nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒04‒14
fourteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Shifts in the Inflation Target and Communication of Central Bank Forecasts By Mewael F. Tesfaselassie
  2. Model uncertainty and monetary policy By Richard Dennis
  3. Optimal Monetary Policy and Price Stability Over the Long-Run By Oleksiy Kryvtsov; Malik Shukayev; Alexander Ueberfeldt
  4. Open Economy Codependence: U.S. Monetary Policy and Interest Rate Pass-through By John C. Bluedoen; Christopher Bowdler
  5. The Optimal Monetary Policy Response to Exchange Rate Misalignments By Campbell Leith; Simon Wren-Lewis
  6. If exchange rates are random walks, then almost everything we say about monetary policy is wrong By Fernando Alvarez; Andrew Atkeson; Patrick J. Kehoe
  7. Robust monetary policy with imperfect knowledge By Athanasios Orphanides; John C. Williams
  8. Financial Market Integration, Costs of Adjusting Hours Worked, and the Money Multiplier By Pierdzioch, Christian; Cenesiz, M. Alper
  9. Optimal Monetary Policy under Downward Nominal Wage Rigidity By Carlsson, Mikael; Westermark, Andreas
  10. Understanding price developments and consumer price indices in south-eastern Europe By Sabine Herrmann; Eva Katalin Polgar
  11. Significant Shift in Causal Relations of Money, Income, and Prices in Pakistan: The price Hikes in the Early 1970s By Fazal Husain; Abdul Rashid
  12. Prepaid cards: vulnerable to money laundering? By Stanley Sienkiewicz
  13. Argentina's Monetary and Exchange Rate Policies after the Convertibility Regime Collapse By Roberto Frenkel; Martín Rapetti
  14. Mr. Wicksell and the global economy: What drives real interest rates? By Michal Brzoza-Brzezina; Jesus Crespo Cuaresma

  1. By: Mewael F. Tesfaselassie
    Abstract: In a model with forward-looking expectations, the paper examines communication of central bank forecasts when the inflation target is subject to unobserved changes. It characterizes the effect of disclosure of forecasts on inflation and output stabilization and the choice of an active versus passive monetary policy. The paper shows that these choices depend on the slope of the Phillips curve, the central bank's preference weight on inflation relative to output and the ratio of the variability of the inflation target relative to the cost-push disturbance. The paper briefly discusses how disclosure of forecasts may be beneficial for a society that is more concerned about inflation stabilization than the central bank.
    Keywords: Forward-looking expectations, inflation target, central bank fore- casts, disclosure policy
    JEL: E42 E43 E52 E58
    Date: 2007–03
  2. By: Richard Dennis
    Abstract: Model uncertainty has the potential to change importantly how monetary policy should be conducted, making it an issue that central banks cannot ignore. In this paper, I use a standard new Keynesian business cycle model to analyze the behavior of a central bank that conducts policy with discretion while fearing that its model is misspecified. I begin by showing how to solve linear-quadratic robust Markov-perfect Stackelberg problems where the leader fears that private agents form expectations using the misspecified model. Next, I exploit the connection between robust control and uncertainty aversion to present and interpret my results in terms of the distorted beliefs held by the central bank, households, and firms. My main results are as follows. First, the central bank's pessimism leads it to forecast future outcomes using an expectations operator that, relative to rational expectations, assigns greater probability to extreme inflation and consumption outcomes. Second, the central bank's skepticism about its model causes it to move forcefully to stabilize inflation following shocks. Finally, even in the absence of misspecification, policy loss can be improved if the central bank implements a robust policy.
    Keywords: Monetary policy
    Date: 2007
  3. By: Oleksiy Kryvtsov; Malik Shukayev; Alexander Ueberfeldt
    Abstract: This paper examines the role of monetary policy in an environment with aggregate risk and incomplete markets. In a two-period overlapping-generations model with aggregate uncertainty and nominal bonds, optimal monetary policy attains the ex-ante Pareto optimal allocation. This policy aims to stabilize the savings rate in the economy via the effect of expected inflation on real returns of nominal bonds. The equilibrium under optimal monetary policy is characterized by positive average inflation and a nonstationary price level. In an application a key finding is that optimal monetary policy combines features of inflation and price-level targeting.
