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on Monetary Economics |
| By: | Carlos Pestana Barros; Luis A. Gil-Alana; Pedro Leão |
| Abstract: | Leão (2005) has recently proposed a new explanation for the short run variability of the velocity of money based on the changes in the composition of the expenditure that occur along the business cycle. This paper presents further empirical evidence in favour of Leão’s Expenditure Composition Hypothesis, and draws new implications of this hypothesis for monetary policy. We use a VAR model to analyze the determinants of the velocity of both M1 and M3 in the USA. The main conclusion is that increases in the weight of investment and durable consumption in total expenditure raise the velocity of both narrow and broad money. This is in line with the Expenditure Composition Hypothesis. Furthermore, we draw a new implication of this hypothesis for monetary policy. The more a central bank’s decisions on the interest rate respond to money growth, the more volatile economic growth will be. In other words, a monetary policy strategy - like that of the ECB – which puts emphasis on money growth is de-stabilizing. |
| Keywords: | Velocity of money; monetary policy; business cycle. |
| JEL: | E12 E32 E40 E41 E52 E58 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:ise:isegwp:wp102007&r=mon |
| By: | Michael D. Bordo; Michael J. Dueker; David C. Wheelock |
| Abstract: | This paper examines the association between monetary policy and stock market booms and busts in the United States, United Kingdom, and Germany during the 20th century. Booms tended to arise when output growth was rapid and inflation was low, and end within a few months of an increase in inflation and monetary policy tightening. Latent variable VAR analysis of post-war data finds that inflation has had a particularly strong impact on market conditions, with disinflation shocks moving the market toward a boom and positive inflation shocks moving the market toward a bust. We conclude that central banks can contribute to financial market stability by minimizing unanticipated changes in inflation. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2007-20&r=mon |
| By: | Pontiggia, Dario |
| Abstract: | In this paper we prove that (I) inefficient natural level of output (Friedman (1968)), (II) central bank's desire to stabilize output around a level that is higher than the inefficient natural level of output, (III) long-run Phillips curve trade-off, and (IV) inflation persistence result in optimal positive long-run inflation. The combination of (I), (II), and (III) makes positive inflation forever in principles desirable as it would result in positive output gap forever. Optimal positive steady-state inflation obtains if and only if there is a long-run incentive for positive inflation. Inflation persistence, defined as costly, in terms of output, disinflation, generates a long-run incentive for positive inflation. Optimal positive steady-state inflation obtains in the basic neo-Wicksellian model (Woodford (2003)) with inflation persistence due to backward-looking rule-of-thumb behaviour by price setters. Optimal positive long-run inflation also obtains in what we refer to as the nonmicrofounded model. Prescinding from hyperinflation, the formula for steady-state inflation is capable of providing a positive theory of inflation. |
| Keywords: | Optimal monetary policy; inflation persistence |
| JEL: | E31 |
| Date: | 2007–05–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:3274&r=mon |
| By: | Sonia Munoz |
| Abstract: | Zimbabwe's failure to address continuing central bank quasi-fiscal losses has interfered with both monetary management and the independence and credibility of the Reserve Bank of Zimbabwe (RBZ). Realized quasi-fiscal losses are estimated to have amounted to about 75 percent of GDP in 2006. Because they were financed by creating money creation or issuing RBZ securities, they contributed to the four-digit inflation reached in 2006. The remedy for the current situation is clearly to eliminate the causes of losses by implementing measures to improve the cash-flow of the bank and restore its financial position. |
| Date: | 2007–04–27 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:07/98&r=mon |
| By: | Kenneth N. Kuttner (Oberlin College, Department of Economics); Adam S. Posen (Peterson Institute for International Economics) |
| Abstract: | This paper assesses the effects of central bank governor appointments on financial market expectations of monetary policy. To measure these effects, we assemble a new dataset of appointment announcements from 15 countries, and conduct an event study analysis on exchange rates, bond yields, and stock prices. The analysis reveals a significant reaction of exchange rates and bond yields to unexpected appointments. The reactions are not unidirectional, and thus do not suggest new governors suffer from a generic credibility problem. Federal Reserve chairman appointments stand out in terms of their unusually pronounced effects on financial markets. |
