nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒07‒07
thirty-six papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Inflation targeting and optimal control theory By Veloso, Thiago; Meurer, Roberto; Da Silva, Sergio
  2. When Inflation Persistence Really Matters: Two examples By Tatiana Kirsanova; David Vines; Simon Wren-Lewis
  3. Macroeconomic Modeling for Monetary Policy Evaluation By Jordi Galí; Mark Gertler
  4. Money demand in post-crisis Russia: De-dollarisation and re-monetisation By Korhonen, Iikka; Mehrotra, Aaron
  5. Expanding Decent Employment in Kenya: The Role of Monetary Policy, Inflation Control, and the Exchange Rate By Robert Pollin; James Heintz
  6. Trend Inflation, Taylor Principle and Indeterminacy By Guido Ascari; Tiziano Ropele
  7. Robust monetary policy with imperfect knowledge By Athanasios Orphanides; John C. Williams
  8. Seigniorage By Willem Buiter
  9. Expectation Effects of Regimes Shifts in Monetary Policy By Zheng Liu; Daniel F. Waggoner; Tao Zha
  10. Liquidity Traps, Learning and Stagnation By George Evans; Eran Guse; Seppo Honkapohja
  11. Banking and Interest Rates in Monetary Policy Analysis: A Quantitative Exploration By Marvin Goodfriend; Bennett T. McCallum
  12. Explaining monetary policy in press conferences By Michael Ehrmann; Marcel Fratzscher
  13. Changes in the Balance of Power Between the Wage and Price Setters and the Central Bank: Consequences for the Phillips Curve and the NAIRU By Jürgen Kromphardt; Camille Logeay
  14. Inflation and Unemployment: Lagos-Wright meets Mortensen-Pissarides By Aleksander Berentsen; Guido Menzio; Randall Wright
  15. Strategic Complementarities and Optimal Monetary Policy By Andrew T. Levin; J. David Lopez-Salido; Tack Yun
  16. Does High Inflation Cause Central Bankers to Lose Their Job? Evidence Based on a New Data Set By Axel Dreher; Jan-Egbert Sturm; JAkob de Haan
  17. Monetary Policy and Financial Sector Reform for Employment Creation and Poverty Reduction in Ghana By Gerald Epstein; James Heintz
  18. Strategic monetary policy in a monetary union with non-atomistic wage setters By Cuciniello, Vincenzo
  19. Flattening of the Short-run Trade-off between Inflation and Domestic Activity: The Analytics of the Effects of Globalization By Assaf Razin; Alon Binyamini
  20. Policy rate decisions and unbiased parameter estimation in typical monetary policy rules By Jiri Podpiera
  21. Monetary Policy and Business Cycles with Endogenous Entry and Product Variety By Florin O. Bilbiie; Fabio Ghironi; Marc J. Melitz
  22. Inflation Persistence and the Philips Curve Revisited By Marika Karanassou; Dennis Snower
  23. Inflation Expectations, the Phillips Curve and Monetary Policy By Fabien Curto Millet
  24. Learning, Sticky Inflation, and the Sacrifice Ratio By John M. Roberts
  25. Endogenous Indexing and Monetary Policy Models By Richard Mash
  26. Hyperinflation, disinflation, deflation, etc.: A unified and micro-founded explanation for inflation By Harashima, Taiji
  27. The Butterfly Effect of Small Open Economies By Jarkko Jääskelä; Mariano Kulish
  28. Monetary Policy and Swedish Unemployment Fluctuations By Annika Alexius; Bertil Holmlund
  29. Distance to Frontier and the Big Swings of the Unemployment Rate: What Room is Left for Monetary Policy? By Hian Teck Hoon; Kong Weng Ho
  30. Monetary Policy Transmission and the Phillips Curve in a Global Context By Ron Smith; M. Hashem Pesaran
  31. Linear-quadratic approximation, external habit and targeting rules By Paul Levine; Joseph Pearlman; Richard Pierse
  32. Real wages and monetary policy transmission in the euro area By Andrew McCallum; Frank Smets
  33. Monetary System. Functional and Institutional Structure By Popa, Catalin C.
  34. Measuring changes in the value of the numeraire By Ricardo Reis; Mark W. Watson
  35. Price setting during low and high inflation: evidence from Mexico By Etienne Gagnon
  36. Global Inflation By Matteo Ciccarelli; Benoît Mojon

  1. By: Veloso, Thiago; Meurer, Roberto; Da Silva, Sergio
    Abstract: We make a case for the usefulness of an optimal control approach for the central banks’ choice of interest rates in inflation target regimes. We illustrate with data from selected developed and emerging countries with longest experience of inflation targeting.
