nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒02‒24
thirty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Money in Monetary Policy Design under Uncertainty: The Two-Pillar Phillips Curve versus ECB-Style Cross-Checking By Beck, Günter; Wieland, Volker
  2. Monetary Policy and Open-Economy Uncertainty By Alessandro Flamini
  3. Testing the Opportunistic Approach to Monetary Policy By Christopher Martin; Costas Milas
  4. Is Numérairology the Future of Monetary Economics? Unbundling Muméraire and Medium of Exchange Through a Virtual Currency and a Shadow Exchange Rate By Buiter, Willem H
  5. Monetary policy through the “credit-cost channel”. Italy and Germany By Giuliana Passamani; Roberto Tamborini
  6. Hitting and Hoping? Meeting the Exchange Rate and Inflation Criteria During a Period of Nominal Convergence By John Lewis
  7. Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate By Anton Nakov
  8. The Transition to Marked-Based Monetary Policy: What Can China Learn from the European Experience? By Oxelheim, Lars; Forssbæck , Jens
  9. Macroeconomic Implications of Gold Reserve Policy of the Bank of England during the Eighteenth Century By Elisa Newby
  10. Seigniorage By Willem H. Buiter
  11. News Shocks and Optimal Monetary Policy By Guido Lorenzoni
  12. Monetary Policy and Macroeconomic Stability in Latin America: The Cases of Brazil, Chile, Colombia and Mexico By Luiz de Mello; Diego Moccero
  13. Inflation Persistence and the Phillips Curve Revisited By Marika Karanassou; Dennis J. Snower
  14. Sticky Prices and Monetary Policy: Evidence from Disaggregated US Data By Boivin, Jean; Giannoni, Marc; Mihov, Ilian
  15. Dollarization and Financial Integration By Arellano, Cristina; Heathcote, Jonathan
  16. Money market uncertainty and retail interest rate fluctuations: A cross-country comparison By Burkhard Raunig; Johann Scharler
  17. "Fixed and Flexible Exchange Rates and Currency Sovereignty" By C. Sardoni; L. Randall Wray
  18. Solving Endogeneity in Assessing the Efficacy of Foreign Exchange Market Interventions By Seok Gil Park
  19. Trade Unions and the Rate of Change of Money Wages in the U.S. By Orley Ashenfelter; George Johnson; John Pencavel
  20. Transmitting shocks to the economy: The contribution of interest and exchange rates and the credit channel By Edda Claus; ris Claus
  21. Endogenous State Prices, Liquidity, Default, and the Yield Curve By Raphael A. Espinoza; Charles A. E. Goodhart; Dimitrios P. Tsomocos
  22. "Expensive Living: The Greek Experience under the Euro" By Taun N. Toay; Theodore Pelagidis
  23. The monetary model of hyperinflation and the adaptive expectations: limits of the association and model validity. By Alexandre Sokic
  24. A note on the national contributions to euro area M3 By Mehrotra, Aaron
  25. Market Power and Wage Inflation. By Daniel Hamermesh
  26. Currency Areas and International Assistance By Tim Worrall; Pierre M. Picard
  27. Genetic algorithm estimation of interest rate term structure By Ricardo Gimeno; Juan M. Nave
  28. Central Bank intraday collateral policy and implications for tiering in rtgs payment systems By John P. Jackson; Mark J. Manning
  29. "FisherÕs Theory of Interest Rates and the Notion of ÒRealÓ: A Critique" By Eric Tymoigne
  30. The Returns to Currency Speculation in Emerging Markets By Craig Burnside; Martin Eichenbaum; Sergio Rebelo
  31. money demand and futures By Chiara Oldani

  1. By: Beck, Günter; Wieland, Volker
    Abstract: The European Central Bank has assigned a special role to money in its two pillar strategy and has received much criticism for this decision. In this paper, we explore possible justifications. The case against including money in the central bank's interest rate rule is based on a standard model of the monetary transmission process that underlies many contributions to research on monetary policy in the last two decades. Of course, if one allows for a direct effect of money on output or inflation as in the empirical 'two-pillar' Phillips curves estimated in some recent contributions, it would be optimal to include a measure of (long-run) money growth in the rule. In this paper, we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output. Such misperceptions cause a bias in policy setting. We find that cross-checking and changing interest rates in response to sustained deviations of long-run money growth helps the central bank to overcome this bias. Our argument in favour of ECB-style cross-checking does not require direct effects of money on output or inflation.