| Keywords: | Central banking, Monetary policy, Credibility, Financial markets, Event study analysis |
| JEL: | E58 E61 G14 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:iie:wpaper:wp07-3&r=mon |
| By: | Joseph Byrne; Alexandros Kontonikas; Alberto Montagnoli |
| Abstract: | In this paper, we examine whether UK inflation is characterized by aggregation bias using three sets of increasingly disaggregated inflation data and a battery of univariate and panel unit root tests. Our results support the existence of aggregation bias since while the unit root hypothesis cannot be rejected for aggregate inflation, it can be rejected for some of its sectoral components, with the rejection frequencies increasing when we use more disaggregate data. Results from structural break analysis indicate that monetary policy shifts are the main factor behind breaks in UK inflation. The panel results typically indicate that when sectoral inflation rates are pooled the unit root hypothesis can be rejected. Our results have important implications for applied econometric analysis, macroeconomic theory and for the conduct of monetary policy. |
| Keywords: | Inflation, Unit Root, Disaggregation, Structural Breaks, Panel Data |
| JEL: | C22 C23 E31 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:gla:glaewp:2007_07&r=mon |
| By: | Michel Beine (CREFI-LSF, Luxembourg University, Luxembourg School of Finance, Luxembourg and DULBEA, Université Libre de Bruxelles, Brussels.); Oscar Bernal (DULBEA, Université Libre de Bruxelles, Brussels.); Jean-Yves Gnabo (jean-yves.gnabo@fundp.ac.be); Christelle Lecourt (FUNDP, Namur) |
| Abstract: | Intervening in the FX market implies a complex decision process for central banks. Monetary authorities have to decide whether to intervene or not, and if so, when and how. Since the successive steps of this procedure are likely to be highly interdependent, we adopt a nested logit approach to capture their relationships and to characterize the prominent features of the various steps of the intervention decision. Our findings shed some light on the determinants of central bank interventions, on the so-called secrecy puzzle and on the identification of the variables influencing the detection of foreign exchange transactions by market traders. |
| Keywords: | FX intervention, Secrecy Puzzle, Market Detection, Nested Logit. |
| JEL: | E58 F31 G15 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:sol:wpaper:07-013&r=mon |
| By: | Cristina Arellano; Jonathan Heathcote |
| Abstract: | How does a country’s choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets. We compare a floating regime to full dollarization. We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen incentives to maintain access to debt markets. Given stronger repayment incentives, more borrowing can be supported, and thus dollarization can increase international financial integration. This prediction of theory is consistent with the experiences of El Salvador and Ecuador, which recently dollarized, as well as with that of highly-indebted countries like Italy which adopted the Euro as part of Economic and Monetary Union. In each case, spreads on foreign currency government debt declined substantially around the time of regime change. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:890&r=mon |
| By: | Oliver Grimm; Stefan Ried |
| Abstract: | We use a two-country model with a central bank maximizing union-wide welfare and two fiscal authorities minimizing comparable, but slightly different country-wide losses. We analyze the rivalry between the three authorities in seven static games. Comparing a homogeneous with a heterogeneous monetary union, we find welfare losses to be significantly larger in the heterogeneous union. The best-performing scenarios are cooperation between all authorities and monetary leadership. Cooperation between the fiscal authorities is harmful to both the whole union’s and the country-specific welfare. |
| Keywords: | monetary union, heterogeneities, policy game, simultaneous policy, sequential policy, coordination, discretionary policies. |
| JEL: | E52 E61 F42 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2007-028&r=mon |
| By: | Zagaglia, Paolo (Dept. of Economics, Stockholm University) |
