal interest rate. An operational instrument rule, in this case, will satisfy the Taylor principle, but will also require that the nominal interest rate does not necessarily respond one to one to an increase in the natural rate of interest. The results of the model are consistent with a well known empirical regularity in macroeconomics, i.e. that employment volatility is relatively larger than real wage volatility.
    Keywords: Optimal Monetary Policy; Unionized Labor Market; Indivisible Labor; Taylor Rule
    JEL: E24 J51 E52 E32 J23 E50
    Date: 2006–06
  7. By: Péter Gábriel (Magyar Nemzeti Bank); Klára Pintér (Magyar Nemzeti Bank)
    Abstract: Our paper aims to assess how the Magyar Nemzeti Bank’s communication affects financial asset prices. We find that the central bank plays the most important role in influencing long-term yields. The effect on the exchange rate is less pronounced, while short-term yields are influenced only by the communication related to the exchange rate. Analysing the direction and channels of communication we observe two asymmetries. The central bank is more successful in signalling monetary policy tightening than easing and with the increase of time horizon the written communication gains in importance and dominates the verbal forms.
    Keywords: communication, transmission mechanism.
    JEL: C22 E43 E52
    Date: 2006
  8. By: Nuno Cassola (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Claudio Morana (International Centre for Economic Research (ICER, Torino) and University of Piemonte Orientale, Faculy of Economics and Quantitative Methods, Via Perrone 18, 28100, Novara, Italy.)
    Abstract: This paper assesses the sources of volatility persistence in Euro Area money market interest rates and the existence of linkages relating volatility dynamics. The main findings of the study are as follows. Firstly, there is evidence of stationary long memory, of similar degree, in all series. Secondly, there is evidence of fractional cointegration relationships relating all series, except the overnight rate. Two common long memory factors are found to drive the temporal evolution of the volatility processes. The first factor shows how persistent volatility shocks are trasmitted along the term structure, while the second factor points to excess persistent volatility at the longer end of the yield curve, relative to the shortest end. Finally, impulse response analysis and forecast error variance decomposition point to forward transmission of shocks only, involving the closest maturities. JEL Classification: C14, C63, E41.
    Keywords: Money market interest rates; liquidity effect, realized volatility, fractional integration and cointegration, fractional vector error correction model.
    Date: 2006–12
  9. By: Ielpo, Florian; Guégan, Dominique
    Abstract: The classical Taylor rules usually do not yield the same estimation error when working in a monthly or a quarterly framework. This brings us to the conclusion that there must be something that monthly Taylor rules can capture and that the quarterly one cannot: we postulate that it simply boils down to the fact that the target rate’s changes are irregularly spaced in time. So as to tackle this issue, we propose to split the target rate chronicle between changes in the target and the associated durations, that is the time spending between two changes in the target rate. In this framework, we propose to consider that changes in rate can be regarded as a real monetary policy decision, whereas the duration period between two changes can be related to a ”wait and see” position or some fine tuning problematic. To show that both these features of monetary policy do not react to the same fundamentals, we propose an econometric understanding of the Fed’s reaction function using a new model derived from financial econometrics that has been proposed by Engle and Russell (2005). We propose to model the changes in target rates with a classical ordered probit and the durations with an autoregressive conditional duration model. We extracted the Fed anticipations regarding inflation and activity using some factor based method, and used these factors as explanatory variables for the changes in rates and the related durations. We show that the target rate level, the scale of the change in target rate and the associated duration do not necessarily react to the same factors and if they do, the impact can be different. This empirical result supports the idea that durations and scale of the change in target rate deserve equal attention when modeling a Central Bank reaction function.
    Keywords: Taylor rule; duration models; probit models; Central Bank expectations; factor based methods.
    JEL: E52 E58
    Date: 2006–03–04
  10. By: Canova, Luciano
    Abstract: This paper estimates the money demand function for Jamaica using cointegration method. This approach provides estimates of the long run structural relations and focuses also on the complex short run feedbacks of monetary policy on strategic macro variables.
    Keywords: jamaica; demand for money; cointegration
    JEL: E50
    Date: 2006
  11. By: Thomas A. Eife (University of Heidelberg, Department of Economics); W. Timothy Coombs (University of Illinois)
    Abstract: The gap between actual and perceived inflation is one of the more unexpected consequences of the euro changeover in January 2002. In this note we argue that this gap was caused by a lack of preparation and experience of the authorities to appropriately communicate with the public during the changeover. Using principles of crisis communication we identify the mistakes made and give policy recommendations for future changeovers.
    Keywords: crisis communication, transformative explanation, perceived inflation, euro changeover
    JEL: E50 E60 Y80
    Date: 2006–12
  12. By: Douch, Mohamed
    Abstract: In this paper we focus on postwar US data and incorporate new nancial measures and monetary policy shocks in a vector autoregression (VAR) system in order to test whether one or the other has any real effect on the economy. We nd econometric evidence that these shocks and events are exogenous, and therefore the exogenous nature of shocks to monetary policy and stock market crashes investigated in this study may help policymakers, especially regarding debates related to eventual relationships between optimal monetary policy and nancial stability.