    Keywords: European Central Bank; monetary policy; monetary policy under uncertainty; money; Phillips curve; quantity theory
    JEL: E32 E41 E43 E52 E58
    Date: 2007–02
  2. By: Alessandro Flamini (Keele University, Centre for Economic Research and School of Economic and Management Studies)
    Abstract: This paper focuses on optimal monetary policy in presence of uncertainty of the structural parameters that characterize an open economy. The framework is a Markov jump-linear-quadratic new Keynesian model, where the central bank searches for the optimal policy in a non certainty equivalence environment. Comparing CPI and domestic inflation targeting, this paper shows that the latter implies considerably less variability in the central bank distribution forecast of the economic dynamics. In particular, the variability of the interest rates distribution forecast is much larger with CPI inflation targeting. The paper also shows that domestic inflation targeting is much less sensitive than CPI inflation targeting to interest rate smoothing and cost-push shocks.
    Keywords: Inflation Targeting; uncertainty; Markov jump linear quadratic system; non-certainty equivalence; small open-economy; optimal monetary policy; domestic and CPI inflation.
    JEL: E52 E58 F41
    Date: 2006–12
  3. By: Christopher Martin (Brunel University); Costas Milas (Keele University, Centre for Economic Research and School of Economic and Management Studies)
    Abstract: The Opportunistic Approach to Monetary Policy is an influential but untested model of optimal monetary policy. We provide the first tests of the model, using US data from 1983Q1-2004Q1. Our results support the Opportunistic Approach. We find that policymakers respond to the gap between inflation and an intermediate target that reflects the recent history of inflation. We find that there is no response of interest rates to inflation when inflation is within 1intermediate target.
    Keywords: Monetary policy, zone of discretion, intermediate inflation target.
    JEL: C51 C52 E52 E58
    Date: 2007–01
  4. By: Buiter, Willem H
    Abstract: The paper discusses some fundamental problems in monetary economics associated with the determination and role of the numéraire. The issues are introduced by formalising a proposal, attributed to Eisler, to remove the zero lower bound on nominal interest rates by unbundling the numéraire and medium of exchange/means of payment functions of money. The monetary authorities manage the exchange rate between the numéraire ('sterling') and the means of payment ('drachma'). The short nominal interest rate on sterling bonds can then be used to target stability for the sterling price level. The paper puts question marks behind two key bits of conventional wisdom in contemporary monetary economics. The first is the assumption that the monetary authorities define and determine the numéraire used in private transactions. The second is the proposition that price stability in terms of that numéraire is the appropriate objective of monetary policy. The paper also discusses the merits of the next step following the decoupling of the numéraire from the currency: doing away with currency altogether - the cashless economy. Because the unit of account plays such a central role in New-Keynesian models with nominal rigidities, monetary economics needs to devote more attention to numérairology - the study of the individual and collective choice processes that govern the adoption of a unit of account and its role in economic behaviour.
    Keywords: cashless economy; optimal inflation; price level determinacy; zero lower bound
    JEL: E3 E4 E5 E6
    Date: 2007–02
  5. By: Giuliana Passamani; Roberto Tamborini
    Abstract: In this paper we wish to extend the empirical content of the "credit-cost channel" of monetary policy that we proposed in Passamani and Tamborini (2005). In the first place, we replicate the econometric estimation of the model for Italy, to which we add Germany. We find confirmation that, in both countries, firms' reliance on bank loans (“credit channel”) makes aggregate supply sensitive to bank interest rates (“cost channel”), which are in turn driven by the inter-bank rate controlled by the central bank plus a credit risk premium charged by banks on firms. The second extension consists of a formal econometric analysis of the idea that the interest rate is an instrument of control for the central bank. The empirical results of the CCC model that, according to Johansen and Juselius (2003), innovations in the inter-bank rate qualify this variables as a "control variable" in the system. Hence we replicate the Johansen and Juselius technique of simulation of rule-based stabilization policy. This is done for both Italy and Germany, on the basis of the respective estimated CCC models, taking the inter-bak rate as the instrument and the inflation of 2% as the target. As a result, we find confirmation that inflation-targeting by way of inter-bank rate control, grafted onto the estimated CCC model, would stabilize inflation through structural shifts of the "AS curve", that is, the path of realizations in the output-inflation space.
