nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒06‒02
twenty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Durable goods and their effect on household saving rations in the euro area. By Samuel Reynard
  2. China: Strengthening Monetary Policy Implementation By Rodolfo Maino; Bernard Laurens
  3. Can a Rule-Based Monetary Policy Framework Work in a Developing Country? The Case of Yemen By Selim Elekdag; Nabil Ben Ltaifa; Todd Schneider; Saade Chami
  4. The Inequality Channel of Monetary Transmission By Marta Areosa; Waldyr Areosa
  5. Monetary Policy Implementation: Results from a Survey By Rodolfo Maino; Inese Buzeneca
  6. Reconsidering the role of monetary indicators for euro area inflation from a Bayesian perspective using group inclusion probabilities By Scharnagl, Michael; Schumacher, Christian
  7. Brazil: taming inflation expectations By Afonso S. Bevilaqua; Mário Mesquita; André Minella
  8. Excess money growth and inflation dynamics By Barbara Roffia; Andrea Zaghini
  9. Productivity shocks and Optimal Monetary Policy in a Unionized Labor Market Economy By Fabrizio Mattesini; Lorenza Rossi
  10. Forecasting Interest Rates: an application for Brazil By Eduardo J. A. Lima; Felipe Luduvice; Benjamin M. Tabak
  11. Money Velocity in an Endogenous Growth Business Cycle with Credit Shocks By Benk, Szilárd; Gillman, Max; Kejak, Michal
  12. Monetary Policy Design under Competing Models of Inflation Persistence By Solange Gouvea; Abhijit Sen Gupta
  13. The CFA Arrangements--More than Just an Aid Substitute? By Etienne B. Yehoue
  14. The Recent Brazilian Disinflation Process and Costs By Alexandre A. Tombini; Sergio A. Lago Alves
  15. Nonlinear Mechanisms of the Exchange Rate Pass-Through: a Phillips curve model with threshold for Brazil By Arnildo da Silva Correa; André Minella
  16. Bulls, Bears and Excess Volatility: can currency intervention help? By Corrado, L.; Miller, M.; Zhang, L.
  17. Modeling and Forecasting the Malawi Kwacha-US Dollar Nominal Exchange Rate By Simwaka, Kisu
  18. Computing Optimal Policy in a Timeless-Perspective: An Application to a Small-Open Economy By Michel Juillard; Florian Pelgrin
  19. Financial dollarization - the role of banks and interest rates By Henrique S. Basso; Oscar Calvo-Gonzalez; Marius Jurgilas
  20. The role of banks in the Brazilian Interbank Market: Does bank type matter? By Daniel O. Cajueiro; Benjamin M. Tabak
  21. Yemen: Exchange Rate Policy in the Face of Dwindling Oil Exports By Faisal Ahmed; Nabil Ben Ltaifa; Todd Schneider; Saade Chami
  22. Long-Range Dependence in Exchange Rates: the case of the European Monetary System By Sergio Rubens Stancato de Souza; Benjamin M. Tabak; Daniel O. Cajueiro

  1. By: Samuel Reynard (Swiss National Bank, Research Unit, Boersenstrasse 15, 8022 Zurich, Switzerland.)
    Abstract: This paper presents a systematic empirical relationship between money and subsequent prices and output, using US, euro area and Swiss data since the 1960-70s. Monetary developments, unlike interest rate stance measures, are shown to provide qualitative and quantitative information on subsequent inflation. The usefulness of monetary analysis is contrasted to weaknesses in modeling monetary policy and inflation with respectively short-term interest rates and real activity measures. The analysis sheds light on the recent change in inflation volatility and persistence as well as on the Phillips curve flattening, and reveals drawbacks in pursuing a low inflation target without considering monetary aggregates. JEL Classification: E52, E58, E41, E3.
    Keywords: Monetary policy, monetary aggregates, inflation, output, Taylor rule, equilibrium interest rate.