    Keywords: Financial crisis; monetary policy
    JEL: E5 G1
    Date: 2005–05–01
  13. By: Dibartolomeo, Giovanni; Rossi, Lorenza; Tancioni, Massimiliano
    Abstract: This paper develops a simple New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model with rule-of-thumb consumers and external habits. Our theoretical model has a closed-form solution which allows the analytical derivation of its dynamical and stability properties. These properties are analyzed and discussed in the light of their implications for the efficacy and the calibration of the conduct of the monetary policy. The model is then evaluated empirically, employing numerical simulations based on Monte Carlo Bayesian estimates of the structural parameters and impulse response analyses based on weakly identified SVECMs. The estimates are repeated for each of the G7 national economies. Providing single country estimates and simulations, we derive some indications on the relative efficacy of monetary policy and of its potential asymmetric effects resulting from the heterogeneity of the estimated models.
    Keywords: Rule-of-thumb; habits; monetary policy transmission; price puzzle; DSGE New Keynesian model; monetary policy; SVECM and Monte Carlo Bayesian estimators. Rule-of-thumb; habits; monetary policy transmission; price puzzle; DSGE New Keynesian model; monetary policy; SVECM and Monte Carlo Bayesian estimators. Rule-of-thumb; habits; monetary policy transmission; price puzzle; DSGE New Keynesian model; monetary policy; SVECM and Monte Carlo Bayesian estimators.
    JEL: E50 E52 C15 E58
    Date: 2004–12
  14. By: Simwaka, Kisu
    Abstract: The Malawi Kwacha was floated in February 1994. Since then, the Reserve Bank of Malawi has periodically intervened in the foreign exchange market. This paper analyses the effectiveness of foreign exchange market interventions carried out by the Reserve Bank of Malawi. We use a GARCH (1, 1) model to simultaneously estimate the effect of intervention on the mean and volatility of the Malawi kwacha. Using monthly exchange rates and official intervention data from January 2002 to February 2006, the empirical results suggest that intervention activities of the Reserve Bank of Malawi affect the kwacha. In line with similar findings elsewhere in the literature, the paper finds that net sales of dollars by the Reserve Bank of Malawi depreciate, rather than appreciate, the kwacha. This effect is very small, however. Moreover, the paper also finds that the Reserve Bank of Malawi intervention reduces the volatility of the kwacha. This shows that the Reserve Bank actually achieves its objective of smoothing out fluctuations of the kwacha. This can be evidenced by the stability of the kwacha during a greater part of 2004. Thus intervention is, to some extent, used as an effective tool for moderating fluctuations of the kwacha. However, its effectiveness is constrained by the amounts of foreign exchange reserves, which are usually low.
    Keywords: Official intervention; foreign exchange market; garch model
    JEL: E58
    Date: 2006–11–20
  15. By: Barry E. Jones (Assistant Professor, Department of Economics, State University of New York at Binghamton, PO Box 6000, Binghamton, NY 13902-6000, USA.); Livio Stracca (Counsellor to the Executive Board, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We propose a numerical test of the non-parametric conditions for additive separability between consumption and real money balances, building on Varian (1983). If additive separability is rejected, then real balances enter into the theoretical IS curve. We test whether or not monetary assets and consumption are additively separable for the euro area using quarterly data from 1991 to 2005. Previous results using a parametric approach suggest that real balances can be excluded from the IS curve. We find that additive separability is violated over this sample period. After 1992, however, violations involve only a few observations and are in some instances related to measurement problems in the data. Overall, our results tend to support the claim that perfect non-separability between consumption and real balances is implausible, but that non-separabilities may not be very important empirically. At the same time, we reject additive separability throughout if we extend the sample period back to the 1980s, a period characterised by higher volatility in inflation and money growth. JEL Classification: C14, C63, E41.
    Keywords: Non-parametric testing, Revealed Preference, Additive Separability, Money, IS Curve.
    Date: 2006–12
  16. By: Westerlund, Joakim; Basher, Syed A.
    Abstract: A common explanation for the inability of the monetary model to beat the random walk in forecasting future exchange rates is that conventional time series tests may have low power, and that panel data should generate more powerful tests. This paper provides an extensive evaluation of this power argument to the use of panel data in the forecasting context. In particular, by using simulations it is shown that although pooling of the individual prediction tests can lead to substantial power gains, pooling only the parameters of the forecasting equation, as has been suggested in the previous literature, does not seem to generate more powerful tests. The simulation results are illustrated through an empirical application.
    Keywords: Monetary Exchange Rate Model; Forecasting; Panel Data; Pooling; Bootstrap.