| Abstract: | I introduce distortionary taxes on consumption, labor and capital income into a New Keynesian model with Calvo pricing and nominal bonds. I study the relation between tax instruments and optimal monetary policy by computing simple rules for monetary and fiscal policy when one tax instrument at a time varies, while the other two are fixed at their steady-state level. The optimal rules maximize the second-order approximation to intertemporal utility. Three results emerge: (a) when prices are sticky, perfect inflation stabilization is optimal independently from the tax instrument adopted; (b) the optimal degree of responsiveness of monetary policy to output varies depending on which tax instrument induces fluctuations in the average tax rate; (c) when prices are flexible, fiscal rules that prescribe unexpected variations in the price level to support debt changes are always welfare-maximizing. |
| Keywords: | Nominal rigidities; distortionary taxation; monetary-policy rules |
| JEL: | E52 E61 E63 |
| Date: | 2007–05–21 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sunrpe:2007_0005&r=mon |
| By: | Jane Ihrig; Steven B. Kamin; Deborah Lindner; Jaime Marquez |
| Abstract: | This paper evaluates the hypothesis that globalization has increased the role of international factors and decreased the role of domestic factors in the inflation process in industrial economies. Toward that end, we estimate standard Phillips curve inflation equations for 11 industrial countries and use these estimates to test several predictions of the globalization and inflation hypothesis. Our results provide little support for that hypothesis. First, the estimated effect of foreign output gaps on domestic consumer price inflation is generally insignificant and often of the wrong sign. Second, we find no evidence that the trend decline in the sensitivity of inflation to the domestic output gap observed in many countries owes to globalization. Finally, and most surprisingly, our econometric results indicate no increase over time in the responsiveness of inflation to import prices for most countries. However, even though we find no evidence that globalization is affecting the parameters of the inflation process, globalization may be helping to stabilize real GDP and hence inflation. Over time, the volatility of real GDP growth has declined by more than the volatility of domestic demand, suggesting that net exports increasingly are acting to buffer output from fluctuations in domestic demand. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:891&r=mon |
| By: | Norbert Funke; Jens R. Clausen; Sonia Munoz; Bakar Ould-Abdallah; Sharmini Coorey |
| Abstract: | Zimbabwe has currently the highest rate of inflation in the world (an annual rate of 1,730 percent in February, 2007). The high rates of inflation have contributed to the contraction of the economy, which has declined by about 30 percent since 1999. This paper examines the stabilization experience of countries that experienced similar rates of inflation (above 1,000 percent) during 1980-2005 and draws lessons for Zimbabwe. First, with appropriate stabilization policies, the fall in inflation can be very rapid and output normally recovers within the first year or two of stabilization. Second, while reforms need to be comprehensive, a strong upfront fiscal consolidation, including elimination of quasi-fiscal activities, is a critical element of a successful stabilization program. Third, although stabilization itself can be done without significant external financing in the first year, most countries benefited from external policy advice and technical support, including from the IMF, during stabilization and from an increase in financial assistance in subsequent years. |
| Date: | 2007–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:07/99&r=mon |
| By: | Jeffrey A. Frankel; Shang-Jin Wei |
| Abstract: | This paper examines two related issues: (a) the implicit methodology used by the U.S. Treasury in determining whether China and America's 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 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 - but also some 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, adding 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 suggest that they have different policy implications. |
| JEL: | F3 F59 O1 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13100&r=mon |
| By: | Idrees Khawaja (Pakistan Institute of Development Economics, Islamabad.); Musleh-ud Din (Pakistan Institute of Development Economics, Islamabad.) |
| Abstract: | Interest spread of the Pakistan’s banking industry has been on the rise for the last two years. The increase in interest spread discourages savings and investments on the one hand, and raises concerns on the effectiveness of bank lending channel of monetary policy on the other. This study examines the determinants of interest spread in Pakistan using panel data of 29 banks. The results show that inelasticity of deposit supply is a major determinant of interest spread whereas industry concentration has no significant influence on interest spread. One reason for inelasticity of deposits supply to the banks is the absence of alternate options for the savers. The on-going merger wave in the banking industry will further limit the options for the savers. Given the adverse implications of banking mergers for a competitive environment, we argue that to maintain a reasonably competitive environment, merger proposals may be subjected to review by an antitrust authority with the central bank retaining the veto over merger approval. |