    Keywords: Macroeconomics and monetary economics, Monetary transmission mechanisms, Structural cointegration models, Italian economy, German economy
    JEL: E51 C32
    Date: 2006
  6. By: John Lewis
    Abstract: This paper analyses the problem faced by CEECs wishing to join the Euro who must hit both an inflation and exchange rate criterion during a period of nominal convergence. This process requires either an inflation differential, an appreciating nominal exchange rate, or a combination of the two, which makes it difficult to simultaneously satisfy the exchange rate and inflation criteria. The authorities can use their monetary policy to hit one criterion, but must essentially just "hope" to satisfy the other one. The paper quantifies the likely size and speed of these convergence effects, their impact on inflation and exchange rates, and their consequences for the simultaneous compliance with both criteria under an inflation targeting setup and under a fixed exchange rate regime. The key result is that under an inflation targeting regime, the nominal appreciation implied by convergence is not big enough to threaten a breach of the exchange rate criterion, but for countries with fixed exchange rates, inflation is likely to exceed the reference value. This result is robust to plausible changes in the assumed convergence scenario.
    Keywords: Central and Eastern Europe; Nominal Convergence; Euro Adoption
    JEL: E52 E61 E31
    Date: 2007–01
  7. By: Anton Nakov (Banco de España; Universitat Pompeu Fabra)
    Abstract: Recent treatments of the issue of a zero floor on nominal interest rates have been subject to some important methodological limitations. These include the assumption of perfect foresight or the introduction of the zero lower bound as an initial condition or a constraint on the variance of the interest rate, rather than an occasionally binding non-negativity constraint. This paper addresses these issues offering a global solution to a standard dynamic stochastic sticky price model with an explicit occasionally binding non-negativity constraint on the nominal interest rate. It turns out that the dynamics and sometimes the unconditional means of the nominal rate, inflation and the output gap are strongly affected by uncertainty in the presence of the zero lower bound. Commitment to the optimal rule reduces unconditional welfare losses to around one-tenth of those achievable under discretionary policy, while constant price level targeting delivers losses which are only 60% larger than under the optimal rule. Even though the unconditional performance of simple instrument rules is almost unaffected by the presence of the zero lower bound, conditional on a strong deflationary shock simple instrument rules perform substantially worse than the optimal policy.
    Keywords: monetary policy, zero floor, interest rate
    JEL: E31 E32 E37 E52
    Date: 2006–12
  8. By: Oxelheim, Lars (Research Institute of Industrial Economics); Forssbæck , Jens (Lund University)
    Abstract: We discuss the prospects for Chinese money market development and transition to market-based monetary policy operations based on a comparative historical analysis of the present Chinese situation and the development in 11 European countries from 1979 up to the launch of European Economic and Monetary Union (EMU). Central banks in the latter group typically had an incentive to encourage the formation of efficient benchmark segments in the domestic money markets for the conduct of open market operations as traditional quantity-oriented instruments became increasingly ineffective. China is displaying many of the same symptoms as the European countries in the 1970s and 1980s, including poor monetary transmission due to excess liquidity and conflicts of interest due to unclear priority among multiple policy goals. We conclude that the current Chinese multiple-target monetary policy is counter-productive to efforts to develop an efficient money market that can serve as arena for an effective market-based monetary policy.