    Keywords: inflation targeting; optimal control theory; Taylor rule; monetary policy
    JEL: E52 C61
    Date: 2007–07–04
  2. By: Tatiana Kirsanova; David Vines; Simon Wren-Lewis
    Abstract: In this paper we present two examples where the presence of inflation persistence could influence the qualitative nature of monetary policy. In the first case the desirability of a monetary policy regime comes under question when extensive inflation persistence exists. In the second case the direction in which interest rates move following a cost push shock changes when inflation persistence becomes important. In both cases, inflation persistence is central to the process influencing policy.
    Keywords: Inflation Persistence, Macroeconomic Stabilisation
    JEL: E52 E61 E63
    Date: 2007–06
  3. By: Jordi Galí; Mark Gertler
    Abstract: We describe some of the main features of the recent vintage macroeconomic models used for monetary policy evaluation. We point to some of the key differences with respect to the earlier generation of macro models, and highlight the insights for policy that these new frameworks have to offer. Our discussion emphasizes two key aspects of the new models: the significant role of expectations of future policy actions in the monetary transmission mechanism, and the importance for the central bank of tracking of the flexible price equilibrium values of the natural levels of output and the real interest rate. We argue that both features have important implications for the conduct of monetary policy.
    Keywords: Monetary policy, new Keynesian model, expectations management, inflation targeting
    JEL: E32
    Date: 2007–06
  4. By: Korhonen, Iikka (BOFIT); Mehrotra, Aaron (BOFIT)
    Abstract: Estimating money demand functions for Russia following the 1998 crisis, we find a stable money demand relationship when augmented by a deterministic trend signifying falling velocity. As predicted by theory, higher income boosts demand for real rouble balances and the income elasticity of money is close to unity. Inflation affects the adjustment towards equilibrium, while broad money shocks lead to higher inflation. We also show that exchange rate fluctuations have a considerable influence on Russian money demand. The results indicate that Russian monetary authorities have been correct in using the money stock as an information variable and that the strong influence of exchange rate on money demand is likely to continue despite de-dollarisation of the Russian economy.
    Keywords: money demand; vector error correction models; dollarisation; Russia
    JEL: E31 E41 E51 P22
    Date: 2007–06–29
  5. By: Robert Pollin (Univ. of Massachusetts); James Heintz (Univ. of Massachusetts)
    Abstract: This IPC Country Study by Robert Pollin and James Heintz examines three policy areas related to monetary policies in Kenya: inflation dynamics and the relationship between inflation and long-run growth; monetary policy targets and instruments; and exchange rate dynamics and the country?s external balance. It concludes with five main policy recommendations
    Keywords: Poverty, Inflation Control, Exchange Rate
    JEL: H21 O23 O17 F23
    Date: 2007–03
  6. By: Guido Ascari; Tiziano Ropele
    Abstract: We show that low trend inflation strongly affects the dynamics of a standard Neo-Keynesian model where monetary policy is described by a standard Taylor rule. Moreover, trend inflation enlarges the indeterminacy region in the parameter space, substantially altering the so-called Taylor principle. The main results hold for di¤erent types of Taylor rules, inertial policy rules and indexation schemes. The key message is that, whatever the set up, the literature on Taylor rules cannot disregard average inflation in both theoretical and empirical analysis.
    Keywords: Sticky Prices, Taylor Rules and Trend Inflation
    JEL: E31 E52
    Date: 2007–06
  7. By: Athanasios Orphanides (Central Bank of Cyprus, 80, Kennedy Avenue, 1076 Nicosia, Cyprus.); John C. Williams (Federal Reserve Bank of San Francisco, 101 Market Street, San Francisco, CA 94105, USA.)
    Abstract: We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess imperfect knowledge about the true structure of the economy. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize fluctuations of unemployment around its natural rate but are uncertain about the economy’s natural rates of interest and unemployment and how private agents form expectations. In particular, we consider two models of expectations formation - rational expectations and learning. We show that in this environment the ability to stabilize the real side of the economy is significantly reduced relative to an economy under rational expectations with perfect knowledge. Furthermore, policies that would be optimal under perfect knowledge can perform very poorly if knowledge is imperfect. Efficient policies that take account of private learning and misperceptions of natural rates call for greater policy inertia, a more aggressive response to inflation, and a smaller response to the perceived unemployment gap than would be optimal if everyone had perfect knowledge of the economy. We show that such policies are quite robust to potential misspecification of private sector learning and the magnitude of variation in natural rates. JEL Classification: E52.