    Date: 2007–05
  2. By: Rodolfo Maino; Bernard Laurens
    Abstract: The People's Bank of China (PBC) has made great strides in modernizing its monetary policy frameworks but their effectiveness will diminish as the sophistication of the economy increases. Empirical evidence supports maintaining a reference to money in China's monetary strategy and enhancing the role of interest rates in its conduct. We advocate adoption of an eclectic strategy involving the monitoring of several indicators, and of a short-term interest rate as the operational target. The PBC should be granted discretion to change its policy rate, and there are no technical obstacles for such a move to occur in the near future.
    Keywords: Monetary policy , China , Monetary policy instruments , Demand for money , Economic indicators , Interest rates ,
    Date: 2007–01–25
  3. By: Selim Elekdag; Nabil Ben Ltaifa; Todd Schneider; Saade Chami
    Abstract: Monetary policy in Yemen is largely rudimentary and ad hoc in nature. The Central Bank of Yemen's (CBY) approach has been based on discretionary targeting of broad money without any clear target to anchor inflation expectations. This paper argues in favor of a new formal monetary policy framework for Yemen emphasizing a proactive and rule-based approach with a greater direct focus on price stability in the context of a flexible management of the exchange rate. Although, as in many developing countries, institutional capacity is a concern, adopting a more formal framework could impel the kind of changes that are required to strengthen the ability of the CBY in achieving low and stable rates of inflation over the medium term.
    Keywords: Monetary policy , Yemen, Republic of , Inflation targeting , Developing countries , Exchange rates , Prices ,
    Date: 2007–01–17
  4. By: Marta Areosa; Waldyr Areosa
    Abstract: We study optimal monetary policy when inequality is present by introducing agents with different productivities, wages, and financial market accesses into a general equilibrium model with sticky prices. Our main results are: (i) There is a channel from interest rate to inflation throughout inequality; (ii) The welfare-based objective of monetary policy includes inequality stabilization; (iii) Higher levels of financial exclusion are associated to bigger welfare losses and to smaller interest rate variability, providing an alternative explanation to why observed interest rate paths are much less volatile than optimal policies implied by most theoretical models of the monetary transmission mechanism.
    Date: 2006–08
  5. By: Rodolfo Maino; Inese Buzeneca
    Abstract: Since the early 1990s, the IMF has been advising countries to shift to the use of indirect instruments for executing monetary policy. This paper provides information about a monetary policy instruments database, maintained by the Monetary and Capital Markets Department of the IMF. We offer an overview of the information contained in the database in the form of comparative summary tables and graphs to illustrate the use of monetary policy instruments by groups of countries (developing, emerging market and developed countries). The main trend that can be identified from the database information is the increasing reliance on money market operations for monetary policy implementation. We emphasize the relevance and usefulness of the data collected through periodic surveys of central banks, for general descriptive and analytical purposes.
    Keywords: Monetary policy , Databases , Central banks ,
    Date: 2007–01–17
  6. By: Scharnagl, Michael; Schumacher, Christian
    Abstract: This paper addresses the relative importance of monetary indicators for forecasting inflation in the euro area in a Bayesian framework. Bayesian Model Averaging (BMA)based on predictive likelihoods provides a framework that allows for the estimation of inclusion probabilities of a particular variable, that is the probability of that variable being in the forecast model. A novel aspect of the paper is the discussion of group-wise inclusion probabilities, which helps to address the empirical question whether the group of monetary variables is relevant for forecasting euro area inflation. In our application, we consider about thirty monetary and non-monetary indicators for inflation. Using this data, BMA provides inclusion probabilities and weights for Bayesian forecast combination. The empirical results for euro area data show that monetary aggregates and non-monetary indicators together play an important role for forecasting inflation, whereas the isolated information content of both groups is limited. Forecast combination can only partly outperform single-indicator benchmark models.
