nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒06‒23
eighteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. A two-pillar strategy to keep inflation expectations at bay: A basic theoretical framework. By Meixing DAI
  2. Optimal exchange rate policy in a low interest rate environment By Pavasuthipaisit, Robert
  3. Monetary hyperinflations and money essentiality. By Alexandre Sokic
  4. The daily and policy-relevant liquidity effects By Daniel L. Thornton
  5. The rise and fall of U.S. inflation persistence By Meredith Beechey; Par Osterholm
  6. Did the FED Inflate a Housing Price Bubble? A Cointegration Analysis between the 1980s and the 1990s By Clemente De Lucia
  7. Monetary policy and stock market booms and busts in the 20th century By Michael D. Bordo; Michael J. Dueker; David C. Wheelock
  8. Monetary Policy with Uncertain Central Bank Preferences for Robustness. By Li Qin; Eleftherios Spyromitros; Moïse Sidiropoulos
  9. Central banks, inflation targeting and employment creation By Gerald Epstein
  10. Monetary Policy Transparency and Financial Market Forecasts in South Africa By Vivek B. Arora
  11. Oil Price Shocks, Monetary Policy and Aggregate Demand in Ghana By Jumah, Adusei; Pastuszyn, Georg
  12. Money and Inflation in the Islamic Republic of Iran By Leo Bonato
  13. Liquidity Traps, Learning and Stagnation By Evans, G.W.; Guse, E.; Honkapohja, S
  14. Milton Friedman and U.S. monetary history: 1961-2006 By Edward Nelson
  15. Is the Euro Sustainable? By Wickens, Michael R
  16. Modalities of Moving to Inflation Targeting in Armenia and Georgia By Andreas Billmeier; Daehaeng Kim; Era Dabla-Norris; V. Kramarenko; Mayra Rebecca Zermeno Livas
  17. Estimation of the Equilibrium Interest Rate: Case of CFA zone By DRAMANI, Latif; LAYE, Oumy
  18. An "Almost-Too-Late" Warning Mechanism For Currency Crises By Jesus Crespo Cuaresma; Tomas Slacik

  1. By: Meixing DAI
    Abstract: Using a simple macro-economic model, this study shows how a two-pillar monetary strategy as practiced by the European central bank (ECB) can be conceived to guarantee dynamic macro-economic stability and the credibility of monetary policy. This strategy can be interpreted as a combination of inflation targeting and monetary base targeting. A commitment to a long-run monetary base growth rate (monetary targeting) corresponding to inflation target could reinforce the credibility of central bank announcements and the role of inflation target as strong and credible nominal anchor for private inflation expectations. However, achieving price stability under inflationtargeting regime associated with Friedman’s money supply rule can generate dynamic instability in output, inflation and money demand. Alternative stabilizing monetary targeting rules, of which the design depends on economic structure and central bank preferences, are discussed relative to their capability to warrant dynamic macroeconomic stability.
    Keywords: two-pillar monetary strategy, inflation targeting, monetary targeting, macroeconomic stability.
    JEL: E44 E52 E58
    Date: 2007
  2. By: Pavasuthipaisit, Robert
    Abstract: This paper examines optimal exchange policy when nominal interest rates are unusually low, as experienced by several Asian economies and Japan since July 2006. The paper finds that in such environments, it is optimal to create a nominal depreciation to offset contractionary disturbances. However, the limited scope of monetary policy easing may compromise the ability of the central bank to create a nominal depreciation especially if the central bank makes decisions on monetary policy making on a discretionary basis. In order to successfully create a nominal depreciation, the central bank needs to rely on the expectations channel, by making a credible promise to keep its currency weak going forward. Finally, trade liberalization, by enhancing the role of the exchange rate channel on the transmission mechanism, may allow the central bank to achieve lower average inflation.
    Keywords: Zero lower bound; liquidity trap; exchange rate policy; open-economy macroeconomics.
    JEL: E58 E52 F41
    Date: 2007–05
  3. By: Alexandre Sokic
    Abstract: This paper aims at drawing new guidelines for investigation of monetary hyperinflation analysis. We propose a MIUF optimizing model and show that monetary hyperinflation can occur as a perfect foresight competitive equilibrium path only when money is essential in the sense of Scheinkman (1980). This result emerges without any ad-hoc assumption implying the inclusion of friction in the adjustment of some nominal variable. It suggests that monetary hyperinflation analysis under perfect foresight requires abandoning the Cagan money demand and adopting a demand for money respecting money essentiality.
    Keywords: monetary hyperinflation, seigniorage, inflation tax, money essentiality.
