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on Monetary Economics |
| By: | Sharon Kozicki and P.A. Tinsley |
| Abstract: | Under bond-rate transmission of monetary policy, the authors show that a generalized Taylor Principle applies, in which the average anticipated path of policy responses to inflation is subject to a lower bound of unity. This result helps explain how bond rates may exhibit stable responses to inflation, even in periods of passive policy. Another possible explanation is time-varying term premiums with risk pricing that depends on inflation. The authors present a no-arbitrage model of the term structure with horizon-dependent policy perceptions and time-varying term premiums to illustrate the mechanics and provide empirical results that support these transmission channels. |
| Keywords: | Interest rates; Transmission of monetary policy |
| JEL: | E3 E5 N1 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:07-30&r=mon |
| By: | Gomes, Orlando |
| Abstract: | The standard new Keynesian monetary policy problem is, in its original presentation, a linear model. As a result, only three possibilities are admissible in terms of long term dynamics: the equilibrium may be a stable node, an unstable node or a saddle point. Fixed point stability (a stable node) is generally guaranteed only under an active monetary policy rule. The benchmark model also considers extremely simple assumptions about expectations (perfect foresight is frequently assumed). In this paper, one inquires how a change in the way inflation expectations are modelled implies a change in monetary policy results when an active Taylor rule is taken. By assuming that inflation expectations are constrained by the evolution of the output gap, we radically modify the implications of policy intervention: endogenous cycles, of various periodicities, and chaotic motion will be observable for reasonable parameter values. |
| Keywords: | Monetary policy; Taylor rule; Inflation expectations; Endogenous business cycles; Nonlinear dynamics and chaos |
| JEL: | C61 E52 E32 |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:2842&r=mon |
| By: | Roberto M. Billi |
| Abstract: | What is the correctly measured inflation rate that monetary policy should aim for in the long-run? This paper characterizes the optimal inflation rate for the U.S. economy in a New Keynesian sticky-price model with an occasionally binding zero lower bound on the nominal interest rate. Real-rate and mark-up shocks jointly determine the optimal inflation rate to be positive but not large. Even allowing for the possibility of extreme model misspecification, the optimal inflation rate is robustly below 1 percent. The welfare costs of optimal inflation and the lower bound are limited.> |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp07-03&r=mon |
| By: | Zeno Rotondi; Giacomo Vaciago (DISCE, Università Cattolica; DISCE, Università Cattolica) |
| Abstract: | This paper compares the European Central Bank’s conduct of monetary policy (1999-2005) with that of the Bundesbank (after the German Unification: 1990-1998) in order to test the hypothesis of an ECB with “Bundesbank’s preferences” put forward in the theoretical literature (Alesina and Grilli 1993, Fatum 2006). Econometric tests and simulations based on monetary policy reaction functions show that the continuation of the former Bundesbank regime is supported by the data. Given this empirical evidence we discuss the lessons for future Monetary Unions stemming from the ECB experience. |
| Keywords: | EMU, Monetary Policy, Reaction Function, Taylor rule, ECB, Bundesbank |
| JEL: | E52 E58 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:ctc:serie3:ief0070&r=mon |
| By: | Gomes, Orlando |
| Abstract: | The new Keynesian monetary policy model studies the response of the inflation – output gap trade-off to policy decisions taken by the Central Bank, concerning the nominal interest rate time trajectory. Under an optimal setup, this model displays a saddle-path stable equilibrium and, if the stable trajectory is followed, the steady state is characterized by an inflation rate that coincides with the selected inflation target. A high inflation target has positive effects over the rise of effective output relatively to its potential level (the monetary policy problem captures this effect), but it has a perverse impact over investment decisions (the referred problem does not capture this effect, taking it as granted). This second relation can be understood by associating to the first macro model a second setup, which takes consumption and investment decisions, i.e., by considering a long term growth setup. The link between the two is present on the impact of inflation over investment decisions. With this integrated framework one is able to simultaneously study short and long-run macroeconomic phenomena and to jointly analyze the behaviour of nominal and real aggregates. The most important results consist on the determination of an optimal inflation target and on the consideration of short term supply shocks as having a long-run impact producing business cycles. |
| Keywords: | Monetary policy; Economic growth; Inflation targeting; Output gap. |
| JEL: | C61 O41 E52 |
| Date: | 2006–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:2849&r=mon |
| By: | Henry E. Siu |