    Keywords: Monetary policy, natural rate misperceptions, rational expectations, learning.
    Date: 2007–06
  8. By: Willem Buiter
    Abstract: In this paper I analyse four different but related concepts, each of which highlights someaspect of the way in which the state acquires command over real resources through its ability to issue fiat money. They are (1) seigniorage (the change in the monetary base), (2) Central Bank revenue (the interest bill saved by the authorities on the outstanding stock of base money liabilities), (3) theinflation tax (the reduction in the real value of the stock of base money due to inflation and (4) the operating profits of the central bank, or the taxes paid by the Central Bank to the Treasury.To understand the relationship between these four concepts, an explicitly intertemporalapproach is required, which focuses on the present discounted value of the current and future resource transfers between the private sector and the state. Furthermore, when the Central Bank is operationally independent, it is essential to decompose the familiar consolidated 'government budget constraint' and consolidated 'government intertemporal budget constraint' into the separate accountsand budget constraints of the Central Bank and the Treasury. Only by doing this can we appreciate the financial constraints on the Central Bank's ability to pursue and achieve an inflation target, and theimportance of cooperation and coordination between the Treasury and the Central Bank when facedwith financial sector crises involving the need for long-term recapitalisation or when confronted with the need to mimic Milton Friedman's helicopter drop of money in an economy faced with a liquidity trap.
    Keywords: inflation tax, central bank budget constraint, coordination of monetary and fiscal policy
    JEL: E4 E5 E6 H6
    Date: 2007–04
  9. By: Zheng Liu; Daniel F. Waggoner; Tao Zha
    Abstract: We assess the quantitative importance of expectation effects of regime shifts in monetary policy in a DSGE model that allows the monetary policy rule to switch between a “bad” regime and a ”good” regime. When agents take into account such regime shifts in forming expectations, the expectation effect is asymmetric. In the good regime, the expectation effect is small despite agents’ disbelief that the regime will last forever. In the bad regime, however, the expectation effect on equilibrium dynamics of inflation and output is quantitatively important, even if agents put a small probability that monetary policy will switch to the good regime. Although the expectation effect dampens aggregate fluctuations in the bad regime, a switch from the bad regime to the good regime can still substantially reduce the volatility of both inflation and output, provided that we allow some “reduced-form” parameters in the private sector to change with monetary policy regime.
    Date: 2007–06
  10. By: George Evans; Eran Guse; Seppo Honkapohja
    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
  11. By: Marvin Goodfriend; Bennett T. McCallum
    Abstract: The paper reconsiders the role of money and banking in monetary policy analysis by including a banking sector and money in an optimizing model otherwise of a standard type. The model is implemented quantitatively, with a calibration based on U.S. data. It is reasonably successful in providing an endogenous explanation for substantial steady-state differentials between the interbank policy rate and (i) the collateralized loan rate, (ii) the uncollateralized loan rate, (iii) the T-bill rate, (iv) the net marginal product of capital, and (v) a pure intertemporal rate. We find a differential of over 3 % pa between (iii) and (iv), thereby contributing to resolution of the equity premium puzzle. Dynamic impulse response functions imply pro-or-counter-cyclical movements in an external finance premium that can be of quantitative significance. In addition, they suggest that a central bank that fails to recognize the distinction between interbank and other short rates could miss its appropriate settings by as much as 4% pa. Also, shocks to banking productivity or collateral effectiveness call for large responses in the policy rate.
    JEL: E44 E52 G21
    Date: 2007–06
  12. By: Michael Ehrmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The question how best to communicate monetary policy decisions remains a highly topical issue among central banks. Focusing on the experience of the European Central Bank, this paper studies how explanations of monetary policy decisions at press conferences are perceived by financial markets. The empirical findings show that ECB press conferences provide substantial additional information to financial markets beyond that contained in the monetary policy decisions, and that the information content is closely linked to the characteristics of the decisions. Press conferences indeed have on average had larger effects on financial markets than even the corresponding policy decisions, and with lower effects on volatility. Moreover, the Q&A part of the press conference fulfils a clarification role about the economic outlook, in particular during periods of large macroeconomic uncertainty. JEL Classification: E52, E58, G14.
    Keywords: Monetary policy; financial markets; real-time analysis; press conference; communication; European Central Bank.