    JEL: E31 E41
    Date: 2007
  4. By: Daniel L. Thornton
    Abstract: In an environment of low inflation, the Federal Reserve faces the risk that it has not provided enough monetary stimulus even when it has pushed the short-term nominal interest rate to its lower bound of zero. Assuming the nominal Treasury-bill rate has been lowered to zero, this paper considers whether further open market purchases of Treasury bills could spur aggregate demand through increases in the monetary base that may stimulate aggregate demand by increasing liquidity for financial intermediaries and households; by affecting expectations of the future paths of short-term interest rates, inflation, and asset prices; or by stimulating bank lending through the credit channel. This paper also examines the alternative policy tools that are available to the Federal Reserve in theory, and notes the practical limitations imposed by the Federal Reserve Act, The tools the Federal Reserve has at its disposal include open market purchases of Treasury bonds and private-sector credit instruments (at least those that may be purchased by the Federal Reserve); unsterilized and sterilized intervention in foreign exchange; lending through the discount window; and, perhaps in some circumstances, the use of options.
    Keywords: Liquidity (Economics) ; Monetary policy
    Date: 2007
  5. By: Meredith Beechey; Par Osterholm
    Abstract: This paper estimates the path of inflation persistence in the United States over the last 50 years and draws implications about the evolution of the Federal Reserve's monetary-policy preferences. Standard models of central-bank optimization predict persistent inflation outcomes. Time variation of the central bank's preference for output stability should be reflected in changes in inflation persistence. We estimate an ARMA(1,q) model with a time-varying autoregressive parameter for monthly U.S. inflation data from 1955 to 2006. The coefficients provide an estimate of the inflation target and the path of inflation persistence. The estimated inflation target over the sample is approximately 2.8 percent and we find that inflation persistence declined substantially during Volcker and Greenspan's tenures to a level significantly less than one and significantly below that of the 1970s and early 1980s.
    Date: 2007
  6. By: Clemente De Lucia (BNP Paribas, Paris, France)
    Abstract: The aim of this work is to verify if the recent episodes of expansionary policies followed by the FED contributed to the creation a housing price bubble. This study compares two different samples, both including periods of recession followed by accommodating monetary policies. The paper showed that even though the long-run relationship between inflation and the interest rate did not change along the whole sample, suggesting an unaltered behavior of the central bank with respect to changes in inflation, the reactivity of housing prices to monetary policy has considerably augmented during the 1990s compared to the 1980s. This is interpreted as evidence that prolonged accommodating monetary policies affected the US real estate market.
    Keywords: Housing Price Bubble, Monetary Policy, Cointegration
    JEL: E31 E41 E52
    Date: 2007–05
  7. 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.
    Keywords: Monetary policy ; Stock exchanges
    Date: 2007
  8. By: Li Qin; Eleftherios Spyromitros; Moïse Sidiropoulos
    Abstract: In this paper,we consider the transparency of monetary policy in a New Keynesian model with misspecification doubts. Model uncertainty allows us to identify a new source of central bank opacity, which refers to a lack of information about central bank’s preference for model robustness. Thus, taking into account this lack of transparency, we study its impacts on macroeconomic variables. We show that greater transparency can reduce the variability of output gap, inflation as well as that of their expected values.
    Date: 2007
  9. By: Gerald Epstein (Political Economy Research Institute, University of Massachusetts)
  10. By: Vivek B. Arora
    Abstract: The transparency of monetary policy in South Africa has increased substantially since the end of the 1990s; but little empirical work has been done to examine the economic benefits of the increased transparency. This paper shows that, in recent years, South African private sector forecasters have become better able to forecast interest rates, are less surprised by reserve bank policy announcements, and are less diverse in the cross-sectional variety of their interest rate forecasts. In addition, there is some evidence that the accuracy of inflation forecasts has increased. The improvements in interest rate and inflation forecasts have exceeded those in real output forecasts, suggesting that increases in reserve bank transparency are likely to have played a role.
    Date: 2007–05–29
  11. By: Jumah, Adusei (Department of Economics, University of Vienna, BWZ, Vienna, Austria); Pastuszyn, Georg (Department of Economics, University of Vienna, BWZ, Vienna, Austria)
    Abstract: The current study examines the relationship between the world oil price and aggregate demand in a developing country, Ghana, via the interest rate channel by means of cointegration analysis. Results of the study indicate that oil price—by impacting the price level positively—negatively impacts real output. The results also indicate that monetary policy is initially eased in response to a surge in the price of oil in order to lessen any growth consequences, but at the cost of higher inflation. The ensuing higher inflation, however, prompts a subsequent tightening of monetary policy leading to a further decline in output. In addition, output does not revert quickly to its initial level after an oil price shock, but declines over an extended period.
    Keywords: Aggregate demand, inflation, monetary policy, oil
    JEL: C32 E50 O13
    Date: 2007–06
  12. By: Leo Bonato
    Abstract: This paper looks at the determinants of inflation in Iran. Unlike the traditional estimates of the demand function for real money balances, the approach followed here focuses on the relationship between nominal variables and inflation. The model estimates are used to address the questions raised by the decline in inflation that occurred up to the first half of 2006, looking at the structural stability of the estimated relationships and the ability of the model to predict inflation at the end of the sample. The estimates confirm the strong relationship between money and inflation when M1 is used, with no evidence of a structural change.
    Date: 2007–05–15
  13. By: Evans, G.W.; Guse, E.; Honkapohja, S
    Abstract: We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.