    Keywords: inflation forecasting, monetary indicators, Bayesian Model Averaging, inclusion probability
    JEL: C11 C52 E31 E37
    Date: 2007
  7. By: Afonso S. Bevilaqua; Mário Mesquita; André Minella
    Abstract: This paper analyzes monetary policy implementation and convergence of inflation and inflation expectations to the targets in Brazil after the crisis in 2002. It covers the initial disinflation and subsequent economic recovery, followed by the inflation rebound and corresponding policy response, and finally the consolidation of disinflation in 2005-06. Monetary policy implementation and the overall improvement in macroeconomic fundamentals have contributed substantially to create a more stable and predictable environment, evidenced by signs of reduction in inflation uncertainty. Furthermore, econometric exercises indicate the critical role played by the targets as attractors for inflation expectations.
    Date: 2007–01
  8. By: Barbara Roffia (European Central Bank, Directorate General Economics, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Andrea Zaghini (Banca d’Italia, Economic Research Department, Via Nazionale 91, 00184 Rome, Italy.)
    Abstract: The paper analyses the short-run impact of periods of strong monetary growth on inflation dynamics for 15 industrialised economies. We find that, over a 3-year horizon, the positive link between monetary aggregates and prices holds in approximately fifty percent of the cases. An econometric investigation suggests that a contemporaneous increase in the gap measures of the real stock price and real housing price and strong dynamics of loans to the private sector significantly increase the probability of turning an episode of excessive money growth into an inflationary outburst. JEL Classification: E31, E40.
    Keywords: Inflation, money growth, quantity theory of money.
    Date: 2007–05
  9. By: Fabrizio Mattesini (Università di Roma 2); Lorenza Rossi (DISCE, Università Cattolica)
    Abstract: In this paper we analyze a general equilibrium dynamic stochastic New Keynesian model characterized by labor indivisibilities, unemployment and a unionized labor market. The presence of monopoly unions introduces real wage rigidities in the model. We show that as in Blanchard Galì (2005) the so called "divine coincidence" does not hold and a trade-off between inflation stabilization and the output stabilization arises. In particular, a productivity shock has a negative effect on inflation, while a reservation-wage shock has an effect of the same size but with the opposite sign. We derive a welfare-based objective function for the Central Bank as a second order Taylor approximation of the expected utility of the economy's representative household, and we analyze optimal monetary policy under discretion and under commitment. Under discretion a negative productivity shock and a positive exogenous wage shock will require an increase in the nominal interest rate. An operational instrument rule, in this case, will satisfy the Taylor principle, but will also require that the nominal interest rate does not necessarily respond one to one to an increase in the interest rate that supports the efficient equilibrium. The results of the model are consistent with a well known empirical regularity in macroeconomics, i.e. that employment volatility is relatively larger than real wage volatility.
    Keywords: Optimal Monetary Policy, Monopolist Union, Labor Indivisibility
    JEL: E24 E32 E50 J23 J51
    Date: 2007–03
  10. By: Eduardo J. A. Lima; Felipe Luduvice; Benjamin M. Tabak
    Abstract: Understanding the links between long and short-term interest rates is crucial for monetary policy makers, since Central Banks decide and set short-term interest rates in order to affect indirectly long-term interest rates, which affects aggregate spending. This paper studies whether VAR/VEC models are useful in predicting long-term interest rates for Brazil. The empirical results suggest that these models are useful in building qualitative scenarios for the Term structure of interest rates, but do not provide good forecasts in terms of accuracy. Furthermore, models that assume that the future path of short-term interest rates (target interest rates) is known by forecasters do not perform better in terms of both directional and forecasting accuracy.
    Date: 2006–10
  11. By: Benk, Szilárd; Gillman, Max (Cardiff Business School); Kejak, Michal
    Abstract: The explanation of velocity in neoclassical monetary business cycle models relies on a goods productivity shocks to mimic the data's procyclic velocity feature; money shocks are not important; and the financial sector plays no role. This paper sets the model within endogenous growth, adds exchange credit shocks, and finds that money and credit shocks explain much of the velocity variation. The role of the shocks varies across sub-periods in an intuitive fashion. Endogenous growth is key to the construction of the money and credit shocks since these have similar effects on velocity, but opposite effects upon growth. The model matches the data's average velocity and simulates most of the velocity volatility that is found in the data. Its underlying money demand is Cagan-like in its interest elasticity, so that money and credit shocks cause greater velocity variation the higher is the nominal interest rate.