    Keywords: Monetary Policy Operations; Money Market; China; European Union; Deregulation
    JEL: E42 E52 F41
    Date: 2007–02–06
  9. By: Elisa Newby
    Abstract: By imposing a simple adjustment cost on gold purchases the Bank of England was able to manage external drains of monetary gold while maintaining the convertibility of pound during the eighteenth century. This was a period during which constant political disturbances and external shocks on the market price of gold made monetary policy a challenging task. The implications of adjustment cost were not just limited to the gold reserves of the Bank, but stabilised consumption and the price level.
    Keywords: Gold standard, Monetary policy, Monetary regimes, Adjustment Costs.
    JEL: C61 E31 E4 E5 N13
    Date: 2007–02
  10. By: Willem H. Buiter
    Abstract: Governments through the ages have appropriated real resources through the monopoly of the 'coinage'. In modern fiat money economies, the monopoly of the issue of legal tender is generally assigned to an agency of the state, the Central Bank, which may have varying degrees of operational and target independence from the government of the day. In this paper I analyse four different but related concepts, each of which highlights some aspect of the way in which the state acquires command over real resources through its ability to issue fiat money. They are (1) seigniorage (the change in the monetary base), (2) Central Bank revenue (the interest bill saved by the authorities on the outstanding stock of base money liabilities), (3) the inflation tax (the reduction in the real value of the stock of base money due to inflation and (4) the operating profits of the central bank, or the taxes paid by the Central Bank to the Treasury. To understand the relationship between these four concepts, an explicitly intertemporal approach is required, which focuses on the present discounted value of the current and future resource transfers between the private sector and the state. Furthermore, when the Central Bank is operationally independent, it is essential to decompose the familiar consolidated 'government budget constraint' and consolidated 'government intertemporal budget constraint' into the separate accounts and budget constraints of the Central Bank and the Treasury. Only by doing this can we appreciate the financial constraints on the Central Bank's ability to pursue and achieve an inflation target, and the importance of cooperation and coordination between the Treasury and the Central Bank when faced with financial sector crises involving the need for long-term recapitalisation or when confronted with the need to mimick Milton Friedman's helicopter drop of money in an economy faced with a liquidity trap.
    JEL: E4 E5 E6 H6
    Date: 2007–02
  11. By: Guido Lorenzoni
    Abstract: This paper studies monetary policy in a model where output fluctuations are caused by shocks to public beliefs on the economy's fundamentals. I ask whether monetary policy can offset the effect of these shocks and whether this offsetting is socially desirable. I consider an environment with dispersed information and two aggregate shocks: a productivity shock and a "news shock" which affects aggregate beliefs. Neither the central bank nor individual agents can distinguish the two shocks when they hit the economy. The main results are: (1) despite the lack of superior information an appropriate monetary policy rule can change the economy's response to the two shocks; (2) monetary policy can achieve full aggregate stabilization, that is, it can induce a path for aggregate output that is identical to that which would arise under full information; (3) however, full aggregate stabilization is typically not optimal. The fact that monetary policy can tackle the two shocks separately is due to two crucial ingredients. First, agents are forward looking. Second, current fundamental shocks will become public information in the future and the central bank will be able to respond to them at that time. By announcing its response to future information, the central bank can influence the expected real interest rate faced by agents with different beliefs and, thus, induce an optimal use of the information dispersed in the economy.
