nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒04‒21
thirty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Pillars of Globalization: A history of monetary policy targets, 1797-1997 By Flandreau, Marc
  2. Real-Time Time-Varying Equilibrium Interest Rates: Evidence on the Czech Republic By Roman Horváth
  3. Monetary Policy before Euro Adoption: Challenges for EU New Members By Jan Filácek; Roman Horváth; Michal Skorepa
  4. The Hungarian Monetary Transmission Mechanism: an Assessment By Balázs Vonnák
  5. Misperceived Money and Inflation Dynamics By COLLARD, Fabrice; DELLAS, Harris
  6. Rescuing the LM (and the money market) in a modern Macro course By Roberto Tamborini
  7. Liquidity preference as rational behaviour under uncertainty By Mierzejewski, Fernando
  8. Interest Rate Pass-Through in Central and Eastern Europe: Reborn from Ashes Merely to Pass Away? By Balázs Égert; Jesus Crespo-Cuaresma; Thomas Reininger
  9. Monetary Transmission Mechanism in Central & Eastern Europe: Gliding on a Wind of Change By Fabrizio Coricelli; Balázs Égert; Ronald MacDonald
  10. Monetary policy credibility and inflation risk premium: a model with application to Brazilian data By Alexandre Lowenkron; Marcio Gomes Pinto Garcia
  11. Learning and the Great Inflation By Carboni, Giacomo; Ellison, Martin
  12. Checking Out: Exits from Currency Unions By Rose, Andrew K
  13. Monetary Policy Inertia or Persistent Shocks: A DSGE Analysis By CARRILLO, Julio; FÈVE, Patrick; MATHÉRON, Julien
  14. The Role of Interbank Markets in Monetary Policy: A Model with Rationing By Xavier Freixas; José Jorge
  15. Monetary Commitment, Institutional Constraints and Inflation: Empirical Evidence for OECD Countries since the 1970s By Andreas Freytag; Friedrich Schneider
  16. Optimal Monetary Policy under Downward Nominal Wage Rigidity By Carlsson, Mikael; Westermark, Andreas
  17. Central Bank Interventions, Communication & Interest Rate Policy in Emerging European Economies By Balázs Égert
  18. "Benjamin Franklin and the Birth of a Paper Money Economy" By Farley Grubb
  19. Monetary Equilibrium and the Differentiability of the Value Function By Aliprantis, C.D.; Camera, G.; Ruscitti, F.
  21. Financial Accelerator Effects in the Balance Sheets of Czech Firms By Roman Horváth
  22. On Some Slippery Slopes: Horizontalists, Structuralists and Diagrams By Peter Howells
  23. "How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes" By Burton A. Abrams
  24. Borders and the Constraints of Globalization By Michele FRATIANNI
  25. Central bank communication, transparency and interest rate volatility: Evidence from the USA By Iris Biefang-Frisancho Mariscal; Peter Howells
  26. Search Frictions on Product and Labor Markets: Money in the Matching Function By Etienne Lehmann; Bruno Van der Linden
  27. Price Rigidity and Flexibility: Recent Theoretical Developments By Levy, Daniel
  28. Relationship between inflation, unemployment and labor force change rate in France: cointegration test By Kitov, Ivan; Kitov, Oleg; Dolinskaya, Svetlana
  29. Exact prediction of inflation in the USA By Ivan, Kitov
  30. Is Mercosur an optimum currency area? By Neves, J. Anchieta; Stocco, Leandro; Da Silva, Sergio

  1. By: Flandreau, Marc
    Abstract: This paper studies the evolution of monetary policy targets over the course of the past 200 years. We argue that policy targets are set as part of an assignment procedure that is intended to address both time consistency and monitoring problems. As a result, central banks, after having been assigned to target the exchange rate in the 19th century, are now entrusted with targeting the rate of inflation. Critical advances in the measurement of inflation have proved decisive in bringing about this radical transformation.