    Keywords: Adaptive Learning, Monetary Policy, Fiscal Policy, Zero Interest Rate Lower Bound, Indeterminacy
    JEL: E63 E52 E58
    Date: 2007–06
  14. By: Edward Nelson
    Abstract: This paper brings together, using extensive archival material from several countries, scattered information about Milton Friedman's views and predictions regarding U.S. monetary policy developments after 1960 (i.e., the period beyond that covered by his and Anna Schwartz's Monetary History of the United States). I evaluate these interpretations and predictions in light of subsequent events.
    Keywords: Federal Reserve System - History ; Friedman, Milton ; Economic history
    Date: 2007
  15. By: Wickens, Michael R
    Abstract: It is widely recognised that the "one-size-fits-all" monetary policy of the euro-zone is a potential problem. How much of a problem has not been much investigated. It is argued in this paper that it may result in the euro not being sustainable in the longer term without drastic changes to other aspects of the EU and, in particular, to fiscal policy. The problem is not the fault of the ECB, but is due to having a single nominal interest rate. As a result, the evidence reveals that national price levels are diverging over time which is leading to a permanent and unsustainable loss of competitiveness. A formal theory of inflation in the euro-zone based on an open-economy version of the New Keynesian model is used to analyse the problem. Although the euro system has automatic stabilising mechanisms arising from the changes in competitiveness and from absorbtion effects, these are shown to be not strong enough. The model is then modified to allow for fiscal transfers between countries and the size of the transfers required to produce a euro that may be sustainable are derived. It is shown that, in effect, this is an inflation tax, requiring high inflation countries to make transfers to low inflation countries as often happens within a single country in the form of unemployed benefits to low activity regions. Ultimately, the choice may lie between closer political union and a break-up of the euro-zone.
    Keywords: ECB; euro; inflation; monetary policy
    JEL: E5 E6
    Date: 2007–06
  16. By: Andreas Billmeier; Daehaeng Kim; Era Dabla-Norris; V. Kramarenko; Mayra Rebecca Zermeno Livas
    Abstract: This paper reviews the current monetary and exchange rate policy frameworks in Armenia and Georgia, and the challenges associated with the choice of a credible nominal anchor in the context of large nominal and real shocks. The paper makes a case for a gradual transition to full-fledged inflation targeting (FFIT) in both countries in the medium term. The implications of this option are examined from various angles. In particular, the monetary transmission mechanisms and compliance with major institutional prerequisites for successful FFIT adoption are analyzed. Based on this analysis, the paper identifies a series of short- and medium-term recommendations, drawing on the experience of emerging market countries that successfully moved to FFIT.
    Date: 2007–06–12
  17. By: DRAMANI, Latif; LAYE, Oumy
    Abstract: • Problem Statement The framework of this study is consisted of the countries of zone CFA and in fact the two central banks (BCEAO and BEAC) in charge of the monetary policy implementation. There was a great resurgence of interest these last years on the question in the way of leading the monetary policy. One of the indicators of this phenomenon is the enormous volume of recent papers and the conferences prepared on this subject. In addition, much of macro economists proposed specific rules of policy or ruled on the way in which the monetary policy should be led. The principal objective of this study is the evaluation of the macroeconomic gold rule in the CFA countries which stipulates that in an economy with equilibrium growth and under simplifying macroeconomic assumptions: the neutral interest rate is equal to the potential growth rate of the economy. • Research Method To achieve this objective we try to determine the weight of the goals of monetary and fiscal policies attaches with a quadratic reaction function which takes into account a target of inflation, public expenditure and interest rate. And then the methodology of determination of the neutral interest rate is derived from a generalized Taylor rule. The estimation of the parameters is based on panel data econometrics, the generalized method of moments and the Kalman filter. These different methods are used to emphasize the robustness of the results of our analysis. • Results and conclusion The estimates carried out on the panel data emphasize a neutral interest rate in the interval of 1.4% to 1.6%. It is generally noticed that the estimates made on the panel data are compatible with those carried out by using the Kalman filter. In addition, it is observed that, overall the level of the natural interest rate in UEMOA zone (1.51) is lower than CEMAC zone (1.65). The most important neutral rate is observed in the Malian economy and the lowest in the Burkina economy. But we notice a larger homogeneity in CEMAC zone (standard deviation of 0.12) than UEMOA zone ( standard deviation of 0.29).
    Keywords: Taylor Rule; equilibrium interest rate; Kalman filter
    JEL: C1 C13 E4 E43 E0
    Date: 2007–06–18
  18. By: Jesus Crespo Cuaresma; Tomas Slacik
    Abstract: We propose exploiting the term structure of relative interest rates to obtain estimates of changes in the timing of a currency crisis as perceived by market participants. Our indicator can be used to evaluate the relative probability of a crisis occurring in one week as compared to a crisis happening after one week but in less than a month. We give empirical evidence that the indicator performs well for two important currency crises in Eastern Europe: the crisis in the Czech Republic in 1997 and the Russian crisis in 1998.
    Keywords: Currency crisis, term structure of interest rates, transition economies.
    JEL: F31 F34 E43
    Date: 2007–06

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