    Keywords: Velocity; business cycle; credit shocks; endogenous growth
    JEL: E13 E32 E44
    Date: 2007–05
  12. By: Solange Gouvea; Abhijit Sen Gupta
    Abstract: Most of the recent research in monetary policy has focused on the use of a single exogenously specified standard ad hoc loss function to evaluate policy performance. This literature has come to the conclusion that backward looking models are more difficult to control i.e. monetary policy performance deteriorates with an increase in inflation persistence. In this paper we test the validity of this conclusion using both a standard ad hoc loss function and a model consistent loss function across competing models of inflation persistence. We find that conclusions vary markedly with different types of loss functions. We also look into the case where the policymaker is uncertain about the pricing behavior of firms and investigate the presence of robust policy rules. We find that the existence of robust rules depend crucially on the type of loss function used to evaluate outcomes.
    Date: 2007–05
  13. By: Etienne B. Yehoue
    Abstract: The CFA franc zone has had one of the longest experiences with a fixed exchange rate for a convertible currency and regional integration of any group of developing countries. France, the anchor country, provides aid to support the zone. This paper asks whether the arrangements are more than just an aid substitute. The paper addresses this issue by evaluating the overall performance of the zone over the period 1960-2004. The analysis reveals that when the zone is hit by a negative shock, France increases its aid, thereby acting as a shock absorber. However, it also finds that the zone displays strong performance in two areas-price stability and fiscal policy. Thus the paper concludes that the arrangements are not an aid substitute; they have real macroeconomic value for the zone and complement aid.
    Keywords: Monetary unions , Africa , Risk management , Development assistance , Fiscal policy , Price stabilization , International cooperation ,
    Date: 2007–02–01
  14. By: Alexandre A. Tombini; Sergio A. Lago Alves
    Abstract: This work revisits the recent disinflation process in Brazil and finds that solely the agents' perception that a policy rupture could occur is capable of triggering a change in the way firms and households used to behave in their pricing and consuming decisions. This change was captured by structural breaks in the parameters of a generalized hybrid Phillips curve, following the 2002 inflation shock. The paper also shows that such parameter changes led to an increase in the disinflation cost evidenced by a free market inflation gain that would have been observed should the coefficients on the Phillips curve have not changed. The paper finds that, maintaining the occurred paths for interest rates, output gap, nominal exchange rates, administered price inflation and exogenous shocks, the free market inflation would have been significantly lower in the absence of such structural break in the underlying inflation process, since mid 2002.
    Date: 2006–06
  15. By: Arnildo da Silva Correa; André Minella
    Abstract: This paper investigates the presence of nonlinear mechanisms of pass-through from the exchange rate to inflation in Brazil. In particular, it estimates a Phillips curve with a threshold for the pass-through. The paper examines whether the short-run magnitude of the pass-through is affected by the business cycle, direction and magnitude of exchange rate changes, and exchange rate volatility. The results indicate that the short-run pass-through is higher when the economy is growing faster, when the exchange rate depreciates above some threshold and when exchange rate volatility is lower. These results have important implications for monetary policy and are possibly related to pricing-to-market behavior, menu costs of price adjustment and uncertainty about the degree of persistence in exchange rate movements.
    Date: 2006–11
  16. By: Corrado, L.; Miller, M.; Zhang, L.
    Abstract: Asset mis-pricing may reflect investor psychology, with excess volatility arising from switches of sentiment. For a floating exchange rate where fundamentals follow a random walk, we show that excess volatility can be generated by the repeated entry and exit of currency `bulls' and `bears' with switches driven by `draw-down' trading rules. We argue that non-sterilised intervention - in support of `monitoring band' - can reduce excess volatility by coordinating beliefs in line with policy. Strategic complementarity in the foreign exchange market suggests that sterilised intervention may also play a coordinating role.
    Keywords: Monitoring Rules, Monitoring Band, Bear and Bull Traders, Excess Volatility, Central Bank Intervention.