    Keywords: central banks; exchange rates; inflation; monetary policy targets
    JEL: E1 E3 E5
    Date: 2007–04
  2. By: Roman Horváth
    Abstract: This paper examines (real-time) equilibrium interest rates in the Czech Republic in 2001:1- 2005:12 estimating various specifications of simple Taylor-type monetary policy rules. First, we estimate it using GMM. Second, we apply structural time-varying coefficient model with endogenous regressors to evaluate fluctuations of equilibrium interest rate over time. The results suggest that there is substantial interest rate smoothing and central bank primarily responds to inflation (forecast) developments. The estimated parameters seem to sustain the equilibrium determinacy. We find that the equilibrium interest rates gradually decreased over sample period to the levels comparable to those of in the euro area reflecting capital accumulation, smaller risk premium and successful disinflation in the Czech economy.
    Keywords: equilibrium interest rates, Taylor rule, augmented Kalman filter
    JEL: E43 E52 E58
    Date: 2006–10–01
  3. By: Jan Filácek; Roman Horváth; Michal Skorepa
    Abstract: This article analyzes the main issues for monetary policy in new EU member states before their euro adoption. These are typically rooted in the challenge of fulfilling concurrently of the Maastricht inflation and exchange rate criterion, as these countries are experiencing equilibrium real exchange rate appreciation. In this article we first distinguish between the wording, written interpretation and “revealed” interpretation of the inflation and exchange rate criteria. Then we discuss the options for monetary policy in the period of fulfilment of these criteria in terms of its transparency, its continuity with the previous monetary policy regime, the choice of central parity for the ERM II, the setting of the fluctuation bandwidth, the probability of fulfilment of both criteria and the impact on economic stability.
    Keywords: monetary policy, euro adoption, ERM II, EU
    JEL: E58 E52 F42 F33
    Date: 2006–11–01
  4. By: Balázs Vonnák (Magyar Nemzeti Bank)
    Abstract: This paper attempts to aggregate and summarise fresh results concerning the monetary transmission mechanism in Hungary. Within a research project at the MNB nine studies have been published investigating the channels through which Hungarian monetary policy affects the economy. We create a framework for synthesising particular results based on Mishkin’s (1996) classification. We analyse how aggregate demand is affected through those channels. Our conclusion is that during the past ten years monetary policy did exert a measurable influence on real activity and prices. The dominance of the exchange rate channel explains why prices respond faster and output responds more mildly than in closed developed economies like the U.S. or the euro area. We expect that after adopting the euro the absence of exchange rate will be compensated by the fact that the interest rate channel will work through foreign demand as well. Therefore, no significant asymmetries can be expected inside the euro area in terms of monetary transmission.
    Keywords: monetary transmission mechanism, monetary policy shock, exchange rate channel.
    JEL: E44 E52 E58
    Date: 2007
  5. By: COLLARD, Fabrice; DELLAS, Harris
    JEL: E32 E52
    Date: 2006
  6. By: Roberto Tamborini
    Abstract: This paper considers recent proposals of introductory-level macroeconomic models that drop the LM apparatus in favour of the straightforward use of the Taylor rule as a means to determine the nominal interest rate and to link the monetary block with the real block of the economy. Whilst one can only agree with the various complaints made against the traditional treatment of the LM apparatus that still survives in modern textbooks, the new IS-AS-TR workhorse has several drawbacks as well, the most serious one being that it completely hides the concept of monetary equilibrium from view, transmitting the faulty idea that the central bank can set the (real!) interest rate at will, with no connection at all with money demand and supply. The paper suggest how a Macro course could be structured around a model of New Keynesian inspiration where the LM block is amended rather than suppressed. Section 2 surveys the foundations of the macro-model. Section 3 deals with the foundations of the role of money in the model, and shows how to derive a consistent LM "gap function" in relation to "output gaps" and "inflation gaps" according to current practice. Section 4 expands upon the monetary block, highlighting that it admits of two monetary policy regimes, the "exogenous-money regime", and the "endogenous-money regime". The latter leads quite naturally to the Taylor rule, while making it clear that this is a particular choice of the central bank, and that it implies an endogenous path of the money stock determined by the underlying money market equilibrium. Section 5 concludes.