    Keywords: Monetary policy framework
    JEL: E5
    Date: 2007
  4. By: John C. Bluedoen; Christopher Bowdler
    Abstract: We analyze the international transmission of interest rates under pegged and non-pegged exchange rate regimes, demonstrating that transmission depends upon the informational properties of a base country`s interest rate change. We differentiate between interest rate movements which are predictable/unpredictable and dependent/independent (i.e., a function of non-monetary factors such as cost-push inflation). Under capital mobility, we show that predictable or dependent interest rate changes should elicit interest rate pass-through for an imperfectly credible peg that is less than unity, whilst interest rate changes that are unpredictable and independent should elicit pass-through greater than unity. Using a real-time identification of unpredictable and independent U.S. federal funds rate changes, we provide evidence consistent with these propositions. When the federal funds rate change is unpredictable and independent, the joint hypothesis of unit within-month pass-through to pegs and zero within-month pass-through to non-pegs cannot be rejected. The same hypothesis is strongly rejected following actual, aggregate federal funds rate changes which include predictable and dependent components. In a dynamic context, we find that maximum interest rate pass-through to pegs is delayed. Moreover, even though there is a full transmission of unpredictable and independent federal funds rate changes, they explain only a small portion of pegged regime interest rate changes.
    Keywords: Interest Rate Pass-Through, Monetary Policy Identification, Open Economy Trilemma, Exchange Rate Regime
    JEL: F33 F41 F42
    Date: 2006
  5. By: Campbell Leith; Simon Wren-Lewis
    Abstract: A common feature of exchange rate misalignments is that they produce a divergence between traded and non-traded goods sectors, leading to pressures on monetary policy makers to react. In this paper we develop a small open economy model which features traded and non-traded goods sectors with which to assess the extent to which monetary policy should respond to exchange rate misalignments. To do so we initially contrast the efficient outcome of the model with that under flexible prices and find that the flex-price equilibrium exhibits an excessive exchange rate appreciation in the face of a positive UIP shock. By introducing sticky prices in both sectors we provide a role for policy in the face of UIP shocks. We then derive a quadratic approximation to welfare which comprises quadratic terms in the output gaps in both sectors as well as sectoral rates of inflation. These can be rewritten in terms of the usual aggregate variables, but only after including terms in relative sectoral prices and/or the terms of trade to capture the sectoral composition of aggregates. We derive optimal policy analytically before giving numerical examples of the optimal response to UIP shocks. Finally, we contrast the optimal policy with a number of alternative policy stances and assess the robustness of results to changes in model parameters.
    Keywords: Exchange Rate Misalignment, Monetary Policy, Non-Traded Goods
    JEL: F41 E52
    Date: 2007
  6. By: Fernando Alvarez; Andrew Atkeson; Patrick J. Kehoe
    Abstract: The key question asked by standard monetary models used for policy analysis, How do changes in short-term interest rates affect the economy? All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: the observation that exchange rates are approximately random walks implies that fluctuations in interest rates are associated with nearly one-for-one changes in conditional variances and nearly no changes in conditional means. In this sense standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong.
    Date: 2007
  7. By: Athanasios Orphanides; John C. Williams
    Abstract: We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess imperfect knowledge about the true structure of the economy. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize fluctuations of unemployment around its natural rate but are uncertain about the economy's natural rates of interest and unemployment and how private agents form expectations. In particular, we consider two models of expectations formation: rational expectations and learning. We show that in this environment the ability to stabilize the real side of the economy is significantly reduced relative to an economy under rational expectations with perfect knowledge. Furthermore, policies that would be optimal under perfect knowledge can perform very poorly if knowledge is imperfect. Efficient policies that take account of private learning and misperceptions of natural rates call for greater policy inertia, a more aggressive response to inflation, and a smaller response to the perceived unemployment gap than would be optimal if everyone had perfect knowledge of the economy. We show that such policies are quite robust to potential misspecification of private sector learning and the magnitude of variation in natural rates.
    Keywords: Monetary policy
    Date: 2007
  8. By: Pierdzioch, Christian; Cenesiz, M. Alper
    Abstract: The money multiplier measures the accumulated effect of a monetary policy shock on key macroeconomic variables like output and hours worked. Conventional wisdom suggests that financial market integration should significantly increase the money multiplier. Based on a dynamic general equilibrium model, we derive the result that costs of adjusting hours worked substantially dampen the effect of financial market integration on the money multiplier. Costs of adjusting hours worked capture in an efficient and stylized manner that adjustment processes in the labor market typically are costly and time consuming. Empirical evidence supports the result of our theoretical analysis.
