nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒05‒04
nineteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Implementing Inflation Targeting: Institutional Arrangements, Target Design, and Communications By Marcel Peter; Geoffrey Heenan; Scott Roger
  2. Balance of Payments Crises Under Inflation Targeting By Michael Kumhof; Shujing Li; Isabel K. Yan
  3. On the Welfare Cost of Inflation and the Recent Behavior of Money Demand By Peter N. Ireland
  4. Monetary Policy in an Equilibrium Portfolio Balance Model By Michael Kumhof; Stijn van Nieuwerburgh
  5. On Stickiness, Cash in Advance, and Persistence By Auray, Stephane; de Blas, Beatriz
  6. Central Bank Boards Around the World: Why Does Membership Size Differ? By Helge Berger; Volker Nitsch; Tonny Lybek
  7. Flattening of the Phillips Curve: Implications for Monetary Policy By Dora M. Iakova
  8. U.S. evolving macroeconomic dynamics - a structural investigation By Luca Benati; Haroon Mumtaz
  9. Central Bank Autonomy: Lessons from Global Trends By Jean-Francois Segalotto; Martin Sommer; Marco Arnone; Bernard Laurens
  10. Testing the Transparency Benefits of Inflation Targeting: Evidence from Private Sector Forecasts By Christopher W. Crowe
  11. Financial Market Risk and U.S. Money Demand By David Cook; Woon Gyu Choi
  12. Dynamic Incentives and the Optimal Delegation of Political Power By Eric Le Borgne; Gauti B. Eggertsson
  13. Financial Versus Monetary Mercantilism: Long-Run View of the Large International Reserves Hoarding By Jaewoo Lee; Joshua Aizenman
  14. How do Capital Controls Affect the Transmission of Foreign Shocks? By Dudley Cooke
  15. A Theory of "Crying Wolf": The Economics of Money Laundering Enforcement By Elod Takats
  16. Audit Committees in Central Banks By Marie-Thérèse Camilleri Gilson; Tonny Lybek; Kenneth Sullivan
  17. Market discipline, financial integration and fiscal rules - what drives spreads in the euro area government bond market? By Simone Manganelli; Guido Wolswijk
  18. Policy Credibility and Sovereign Credit--The Case of New EU Member States By David Hauner; Jiri Jonas; Manmohan S. Kumar
  19. Banking Sector Integration and Competition in CEMAC By Samer Y. Saab; Jerome Vacher

  1. By: Marcel Peter; Geoffrey Heenan; Scott Roger
    Abstract: Transparency is a central element in most aspects of the design and operation of inflation targeting regimes. This paper focuses on three elements of inflation targeting most closely associated with transparency: (i) the institutional arrangements supporting inflation targeting; (ii) the specification of the inflation target; and (iii) the central bank's policy communications. The paper is primarily aimed at providing practical advice to countries planning to develop an inflation targeting framework, but many of the issues are relevant for any credible, independent monetary policy.
    Keywords: Monetary policy , inflation targeting , Inflation targeting , Monetary policy ,
    Date: 2006–12–21
  2. By: Michael Kumhof; Shujing Li; Isabel K. Yan
    Abstract: This paper analyzes a small open economy model under inflation targeting. It shows why such a monetary regime is vulnerable to speculative attacks that take place over a short period rather than instantaneously. The speed at which the regime collapses, and the extent of reserve losses, are increasing in the central bank's explicit or implicit commitment to intervene in the foreign exchange market. Attacks are therefore ranked, from most to least severe, as follows: Exchange rate targeting, CPI inflation targeting, domestic nontradables inflation targeting, and money targeting. Under inflation targeting the size of the attack is increasing in the tradables consumption share.
    Keywords: Balance of payments crisis , inflation targeting , exchange rate targeting , foreign exchange intervention , flow speculative attack ,
    Date: 2007–04–09
  3. By: Peter N. Ireland (Boston College)
    Abstract: Post-1980 U.S. data trace out a stable long-run money demand relationship of Cagan's semi-log form between the M1-income ratio and the nominal interest rate, with an interest semi-elasticity of 1.79. Integrating under this money demand curve yields estimates of the welfare cost of modest departures from Friedman's zero nominal interest rate rule for the optimum quantity of money that are quite small. The results suggest that the Federal Reserve's current policy, which generates low but still positive rates of inflation, provides an adequate approximation in welfare terms to the alternative of moving all the way to the Friedman rule.