    Date: 2007
  7. By: Mierzejewski, Fernando
    Abstract: An important concern of macroeconomic analysis is how interest rates affect the cash balance demanded at a certain level of nominal income. In fact, the interest-rate- elasticity of the liquidity demand determines the effectiveness of monetary policy, which is useless under absolute liquidity preference, i.e. when the money demand is perfectly elastic. An actuarial approach is developed in this paper for dealing with random income. Assuming investors face liquidity constraints, a level of surplus exists which maximises expected value. Moreover, the optimal liquidity demand is expressed as a Value at Risk and the comonotonic dependence structure determines the amount of money demanded by the economy. As a consequence, the interest-rate-elasticity depends on the kind of risks and expectations. The more unstable the economy, the greater the interest-rate-elasticity of the money demand. Moreover, part of the adjustment to reestablish the short-run monetary equilibrium may be performed through volatility shocks.
    Keywords: Money demand; Monetary policy; Economic capital; Distorted risk principle; Value-at-Risk.
    JEL: E40 E44 E41 E58 E0 E52 E12
    Date: 2006–11–30
  8. By: Balázs Égert; Jesus Crespo-Cuaresma; Thomas Reininger
    Abstract: In this study, we seek to better understand the interest rate pass-through in five Central and Eastern European countries – the Czech Republic, Hungary, Poland, Slovakia and Slovenia, the CEE-5. Our pass-through estimates for several retail rates are generally lower than those reported in the literature, given the absence of cointegration between policy rates and long- or even short-term market rates. In addition, the pass-through has been declining over time in the CEE-5, and we argue that it is likely to decrease further in the future. Finally, the pass-through appears similar in the CEE-5 than in Spain and is higher than in core euro area countries. Hence, euro adoption by the CEE-5 would not further increase heterogeneity within the euro area with regard to the interest rate passthrough. However, substantially more research is needed to establish commonalities and differences between the CEE-5 and the euro area with respect to the reaction of prices and output to monetary policy action.
    Keywords: interest rate pass-through, monetary transmission mechanism, transition economies, Central and Eastern Europe, Austria, Germany, Spain.
    JEL: E43 E50 E52 C22 G21 O52
    Date: 2006–11–01
  9. By: Fabrizio Coricelli; Balázs Égert; Ronald MacDonald
    Abstract: This paper surveys recent advances in empirical studies of the monetary transmission mechanism (MTM), with special attention to Central and Eastern Europe. In particular, while laying out the functioning of the separate channels in the MTM, it explores possible interrelations between different channels and their impact on prices and the real economy. The empirical ndings for Central and Eastern Europe are then briey compared with results for industrialized countries, especially for the euro area. We highlight potential pitfalls in the literature and assess the relative importance, and potential development, of the different channels, emphasizing the relevant asymmetries between Central and Eastern European countries and the euro area.
    Keywords: Monetary transmission, transition, Central and Eastern Europe, credit channel, interest rate channel, interest-rate pass-through, exchange rate channel, exchange rate pass-through, asset price channel
    JEL: E31 E51 E58 F31 O11 P20
    Date: 2006–11–01
  10. By: Alexandre Lowenkron (Banco BBM); Marcio Gomes Pinto Garcia (Department of Economics, PUC-Rio)
    JEL: E58 E44 G12 E65
    Date: 2007–04
  11. By: Carboni, Giacomo; Ellison, Martin
    Abstract: We respond to the challenge of explaining the Great Inflation by building a coherent framework in which both learning and uncertainty play a central role. At the heart of our story is a Federal Reserve that learns and then disregards the Phillips curve as in Sargent's Conquest of American Inflation, but at all times takes into account that its view of the world is subject to considerable uncertainties. Allowing Federal Reserve policy to react to these perceived uncertainties improves our ability to explain the Great Inflation with a learning model. Bayesian MCMC estimation results are encouraging and favour a model where policy reacts to uncertainty over a model where uncertainty is ignored. The posterior likelihood is higher and the internal Federal Reserve forecasts implied by the model are closer to those reported in the Greenbook.
