nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒06‒30
twenty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Optimal Monetary Policy Under Inflation Targeting: Is Zero the Optimal Perception of Inflation Inertia? By Páez-Farrell, Juan
  2. Gold Prices and Inflation By Greg Tkacz
  3. Cross-Country Estimates of the Degree of Fiscal Dominance and Central Bank Independence By Carlos de Resende
  4. Inflation Dynamics in Latin America By Carlos Capistrán; Manuel Ramos Francia
  5. Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious? By Carlos Capistrán
  6. Uncertainty about the Persistence of Cost-Push Shocks and the Optimal Reaction of the Monetary Authority. By Arnulfo Rodríguez; Fidel González; Jesús R. González García
  7. Long-Run Inflation-Unemployment Dynamics: The Spanish Phillips Curve and Economic Policy By Marika Karanassou; Hector Sala; Dennis Snower
  8. Productivity Growth, Transparency, and Monetary Policy By Ichiro Muto
  9. Recursive Thick Modeling and the Choice of Monetary Policy in Mexico. By Arnulfo Rodríguez; Pedro N. Rodríguez
  10. Time Series Approach to Test a Change in Inflation Persistence: The Mexican Experience. By Manuel Ramos Francia; Daniel Chiquiar; Antonio E. Noriega
  11. Liquidity Traps, Learning and Stagnation By Evans, George W; Guse, Eran; Honkapohja, Seppo
  12. Karl Brunner il monetarista By Michele FRATIANNI
  13. Is the Euro Sustainable? By Mike Wickens
  14. Optimising Indexation Arrangements under Calvo Contracts and their Implications for Monetary Policy By Le, Vo Phuong Mai; Minford, Patrick
  15. The yield spread and GDP growth - Time Varying Leading Properties and the Role of Monetary Policy By Hogrefe, Jens
  16. The monetary transmission mechanism in Turkey : New developments By Erdem Basci; Ozgur Ozel; Cagri Sarikaya
  17. Monetary Policy and Swedish Unemployment Fluctuations By Alexius, Annika; Holmlund, Bertil
  18. Disagreement and Biases in Inflation Expectations By Carlos Capistrán; Allan Timmermann
  19. Inflation Dynamics and Trade Openness By Aron, Janine; Muellbauer, John
  20. Inflation Dynamics in Mexico: A Characterization Using the New Phillips Curve By Manuel Ramos Francia; Alberto Torres García
  21. Capital Controls and Foreign Investor Subsidies Implicit in South Africa's Dual Exchange Rate System By Huizinga, Harry; Schaling, Eric; van der Windt, Peter C
  22. Interest Rate Pass-Through in Turkey By Halil Ibrahim Aydin

  1. By: Páez-Farrell, Juan (Cardiff Business School)
    Abstract: Recent research has suggested that in deriving optimal policy under discretion, policymakers should react as if there were no structural inflation persistence in order to improve welfare. This paper considers whether such a strong result extends to an inflation targeting central bank with a more general Phillips curve formulation. The findings indicate that if anything, a central banker that assumes a high degree of inflation inertia is often preferable.
    Keywords: optimal monetary policy; discretion; uncertainty; inflation persistence
    JEL: E31 E52 E61 E63
    Date: 2007–06
  2. By: Greg Tkacz
    Abstract: Using data for 14 countries over the 1994 to 2005 period, we assess the leading indicator properties of gold at horizons ranging from 6 to 24 months. We find that gold contains significant information for future inflation for several countries, especially for those that have adopted formal inflation targets. This finding may arise from the manner in which inflation expectations are formed in these countries, which may result in more rapidly mean-reverting inflation rates. Compared to other inflation indicators for Canada, gold remains statistically significant when combined with variables such as the output gap or the growth rate of a broad monetary aggregate.
    Keywords: Inflation and prices; Exchange rates
    JEL: E31 E44
    Date: 2007
  3. By: Carlos de Resende
    Abstract: This paper studies the interdependence between fiscal and monetary policies, and their joint role in the determination of the price level ...
    Keywords: Central bank research; Fiscal policy; Inflation: costs and benefits
    JEL: E31 E42 E50 E63
    Date: 2007
  4. By: Carlos Capistrán; Manuel Ramos Francia
    Abstract: We analyze inflation's persistence in the 1980-2006 period for the ten largest Latin American economies using univariate time-series techniques. Although the estimated degree of inflation persistence appears to be different across countries, for the region as a whole the persistence seems to be very high. However, the estimated degree of persistence falls in all countries once we permit structural breaks in the mean of inflation. The timing of these breaks coincides with shifts in the monetary policy regimes and is similar across countries. Regardless of the changes in the mean, the degree of persistence appears to be decreasing in the region, even though for some countries persistence does not seem to be changing.