| Abstract: | I characterize time consistent equilibrium in an economy with price rigidity and an optimizing monetary authority operating under discretion. Firms have the option to increase their frequency of price change, at a cost, in response to higher inflation. Previous studies, which assume a constant degree of price rigidity across inflation regimes, find two time consistent equilibria—one with low inflation, the other with high inflation. In contrast, when price rigidity is endogenous, the high inflation equilibrium ceases to exist. Hence, time consistent equilibrium is unique. This result depends on two features of the analysis: (1) a plausible quantitative specification of the fixed cost of price change, and (2) the presence of an arbitrarily small cost of inflation that is independent of price rigidity. |
| Keywords: | Monetary policy |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:390&r=mon |
| By: | Calza, Alessandro; Monacelli, Tommaso; Stracca, Livio |
| Abstract: | We study the role of institutional characteristics of mortgage markets in affecting the strength and timing of the effects of monetary policy shocks on house prices and consumption in a sample of OECD countries. With frictionless credit markets, those characteristics should in principle be immaterial for the transmission of monetary impulses. We document three facts: (1) there is significant divergence in the structure of mortgage markets across the main industrialized countries; (2) at the business cycle frequency, the correlation between consumption and house prices increases with the degree of flexibility/development of mortgage markets; (3) the transmission of monetary policy shocks on consumption and house prices is stronger in countries with more flexible/developed mortgage markets. We then build a two-sector dynamic general equilibrium model with price stickiness and collateral constraints, where the ability of borrowing is endogenously linked to the nominal value of a durable asset (housing). We study how the response of consumption to monetary policy shocks is affected by alternative values of three key institutional parameters: (i) down-payment rate; (ii) mortgage repayment rate; (iii) interest rate mortgage structure (variable vs. fixed interest rate). In line with our empirical evidence, the sensitivity of consumption to monetary policy shocks increases with lower values of (i) and (ii), and is larger under a variable-rate mortgage structure. |
| Keywords: | collateral constraint; house prices; monetary policy; mortgage markets |
| JEL: | E21 E44 E52 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6231&r=mon |
| By: | Uwe Böwer (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); André Geis (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Adalbert Winkler (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | Commodity prices play an important role in economic developments in most of the 24 Western and Central African (WCA) countries covered in this paper. It is confirmed that in the light of rising commodity prices between 1999 and 2005, net oil exporters recorded strong growth rates while net oil-importing countries – albeit benefiting from increases in their major non-oil commodity export prices – displayed somewhat lower growth. For most WCA economies, inflation rates appear less affected by commodity price changes and more determined by exchange rate regimes as well as monetary and fiscal policies. While passthrough effects from international to domestic energy prices were significant, notably in oilimporting countries, second-round effects on overall prices seem limited. Governments of oil-rich countries reacted prudently to windfall revenues, partly running sizable fiscal surpluses. A favourable supply response to rising spending as well as sterilisation efforts and increasing money demand also helped to dampen inflationary pressures. However, substantial excess reserves of commercial banks reflect challenges in financial sector developments and the effectiveness of monetary policy in many WCA countries. Given currently widelyused fixed exchange rate regimes, fiscal policy will continue to carry the main burden of macroeconomic adjustment and of sustaining non-inflationary growth, which remains the key policy challenge facing WCA authorities. |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbops:20070060&r=mon |
| By: | Le, Vo Phuong Mai (Cardiff Business School); Minford, Patrick (Cardiff Business School) |
| Abstract: | This paper investigates optimal indexation in the New Keynesian model, when the indexation choice includes the possibility of partial indexation and of varying weights on rational and lagged indexation. It finds that the Calvo contract adjusted for rationally expected indexation under both inflation and price level targeting regimes delivers the highest expected welfare under both restricted and full current information. Rational indexation eliminates the effectiveness of monetary policy on welfare when there is only price-level targeting under the current micro information. If including both wage setting and full current information, monetary policy is effective; and a price-level targeting rule delivers the highest benefits because it minimises the size of shocks to prices and thus dispersion. However, even less than full rational indexation ensures that there is very little nominal rigidity in the adapted world of Calvo contracts. |
| Keywords: | optimal indexation; price-level target; inflation target; Calvo contracts; rational expectation; New Keynesian model |
| JEL: | E50 E52 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:wpaper:2007/7&r=mon |