    Keywords: Great Inflation; learning; monetary policy; uncertainty
    JEL: E52 E58 E65
    Date: 2007–04
  12. By: Rose, Andrew K
    Abstract: This paper studies the characteristics of departures from monetary unions. During the post-war period, almost seventy distinct countries or territories have left a currency union, while over sixty have remained continuously in currency unions. I compare countries leaving currency unions to those remaining within them, and find that leavers tend to be larger, richer, and more democratic; they also tend to have higher inflation. However, there are typically no sharp macroeconomic movements before, during, or after exits.
    Keywords: country; data; empirical; monetary; panel; probit; statistic
    JEL: E42 E58
    Date: 2007–04
  13. By: CARRILLO, Julio; FÈVE, Patrick; MATHÉRON, Julien
    JEL: L52 E31 E32 E52
    Date: 2007–02
  14. By: Xavier Freixas; José Jorge
    Abstract: This paper analyses the impact of asymmetric information in the interbank market and establishes its crucial role in the microfoundations of the monetary policy transmission mechanism. We show that interbank market imperfections induce an equilibrium with rationing in the credit market. This has three major implications: first, it reconciles the irresponsiveness of business investment to the user cost of capital with the large impact of monetary policy (magnitude puzzle), second, it shows that monetary policy affects long term credit (composition puzzle) and finally, that banks’ liquidity positions condition their reaction to monetary policy (Kashyap and Stein liquidity puzzle).
    Keywords: Banking, Rationing, Monetary Policy
    JEL: E44 G21
    Date: 2007–03
  15. By: Andreas Freytag (University of Jena, School of Busniess and Economics); Friedrich Schneider (Department of Economics, Johannes Kepler University Linz)
    Abstract: Central bank independence (CBI) is a very important precondition for price stability. However, the empirical evidence for a correlation between both is relatively weak. In this paper, this weakness is countered with a) an extended measure of monetary commitment, which includes well-known criteria for CBI and external criteria such as convertibility and exchange rate regimes and b) the argument that monetary commitment can grant price stability best if it is backed by an adequate assignment of economic policy. An empirical assessment with data from four decades confirms the crucial role of monetary commitment for price stability.
    Keywords: central bank independence, price stability, monetary commitment
    JEL: E50
    Date: 2007–03–30
  16. By: Carlsson, Mikael (Research Department, Central Bank of Sweden); Westermark, Andreas (Department of Economics, Uppsala University)
    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: 2007–04–01
  17. By: Balázs Égert
    Abstract: This paper analyses the effectiveness of foreign exchange interventions in Croatia, the Czech Republic, Hungary, Romania, Slovakia and Turkey using the event study approach. Interventions are found to be effective only in the short run when they ease appreciation pressures. Central bank communication and interest rate steps considerably enhance their effectiveness. The observed effect of interventions on the exchange rate corresponds to the declared objectives of the central banks of Croatia, the Czech Republic, Hungary and perhaps also Romania, whereas this is only partially true for Slovakia and Turkey. Finally, interventions are mostly sterilized in all countries except Croatia. Interventions are not much more effective in Croatia than in the other countries studied. This suggests that unsterilized interventions do not automatically inuence the exchange rate.
    Keywords: central bank intervention, communication, foreign exchange intervention, verbal intervention
    JEL: F31
    Date: 2006–11–01
  18. By: Farley Grubb (Department of Economics,University of Delaware)
    Abstract: Paper money has often been controversial and misunderstood. Why it has value, why that value changes over time, how it influences economic activity, who should be allowed to make it, how its use and creation should be controlled, and whether it should exist at all—are questions that have perplexed the public, vexed politicians, and puzzled economic experts. Knowing how, when, and why paper money first became commonplace in America and the nature of the institutions propagating it, can help us better comprehend paper money’s role in society. Benjamin Franklin (1706-1790) dealt often with this topic and his writings can teach us much about it.
    Keywords: Monetary Policy, Economic History
  19. By: Aliprantis, C.D.; Camera, G.; Ruscitti, F.
    Abstract: In this study we offer a new approach to proving the differentiability of the value function, which complements and extends the literature on dynamic programming. This result is then applied to the analysis of equilibrium in the recent class of monetary economies developed in [13]. For this type of environments we demonstrate that the value function is differentiable and this guarantees that the marginal value of money balances is well defined.