    Keywords: Inflation, Inflation Persistence, Latin America, Monetary Policy, Multiple Breaks, Time Series
    JEL: E31 E42 C22
    Date: 2006–11
  5. By: Carlos Capistrán
    Abstract: Inflation forecasts of the Federal Reserve seem to have systematically under-predicted inflation from the fourth quarter of 1968 until Volcker's appointment as Chairman, and to systematically over-predict it afterwards until the second quarter of 1998. Furthermore, under quadratic loss, commercial forecasts seem to have information not contained in those forecasts. To investigate the cause of this apparent irrationality, this paper recovers the loss function implied by Federal Reserve's inflation forecasts. The results suggest that the cost of having inflation above an implicit time-varying target was larger than the cost of having inflation below it for the period since Volcker, and that the opposite was true for the pre-Volcker era. Once these asymmetries are taken into account, the Federal Reserve's inflation forecasts are found to be rational.
    Keywords: Inflation forecasts, Forecast evaluation, Monetary policy
    JEL: C53 E52
    Date: 2006–12
  6. By: Arnulfo Rodríguez; Fidel González; Jesús R. González García
    Abstract: In this paper we formalize the uncertainty about the persistence of cost-push shocks using an open economy optimal control model with Markov regime-switching and robust control. The latter is used in only one of the regimes producing relatively more persistent cost-push shocks in that regime. Conditional on being in the regime with relatively less persistence, we obtain two main results: a) underestimating the probability of switching to the regime with relatively more persistent cost-push shocks causes higher welfare losses than its overestimation; and b) the welfare losses associated with either underestimation or overestimation of such probability increase with the size of the penalty on inflation deviations from its target. Keywords: Model uncertainty, Robustness, Markov regime-switching, Monetary policy, Inflation targeting.
    Keywords: Model uncertainty, Robustness, Markov regime-switching, Monetary policy, Inflation targeting
    JEL: C61 E61
    Date: 2007–03
  7. By: Marika Karanassou; Hector Sala; Dennis Snower
    Abstract: This paper takes a new look at the long-run dynamics of inflation and unemployment in response to permanent changes in the growth rate of the money supply. We examine the Phillips curve from the perspective of what we call “frictional growth,” i.e. the interaction between money growth and nominal frictions. After presenting a theoretical model of this phenomenon, we construct an empirical model of the Spanish economy and, in this context, we evaluate the long-run inflation-unemployment tradeoff for Spain and examine how recent policy changes have affected it.
    Keywords: Inflation-unemployment tradeoff, Phillips curve, staggered wage contracts, nominal inertia, forward-looking expectations, monetary policy
    JEL: E2 E3 E4 E5 J3
    Date: 2007–06
  8. By: Ichiro Muto (Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: In this study, we investigate how central bank transparency about views on future productivity growth influences social welfare. To this end, we use a New Keynesian framework in which both the central bank and private agents are engaged in filtering problems regarding the persistence of productivity growth. Since the central bank and private agents do not know the true value of the signal-to-noise ratio, the gain parameters used in the filtering problems can be heterogeneous. If the central bank is not transparent, private agents must conjecture the central bank's estimate of the efficient level of the real interest rate. Under this setup, we show that central bank transparency does not necessarily improve social welfare. It can potentially yield a welfare loss, depending on (i) the gain parameters used by the central bank and private agents and (ii) private agents' conjecture on the gain parameter used by the central bank. If the central bank is uncertain about the combination of these gain parameters, it is sensible for the central bank to respond strongly to the variations of the inflation rate, because the misperceptions about these parameters become the source of demand shock.
    Keywords: New Keynesian Model, Monetary Policy, Transparency, Productivity Growth, Learning
    JEL: E52
    Date: 2007–06
  9. By: Arnulfo Rodríguez; Pedro N. Rodríguez
    Abstract: The choice of monetary policy is the most important concern of central banks. However, this choice is always confronted, inter alia, with two relevant aspects of economic policy: parameter instability and model uncertainty. This paper deals with both types of uncertainty using a very specific class of models in an optimal control framework. For optimal policy rates series featuring the first two moments similar to those of the actual nominal interest rates in Mexico, we show that recursive thick modeling gives a better approximation than recursive thin modeling. We complement previous work by evaluating the usefulness of both recursive thick modeling and recursive thin modeling in terms of direction-of-change forecastability.