    Date: 2007–06
  13. By: Jürgen Kromphardt; Camille Logeay
    Abstract: In this paper we introduce and test the hypothesis that the relation between inflation and unemployment has been in many countries subject to a significant change in the early 1990's after the disinflation period. That period began between 1975 and 1980 after the first (or the second) oil price shock in autumn 1973. During the disin°ation period, inflation and unemployment were the result of the struggle between the wage and price setters trying to influence the distribution of income to their favour and the Central Bank fighting against inflation. Since the wage and price setters did not fully believe in an \unconditional" pursuit of the anti-inflationary policy, the result was a gradual decline of the inflation rate rendered possible by a rising rate of unemployment. Our hypothesis was inspired by the observation that the statistical Phillips curves are now rather flat in many countries. If such horizontal Phillips curves will also result when they are estimated taking into account the most important other factors influencing the inflation rate (mainly supply shocks) they may be explained by the hypothesis that during the 1990's, wage and price setters finally accepted the new rigour of the monetary policy and tried no more (nor had the market power { due to increasing globalisation and international competition) to pursue a policy which raises the inflation rate significantly above the target inflation rate of the Central Bank. In that case a "break" in the parameters of the Phillips-Curve should be observed. We use econometric methods to test whether the presumed \break" in the re- lation between inflation and unemployment can be shown to exist. We restrict our study to the four largest countries of the Euro area (Germany, France, Italy and Spain), the UK and the USA. The result are very di®erent for the countries; therefore we intend in a further step to detect the reasons for there divergences.
    Keywords: Phillips curve, unemployment, inflation, wage and price setting, Central Bank, structural break
    JEL: E10 E50 C22 C32
    Date: 2007–06
  14. By: Aleksander Berentsen; Guido Menzio; Randall Wright
    Abstract: Inflation and unemployment are central issues in macroeconomics. While progress has been made on these issues recently using models that explicitly incorporate search-type frictions, existing models analyze either unemployment or inflation in isolation. We develop a framework to analyze unemployment and inflation together. This makes contributions to disparate literatures, and provides a unified model for theory, policy, and quantitative analysis. We discuss optimal fiscal and monetary policy. We calibrate the model, and discuss the extent to which it can account for salient aspects of a half century’s experience with inflation, unemployment, interest rates, and velocity. Depending on some details concerning how one calibrations certain parameters, the model can do a good job matching the data.
    Date: 2007–06
  15. By: Andrew T. Levin; J. David Lopez-Salido; Tack Yun
    Abstract: In this paper, we show that strategic complementarities–such as firm-specific factors or quasikinked demand–have crucial implications for the design of monetary policy and for the welfare costs of output and inflation variability. Recent research has mainly used log-linear approximations to analyze the role of these mechanisms in amplifying the real effects of monetary shocks. In contrast, our analysis explicitly considers the nonlinear properties of these mechanisms that are relevant for characterizing the deterministic steady state as well as the second-order approximation of social welfare in the stochastic economy. We demonstrate that firm-specific factors and quasi-kinked demand curves yield markedly different implications for the welfare costs of steady-state inflation and inflation volatility, and we show that these considerations have dramatic consequences in assessing the relative price distortions associated with the Great Inflation of 1965-1979.
    Keywords: firm-specific factors, quasi-kinked demand, welfare analysis
    JEL: E31 E32 E52
    Date: 2007–06
  16. By: Axel Dreher (Department of Management, Technology, and Economics, ETH Zurich); Jan-Egbert Sturm (Department of Management, Technology, and Economics, ETH Zurich); JAkob de Haan (University of Groningen, The Netherlands and CESifo, Munich, Germany,)
    Abstract: This paper introduces new data on the term in office of central bank governors in 137 countries for 1970-2004. Our panel models show that the probability that a central bank governor is replaced in a particular year is positively related to the share of the term in office elapsed, political and regime instability, the occurrence of elections, and inflation. The latter result suggests that the turnover rate of central bank governors (TOR) is a poor indicator of central bank independence. This is confirmed in models for cross-section inflation in which TOR becomes insignificant once its endogeneity is taken into account.
    Keywords: central bank governors, central bank independence, inflation
    JEL: E5
    Date: 2007–06
  17. By: Gerald Epstein (Univ. of Massachusetts); James Heintz (Univ. of Massachusetts)
    Abstract: .