    Keywords: Monetary Equilibrium ; Differentiability ; Value Function
    JEL: E00 C61
    Date: 2007–04
  20. By: Edda Claus; Iris 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.
    JEL: E32 E44 E50 F41
    Date: 2007–02
  21. By: Roman Horváth
    Abstract: The paper examines a financial accelerator mechanism in analyzing determinants of corporate interest rates. Using a panel of the financial statements of 448 Czech firms from 1996–2002, we find that balance sheet indicators matter for the interest rates paid by firms. Market access is particularly important in this regard. The strength of corporate balance sheets seem to vary with firm size. There is also evidence that monetary policy has a stronger effect on smaller than on larger firms. On the other hand, we find no asymmetry in the monetary policy effects over the business cycle.
    Keywords: balance sheet channel, financial accelerator, interest rates, monetary policy transmission
    JEL: G11 G32
    Date: 2006–11–01
  22. By: Peter Howells (School of Economics, University of the West of England)
    Abstract: Since Basil Moore published Horizontalists and Verticalists in 1988, there have been numerous attempts to model an endogenous money supply within a graphical framework which would also facilitate discussion of some of the controversial issues surrounding it. These have not generally been very successful until Fontana’s recent (2003, 2006) adoption of a pure flow of funds framework. More recently, the ‘New Keynesian consensus’ in macroeconomics has finally forced a rejection of the exogenous money paradigm and the LM part of the familiar IS/LM/AS model. In this paper we show how, with some modification, Fontana’s approach can be combined with ‘mainstream’ replacements of IS/LM (Carlin and Soskice, 2006; Bofinger, Mayer and Wollmerhäuser, 2006) to produce a model of the monetary sector which illustrates both the current wisdom about monetary policy (e.g. Woodford, 2003) and the post-Keynesian insights that have been developed over the last twenty years.
    Keywords: Macroeconomics; Post Keynesian;
    JEL: E12
    Date: 2007–03
  23. By: Burton A. Abrams (Department of Economics,University of Delaware)
    Abstract: Evidence from the Nixon tapes, now available to researchers, shows that President Richard Nixon pressured the chairman of the Federal Reserve, Arthur Burns, to engage in expansionary monetary policies in the run up to the 1972 election. This paper quotes the relevant conversations from the Nixon tapes. Questions remain as to whether Burns followed an expansionary policy in an already-inflationary environment out of conviction or because of political pressure.
    Date: 2006
  24. By: Michele FRATIANNI (Indiana University, Graduate School of Business Bloomington)
    Abstract: National borders are a big hurdle to the expansion of the open economy. Integration today remains imperfect because national borders translate into trading costs, including differences in monetary regimes. Political borders shelter many goods and services from external competition and, consequently, represent a critical exogenous force in the integration process. Borders are thicker for the small countries than the large countries. Regional trade arrangements have softened or, in some cases, pushed outward national borders, but in the process new borders have emerged. Borders affect also finance and monies. While the speed of financial integration suggests currency consolidation and a decline in the ratio of independent monies to sovereign nations, the formation of multilateral monetary unions pushes the ratio towards unity.