    Keywords: inflation, welfare cost, money demand, Friedman rule
    JEL: E31 E41 E52
    Date: 2007–04–20
  4. By: Michael Kumhof; Stijn van Nieuwerburgh
    Abstract: Standard theory shows that sterilized foreign exchange interventions do not affect equilibrium prices and quantities, and that domestic and foreign currency denominated bonds are perfect substitutes. This paper shows that when fiscal policy is not sufficiently flexible in response to spending shocks, perfect substitutability breaks down and uncovered interest rate parity no longer holds. Government balance sheet operations can be used as an independent policy instrument to target interest rates. Sterilized foreign exchange interventions should be most effective in developing countries, where fiscal volatility is large and where the fraction of domestic currency denominated government liabilities is small.
    Keywords: Sterilized foreign exchange intervention , imperfect asset substitutability , uncovered interest parity , portfolio balance theory ,
    Date: 2007–04–02
  5. By: Auray, Stephane (Universite Lille 3, GREMARS and CIRPEE, Villeneuve d'Acsq cedex, France); de Blas, Beatriz (Departamento de Análisis Económico (Teoría e Historia Económica). Universidad Autónoma de Madrid.)
    Abstract: This paper shows that a model which combines sticky price and sticky wages with investment in the cash-in-advance constraint generates business cycle dynamics consistent with empirical evidence. The model reproduces the responses of the key macroeconomic variables to technology and money supply shocks. In particular, the model generates enough output and inflation persistence with standard stickiness parameters. This setup is also able to generate the liquidity effect after a money injection, overcoming other standard new Keynesian models.
    Keywords: sticky prices; sticky wages; monetary facts; labor market facts; cash-in-advance
    JEL: E32 E41 E52
    Date: 2007–03
  6. By: Helge Berger; Volker Nitsch; Tonny Lybek
    Abstract: This paper analyzes empirically differences in the size of central bank boards across countries. Defining a board as the body that changes monetary instruments to achieve a specified target, we discuss the possible determinants of a board's size. The empirical relevance of these factors is examined using a new dataset that covers the de jure membership size of 84 central bank boards at the end of 2003. We find that larger and more heterogeneous countries, countries with stronger democratic institutions, countries with floating exchange rate regimes, and independent central banks with more staff tend to have larger boards.
    Keywords: Committee , council , governance , decision making , monetary policy , Central banks , Governance , Monetary policy ,
    Date: 2006–12–29
  7. By: Dora M. Iakova
    Abstract: Over the past decade, inflation has become less responsive to domestic demand pressures in many industrial countries. This development has been attributed, in part, to globalization forces. A small macroeconomic model, estimated on UK data using Bayesian estimation, is used to analyze the monetary policy implications of this structural change. The focus is on the implications of a globalization-related flattening of the Phillips curve for the trade-off between inflation and output gap variability and for the efficient monetary policy response rule.
    Keywords: Phillips curve , efficient monetary policy rules , globalization ,
    Date: 2007–04–05
  8. By: Luca Benati (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Haroon Mumtaz (Monetary Assessment and Strategy Division, Bank of England, Threadneedle Street, London, EC2R 8AH, United Kingdom.)
    Abstract: We fit a Bayesian time-varying parameters structural VAR with stochastic volatility to the Federal Funds rate, GDP deflator inflation, real GDP growth, and the rate of growth of M2. We identify 4 shocks–monetary policy, demand non-policy, supply, and money demand–by imposing sign restrictions on the estimated reduced-form VAR on a period-by-period basis. The evolution of the monetary rule in the structural VAR accords well with narrative accounts of post-WWII U.S. economic history, with (e.g.) significant increases in the long-run coefficients on inflation and money growth around the time of the Volcker disinflation. Overall, however, our evidence points towards a dominant role played by good luck in fostering the more stable macroeconomic environment of the last two decades. First, the Great Inflation was due, to a dominant extent, to large demand non-policy shocks, and to a lower extent to supply shocks. Second, imposing either Volcker or Greenspan over the entire sample period would only have had a limited impact on the Great Inflation episode, while imposing Burns and Miller would have resulted in a counterfactual inflation path remarkably close to the actual historical one. Although the systematic component of monetary policy clearly appears to have improved over the sample period, this does not appear to have been the dominant influence in post-WWII U.S. macroeconomic dynamics. JEL Classification: E32, E47, E52, E58.
