nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒03‒17
thirteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Two-Pillar Monetary Policy and Bootstrap Expectations By Heinz-Peter Spahn
  2. Global Monetary Policy Shocks in the G5: A SVAR Approach By Joao Miguel Sousa; Andrea Zaghini
  3. Understanding the New-Keynesian Model when Monetary Policy Switches Regimes By Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
  4. The Taylor rule and interest rate uncertainty in the U.S. 1955-2006 By Mandler, Martin
  5. The monetary transmission mechanism in Pakistan: a sectoral analysis By Alam, Tasneem; Waheed, Muhammad
  6. Inflation Illusion, Credit, and Asset Pricing By Monika Piazzesi; Martin Schneider
  7. Unemployment, Inflation and Monetary Policy in a Dynamic New Keynesian Model with Hiring Costs By Abbritti, Mirko; Boitani, Andrea; Damiani, Mirella
  8. Do Exchange Rates Move in Line With Uncovered Interest Parity? By Huisman, R.; Mahieu, R.J.; Mulder, A.
  9. The Influence of Actual and Unrequited Interventions By Kathryn M.E. Dominguez; Freyan Panthaki
  10. Significant Shift in Causal Relations of Money, Income, and Prices in Pakistan: The price Hikes in the Early 1970s By Husain, Fazal; Rashid, Abdul
  11. World Real Interest Rates: A Global Savings and Investment Perspective By Brigitte Desroches; Michael Francis
  12. Predicting the Term Structure of Interest Rates: Incorporating parameter uncertainty, model uncertainty and macroeconomic information By Michiel D. de Pooter; Francesco Ravazzolo; Dick van Dijk
  13. Dollarization and exchange rate fluctuations By Honohan, Patrick

  1. By: Heinz-Peter Spahn
    Abstract: The paper integrates the two-pillar Phillips curve, which explains expected inflation by the money growth trend, within a simple macro model. A Taylor-like interest rule contains also a money growth target. The model takes into account serially correlated supply and money demand shocks; the latter induce goods demand shocks, thereby establishing a feedback mechanism from money to markets which is missing in the modern New Keynesian approach. Two groups of market agents are distinguished from which one derives inflation expectations from money growth trend figures whereas the other builds rational expectations by way of learning. The inspection of output and inflation variances show that a policy of reacting to excess money growth requires precise information on shock characteristics whereas inflationgap and output-gap oriented interest policies provide more robust stabilization services.
    Date: 2007
  2. By: Joao Miguel Sousa (Banco de Portugal); Andrea Zaghini (Banca d'Italia and CFS)
    Abstract: The paper constructs a global monetary aggregate, namely the sum of the key monetary aggregates of the G5 economies (US, Euro area, Japan, UK, and Canada), and analyses its indicator properties for global output and inflation. Using a structural VAR approach we find that after a monetary policy shock output declines temporarily, with the downward effect reaching a peak within the second year, and the global monetary aggregate drops significantly. In addition, the price level rises permanently in response to a positive shock to the global liquidity aggregate. The similarity of our results with those found in country studies might supports the use of a global monetary aggregate as a summary measure of worldwide monetary trends.
    Keywords: Monetary Policy, Structural VAR, Global Eco
    JEL: E52 F01
    Date: 2006–12–20
  3. By: Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
    Abstract: This paper studies a New-Keynesian model in which monetary policy may switch between regimes. We derive sufficient conditions for indeterminacy that are easy to implement and we show that the necessary and sufficient condition for determinacy, provided by Davig and Leeper, is necessary but not sufficient. More importantly, we use a two-regime model to show that indeterminacy in a passive regime may spill over to an active regime, no matter how active the latter regime is. As a result, a passive monetary policy is more damaging than has been previously thought. Our results imply that the propagation of shocks in an active regime, such as that of the Federal Reserve in the post-1982 period, may be substantially affected by the possibility of a return to a passive regime of the kind that was followed in the 1960s and 1970s.