    JEL: D83 E32 E52
    Date: 2007–02
  12. By: Luiz de Mello; Diego Moccero
    Abstract: In 1999, new monetary policy regimes were adopted in Brazil, Chile, Colombia and Mexico, combining inflation targeting with floating exchange rates. These regime changes have been accompanied by lower volatility in the monetary stance in Brazil, Colombia and Mexico, despite higher inflation volatility in Brazil and Colombia. This paper estimates a conventional New Keynesian model for these four countries and shows that: i) the post-1999 regime has been associated with greater responsiveness by the monetary authority to changes in expected inflation in Brazil and Chile, while in Colombia and Mexico monetary policy has become less counter-cyclical, ii) lower interest-rate volatility in the post-1999 period owes more to a benign economic environment than to a change in the policy setting, and iii) the change in the monetary regime has not yet resulted in a reduction in output volatility in these countries. <P>Politique monétaire et stabilité macroéconomique en Amérique latine : Brésil, Chili, Colombie et Mexique <BR>De nouveaux régimes monétaires ont été adoptés par le Brésil, le Chili, la Colombie et le Mexique en 1999. Basés sur le ciblage de l’inflation et des taux de change flottants, ces régimes ont été accompagnés d’une réduction de la volatilité de la politique monétaire au Brésil, en Colombie et au Mexique, en dépit de l’augmentation de la volatilité de l’inflation au Brésil et en Colombie. Ce document estime un modèle conventionnel du type « New Keynesian » pour ces quatre pays et démontre que: i) les autorités monétaires ont réagi plus fortement aux changements des expectatives d’inflation à partir de 1999 au Brésil et au Chili, tandis que la politique monétaire est devenue moins contre-cyclique en Colombie et au Mexique, ii) la réduction de la volatilité du taux d’intérêt à partir de 1999 est due à un environnement économique plus favorable plutôt qu’à l’adoption d’un nouveau régime monétaire, et iii) le changement du régime monétaire n’a pas encore conduit à une réduction de la volatilité de l’activité en ces pays.
    JEL: C15 C22 E52 O52
    Date: 2007–02–14
  13. By: Marika Karanassou (Queen Mary, University of London and IZA); Dennis J. Snower (Kiel Institute for World Economics, CEPR and IZA)
    Abstract: A major criticism against staggered nominal contracts is that they give rise to the so called "persistency puzzle" - although they generate price inertia, they cannot account for the stylised fact of inflation persistence. It is thus commonly asserted that, in the context of the new Phillips curve (NPC), inflation is a jump variable. We argue that this "persistency puzzle" is highly misleading, relying on the exogeneity of the forcing variable (e.g. output gap, marginal costs, unemployment rate) and the assumption of a zero discount rate. We show that when the discount rate is positive in a general equilibrium setting (in which real variables not only affect inflation, but are also influenced by it), standard wage-price staggering models can generate both substantial inflation persistence and a nonzero inflation-unemployment tradeoff in the long-run. This is due to frictional growth, a phenomenon that captures the interplay of nominal staggering and permanent monetary changes. We also show that the cumulative amount of inflation undershooting is associated with a downward-sloping NPC in the long-run.
    Keywords: inflation dynamics, persistence, wage-price staggering, new Phillips curve, monetary policy, frictional growth
    JEL: E31 E32 E42 E63
    Date: 2007–02
  14. By: Boivin, Jean; Giannoni, Marc; Mihov, Ilian
    Abstract: This paper disentangles fluctuations in disaggregated prices due to macroeconomic and sectoral conditions using a factor-augmented vector autoregression estimated on a large data set. On the basis of this estimation, we establish eight facts: (1) Macroeconomic shocks explain only about 15% of sectoral inflation fluctuations; (2) The persistence of sectoral inflation is driven by macroeconomic factors; (3) While disaggregated prices respond quickly to sector-specific shocks, their responses to aggregate shocks are small on impact and larger thereafter; (4) Most prices respond with a significant delay to identified monetary policy shocks, and show little evidence of a 'price puzzle'' contrary to existing studies based on traditional VARs; (5) Categories in which consumer prices fall the most following a monetary policy shock tend to be those in which quantities consumed fall the least; (6) The observed dispersion in the reaction of producer prices is relatively well explained by the degree of market power; (7) Prices in sectors with volatile idiosyncratic shocks react rapidly to aggregate monetary policy shocks; (8) The sector-specific components of prices and quantities move in opposite directions.
    Keywords: factor-augmented VAR; monetary policy; price stickiness
    JEL: C3 D2 E31 E4 E5
    Date: 2007–02
  15. By: Arellano, Cristina; Heathcote, Jonathan
    Abstract: How does a country’s choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets. We compare a floating regime to full dollarization. We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen incentives to maintain access to debt markets. Given stronger repayment incentives, more borrowing can be supported, and thus dollarization can increase international financial integration. This prediction of theory is consistent with the experiences of El Salvador and Ecuador, which recently dollarized, as well as with that of highly-indebted countries like Italy which adopted the Euro as part of Economic and Monetary Union: in each case, around the time of regime change, spreads on foreign currency government debt declined substantially.