    Keywords: Macroeconomic policy, Model uncertainty, Optimal control, Monetary policy, Inflation targeting
    JEL: C61 E61
    Date: 2007–03
  10. By: Manuel Ramos Francia; Daniel Chiquiar; Antonio E. Noriega
    Abstract: When monetary policy has an explicit inflation target, observed inflation should be a stationary process. In countries where, for a variety of reasons, the determinants of inflation could lead it to follow a non-stationary process, the adoption of an inflation targeting framework should therefore induce a fundamental change in the stochastic process governing inflation. This paper studies the time series properties of Mexican inflation during 1995-2006, using recently developed techniques to detect a change in the persistence of economic time series. Consistent with the adoption of an inflation-targeting framework, the results suggest that inflation in Mexico seems to have switched from a nonstationary to a stationary process around the end of year 2000 or the beginning of 2001.
    Keywords: Inflation, Persistence change, Stationarity, Unit root tests, Unknown direction of change
    JEL: C12 C22 E31 E52 E58
    Date: 2007–01
  11. By: Evans, George W; Guse, Eran; Honkapohja, Seppo
    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; fiscal policy; indeterminacy; monetary policy; zero interest rate lower bound
    JEL: E52 E58 E63
    Date: 2007–06
  12. By: Michele FRATIANNI (Indiana University, Graduate School of Business Bloomington)
    Abstract: Karl Brunner (1916-1989) was, with Milton Friedman and Allan Meltzer, the leader of the monetarist revolution of the Sixties and the Seventies. His work on asset markets placed the credit market, along with the money market, at center stage and focused on monetary policy as a primary source of instability. With Allan Meltzer he challenged the validity of the Keynesian paradigm and proposed an alternative model of the economy where the transmission of monetary impulses to the economy did not depend exclusively on the interest sensitivity of the demand for money but on the relative interest elasticities of the asset markets as well on variations in wealth. An unexpected feature of the alternative model is that fiscal policy determines the price level. Brunner had a strong foundation in methodology and was an adherent of the empirical philosophy school. In addition to asset markets and macroeconomics, Krunner wrote extensively on the nature of man, the role of markets and institutions. Finally, Brunner launched and managed the Journal of Money, Credit and Banking , the Journal of Monetary Economics, the Konstanzer Seminar on Monetary Theory and Monetary Policy, the Interlaken Conference on Analysis and Ideology, the Carnegie-Rochester Conference Series on Public Policy, and the Shadow Open Market Committee (the last two with Allan Meltzer).
    Keywords: IS-LM model, credit market, monetarism, money supply
    JEL: B22 B31 E44 E51 E58
    Date: 2007–06
  13. By: Mike Wickens
    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 in.ation 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: euro, ECB, monetary policy, inflation
    JEL: E5 E6
    Date: 2007–06
  14. By: Le, Vo Phuong Mai; Minford, Patrick
    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: Calvo contracts; inflation target; New Keynesian model; optimal indexation; price-level target; rational expectation
    JEL: E50 E52
    Date: 2007–06
  15. By: Hogrefe, Jens
    Abstract: The yield spread is a well documented leading indicator of GDP growth. Estrella (2005) proposes a model to explain this relationship. Within the model, the leading properties of the yield spread are determined by the monetary policy. Accordingly, changes of the leading properties that have been reported in many studies should correspond to changes of the monetary policy. This paper analyzes whether and what form of time variation of the leading properties can be found in four major industrialized countries (France, Germany, the UK and the US). The results are connected with time varying behavior of the monetary policy by modeling a joint state dependency of the leading properties and the reaction parameters of the monetary policy. Time variation of the leading properties seem to exist in all countries under consideration. For the US and Germany they are best modeled as a structural break while France and the UK exhibit recurring phases. Evidence for a link between the time variations of the monetary policy and the leading properties can be found. However, a clear determination of the leading properties by the monetary policy cannot be confirmed.
    Keywords: leading indicator, yield spread, GDP growth, monetary policy, Markov-Switching
    JEL: C32 E37 E43 E52
    Date: 2007
  16. By: Erdem Basci; Ozgur Ozel; Cagri Sarikaya
    Date: 2007
  17. By: Alexius, Annika (Department of Economics); Holmlund, Bertil (Department of Economics)
    Abstract: A widely spread belief among economists is that monetary policy has relatively short-lived effects on real variables such as unemployment. Previous studies indicate that monetary policy affects the output gap only at business cycle frequencies, but the effects on unemployment may well be more persistent in countries with highly regulated labor markets. We study the Swedish experience of unemployment and monetary policy. Using a structural VAR we find that around 30 percent of the fluctuations in unemployment are caused by shocks to monetary policy. The effects are also quite persistent. In the preferred model, almost 30 percent of the maximum effect of a shock still remains after ten years.