| By: | Christian Proaño Acosta (IMK at the Hans Boeckler Foundation, University of Bielefeld) |
| Abstract: | The high degree of persistence in the national inflation differentials of the majority of EMU Member States observed since the introduction of the euro has raised serious concerns among researchers and policy-makers alike. In this paper the main theoretical arguments which explain the existence of such inflation differentials within a monetary union are reviewed and, by means of econometric methods, their dynamic behaviour prior and after the introduction of the euro is analyzed. Furthermore, the empirical evidence for different degrees of correlation between the country-specific business cycles fluctuations and the arise of national inflation differentials with respect to the euro area average are investigated through single-equation GMM and panel TSLS estimations. |
| Keywords: | Inflation differentials, convergence and stationary tests, GMM es- timation, Phillips Curve |
| JEL: | C23 C33 E31 E32 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:imk:wpaper:05-2007&r=mon |
| By: | William A. Brock; Steven N. Durlauf; James M. Nason; Giacomo Rondina |
| Abstract: | This paper contributes to the policy evaluation literature by developing new strategies to study alternative policy rules. We compare optimal rules to simple rules within canonical monetary policy models. In our context, an optimal rule represents the solution to an intertemporal optimization problem in which a loss function for the policymaker and an explicit model of the macroeconomy are specified. We define a simple rule to be a summary of the intuition policymakers and economists have about how a central bank should react to aggregate disturbances. The policy rules are evaluated under minimax and minimax regret criteria. These criteria force the policymaker to guard against a worst-case scenario, but in different ways. Minimax makes the worst possible model the benchmark for the policymaker, while minimax regret confronts the policymaker with uncertainty about the true model. Our results indicate that the case for a model-specific optimal rule can break down when uncertainty exists about which of several models is true. Further, we show that the assumption that the policymaker’s loss function is known can obscure policy trade-offs that exist in the short, medium, and long run. Thus, policy evaluation is more difficult once it is recognized that model and preference uncertainty can interact. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2007-07&r=mon |
| By: | Farley Grubb |
| Abstract: | The U.S. Congress issued paper money called Continental Dollars to finance the American Revolution. The story of the Continental Dollar is familiar to all -- excessive amounts were issued causing hyper-inflation. It became worthless and was forgotten. However, the details of this story, including its veracity, are less well known. Scholars even disagree over how much was issued. Evidence is gathered to establish the exact amount and time path of Continental Dollars emitted and then remitted to the U.S. Treasury and burned. Why some Dollars were hoarded rather than trashed between 1779 and 1790 is also documented. |
| JEL: | N1 N11 N2 N21 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13047&r=mon |
| By: | Gomes, Orlando |
| Abstract: | Models dealing with monetary policy are generally based on microfoundations that characterize the behaviour of representative agents (households and firms). To explain the representative consumer behaviour, it is generally assumed a utility function in which the intertemporal elasticity of substitution is constant. Recent literature casts some doubts about the relevance of considering such a constant elasticity value. In this note, we explore the new Keynesian monetary policy model under the assumption that the elasticity of substitution changes with expectations regarding real economic performance. As a result, one observes that some combinations of parameter values allow for a stable fixed point outcome, while other combinations of parameters are compatible with cycles of various periodicities and even a-periodic fluctuations. |
| Keywords: | Monetary policy; Intertemporal elasticity of substitution; Stability; Nonlinear dynamics. |
| JEL: | C62 E52 E32 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:2890&r=mon |
| By: | Le, Vo Phuong Mai (Cardiff Business School); Minford, Patrick (Cardiff Business School) |
| Abstract: | Calvo contracts, which are the basis of the current generation of New Keynesian models, widely include indexation to general inflation. We argue that the indexing formula should be expected inflation rather than lagged inflation. This is likely to optimise the welfare of the representative agent in a general equilibrium model of the New Keynesian type. This is shown analytically for a simplified model and by numerical simulation for a full model with price and wage contracts as well as capital. The consequence of such indexation is that monetary policy no longer has any effect on welfare. |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:wpaper:2007/8&r=mon |
| By: | Frankel, Jeffrey A; Wei, Shang-Jin |