    JEL: F47 F31 C32 C15 C33
    Date: 2006–12–20
  17. By: Maria A. Caraballo; Carlos Usabiaga
    Abstract: This paper analyses the effects of supply shocks on the Spanish inflation rate. Our goal is to determine if there is a homogeneous behaviour across regions with regard to that issue or if, on the contrary, there are regions more inflationary than others. In this sense, this paper tries to throw some light on the causes of the recent increase in the Spanish inflation rate and the relation of this fact with the evolution of oil prices. The methodology applied is based on the seminal paper of Ball and Mankiw (1995). Those authors assume that a good proxy for supply shocks is the third moment of the distribution of changes in relative prices, and show that for no trend inflation regimes the presence of nominal rigidities, like menu costs, implies a positive relationship between inflation and skewness -i.e., the supply shocks-, that is magnified by the variance of the distribution. In order to achieve these goals, we have chosen the 1993-2005 period, given that it fulfils the features required to apply the methodology above mentioned. The data used are the monthly consumer price indexes of each region, disaggregated in 57 categories. As a first stage, we have checked that the skewness of the distribution of changes in relative prices is a good proxy for supply shocks. After that, the relationship between inflation and the higher moments of the distribution is estimated. Moreover, control variables as interest rates and unemployment rates have been introduced. The analysis has been carried out in two ways. On one hand, each region is analysed separately and, on the other hand, we have used panel data techniques in order to test homogeneity across regions. Our results point out that Spanish regions show a common pattern with regard to inflation behaviour and that they are vulnerable to supply shocks.
    Date: 2006–08
  18. By: Juan Marcelo, Ochoa
    Abstract: This paper attempts to provide an economic interpretation of the factors that drive the movements of interest rates of bonds of different maturities in a continuous-time no arbitrage term structure model for Chile. The dynamics of yields in the model are explained by two latent factors, namely the instantaneous short rate and its time-varying central tendency. The model estimates suggest that the short end of the yield curve is mainly driven by changes in first latent factor, while long-term interest rates are mainly explained by the second latent factor. Consequently, when examining movements in the term structure, one should think of at least two forces that hit the economy: temporary shocks that change short-term and medium-term interest rates by much larger amounts than long-term interest rates, causing changes in the slope of the yield curve; and long-lived innovations which have persistent effects on the level of the yield curve.
    Keywords: Affine term structure model; yield curve; Kalman filter
    JEL: E20 E44 C33 E43 G12
    Date: 2006–11
  19. By: Feridun, Mete
    Abstract: This study attempts to outline the practical steps which need to be undertaken to use autoregressive integrated moving average (ARIMA) time series models for forecasting Pakistan’s inflation. A framework for ARIMA forecasting is drawn up. On the basis of insample and out-of-sample forecast it can be concluded that the model has sufficient predictive powers and the findings are well in line with those of other studies. Further, in this study, the main focus is to forecast the monthly inflation on short-term basis, for this purpose, different ARIMA models are used and the candid model is proposed. On the basis of various diagnostic and selection & evaluation criteria the best and accurate model is selected for the short term forecasting of inflation.
    Keywords: Forecasting inflation; ARIMA
    JEL: E10
    Date: 2006
  20. By: abu-qarn, aamer; abu-bader, suleiman
    Abstract: This paper examines the suitability of the proposed monetary union among the members of the Gulf Cooperation Council (GCC). To do so, we identify the underlying structural shocks that these economies are subject to and assess the extent to which the shocks are symmetric. Additionally, we test for common trends and common business cycles among the GCC economies. We find that while the transitory demand shocks are typically symmetric, the permanent supply shocks are asymmetric. Furthermore, we do not find synchronous long-run and short-run movements in output. Despite the progress that has been made in terms of integration, our findings indicate that the conditions for forming a GCC monetary union have not as yet been met.
    Keywords: Gulf Cooperation Council; GCC; optimal monetary union; cointegration; common cycles; structural VAR
    JEL: F33 F36
    Date: 2006
  21. By: Efrem Castelnuovo (University of Padua)
    Abstract: This paper estimates a reduced-form model for the short-term U.S. inflation expectations and assesses the empirical relevance of the role played by some proxies of the business cycle in shaping forecasters’ projections. In particular, we consider both standard indicators of the "domestic" economic slack (such as the U.S. output and unemployment gap) and "global" measures of the business cycle (their G7 counterparts). Two main findings stand out. First, all the measures of economic slack we take into account turn out to be statistically significant when considered one at a time. Second, horserace regressions contrasting domestic and global measures of economic slack favors the latter, i.e. when global indicators are considered, domestic indicators take the wrong sign and lose their significance. These results are robust to the introduction of several additional indicators of inflationary pressures in the empirical model. Rolling regressions confirm our findings also at a subsample level. Overall, our results suggest that further research is needed for better understanding the role played by measures of the international economic slack in predicting the U.S. inflation expectations.
    Keywords: inflation expectations, output gap, unemployment gap, domestic factors, global factors
    JEL: F02 E31 E52 E58 F41
    Date: 2006–12
  22. By: Sánchez, Julián (Departamento de Análisis Económico (Teoría e Historia Económica). Universidad Autónoma de Madrid)
    Abstract: We present in this paper a model that explains the role of the external financing of capital in the evolution of a primitive economy constituted by families and firms. Our aim is to clarify which are the essential financial elements that in more complex and advanced economies could explain the evolution of their financial structures towards fragility. Now we begin studying the stability of the financial structure of a rudimentary economy with endogenous money.
    JEL: E12 G10 E32 E51

This nep-mon issue is ©2007 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.