    Keywords: Unemployment; Monetary policy; structural VARs
    JEL: E24 J60
    Date: 2007–06–18
  18. By: Carlos Capistrán; Allan Timmermann
    Abstract: Recent empirical work documents substantial disagreement in inflation expectations obtained from survey data. Furthermore, the extent of such disagreement varies systematically over time in a way that reflects the level and variance of current inflation. This paper offers a simple explanation for these facts based on asymmetries in the forecaster's costs of over- and under-predicting inflation. Our model implies biased forecasts with positive serial correlation in forecast errors and a cross-sectional dispersion that rises with the level and the variance of the inflation rate. It also implies that biases in forecaster's ranks should be preserved over time and that forecast errors at different horizons can be predicted through the spread between the short- and long-term variance of inflation. We find empirically that these patterns are present in inflation forecasts from the Survey of Professional Forecasters.
    Keywords: Inflation, Expectations, Forecasting, Asymmetric loss, Inflation dynamics
    JEL: C53 E31 E37
    Date: 2006–06
  19. By: Aron, Janine; Muellbauer, John
    Abstract: It is difficult to obtain reliable measures of evolving openness to trade, despite its relevance to models of growth, inflation and exchange rates. Our innovative technique measures trade openness encompassing both observable trade policy (tariffs and surcharges) and unobservable trade policy (quotas and other non-tariff barriers), and such factors as capital controls, sanctions and dual exchange rates (often used in composite trade measures). The share of manufactured imports in home demand for manufactured goods is estimated in STAMP (Koopman et al., 2000) using measured trade policy and controlling for fluctuations in domestic demand, relative prices of imports and the exchange rate. The unmeasured trade policy component is captured by a smooth non-linear stochastic trend. The two elements of openness, the stochastic trend and the rates of tariffs and surcharges, are included in a model of wholesale price inflation in South Africa. The evidence suggests that increased openness has significantly reduced the mean inflation rate and has reduced the exchange rate pass-through into wholesale prices.
    Keywords: inflation dynamics; modelling inflation; trade openness
    JEL: C22 E31 F13 F41
    Date: 2007–06
  20. By: Manuel Ramos Francia; Alberto Torres García
    Abstract: The paper describes the dynamics of inflation in the Mexican economy from 1992 to 2006 using the New Phillips curve framework. The purpose is to identify key structural characteristics of the economy (structural parameters) that define the short-run dynamics of inflation. Results show that despite a previous history of high inflation, a hybrid version of the New Phillips curve fits the data well for the period 1992-2006. The short-run dynamics of inflation in Mexico are best described when both backward and forward looking components are considered. In addition, estimates for the sub-sample 1997-2006 show that as inflation has fallen, on average, prices remain fixed for a longer horizon, the fraction of firms that use a backward looking rule of thumb to set their price decreases and the forward looking component of the inflation process gains importance.
    Keywords: Inflation dynamics, Phillips Curve
    JEL: E31
    Date: 2006–12
  21. By: Huizinga, Harry; Schaling, Eric; van der Windt, Peter C
    Abstract: Both in theory and practice, capital controls and dual exchange rate systems can be part of a country's optimal tax policy. We first show how a dual exchange rate system can be interpreted as a tax (or subsidy) on international capital income. We show that a dual exchange rate system, with separate commercial and financial exchange rates, drives a wedge between the domestic and foreign returns on comparable assets. As a borrower, the government itself is a direct beneficiary. Secondly, based on data from South Africa, we present empirical evidence of this revenue implicit in a dual exchange rate system; a revenue that amounted to as much as 0.1 percent of GDP for the South African government. However, this paper also shows that both the capital controls and the dual exchange rate system in South Africa gave rise to many perverse unanticipated effects. The latter may render capital controls and dual exchange rate systems unattractive in the end and, thereby, provides a rationale for the recent trend in exchange rate liberalization and unification.
    Keywords: capital controls; Dual exchange rate systems; financial repression
    JEL: H21
    Date: 2007–06
  22. By: Halil Ibrahim Aydin
    Date: 2007

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