| Keywords: | Banks, Determination of Interest Rates, Mergers, Acquisitions |
| JEL: | G21 E43 G34 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:pid:wpaper:2007:22&r=mon |
| By: | Campbell, Rachel; Koedijk, Kees; Lothian, James R; Mahieu, Ronald J |
| Abstract: | We review Irving Fisher’s seminal work on UIP and on the closely related equation linking interest rates and inflation. Like Fisher, we find that the failures of UIP are connected to individual episodes in which errors surrounding exchange rate expectations are persistent, but eventually transitory. We find considerable commonality in deviations from UIP and PPP, suggesting that both of these deviations are driven by a common factor. Using a dynamic latent factor model, we find that deviations from UIP are almost entirely due to forecasting errors in exchange rates, a result consistent with those reported by Fisher a century ago. |
| Keywords: | Expectations formation; Irving Fisher; small-sample problems; UIP |
| JEL: | F31 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6294&r=mon |
| By: | Joe Crowley |
| Abstract: | This paper examines interest rate spreads in English-speaking African countries. Higher spreads were found to be associated with lower inflation, a greater number of banks, and greater public ownership of banks. Higher deposit interest rates were found to be associated with lower interest rate spreads, but higher net interest margins. A large increase in spreads in the late 1980s and 1990s may be explained by a strengthening of financial sector supervision. Limited data suggested that poor governance, weak regulatory frameworks and property rights, and higher required reserve ratios are associated with higher spreads. |
| Date: | 2007–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:07/101&r=mon |
| By: | Marta Gomez-Puig (Faculty of Economics, University of Barcelona.) |
| Abstract: | Yield spreads over 10-year German government securities of the EU-15 countries converged dramatically in the seven years after the beginning of Monetary Integration. In this paper, we investigate the relative influence of systemic and idiosyncratic risk factors on their behaviour. Our conclusions suggest that in EMU-countries the relative importance of domestic risk factors (both credit and liquidity risk factors) is higher than that of international factors, which appear to play a secondary but significant role in non-EMU countries. |
| Keywords: | Monetary integration, sovereign securities markets, systemic, idiosyncratic risk. |
| JEL: | E44 F36 G15 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:ira:wpaper:200711&r=mon |
| By: | Zsolt Darvas (Department of Mathematical Economics and Economic Analysis, Corvinus University of Budapest); Zoltán Schepp (University of Pécs) |
| Abstract: | This paper shows that error correction models assuming that long-maturity forward rates are stationary outperform the random walk in out of sample forecasting at forecasting horizons mostly above one year, for US dollar exchange rates against nine industrial countries’ currencies, using the 1990-2006 period for evaluating the out of sample forecasts. The improvement in forecast accuracy of our models is economically significant for most of the exchange rate series, and statistically significant according to a bootstrap test. Our results are robust to the specification of the error correction model and to the underlying data frequency. |
| Keywords: | bootstrap, forecasting performance, out of sample, random walk, VECM |
| JEL: | E43 F31 F47 |
| Date: | 2007–05–18 |
| URL: | http://d.repec.org/n?u=RePEc:mkg:wpaper:0705&r=mon |
| By: | Stanley Watt; Saade Chami; Donal McGettigan |
| Abstract: | Jordan has seen a large increase in its international reserve holdings in recent years. While a healthy reserve buffer is needed under a fixed exchange rate regime, determining optimal reserve levels is not straightforward. In this paper, we first use several traditional measures of reserves adequacy to compare Jordan's reserve holdings with other emerging market (EM) countries. Subsequently, we analyze Jordan's reserve holdings using a reserves-optimizing model, based on Jeanne and Ranciere (2006) (J-R), but extended to allow reserve holdings to influence the likelihood of a sudden stop. The overall analysis suggests that Jordan's reserve holdings provide sufficient support to sustain the dinar peg and to deal with the most extreme capital account disruptions. |
| Date: | 2007–05–03 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:07/103&r=mon |