    Keywords: Monetary Policy Financial Sector; Reform; Ghana
    Date: 2006–06
  18. By: Cuciniello, Vincenzo
    Abstract: In a micro-founded framework in line with the new open economy macroeconomics, the paper shows that more centralized wage setting (CWS) and central bank conservatism (CBC) curb unemployment only if labor market distortions are sizeable. When labor market distortions are sufficiently low, employment may be maximized by atomistic wage setters or a populist CB. The comparison between a national monetary policy (NMP) regime and the monetary union (MU) reveals that a move to a MU boosts inflation in the absence of strategic effects. However, when strategic interactions between CB(s) and trade unions are taken into account, the shift to a MU when monopoly distortions are sizeable unambiguously increases welfare and employment either in presence of a sufficiently conservative CB or with a fully CWS. Finally, when labor market distortions are less relevant, an ultra-populist CB or atomistic wage setters are optimal for the society and a shift to a MU regime is unambiguously welfare improving.
    Keywords: Central bank conservatism; centralization of wage setting; inflationary bias; monetary union.
    JEL: F41 F31 E42
    Date: 2007–04
  19. By: Assaf Razin; Alon Binyamini
    Abstract: This paper reviews the analytics of the effects of globalization on the Phillips curve and the utility-based objective function of the central bank. It demonstrates that in an endogenous-policy set up, when trade in goods is liberalized, financial openness increases, and in- and out-labor migration are allowed, policymakers become more aggressive on inflation and less responsive to the output gap. In other words, globalization induces the monetary authority, when guided in its policy by the welfare criterion of a representative household, to put more emphasis on the reduction of inflation variability, at the expense of an increase in the output gap variability.
    Date: 2007–06
  20. By: Jiri Podpiera (Corresponding address: External Economic Relations Division, Czech National Bank, Na P?íkop? 28, 115 03, Prague 1, Czech Republic.)
    Abstract: Policymakers do not always follow a simple rule for setting policy rates for various reasons and thus their choices are co-driven by a decision to follow a rule or not. Consequently, some observations are censored and cause bias in conventional estimators of typical Taylor rules. To account for the censored and discrete process of policy rate setting, I devise a new method for monetary policy rule estimation and demonstrate its ability to outperform the existing conventional estimators using two examples. JEL Classification: E4, E5.
    Keywords: Monetary policy; Policy rule; Bias in parameters.
    Date: 2007–06
  21. By: Florin O. Bilbiie; Fabio Ghironi; Marc J. Melitz
    Abstract: This paper studies the role of endogenous producer entry and product creation for monetary policy analysis and business cycle dynamics in a general equilibrium model with imperfect price adjustment. Optimal monetary policy stabilizes product prices, but lets the consumer price index vary to accommodate changes in the number of available products. The free entry condition links the price of equity (the value of products) with marginal cost and markups, and hence with inflation dynamics. No-arbitrage between bonds and equity links the expected return on shares, and thus the financing of product creation, with the return on bonds, affected by monetary policy via interest rate setting. This new channel of monetary policy transmission through asset prices restores the Taylor Principle in the presence of capital accumulation (in the form of new production lines) and forward-looking interest rate setting, unlike in models with traditional physical capital. We also study the implications of endogenous variety for the New Keynesian Phillips curve and business cycle dynamics more generally, and we document the effects of technology, deregulation, and monetary policy shocks, as well as the second moment properties of our model, by means of numerical examples.
    JEL: E31 E32 E52
    Date: 2007–06
  22. By: Marika Karanassou; Dennis Snower
    Abstract: A major criticism against staggered nominal contracts is that they give rise to the so called "persistency puzzle" - although they generate price inertia, they cannot account for the stylised fact of inflation persistence. It is thus commonly asserted that, in the context of the new Phillips curve (NPC), inflation is a jump variable. We argue that this "persistency puzzle" is highly misleading, relying on the exogeneity of the forcing variable (e.g. output gap, marginal costs, unemployment rate) and the assumption of a zero discount rate. We show that when the discount rate is positive in a general equilibrium setting (in which real variables not only affect inflation, but are also influenced by it), standard wage-price staggering models can generate both substantial inflation persistence and a nonzero inflation-unemployment tradeoff in the long-run. This is due to frictional growth, a phenomenon that captures the interplay of nominal staggering and permanent monetary changes. We also show that the cumulative amount of inflation undershooting is associated with a downward-sloping NPC in the long-run.