    Keywords: Bayesian VARs, stochastic volatility, identified VARs, time-varying parameters, frequency domain, Great Inflation, Lucas critique.
    Date: 2007–04
  9. By: Jean-Francois Segalotto; Martin Sommer; Marco Arnone; Bernard Laurens
    Abstract: We calculate indexes of central bank autonomy (CBA) for 163 central banks as of end-2003, and comparable indexes for a subgroup of 68 central banks as of the end of the 1980s. The results confirm strong improvements in both economic and political CBA over the past couple of decades, although more progress is needed to boost political autonomy of the central banks in emerging market and developing countries. Our analysis confirms that greater CBA has on average helped to maintain low inflation levels. The paper identifies four broad principles of central bank autonomy that have been shared by the majority of countries. Significant differences exist in the area of banking supervision where many central banks have retained a key role. Finally, we discuss the sequencing of reforms to separate the conduct of monetary and fiscal policies.
    Keywords: Central bank autonomy , political autonomy , economic autonomy ,
    Date: 2007–04–17
  10. By: Christopher W. Crowe
    Abstract: I test whether inflation targeting (IT) enhances transparency using inflation forecast data for 11 IT adoption countries. IT adoption promotes convergence in forecast errors, suggesting that it enhances transparency. This effect is robust to dropping observations, is strengthened by using instrumental variable estimation to eliminate mean-reversion, and is absent in placebo regressions (where IT adoption is shifted by a year). This result supports Morris and Shin's (2002) contention that better public information is most beneficial for forecasters with bad private information. However, it does not support their hypothesis that better public information could make private forecasts less accurate.
    Keywords: Inflation targeting , inflation forecasts , Central Bank transparency , propensity score matching , Inflation targeting , Inflation , Economic forecasting , Central banks , Transparency , Private sector , Forecasting models , Economic models ,
    Date: 2007–01–08
  11. By: David Cook; Woon Gyu Choi
    Abstract: This paper examines empirically U.S. broad money demand emphasizing the role of financial market risk. We find that money demand rises with the liquidity risk of stock markets or the credit risk of corporate bond markets. After controlling for the effect of financial market risk, money demand becomes relatively stable over the last 35 years. At the sectoral level, household money holdings continue to be stable in a traditional model controlling for a decline in transactions costs for investing in mutual funds in the early 1990s. In contrast, business money holdings have been consistently (positively) associated with credit risk.
    Keywords: Money demand , financial market risk , stock market liquidity , money market mutual funds ,
    Date: 2007–04–17
  12. By: Eric Le Borgne; Gauti B. Eggertsson
    Abstract: This paper proposes a theory to explain why a politician delegates policy tasks to a technocrat in an independent institution. It formalizes the rationales for delegation highlighted by Hamilton (1788) and by Blinder (1998). Delegation trades-off the cost of having a possibly incompetent technocrat with a long-term job contract against the benefit of having a technocrat who (i) invests more effort into the specialized policy task and (ii) is better insulated from the whims of public opinion. One natural application of the theory is in the field of monetary policy where the model provides a new theory of central bank independence.
    Keywords: Delegation , elections , career concerns , learning-by-doing , insulation , Central Bank Independence ,
    Date: 2007–04–17
  13. By: Jaewoo Lee; Joshua Aizenman
    Abstract: The sizable hoarding of international reserves by several East Asian countries has been frequently attributed to a modern version of monetary mercantilism-hoarding international reserves in order to improve competitiveness. From a long-run perspective, manufacturing exporters in East Asia adopted financial mercantilism-subsidizing the cost of capital- during decades of high growth. They switched to hoarding large international reserves when growth faltered, making it harder to disentangle the monetary mercantilism from a precautionary response to the heritage of past financial mercantilism. Monetary mercantilism also lowers the cost of hoarding through its short-term boost to external competitiveness, but may be associated with negative externalities leading to competitive hoarding.