    JEL: D52 F31 G12
    Date: 2007–01
  17. By: Simwaka, Kisu
    Abstract: This study develops a blended version of the monetary and portfolio models for the MK/USD exchange rate, and assesses the forecasting performance of the model against a simple random walk. The results indicate that the model performs better than the simple random walk on the 6, 12 and 24 months forecasting horizons. However, the model does not perform well on the 3-month horizon, which is supported by theory suggesting that exchange rate movements are not driven by fundamentals in the short term. We also add a variable drift term to the random walk process and compare its performance against both the simple random walk and the fundamental model. The results show that random walk (with a variable drift) performs better than the other models in out-of-sample process at both short term and long term horizons. This result suggests that this (the random walk with a drift) process might be the best tool for exchange rate forecasting on all the forecast horizons. When it comes to exchange rate forecasting in the long term, a fundamental model might still be the best alternative. Regarding the structural model (with fundamental determinants of nominal exchange rate), the empirical results indicate that a worsening current account balance and decreases in net external flows result the depreciation of exchange rates. This is in line with practical experience. On the other hand, higher domestic interest rates have an insignificant impact on exchange rate. In an economy with several structural bottlenecks and poor infrastructural services, high interest rates cannot be expected to induce capital flows. A rise in domestic inflation is associated with a deprecated exchange rate. Lastly, consistent with theoretical expectations, another significant finding is that an easing in monetary policy (increase in money supply growth) is associated with a depreciation of the exchange rate. These findings lead us to make the following conclusions. Developments in the current account balance have implications on the exchange rate market. Measures aimed at improving the current account position, for example through exports, are also instrumental in stabilizing the exchange rate – through appreciation. Considering that Malawi has been traditionally depending on tobacco as its chief foreign exchange earner, and taking into account the anti-smoking campaign militating against the crop amidst low prices, it is imperative that Malawi should diversify into other foreign exchange earner (for instance tourism) in order to ensure macroeconomic stability, which itself is a pre-requisite for economic growth and therefore poverty reduction. Thus, policies that influence exports and imports of goods and services also determine exchange rate movements. Likewise, prospects concerning funding for a donor aid dependent economy like ours may influence the direction of market forces in determining the exchange rate movements. Big swings in external funding could cause instability Therefore, government’s credibility regarding the use of external public funds and implementation of related reforms is important in as far as stability of the foreign exchange market and overall macroeconomic stability are concerned. The insignificant impact of higher domestic interest on attracting capital flows calls for the need for government to address some structural bottlenecks. For instance, infrastructure services such road network and utilities (electricity and water supply) require improvement. Otherwise, currently, Malawi needs lower interest rates in order to reduce the cost of credit necessary for private sector development. The general picture from the results is that developments in the external sector of the economy, which are not under the ambit of domestic authorities, probably contributed more to fluctuations of the Malawi kwacha. If indeed the above diagnosis is accurate, the policy implications of government’s ability in influencing the behavior of the exchange rate is limited. This is because the ability of a small economy like that of Malawi to fully insulate itself from external shocks is constrained. It will mainly be confined to limiting the contributions of inconsistencies in domestic policy and administering some confidence building measures, at least in the short-term-to medium term It is worthy to note that divergent opinions exist as to the usefulness of devaluation (or depreciation) as a policy tool. There are those that believe devaluation as a policy tool can boost exports and so crate jobs. It should be noted however that since the kwacha was floated in 1994, it has been on a depreciating trend almost continuously without corresponding gains from the export sector. Without losing sight of the interest of exporters, it should be noted that a depreciated kwacha has implications in terms of increased import expenditures (oil import bill), government debt service, domestic inflation and cost of imported intermediate inputs. In the short term, what we should strive as a nation is to have a stable Malawi kwacha exchange rate. In the long run, the viable option is in ensuing a competitive export market is increased productivity among exporting firms. This may include export diversification and implementing measures to limit market imperfections.