    Keywords: Inflation dynamics, persistence, wage-price staggering, new Phillips curve, monetary policy, frictional growth
    JEL: E31 E32 E42 E63
    Date: 2007–06
  23. By: Fabien Curto Millet
    Abstract: Conjectures about inflation expectations are inextricably linked to our understanding of the relationship between the real and monetary sides of the economy; yet, direct empirical research on the matter has been scarce at best. This paper therefore examines the empirical properties of inflation expectations data constructed on the basis of both qualitative and quantitative surveys of consumers for a set of eight European countries. The rational perceptions hypothesis is tested and rejected by the data, a finding which in turn leads us to reject the rational expectations hypothesis and casts doubt on the New Keynesian Phillips Curve model. The popular alternative of using “rule-of-thumb” expectations in such models empirically is also found to be unrobust. Similarly, the conjecture by Akerlof et al. (2000) of a non-vertical long-run Phillips curve arising from the presence of “near-rational” expectations cannot be supported. The Mankiw and Reis (2002) Phillips curve based on the idea of “sticky information” succeeds in its intuition of a gradual adjustment of expectations, but its assumption of rational updating is challenged by the data in the context of the natural experiment provided by the UK's ERM disinflation. Instead, the adjustment mechanism for expectations appears to display largely adaptive characteristics. Finally, the paper provides some insights into the nature of the interaction between monetary policy and inflation expectations.
    Keywords: Inflation expectations, inflation perceptions, survey data, rationality, Phillips curve, consumers, expectations distribution, inflation targeting
    JEL: D84 E31 E52 E58 E61 E65 C22 C42
    Date: 2007–06
  24. By: John M. Roberts
    Abstract: Over the past forty years, U.S. inflation has exhibited highly persistent movements. Moreover, these shifts in inflation have typically had real consequences, implying a "sacrifice ratio," whereby disinflations are typically associated with recessions and persistent increases in inflation often associated with booms. One hypothesis about the source of the sacrifice ratio is that inflation - and not just the price level - is sticky. Another is that private-sector agents typically must infer changes in inflation objectives indirectly from central bank interest- rate policy. The resulting learning process can lead to a sacrifice ratio trade-off. In this paper, I allow for both sticky inflation and learning in interpreting U.S. macroeconomic developments since 1955. Two key empirical findings are, first, that allowing for learning reduces the evidence for sticky inflation. Second, there is less evidence for sticky inflation in the post-1983 period than earlier. Indeed, in some estimates, there is little evidence of sticky inflation in the period since 1983, although this result is sensitive to the details of the specification. Nonetheless, simulation results suggest that for realistic models, the sacrifice ratio can be accounted for entirely by learning.
    Date: 2007–06
  25. By: Richard Mash
    Abstract: Models in which firms use rules of thumb or partial indexing in their price setting have become prominent in the recent monetary policy literature. The extent to which these firms adjust their prices to lagged inflation has been taken as fixed. We consider the implications of firms choosing the optimal degree of indexation so these simple pricing rules deliver prices as close as possible to those which would be chosen optimally. We find that the degree of indexation depends on the extent of persistence in the economy such that models with constant indexation are vulnerable to the Lucas critique. We also study the interactions between firms price setting and the macroeconomic environment finding that, for the models which appear most plausible on microeconomic grounds, the Nash equilibrium between firms and the policy maker is characterised by zero indexation and zero macroeconomic persistence.
    Keywords: Indexing, Monetary Policy, Phillips curve, Inflation persistence, Microfoundations
    JEL: E52 E58 E22
    Date: 2007–06
  26. By: Harashima, Taiji
    Abstract: In this paper, I present a unified and micro-founded explanation for various types of inflation without assuming ad hoc frictions or irrationality. The explanation is similar to the conventional inflation theory in the sense that an independent central bank can control inflation and also similar to the fiscal theory of the price level in the sense that a source of inflation lies in the behavior of government. Inflation accelerates or decelerates through the simultaneous optimization of a government and the representative household if their time preference rates are heterogeneous. This inflation acceleration mechanism will be prevented from working if a central bank is truly independent.
    Keywords: Hyperinflation; chronic inflation; disinflation; deflation; central bank independence; the fiscal theory of the price level
    JEL: E58 E31 E63
    Date: 2007–07–05
  27. By: Jarkko Jääskelä (Reserve Bank of Australia); Mariano Kulish (Reserve Bank of Australia)
    Abstract: The rational expectations equilibrium of a small open economy can be subject to indeterminacy if foreign monetary policy does not satisfy the Taylor principle. We study the implications of foreign-induced indeterminacy for the conduct of monetary policy in a small open economy. In the canonical sticky-price small open economy model, we find that indeterminacy arising in the large economy can increase the volatility of the small economy. Our main finding, however, is that ‘smallness’ is a property of the unique rational expectations equilibrium of the large economy, and not a general property of the small open economy model. If the <em>large</em> economy fails to anchor expectations, shocks to the small economy can affect the large one. This form of indeterminacy gives rise to a ‘butterfly effect’. Additional assumptions are required to preserve the ‘smallness’ of the small economy.