    Keywords: borders, gravity model, integration, monetary unions, rta
    JEL: E58 F15 F33 G15
    Date: 2007–04
  25. By: Iris Biefang-Frisancho Mariscal (School of Economics, University of the West of England); Peter Howells (School of Economics, University of the West of England)
    Abstract: The FOMC has changed its way of communication twice, recently: from 2000-2003, the Committee imparted information about its assessment on the economic outlook (the balance-of-risk statements) and since August 2003 the FOMC informs additionally about its outlook’s implications on the future federal funds target rate (forward-looking language). The result should be that agents do not need to deduce FOMC’s likely policy move on every twitch of central bank communication and macroeconomic news. Markets have anticipated FOMC policy decisions on the day of the meeting very well since 1994. Therefore, the focus of the paper is on the behaviour of market rates between FOMC meetings and on testing for greater ‘smoothness’ and lower volatility of market rates since 2000. We apply an EGARCH model to forward rates at the short end of the yield curve. The model is used to test for the effects of the three disclosure regimes (pre-2000, 2000-2003, post-2003) on the dependence of previous and current changes of the market rates in the conditional mean equation. It is expected to observe higher inertia during the periods when market participants are better informed. Furthermore, generally, news increases interest rate volatility, since markets adjust interest rates in response to relevant news. However, other FOMC communication (other than the press statements after the FOMC meeting), may have a lower news value in the new disclosure regimes than it had in the pre-2000 period. Therefore, ‘other’ central bank communication may affect the volatility of interest rates differently in the three different regimes. This effect is tested for in the conditional variance of the regression model. We find that there is evidence of differences in smoothness between the period until 2000 and the period of the balance-of-risk statement. Furthermore, we find that the effect of other than Fed press statements after FOMC meetings varies in the three periods. This is particularly so for Fed communication concerning economic outlook and speeches by the chairman of the Board.
    Keywords: Macroeconomics; Post Keynesian;
    JEL: E12
    Date: 2007–03
  26. By: Etienne Lehmann (CREST, Université Catholique de Louvain and IZA); Bruno Van der Linden (Université Catholique de Louvain, FNRS, ERMES and IZA)
    Abstract: This paper builds a macroeconomic model of equilibrium unemployment in which firms persistently face difficulties in selling their production and this affects their decisions to create jobs. Due to search-frictions on the product market, equilibrium unemployment is a U-shaped function of the ratio of total demand to total supply on this market. When prices are at their Competitive Search Equilibrium values, the unemployment rate is minimized. Yet, the Competitive Search Equilibrium is not efficient. Inflation is detrimental to unemployment.
    Keywords: equilibrium unemployment, matching, inflation, demand constraints
    JEL: E12 E24 E31 J63
    Date: 2007–03
  27. By: Levy, Daniel
    Abstract: The price system, the adjustment of prices to changes in market conditions, is the primary mechanism by which markets function and by which the three most basic questions get answered: what to produce, how much to produce and for whom to produce. To the behaviour of price and price system, therefore, have fundamental implications for many key issues in microeconomics and industrial organization, as well as in macroeconomics and monetary economics. In microeconomics, managerial economics, and industrial organization, economists focus on the price system efficiency. In macroeconomics and monetary economics, economists focus on the extent to which nominal prices fail to adjust to changes in market conditions. Nominal price rigidities play particularly important role in modern monetary economics and in the conduct of monetary policy because of their ability to explain short-run monetary non-neutrality. The behaviour of prices, and in particular the extent of their rigidity and flexibility, therefore, is of central importance in economics. This introductory essay briefly summarizes the eight studies of price rigidity that are included in this special issue.