    JEL: E3 E5 E52
    Date: 2007–03
  4. By: Mandler, Martin
    Abstract: We use a Taylor rule with time-varying policy coefficients in combination with an unobserved components model for the output gap to estimate the uncertainty about future values of the Federal Funds Rate. The model makes it possible to separate ex-ante interest rate uncertainty into three components: 1) uncertainty about the Fed's future policy coefficients, 2) uncertainty about future economic fundamentals, and 3) residual uncertainty. The results show important changes in uncertainty about future short-term interest rates over time with peaks in the late 1960s/early 1970s, mid 1970s and late 1970s/early 1980s. While for one-quarter forecasts uncertainty about the Fed's policy reaction is more important than uncertainty about economic fundamentals this result is reversed for the two-quarter forecast horizon. Results from a modified model with regime shifts in the variance of the policy shocks confirm the previous findings but show changes in residual uncertainty to be important as well.
    Keywords: monetary policy rules; interest rate uncertainty; Kalman filter
    JEL: C53 C32 E52
    Date: 2007–03
  5. By: Alam, Tasneem; Waheed, Muhammad
    Abstract: The present paper takes a first step in investigating the monetary transmission mechanism in Pakistan at a sectoral level. Using quarterly data spanning from 1973:1 to 2003:4, we examine whether monetary policy shocks have different sectoral effects. Taking note of structural transformation of the economy and the monetary and financial reforms during 1990s, we also assess whether the reform process has notable impact on the monetary transmission mechanism. We find evidence supporting sector-specific variation in the real effects of monetary policy. Our results also suggest significant changes in the transmission of monetary shock to real sector of the economy during post-reform period.
    Keywords: Monetary transmission mechanism; VAR; Pakistan; Sectoral analysis
    JEL: C22 E52
    Date: 2006–09
  6. By: Monika Piazzesi; Martin Schneider
    Abstract: This paper considers asset pricing in a general equilibrium model in which some, but not all, agents suffer from inflation illusion. Illusionary investors mistake changes in nominal interest rates for changes in real rates, while smart investors understand the Fisher equation. The presence of smart investors ensures that the equilibrium nominal interest rate moves with expected inflation. The model also predicts a nonmonotonic relationship between the price-to-rent ratio on housing and nominal interest rates -- housing booms occur both when the nominal rate is especially low and when it is especially high. In either situation, disagreement about real interest rates between smart and illusionary investors stimulates borrowing and lending and drives up the price of collateral. The resulting housing boom is stronger if credit markets are more developed. We document that many countries experienced a housing boom in the high-inflation 1970s and a second, stronger, boom in the low-inflation 2000s.
    JEL: E2 E4 G1
    Date: 2007–03
  7. By: Abbritti, Mirko; Boitani, Andrea; Damiani, Mirella
    Abstract: The dynamic general equilibrium model with hiring costs presented in this paper delivers involuntary unemployment in the steady state and involuntary fluctuations in unemploy- ment. After calibrating the model, through simulations we are able to show that our model with labour market imperfections outperforms the standard NK model as for the persis- tence of responses to monetary shocks. Besides, the model can be easily used to assess the impact of di¤erent market imperfections on both the steady state and the dynamics of the economy. We are also able to show how two economies, differing in their degrees of imperfection, react to policy or non policy shocks: a rigid economy turns out to be less volatile than a flexible economy. Something that reflects the actual experience of the US (flexible) and European (rigid) economies.
    Keywords: Hiring Costs; Wage bargaining; Output Gap; New Keynesian Phillips Curve; Monetary Policy
    JEL: E24 J64 E32 E31 E52
    Date: 2006–09
  8. By: Huisman, R.; Mahieu, R.J.; Mulder, A. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: According to uncovered interest rate Parity (UIP), the expected relative change in an exchange rate is equal to the difference between interest rates between the two currencies. Empirically, UIP is frequently rejected. In this paper, we examine whether exchange rates have at least any tendency to move in the direction predicted by UIP and whether exchange rates tend to move more in line with UIP in periods with large interest rate differentials.