    Keywords: Mercantilism , cost of capital , competitive real depreciations , self insurance , precautionary hoarding ,
    Date: 2006–12–22
  14. By: Dudley Cooke (University of Essex)
    Abstract: This paper studies the short-run transmission of foreign shocks in a small open economy with capital controls and a fixed exchange rate. Capital controls alter the transmission of shocks because endogenous changes in the domestic nominal interest rate affect savings and investment decisions. The economy's reaction to export shocks hinges on how the government chooses to restrict capital flows; that is, whether inflows or outflows are restricted. For foreign interest rate shocks, private capital flows are important, but so are the government's holdings of foreign exchange reserves. Finally, a simple graphical apparatus is developed to provide a contrast to the case when capital flows are unrestricted.
    Keywords: capital controls; foreign shocks
    JEL: E58 F32 F41
    Date: 2007–04
  15. By: Elod Takats
    Abstract: The paper shows how excessive reporting, called "crying wolf", can dilute the information value of reports. Excessive reporting is investigated by undertaking the first formal analysis of money laundering enforcement. Banks monitor transactions and report suspicious activity to government agencies, which use these reports to identify investigation targets. Banks face fines should they fail to report money laundering. However, excessive fines force banks to report transactions which are less suspicious. The empirical evidence is shown to be consistent with the model's predictions. The model is used to suggest implementable corrective policy measures, such as decreasing fines and introducing reporting fees.
    Keywords: Money laundering , USA Patriot Act , disclosure , auditing ,
    Date: 2007–04–05
  16. By: Marie-Thérèse Camilleri Gilson; Tonny Lybek; Kenneth Sullivan
    Abstract: This paper reviews the tasks and design of audit committees, increasingly recommended as a way to strengthen financial accountability and good central bank governance. It outlines the motivations for the establishment of audit committees in commercial corporations and public sector entities, and explains how audit committees interact with other governance bodies within a central bank. The paper focuses on the functions of an audit committee, since the terminology of the governance structure is often country-specific. It summarizes operational issues to consider in designing an effective audit committee and discusses the implications for central bank legislation.
    Keywords: Central Bank governance , audit committees ,
    Date: 2007–04–03
  17. By: Simone Manganelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Guido Wolswijk (Fiscal Policies Division of DG-Economics, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper studies the determinants of interest rate spreads of euro area 10 year government bonds against the benchmark, the German bund, after the introduction of the euro. In particular, it pays attention to the question whether market discipline is advanced or obstructed by financial integration and by fiscal rules like the Stability and Growth Pact. We first argue that financial integration – by improving market efficiency – is instrumental for markets to exert their disciplinary role. Next, we discuss the relationships between market discipline and fiscal rules, arguing that these in principle may reinforce each other. Finally, we provide strong empirical evidence that spreads depend on the ratings of the underlying bond and to a large extent are driven by the level of short-term interest rates. JEL Classification: G12, G18, C23.
    Keywords: Bond spreads, credit risk, liquidity risk.
    Date: 2007–04
  18. By: David Hauner; Jiri Jonas; Manmohan S. Kumar
    Abstract: References to policy credibility, particularly with regard to fiscal policy, are ubiquitous in both economic literature and financial markets, even though it is not directly observable. The case of the EU new member states (NMS)-emerging markets joining a supranational entity that is generally considered to have higher policy credibility-provides a unique experiment to assess the effects of credibility on sovereign credit. This paper examines the impact of EU accession on three key variables that can reflect in varying degrees policy credibility: sovereign ratings, foreign currency spreads, and local currency yields. The results suggest that the NMS appear to have enjoyed higher credibility compared to their peers.
    Keywords: Policy credibility , credit spreads , sovereign ratings , EU new member states , Fiscal policy , Europe , European Union , Credit , Currencies , Foreign exchange , Economic models ,
    Date: 2007–01–09
  19. By: Samer Y. Saab; Jerome Vacher
    Abstract: This paper considers the extent of retail banking integration in the Communauté Economique et Monétaire d'Afrique Centrale (CEMAC) and the level of bank competition at the regional level. Using a mix of quantitative and qualitative indicators, the paper finds some evidence of price convergence in average interest rate spreads. However, this observed fact is not supported by an increase in cross-border flows in retail loans and deposits, and price convergence may merely reflect excess liquidity in the region. Other data also indicate that bank competition within the CEMAC as a region is limited, complementing the findings on integration. Addressing shortfalls in legal and regulatory frameworks, infrastructure, and markets would facilitate integration.
    Keywords: CEMAC , monetary union , banking sector integration , bank ccompetition ,
    Date: 2007–01–11

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