| Abstract: | This paper examines two related issues: (a) the implicit methodology used by the U.S. Treasury in determining whether China and its other trading partners manipulate their exchange rates, and (b) the nature of the Chinese exchange rate regime since July 2005. On the first issue, we investigate the roles of both economic variables consistent with the IMF definition of manipulation - the partners' overall current account/GDP, its reserve changes, and the real overvaluation of its currency - and variables suggestive of American domestic political considerations -- the bilateral trade balance, US unemployment, and an election year dummy. The econometric results suggest that the Treasury verdicts are driven heavily by the US bilateral deficit, though other variables also turn out to be quite important. On the issue of China's de facto exchange rate regime, we apply the technique introduced by Frankel and Wei (1994) to estimate implicit basket weights and add several refinements. Within 2005, the de facto regime remained a peg to the dollar. However, there was a modest but steady increase in flexibility subsequently. We test whether US pressure has promoted RMB flexibility. We also test whether the recent appreciation against the dollar is due to a trend appreciation against the reference basket or a declining weight on the dollar in the reference basket, and argue that they have different policy implications. |
| Keywords: | Chinese economy; implicit currency weights; renminbi |
| JEL: | F3 F5 O1 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6264&r=mon |
| By: | Felix Hammermann |
| Abstract: | Why is inflation, 15 years after transition started, still considerably higher in Romania than in the eight EU member states (EU-8) that joined in May 2004? Panel estimation based on ten central and eastern European countries allows us to decompose the inflation differential between Romania and the EU-8. The decomposition suggests that neither the revenue, nor the balance of payments, nor the financial stability motive are driving inflation; rather structural differences are at play. The employment motive, together with indicators reflecting the prolonged structural change, explain most of the inflation gap vis-à-vis the EU-8. |
| Keywords: | inflation, panel data, transition economics |
| JEL: | E58 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1322&r=mon |
| By: | Luc Aucremanne (National Bank of Belgium, Research Department); Marianne Collin (National Bank of Belgium, Research Department); Thomas Stragier (National Bank of Belgium, Research Department) |
| Abstract: | We find strong econometric support for a break in the relationship between perceived and HICP inflation in the euro area, triggered by the introduction of euro notes and coins in January 2002. The break is fairly homogeneous across individuals with different socio-economic characteristics. We found no support for the thesis according to which perceptions are systematically formed by frequently purchased products. A similar break is found when national CPIs instead of HICPs are used as benchmarks. The role of the non-inclusion of owner-occupied housing in the HICP was negligible. Therefore the credibility of the HICP per se is not at stake. |
| Keywords: | inflation, perceived inflation, panel unit roots tests |
| JEL: | C22 C23 D12 E31 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbb:reswpp:200704-24&r=mon |
| By: | Antonio Diez de los Rios |
| Abstract: | This paper presents a multifactor asset pricing model for currency, bond, and stock returns for ten emerging markets to investigate the effect of the exchange rate regime on the cost of capital and the integration of emerging financial markets. Since there is evidence that a fixed exchange rate regime reduces the currency risk premia demanded by foreign investors, the tentative conclusion is that a fixed exchange rate regime system can help reduce the cost of capital in emerging markets. |
| Keywords: | Exchange rate regimes; Development economics |
| JEL: | F30 F33 G15 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:07-29&r=mon |
| By: | Minoas Koukouritakis (Department of Economics, University of Crete, Greece) |
| Abstract: | This paper examines the validity of the purchasing power parity between each of the twelve new EU countries vis-à-vis the Eurozone. Using the Johansen cointegration methodology for a period that begins from the mid-1990s and allowing for a structural break for the countries that joined the EU on May 2004, it is found that there is a long-run equilibrium relationship among the nominal exchange rate, the domestic prices and the foreign prices, for all the new EU countries. The evidence also suggests that the PPP vector enters the cointegration space for Bulgaria, Cyprus, Romania and Slovenia, which means that only for these countries the long-run PPP vis-à-vis the Eurozone is verified. For the rest of the new EU countries the long-run PPP is violated, may due to the fact that the currencies of these countries have been pegged to the euro and cannot reflect the inflation differences vis-à-vis the Eurozone. |
| Keywords: | Purchasing Power Parity, EU Enlargement, Cointegration, Structural Break, Symmetry and Proportionality. |
| JEL: | F15 F42 |
| Date: | 2007–04–17 |
| URL: | http://d.repec.org/n?u=RePEc:crt:wpaper:0720&r=mon |
| By: | Jeffrey Frankel |