    Keywords: indeterminacy; small open economy; rational expectations
    JEL: E30 E32 E52 E58 F41
    Date: 2007–06
  28. By: Annika Alexius; Bertil Holmlund
    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: J60 E24
    Date: 2007–06
  29. By: Hian Teck Hoon; Kong Weng Ho
    Abstract: This paper builds upon Hoon and Phelps (1992, 1997) to ask how much of the evolution of the unemployment rate over several decades in country can be explained by real factors in an equilibrium model of the natural rate where country's productivity growth depends upon its distance from the world's technological leader. One motivating contemporary example includes the evolution of unemployment rates in Europe as it recovered from the second world war and caught up technologically to the US. Another example that may be less familiar to many people is Singapore (the second fastest growing economy from 1960 to 2000 in Barro's data set of 112 countries) that is best thought of as catching up to the world's technological leaders (the G5 countries with whom it trades extensively and from where it receives substantial foreign direct investments) and that saw its unemployment rate go down from double-digit levels in the early 1960's to the low 2 to 3 percent in the late 1990's. How much of the big movements in the unemployment rate can be explained by non-monetary factors in a model of an endogenous natural rate exhibiting both monetary neutrality and super-neutrality? What room is left for monetary policy in explaining the movements of the unemployment rate? The paper develops the theory and seeks to ask how much non-monetary factors can quantitatively account for the evolution of the unemployment rate.
    Date: 2007–06
  30. By: Ron Smith; M. Hashem Pesaran
    Abstract: The standard derivation of a Phillips curve from a DSGE model requires that all variables are measured as deviations from their steady states. But in practice this is not done. The steady state for output is estimated by some statistical procedure, such as the HP filter, and the steady state for other variables, including inflation, is treated as a constant. This is inconsistent with the theory and raises econometric problems since inflation, for instance, is a very persistent series. We argue that the natural definition of the steady state is the long-horizon forecast and estimate these permanent components from a cointegrating VAR that takes account of global interactions. This estimate of the steady state will reflect any long-run theoretical relationships embodied in the cointegrating vectors. We then estimate Phillips Curves and other standard monetary transmission equations using deviations from the steady states on US data. This is both consistent with the theory and uses the relevant economic information about steady states.
    Keywords: Global VAR (GVAR), Phillips Curve, Monetary Transmisssion
    JEL: C32 E17 F37 F42
    Date: 2007–06
  31. By: Paul Levine (Department of Economics, University of Surrey, Guildford, Surrey, GU2 7XH, United Kingdom.); Joseph Pearlman (London Metropolitan University, 31 Jewry Street, London, EC3N 2EY, United Kingdom.); Richard Pierse (Department of Economics, University of Surrey, Guildford, Surrey, GU2 7XH, United Kingdom.)
    Abstract: We examine the linear-quadratic (LQ) approximation of non-linear stochastic dynamic optimization problems in macroeconomics, in particular for monetary policy. We make four main contributions: first, we draw attention to a general Hamiltonian framework for LQ approximation due toMagill (1977). We show that the procedure for the ‘large distortions’ case of Benigno and Woodford (2003, 2005) is equivalent to the Hamiltonian approach, but the latter is far easier to implement. Second, we apply the Hamiltonian approach to a Dynamic Stochastic General Equilibrium model with external habit in consumption. Third, we introduce the concept of target-implementability which fits in with the general notion of targeting rules proposed by Svensson (2003, 2005). We derive sufficient conditions for the LQ approximation to have this property in the vicinity of a zero-inflation steady state. Finally, we extend the Hamiltonian approach to a non-cooperative equilibrium in a two-country model. JEL Classification: E52, E37, E58.
    Keywords: Linear-quadratic approximation, dynamic stochastic general equilibrium models, utility-based loss function.