    JEL: F31 F00
    Date: 2007–05–25
  18. By: Michel Juillard; Florian Pelgrin
    Abstract: Since the contribution of Kydland and Prescott (1977), it is well known that the optimal Ramsey policy is time inconsistent. In a series of recent contributions, Woodford (2003) proposes a new methodology to circumvent this problem, namely the timeless perspective solution. However, one main limitation is that it is not yet empirically implementable. In this paper, we develop a new methodology to compute initial values of the Lagrange multipliers in order to implement the timeless-perspective solution. In so doing, we also provide a generalization of the Ramsey and timeless-perspective problems. We apply our results to a small-open economy model in Canada.
    Keywords: Monetary policy framework
    JEL: C6 E5 E6
    Date: 2007
  19. By: Henrique S. Basso (School of Economics, Mathematics and Statistics, Birkbeck College, University of London, Malet Street, London, WC1E 7HX, United Kingdom.); Oscar Calvo-Gonzalez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marius Jurgilas (Department of Economics, College of Liberal Arts, University of Connecticut, 341 Mansfield Road, Unit1063, CT 06269-1063 USA.)
    Abstract: This paper develops a model to explain the determinants of financial dollarization. Expanding on the existing literature, our framework allows interest rate differentials to play a role in explaining financial dollarization. It also accounts for the increasing presence of foreign banks in the local financial sector. Using a newly compiled data set on transition economies we find that increasing access to foreign funds leads to higher credit dollarization, while it decreases deposit dollarization. Interest rate differentials matter for the dollarization of both loans and deposits. Overall, the empirical results lend support to the predictions of our theoretical model. JEL Classification: E44, G21.
    Keywords: Financial Dollarization, Foreign Banks, Interest Rate Differentials, Transition Economies.
    Date: 2007–05
  20. By: Daniel O. Cajueiro; Benjamin M. Tabak
    Abstract: This paper presents an empirical analysis of the Brazilian interbank network structure. The Brazilian interbank market clearly presents a topology that is compatible to the free-scale networks. This market is characterized by money centers, which have exposures to many banks and are the most important source of large amounts of lending. Therefore, they have important positions in the network taken into account by the minimal spanning tree and the power domination measures of the network. We also develop a methodology to compare di®erent banks and their relative importance in the network.
    Date: 2007–01
  21. By: Faisal Ahmed; Nabil Ben Ltaifa; Todd Schneider; Saade Chami
    Abstract: This paper investigates the likely implications of declining oil production on Yemen's equilibrium exchange rate, and discusses policy options to ensure a smooth transition to a nonoil economy. The empirical results suggest that, as oil production and foreign exchange earnings fall, the Yemeni rial will have to adjust downward in real effective terms to keep pace with the equilibrium exchange rate. In light of strong pass-through from exchange rate depreciation to domestic inflation, this could entail a substantial depreciation in nominal terms. Given the nature of the adjustment, a floating exchange rate regime appears to be the best option, if supported by appropriate macroeconomic policies. However, given public fixation on a exchange rate stability, a softly managed float would be a better option for Yemen whereby the central bank may have to lead the market toward the equilibrium exchange rate.
    Keywords: Exchange rate policy , Yemen, Republic of , Oil exports ,
    Date: 2007–01–17
  22. By: Sergio Rubens Stancato de Souza; Benjamin M. Tabak; Daniel O. Cajueiro
    Abstract: In this work we measure the evolution of the long-range dependence phenomenon of returns and volatilities of nominal British exchange rates (British pound against US dollar) futures contracts negotiated on the Chicago Mercantile Exchange from 1986 to 2004. The measurement employs the R/S classic analysis, Detrended Fluctuation Analysis and Generalized Hurst exponents, upon a 1008-observation window, which moves along the data. We obtain as a result, the effects of the 1992 European financial crises on the measurements of the long-range dependency phenomenon. After the crisis the returns of this futures contract showed no signs of the long-range memory, which existed before the crisis. The volatility presented moderate long-range memory the whole time. We also test for long-memory in European currencies inside the European Monetary System and find evidence of moderate long memory, which suggests that being inside the EMS increases predictability.
    Date: 2007–01

This nep-mon issue is ©2007 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.