| Abstract: | This paper is an econometric investigation of the determinants of the real value of the South African rand over the period 1984-2006. The results show a relatively good fit. As so often with exchange rate equations, there is substantial weight on the lagged exchange rate, which can be attributed to a momentum component. Nevertheless, economic fundamentals are significant and important. This is especially true of an index of the real prices of South African mineral commodities, which even drives out real income as a significant determinant of the rand's value. An implication is that the 2003-2006 real appreciation can be attributed to the Dutch Disease. In other respects, the rand behaves like currencies of industrialized countries with well-developed financial markets. In particular, high South African interest rates raise international demand for the rand and lead to real appreciation, controlling for a forward-looking measure of expected inflation and a measure of default risk or country risk. It is in the latter respects, in particular, that the paper hopes to have improved on earlier studies of the rand. |
| JEL: | F31 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13050&r=mon |
| By: | Jean-Pierre Allegret (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Alain Sand-Zantman (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]) |
| Abstract: | This paper studies to what extent the diversity of exchange rate regimes within Mercosur exerts an influence on the feasibility of a monetary union in this area. A semi-structural VAR model is built for each country, including a set of international and domestic variables. Based on impulse response functions and forecast error decomposition, we conclude that differences of exchange rate regime explain significantly the divergences of economic dynamics triggered by foreign or domestic shocks. Second, we decompose the structural innovations generated by each country model into unobservable common and idiosyncratic components, using a state-space model. This last exercise, intended to assess the degree of policy coordination between the Mercosur members, did not disclose any common component for the structural innovations generated by the three national models. |
| Keywords: | co-movement ; Cycles ; Mercosur ; optimum currency area ; unobserved components model |
| Date: | 2007–04–19 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:halshs-00142506_v1&r=mon |
| By: | Eugene Amromin; Sujit Chakravorti |
| Abstract: | During the last decade, debit card transactions grew rapidly in most advanced countries. While check usage declined and has almost disappeared in some countries, the stock of currency in circulation has not declined as fast. We use panel estimation techniques to analyze the change in transactional demand for cash resulting from greater usage of debit cards in 13 countries from 1988 to 2003. We are able to disentangle cash’s store of value function from its payment function by separating cash into three denomination categories. We find that the demand for low denomination notes and coins decreases as debit card usage increases because merchants need to make less change for customer purchases. On the other hand, the demand for high denomination notes is generally less affected suggesting that these denomination notes are also used for non-transactional purposes. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-07-04&r=mon |
| By: | Irène Andreou (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Gilles Dufrénot (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - [Université de la Méditerranée - Aix-Marseille II][Université de droit, d'économie et des sciences - Aix-Marseille III] - [Ecole des Hautes Etudes en Sciences Sociales]); Alain Sand-Zantman (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Aleksandra Zdzienicka-Durand (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]) |
| Abstract: | We propose a measure of the probability of crises associated with an aggregate indicator, where the percentage of false alarms and the proportion of missed signals can be combined to give an appreciation of the vulnerability of an economy. In this perspective, the important issue is not only to determine whether a system produces true predictions of a crisis, but also whether there are forewarning signs of a forthcoming crisis prior to its actual occurrence. To this end, we adopt the approach initiated by Kaminsky, Lizondo and Reinhart (1998), analyzing each indicator and calculating each threshold separately. We depart from this approach in that each country is also analyzed separately, permitting the creation of a more “custom-made” early warning system for each one. |
| Keywords: | composite indicator ; currency crisis ; early warning system |
| Date: | 2007–04–19 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:halshs-00142433_v1&r=mon |
| By: | C.N.V. Krishnan; Peter H. Ritchken; James B. Thomson |
| Abstract: | Predictions of firm-by-firm term structures of credit spreads based on current spot and forward values can be improved upon by exploiting information contained in the shape of the credit-spread curve. However, the current credit-spread curve is not a sufficient statistic for predicting future credit spreads; the explanatory power can be increased further by exploiting information contained in the shape of the riskless-yield curve. In the presence of credit-spread and riskless factors, other macroeconomic, marketwide, and firm-specific risk variables do not significantly improve predictions of credit spreads. Current credit-spread and riskless-yield curves impound essentially all marketwide and firm-specific information necessary for predicting future credit spreads. |
| Keywords: | Corporate bond ; Rate of return |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0705&r=mon |