    Keywords: Price Rigidity; Price Flexibility; Cost of Price Adjustment; Menu Cost; Managerial and Customer Cost of Price Adjustment; New Keynesian Economics; Price System
    JEL: E31 E50 M30 D21 D40 M20 L11 E12 E52 L16
    Date: 2007–04–17
  28. By: Kitov, Ivan; Kitov, Oleg; Dolinskaya, Svetlana
    Abstract: A linear and lagged relationship between inflation, unemployment and labor force change rate, π(t)=A0UE(t-t0)+A1dLF(t-t1)/LF(t-t1)+A2 (where A0, A1, and A2 are empirical country-specific coefficients), was found for developed economies. The relationship obtained for France is characterized by A0=-1, A1=4, A2=0.095, t0=4 years, and t1=4 years. For GDP deflator, it provides a root mean square forecasting error (RMFSE) of 1.0% at a four-year horizon for the period between 1971 and 2004. The relationship is tested for cointegration. All three variables involved in the relationship are proved to be integrated of order one. Two methods of cointegration testing are used. First is the Engle-Granger approach based on the unit root test in the residuals of linear regression, which also includes a number of specification tests. Second method is the Johansen cointegration rank test based on a VAR representation, which is also proved to be an adequate one via a set of appropriate tests. Both approaches demonstrate that the variables are cointegrated and the long-run equilibrium relation revealed in previous study holds together with statistical estimates of goodness-of-fit and RMSFE. Relationships between inflation and labor force and between unemployment and labor force are tested separately in appropriate time intervals, where the Banque de France monetary policy introduced in 1995 does not disturb the long-term links. All the individual relationships are cointegrated in corresponding intervals. The VAR and vector error correction (VEC) models are estimated and provide just a marginal improvement in RMSFE at the four-year horizon both for GDP deflator (down to 0.9%) and CPI (~1.1%) on the results obtained in the regression study. The VECM approach also allows re-estimation of the coefficients in the individual and generalized relationship between the variables both for cointegration rank 1 and 2. Comparison of the standard cointegration approach to the integral approach to the estimation of the coefficients in the individual and generalized relationships between the studied variables demonstrates the superiority of the latter. The cumulative inflation curve or inflation index, which is the actually measured evolution of price level, is much better predicted in the framework of the integral approach, which is a powerful tool for revealing true relationships between non-stationary variables and can be potentially used for rejection of spurious regression. The cumulative curves allow avoiding obvious drawbacks of the VECM representation and cointegration tests – increasing signal to noise ratio after differentiation and severe dependence on statistical properties of error terms. The confirmed validity of the linear lagged relationship between inflation, unemployment and labor force change indicates that since 1995 the Banque de France has been wrongly applying the policy fixing the monetary growth to the reference value around 4.5%. As a result of the policy, during the last ten years unemployment in France was twice as large as the one dictated by its long-term equilibrium link to labor force change. This increased unemployment compensates the forced price stability.
    Keywords: cointegration; inflation; unemployment; labor force; forecasting; France; VAR; VECM
    JEL: C32 E37 E31 J21 E32
    Date: 2007–02
  29. By: Ivan, Kitov
    Abstract: A linear and lagged relationship between inflation and labor force growth rate has been recently found for the USA. It accurately describes the period after the late 1950s with linear coefficient 4.0, intercept -0.03, and the lag of 2 years. The previously reported agreement between observed and predicted inflation is substantially improved by some simple measures removing the most obvious errors in the labor force time series. The labor force readings originally obtained from the Bureau of Labor Statistics (BLS) website are corrected for step-like adjustments. Additionally, a half-year time shift between the inflation and the annual labor force readings is compensated. GDP deflator represents the inflation. Linear regression analysis demonstrates that the annual labor force growth rate used as a predictor explains almost 82% (R2=0.82) of the inflation variations between 1965 and 2002. Moving average technique applied to the annual time series results in a substantial increase in R2. It grows from 0.87 for two-year wide windows to 0.96 for four-year windows. Regression of cumulative curves is characterized by R2>0.999. This allows effective replacement of GDP deflation index by a “labor force growth” index. The linear and lagged relationship provides a precise forecast at the two-year horizon with root mean square forecasting error (RMSFE) as low as 0.008 (0.8%) for the entire period between 1965 and 2002. For the last 20 years, RMSFE is only 0.4%. Thus, the forecast methodology effectively outperforms any other forecasting technique reported in economic and financial literature. Moreover, further significant improvements in the forecasting accuracy are accessible through improvements in the labor force measurements in line with the US Census Bureau population estimates, which are neglected by BLS.
    Keywords: inflation; labor force; forecast; the USA
    JEL: E61 E31 J21
    Date: 2006–07
  30. By: Neves, J. Anchieta; Stocco, Leandro; Da Silva, Sergio
    Abstract: We find that generalized purchasing power parity does not hold for Mercosur, and thus that the South American trade group does not constitute an optimum currency area. We also find that the role of the United States cannot be neglected in the region, and that high short run volatility of real exchange rates is accompanied by slow adjustment processes of between 2 and 16 years (PPP puzzle).
    Keywords: generalized purchasing power parity; optimum currency area; Mercosur; PPP puzzle
    JEL: F31 F36
    Date: 2007–04–16

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