    Keywords: Financial market integration; Money multiplier; Costs of adjusting hours worked
    JEL: F36 F41 E44
    Date: 2007–04–01
  9. By: Carlsson, Mikael (Research Department); Westermark, Andreas (Department of Economics)
    Abstract: We develop a New Keynesian model with staggered price and wage setting where downward nominal wage rigidity (DNWR) arises endogenously through the wage bargaining institutions. It is shown that the optimal (discretionary) monetary policy response to changing economic conditions then becomes asymmetric. Interestingly, we find that the welfare loss is actually slightly smaller in an economy with DNWR. This is due to that DNWR is not an additional constraint on the monetary policy problem. Instead, it is a constraint that changes the choice set and opens up for potential welfare gains due to lower wage variability. Another finding is that the Taylor rule provides a fairly good approximation of optimal policy under DNWR. In contrast, this result does not hold in the unconstrained case. In fact, under the Taylor rule, agents would clearly prefer an economy with DNWR before an unconstrained economy ex ante.
    Keywords: Monetary Policy; Wage Bargaining; Downward Nominal Wage Rigidity
    JEL: E52 E58 J41
    Date: 2007–04–10
  10. By: Sabine Herrmann (Deutsche Bundesbank, Wilhelm-Epstein-Strasse 14, 60431 Frankfurt am Main, Germany.); Eva Katalin Polgar (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The primary goal of monetary policy in most economies of the world is to achieve and maintain price stability. This paper evaluates price developments and consumer price indices in south-eastern European countries, i.e. countries that have either recently joined the EU or are candidate or potential candidate countries. It is motivated by the fact that, in transition countries, inflation has generally been higher and more volatile than in advanced economies. The analysis reveals that the subindex housing/energy appears to be the main driving force behind overall inflation in the region. In most of the countries under review, administered prices prove to be an important factor in consumer price developments, with their weights increasing over time. Inflation volatility in south-eastern Europe is significantly higher than in the euro area. While this is partly due to a higher level of inflation, it also reflects a more pronounced share for the most volatile sub-indices as well as the marked impact of administered prices on the overall price index, a phenomenon which has also been seen in the central and eastern European countries. While in most south-eastern European countries no HICP has been calculated yet, there is little evidence suggesting that the future use of the HICP will result in a systematic change in inflation patterns in the respective countries. However, as deviations have been observed in a few countries for certain periods, without further information on the structure of the respective national CPI and the HICP such differences cannot be fully excluded. JEL Classification: E21, O52, O57, P22.
    Keywords: South-eastern Europe, inflation developments, inflation volatility, consumer price indices, HICP, administered prices.
    Date: 2007–03
  11. By: Fazal Husain (Pakistan Institute of Development Economics, Islamabad); Abdul Rashid (College of Business Management, Karachi)
    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 E4 N4
    Date: 2006
  12. By: Stanley Sienkiewicz
    Abstract: This paper discusses the potential money laundering threat that prepaid cards face as they enter the mainstream of consumer payments. Over the past year, several government agencies have issued reports describing the threat to the U.S. financial system, including the use of prepaid cards by money launderers. Also, this paper incorporates the presentations made at a workshop hosted by the Payment Cards Center at which Patrice Motz, executive vice president, Premier Compliance Solutions, and Paul Silverstein, executive vice president, Epoch Data Inc., led discussions. These two leading anti-money laundering strategists explained how money laundering occurs in financial payments and how firms can mitigate and detect money laundering activities. This paper provides an overview of money laundering, describes how prepaid cards could be abused, and outlines how both the government and the payment sectors have responded to mitigate risks.
    Date: 2007
  13. By: Roberto Frenkel; Martín Rapetti
    Abstract: This paper offers a comprehensive look at how Argentina managed a remarkable economic recovery from its collapse in 2001. The authors show how the Argentine government's policy of targeting a stable and competitive real exchange rate was crucial to the country's economic recovery. They also analyze the various sources of aggregate demand and government revenue in different phases of the expansion. In addition to the crucial role of the exchange rate, the authors look at other policies - such as an export tax, capital controls, and the default on much of the country's sovereign debt - which were met with disapproval by many economists and other commentators but played an important role in the recovery.
    JEL: E58 E52 E42 F31 F41
    Date: 2007–04
  14. By: Michal Brzoza-Brzezina; Jesus Crespo Cuaresma
    Abstract: We use a Bayesian dynamic latent factor model to extract world, regional and country factors of real interest rate series for 22 OECD economies. We find that the world factor plays a privileged role in explaining the variance of real rates for most countries in the sample, and accounts for the steady decrease in interest rates in the last decades. Moreover, the relative contribution of the world factor is rising over time. We also find relevant differences between the group of countries that follow fixed exchange rate strategies and those with flexible regimes.
    Keywords: Real interest rates, natural rate of interest, Bayesian dynamic factor models.
    JEL: E43 C11 E58
    Date: 2007–04

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