    Keywords: dollarization; sovereign debt
    JEL: F33 F34 F36
    Date: 2007–02
  16. By: Burkhard Raunig (Oesterreichische Nationalbank, Economic Studies Division, Vienna, Austria); Johann Scharler (Department of Economics, Johannes Kepler University Linz, Austria)
    Abstract: This paper analyzes empirically the relationship between money market uncertainty and unexpected deviations in retail interest rates in a sample of 10 OECD countries. We find that, with the exception of the US, money market uncertainty has only a modest impact on the conditional volatility of retail interest rates. Even for the US we find that the effects of money market uncertainty are spread out over time. Our results are consistent with the hypothesis that banking relationships include implicit insurance arrangements and thereby reduce uncertainty.
    Keywords: Interest Rate Pass-Through; Relationship Banking; Conditional Volatility
    JEL: E43 G21
    Date: 2007–02
  17. By: C. Sardoni; L. Randall Wray
    Abstract: This paper provides an analysis of KeynesÕs original ÒBancorÓ proposal as well as more recent proposals for fixed exchange rates. We argue that these schemes fail to pay due attention to the importance of capital movements in todayÕs economy, and that they implicitly adopt an unsatisfactory notion of money as a mere medium of exchange. We develop an alternative approach to money based on the notion of currency sovereignty. As currency sovereignty implies the ability of a country to implement monetary and fiscal policies independently, we argue that it is necessarily contingent on a countryÕs adoption of floating exchange rates. As illustrations of the problems created for domestic policy by the adoption of fixed exchange rates, we briefly look at the recent Argentinean and European experiences. We take these as telling examples of the high costs of giving up sovereignty (Argentina and the European countries of the EMU) and the benefits of regaining it (Argentina). A regime of more flexible exchange rates would have likely produced a more viable and dynamic European economic system, one in which each individual country could have adopted and implemented a mix of fiscal and monetary policies more suitable to its specific economic, social, and political context. Alternatively, the euro area will have to create a fiscal authority on par with that of the U.S. Treasury, which means surrendering national authority to a central governmentÑan unlikely possibility in todayÕs political climate. We conclude by pointing out some of the advantages of floating exchange rates, but also stress that such a regime should not be regarded as a sort of panacea. It is a necessary condition if a country is to retain its sovereignty and the power to implement autonomous economic policies, but it is not a sufficient condition for guaranteeing that such policies actually be aimed at providing higher levels of employment and welfare.
    Date: 2007–01
  18. By: Seok Gil Park (Indiana University)
    Abstract: Sterilized foreign exchange market interventions have been suspected of being inefficient by many empirical studies, but they are plagued by endogeneity problems. To solve the problems, this paper identifies a system that depicts interactions between the interventions and the foreign exchange rate. The model shows that the interventions are effective when the interventions alter the market participants' conditional expectations of the rate without decreasing the conditional variances. This paper estimates Markov-switching type policy reaction functions by conditional MLE, and market demand/supply curves by IV estimation with generated regressors. The empirical results verify that the interventions of the Bank of Korea from 2001 to 2002 were indeed effective.
    Keywords: Sterilized intervention, Endogeneity, Markov-switching policy function
    JEL: F31 E58 G15
    Date: 2007–02
  19. By: Orley Ashenfelter; George Johnson; John Pencavel
  20. By: Edda Claus; ris Claus
    Abstract: Understanding the transmission channels of shocks is critical for successful policy response. This paper develops a dynamic general equilibrium model to assess the relative importance of the interest rate, the exchange rate and the credit channels in transmitting shocks in an open economy. The relative contribution of each channel is determined by comparing the impulse responses when the relevant channel is suppressed with the impulse responses when all three channels are operating. The results suggest that all three channels contribute to business cycle fluctuations and the transmission of shocks to the economy. But the magnitude of the impact of the interest rate channel crucially depends on the inflation process and the structure of the economy.