    Date: 2007–06
  32. By: Andrew McCallum; Frank Smets
    Abstract: We use the Factor-Augmented Vector Autoregression (FAVAR) approach of Bernanke, Boivin and Eliasz (2005) to estimate the effects of monetary policy shocks on wages and employment in the euro area. The use of a large data set comprising country, sectoral and euro area-wide data allows us to better identify common monetary policy shocks in the euro area and their effects on labour market outcomes. At the same time the FAVAR approach gives us estimates of how relative wages and employment in the various countries and sectors respond to these common shocks. The ultimate objective of our work is to relate the estimated cross-country differences in wage and employment responses to differences in labour market institutions and sectoral composition.
    Keywords: VAR, factor models, rigidity, labour market
    JEL: E3 E4 J3 J6
    Date: 2007–06
  33. By: Popa, Catalin C.
    Abstract: This paperwork is meant to treat some contemporary and stringent global problems, related to the almost new problematic of international monetary system and its crises, since the Bretton Woods system breakdown. In the last 3 decades, this subsystem of global economy becomes the most important and the most instable as well. The last contagious monetary or financial crises proved that in the absence of a coherent minimum control regarding the free movement of foreign capital between nations, the market is unreliable and incapable to fit itself in the new economical realities related to risks appraisal and fixed assets real value. In these circumstances a new wave of scientific researches regarding the institutional and functional architecture of a new global monetary system is quite necessary and welcomed, being useful for reconfiguration of global reality from the financial markets point of view. In this order the paperwork explains from a logical perspective, the functional particularities of market forces mechanisms regarding the monetary system specific instrument and activities. The conclusions underline the importance of liquidities and the fundamental relevance of real risks appraisal in market mechanism for assuring a proper action and activity of the international monetary system as a global component.
    Keywords: monetar; financiar; IMF; sistem monetar si financiar
    JEL: F33 F50
    Date: 2007–02–01
  34. By: Ricardo Reis; Mark W. Watson
    Abstract: This paper estimates a common component in many price series that has an equiproportional effect on all prices. Changes in this component can be interpreted as changes in the value of the numeraire since, by definition, they leave all relative prices unchanged. The first aim of the paper is to measure these changes. The paper provides a framework for identifying this component, suggests an estimator for the component based on a dynamic factor model, and assesses its performance relative to alternative estimators. Using 187 U.S. time-series on prices, we estimate changes in the value of the numeraire from 1960 to 2006, and further decompose these changes into a part that is related to relative price movements and a residual ‘exogenous’ part. The second aim of the paper is to use these estimates to investigate two economic questions. First, we show that the size of exogenous changes in the value of the numeraire helps distinguish between different theories of pricing, and that the U.S. evidence argues against several strict theories of nominal rigidities. Second, we find that changes in the value of the numeraire are significantly related to changes in real quantities, and discuss interpretations of this apparent non-neutrality.
    Keywords: Inflation, Money illusion, Monetary neutrality, Price index
    JEL: E31 C43 C32
    Date: 2007–06
  35. By: Etienne Gagnon
    Abstract: This paper provides new insight into the relationship between inflation and consumer price setting by examining a large data set of Mexican consumer prices covering episodes of both low and high inflation, as well as the transition between the two. Overall, the economy shares several characteristics with time-dependent models when the annual inflation rate is low (below 10-15%), while displaying strong state dependence when inflation is high (above 10-15%). At low inflation levels, the aggregate frequency of price changes responds little to movements in inflation because movements in the frequency of price decreases partly offset movements in the frequency of price increases. When the annual inflation rate rises beyond 10-15 percent, however, there are no longer enough price decreases to counterbalance the rising occurrence of price increases, making the frequency of price changes more responsive to inflation. It is shown that a simple menu-cost model with idiosyncratic technology shocks predicts remarkably well the level of the average frequency and magnitude of price changes over a wide range of inflation.
    Date: 2007
  36. By: Matteo Ciccarelli; Benoît Mojon
    Abstract: This paper shows that ination in industrialized countries is largely a global phenom- enon. First, inations of (22) OECD countries have a common factor that alone accounts for nearly 70% of their variance. This large variance share that is associated to Global Ination is not only due to the trend components of ination (up from 1960 to 1980 and down thereafter) but also to uctuations at business cycle frequencies. Second, Global In- ation is, consistently with standard models of ination, a function of real developments at short horizons and monetary developments at longer horizons. Third, there is a very robust "error correction mechanism" that brings national ination rates back to Global Ination. This model consistently beats the previous benchmarks used to forecast ination 1 to 8 quarters ahead across samples and countries.
    Keywords: Inflation, common factor, international business cycle, OECD countries
    JEL: E31 E37 F42
    Date: 2007–06

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