    Keywords: Exchange rates;Uncovered interest rate parity;Logit models;
    Date: 2007–02–19
  9. By: Kathryn M.E. Dominguez; Freyan Panthaki
    Abstract: Intervention operations are used by governments to manage their exchange rates but officials rarely confirm their presence in the market, leading inevitably to erroneous reports in the financial press. There are also reports of what we term, unrequited interventions, interventions that the market expects but do not materialize. In this paper we examine the effects of various types of intervention news on intra-day exchange rate behavior. We find that unrequited interventions have a statistically significant influence on returns, volatility and order flow, suggesting that the expectation of intervention, even when governments do not intervene, can affect currency values.
    JEL: F3 F31 G14 G15
    Date: 2007–03
  10. By: Husain, Fazal; Rashid, Abdul
    Abstract: This study extends the analysis of casuality by Husain and Rashid by taking care of the shift in the variables due to the price hikes in the early 1970s. We investigate the casual relations between real money and real income, between nominal money and nominal income, and between nominal money and prices using using the annual data set from 1959-60 to 2003-04, examining the stochastic properties of the variables used in the analysis and taking care of the expected shifts in the series through dummies. The analysis indicates significant shifts in the variables during the sample period. In this context, the shift of the early 1970s seems to be more important to be incorporated in the analysis. The study finds an active role of money in the Pakistani economy, as it is found to be the leading variable in changing prices without any feed back. In the case of income, the study finds the feed back mechanism of money, which is generally missing in the earlier studies probably because of not taking care of the shift in the macroeconomic variables in Pakistan in the early 1970s.
    Keywords: Money; Income; Prices; Price hikes; Casual relations; Pakistan
    JEL: E3 N4 E4
    Date: 2006
  11. By: Brigitte Desroches; Michael Francis
    Abstract: Over the past 15 years, long-term interest rates have declined to levels not seen since the 1970s. This paper explores possible shifts in global savings and investment that have led to this fall in the world real interest rate. There are several key findings. First, the authors identify the relative weakness in investment demand as more important than the relative increase in desired global savings to explain the decline in global interest rates. Second, the results indicate that the key factors explaining movements in savings and investment are variables that evolve relatively slowly over time, such as labour force growth and age structure. The conclusions suggest that over the coming years, world real interest rates are likely to continue to adjust slowly, reflecting longterm trends.
    Keywords: Interest rates; International topics
    JEL: E2 E4 F3
    Date: 2007
  12. By: Michiel D. de Pooter (Erasmus Universiteit Rotterdam); Francesco Ravazzolo (Erasmus Universiteit Rotterdam); Dick van Dijk (Erasmus Universiteit Rotterdam)
    Abstract: We forecast the term structure of U.S. Treasury zero-coupon bond yields by analyzing a range of models that have been used in the literature. We assess the relevance of parameter uncertainty by examining the added value of using Bayesian inference compared to frequentist estimation techniques, and model uncertainty by combining forecasts from individual models. Following current literature we also investigate the benefits of incorporating macroeconomic information in yield curve models. Our results show that adding macroeconomic factors is very beneficial for improving the out-of-sample forecasting performance of individual models. Despite this, the predictive accuracy of models varies over time considerably, irrespective of using the Bayesian or frequentist approach. We show that mitigating model uncertainty by combining forecasts leads to substantial gains in forecasting performance, especially when applying Bayesian model averaging.
    Keywords: Term structure of interest rates; Nelson-Siegel model; Affine term structure model; forecast combination; Bayesian analysis
    JEL: C5 C11 C32 E43 E47 F47
    Date: 2007–03–09
  13. By: Honohan, Patrick
    Abstract: Although the worldwide growth in dollarization of bank deposits has recently slowed, it has already reached very high levels in dozens of countries. Building on earlier findings that allowed the main cross-country variations in the share of dollars to be explained in terms of national policies and institutions, this paper turns to analysis of short-run variations, particularly the response of dollarization to exchange rate changes, which is shown to be too small to warrant " fear of floating " by dollari zed economies. But high dollarization is shown to increase the risk of depreciation and even suspension, as indicated by interest rate spreads. While specific policy is needed to deal with the risks associated with dollarization, the underlying causes of unwanted dollarization should also be tackled.
    Keywords: Economic Theory & Research,Banks & Banking Reform,Macroeconomic Management,Fiscal & Monetary Policy,Financial Economics
    Date: 2007–03–01

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