    Keywords: Transmission channels, open economy, general equilibrium model
    Date: 2007–02–19
  21. By: Raphael A. Espinoza; Charles A. E. Goodhart; Dimitrios P. Tsomocos
    Abstract: We show, in an exchange economy with default, liquidity constraints and no aggregate uncertainty, that state prices in a complete markets general equilibrium are a function of the supply of liquidity by the Central Bank. Our model is derived along the lines of Dubey and Geanakoplos (1992). Two agents trade goods and nominal assets (Arrow-Debreu (AD) securities) to smooth consumption across periods and future states, in the presence of cashin-advance financing costs. We show that, with Von Neumann-Morgenstern logarithmic utility functions, the price of AD securities, are inversely related to liquidity. The upshot of our argument is that agents’ expectations computed using risk-neutral probabilities give more weight in the states with higher interest rates. This result cannot be found in a Lucas-type representative agent general equilibrium model where there is neither trade or money nor default. Hence, an upward yield curve can be supported in equilibrium, even though short-term interest rates are fairly stable. The risk-premium in the term structure is therefore a pure default risk premium.
    Keywords: cash-in-advance constraints; risk-neutral probabilities; state prices; term structure of interest rates
    JEL: E43 G12
    Date: 2006
  22. By: Taun N. Toay; Theodore Pelagidis
    Abstract: Apart from its widely accepted direct advantages, the introduction of the euro has been accompanied by a surge of inflation in most of the EU member states. At the same time, wagesÐin part, wages of the unskilledÐare relatively losing ground, while the purchasing power of the average European seems also to have weakened since the introduction of the single currency. In this paper we deal with five relevant central issues to interpret "expensiveness" in Greece. First, we examine to what extent recent inflation trends are attributable to the constraints imposed by the monetary unionÐnamely negative demand disturbances in certain Greek regions. Second, we investigate to what extent these patterns are also due to the adoption of the euroÐincluding conversion period effectsÐover product market and other domestic rigidities. Third, we investigate the impact of seasonal effects on inflation, in the context of the Greek so-called traditional "petit-bourgeois capitalism." Fourth, we explore the extent to which unemployment is another factor that drives wages and purchasing power down. Fifth, we apply the Balassa-Samuelson effect to see whether it constitutes the culprit for price hikes in nontradable products in particular. We find that all the aforementioned factors contribute to the Greek expensiveness.
    Date: 2006–12
  23. By: Alexandre Sokic
    Abstract: This article highlights the strict association met in the literature between the adaptive expectations assumption and the correct running of the monetary model of hyperinflation. A complete resolution of the model is carried out under the adaptive expectations hypothesis. It is shown that the assumption of adaptive expectations is not sufficient to ensure the validity of the model for the explanation of monetary hyperinflation. This result raises the question of the field of validity of this model already posed by the introduction of rational expectations. The possibility of development of self-generating hyperinflationary bubbles strengthens the relevance of this question.
    Keywords: hyperinflation, seigniorage, hyperinflationary bubbles
    JEL: E31
    Date: 2007
  24. By: Mehrotra, Aaron (Bank of Finland, BOFIT)
    Abstract: We examine developments in national contributions to euro area M3 for a sample of nine euro area countries during 1999–2005. We investigate the co-movements of national contributions with euro area M3 and discuss possible reasons for divergencies in growth rates of national contributions. Finally, we evaluate the information content of national contributions to M3 using formal tests of causality between monetary aggregates, consumer prices and equity prices.
    Keywords: national contribution; M3; euro area
    JEL: E31 E51
    Date: 2007–01–19
  25. By: Daniel Hamermesh
  26. By: Tim Worrall (Department of Economics Keele University); Pierre M. Picard (University of Manchester, School of Social Sciences, Department of Economics)
    Abstract: This paper considers a simple stochastic model of international trade with three countries. Two of the tree countries are in an economic union. Comparisons are made between equilibrium welfare for these two countries under fixed and flexible exchange rate regimes. Within the model it is shown that flexible exchange rate regimes generate greater welfare. However, we then consider comparisons of welfare when the two countries also engage in some international assistance in order to share risk. Such risk-sharing is limited by enforcement constraints of cross border assistance. It is shown that taking into account limited commitment risk-sharing fixed exchange rates or currency areas can dominate flexible exchange rate regimes reversing the previous result.
    Keywords: Monetary Union; Currency Areas; Fiscal Federalism; Limited Commitment; Mutual Insurance
    JEL: F12 F15 F31 F33
    Date: 2007–01
  27. By: Ricardo Gimeno (Banco de España); Juan M. Nave (Universidad CEU Cardenal Herrera)
    Abstract: The term structure of interest rates is an instrument that gives us the necessary information for valuing deterministic financial cash flows, measuring the economic market expectations and testing the effectiveness of monetary policy decisions. However, it is not directly observable and needs to be measured by smoothing data obtained from asset prices through statistical techniques. Adjusting parsimonious functional forms - as proposed by Nelson and Siegel (1987) and Svensson (1994) - is the most popular technique. This method is based on bond yields to maturity and the high degree of non linearity of the functions to be optimised make it very sensitive to the initial values employed. In this context, this paper proposes the use of genetic algorithms to find these values and reduce the risk of false convergence, showing that stable time series parameters are obtained without the need to impose any kind of restrictions.
    Keywords: forward and spot interest rates, nelson and siegel model, non-linear optimization, numerical methods, svensson model, yield curve estimation
    JEL: G12 C51 C63
    Date: 2006–12
  28. By: John P. Jackson; Mark J. Manning
    Abstract: In this paper we present a model of a Real-Time Gross Settlement (RTGS) payment system with tiered membership where settlement is facilitated by intraday credit extensions from the central bank. RTGS systems process and settle payment instructions individually in real time, ensuring intraday finality. Furthermore, central banks typically provide the settlement accounts across which payments are processed; hence, settlement is typically effected in central bank money, thereby eliminating counterparty risks between members once settlement has taken place. The model allows us to examine the key factors that influence both an agent.s decision over whether to participate directly in an RTGS payment system, and a central bank.s decision as to whether to require collateralisation of intraday credit extensions to payment system participants.
    Date: 2007–01
  29. By: Eric Tymoigne
    Abstract: By providing five different criticisms of the notion of real rate, the paper argues that this concept, as Fisher defined it or as a definition, is not relevant to economic analysis. Following Keynes and other post-Keynesians, the article shows that the notion of real rate is microeconomically and macroeconomically unfounded. Adjusting interest rates for inflation does not protect the purchasing power of wealth, and it is impossible to do so at the macroeconomic level. In addition, an empirical interpretation of the break in the correlation between interest rates and inflation since 1953 is provided.
    Date: 2006–12
  30. By: Craig Burnside; Martin Eichenbaum; Sergio Rebelo
    Abstract: The carry trade strategy involves selling forward currencies that are at a forward premium and buying forward currencies that are at a forward discount. We compare the payoffs to the carry trade applied to two different portfolios. The first portfolio consists exclusively of developed country currencies. The second portfolio includes the currencies of both developed countries and emerging markets. Our main empirical findings are as follows. First, including emerging market currencies in our portfolio substantially increases the Sharpe ratio associated with the carry trade. Second, bid-ask spreads are two to four times larger in emerging markets than in developed countries. Third and most dramatically, the payoffs to the carry trade for both portfolios are uncorrelated with returns to the U.S. stock market.
    JEL: F3 F41
    Date: 2007–02
  31. By: Chiara Oldani (ISAE - Institute for Studies and Economic Analyses)
    Abstract: This paper introduces a micro-model of portfolio utility to look at the effects of futures in the allocation process, starting from Lancaster-type utility model (1991), further developed by Glennon and Lane (1996) on money demand; results underline the role of portfolio substitution and crowding out of inefficient financial assets. The synthetic model can be represented by money and financial innovation, lowering the dimension of the assets from 3 to 2. Statistical evidences confirm the validity of assumptions for the US economy at a static level.
    Keywords: futures, money demand model, utility, substitution.
    JEL: D8 E41 G11
    Date: 2006–05

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