nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒07‒13
25 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Wealth Effects, the Taylor Rule and the Liquidity Trap By Barbara Annicchiarico; Giancarlo Marini; Alessandro Piergallini
  2. Arbitrage-Free Bond Pricing with Dynamic Macroeconomic Models By Michael F. Gallmeyer; Burton Hollifield; Francisco Palomino; Stanley E. Zin
  3. Global Monetary Policy Shocks in the G5: a SVAR Approach By Joao Miguel Sousa; Andrea Zaghini
  4. Monetary policy and natural disasters in a DSGE model: how should the Fed have responded to Hurricane Katrina? By Benjamin D. Keen; Michael R. Pakko
  5. Inflation persistence: Implications for a design of monetary policy in a small open economy subject to external shocks By Karlygash Kuralbayeva
  6. Taylor rules with headline inflation: a bad idea By Rajeev Dhawan; Karsten Jeske
  7. Whatever became of the Monetary Aggregates? By Charles Goodhart
  8. Economic Integration and the Foreign Exchange By Enzo Weber
  9. Inflation expectations, real interest rate and risk premiums -- evidence from bond market and consumer survey data By Dong Fu
  10. Counteracting counterfeiting? False money as a multidimensional justice issue in 16th and 17th century monetary analysis By Jérôme Blanc; Ludovic Desmedt
  11. Understanding the New Keynesian model when monetary policy switches regimes By Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
  12. Monitoring Bands and Monitoring Rules: how currency intervention can change market composition By Luisa Corrado; Marcus Miller; Lei Zhang
  13. Structural reforms in EMU and the role of monetary policy – a survey of the literature By Nadine Leiner-Killinger; Víctor López Pérez; Roger Stiegert; Giovanni Vitale
  14. Testing similarities of short-run inflation dynamics among EU countries after the Euro By Giulio PALOMBA; Alberto ZAZZARO; Emma SARNO
  15. Monetary Policy and Potential Output Uncertainty: A Quantitative Assessment By Simona Delle Chiaie
  16. Pricing-to-market with state-dependent pricing By Anthony Landry
  17. The Evolution of Inflation and Unemployment: Explaining the Roaring Nineties By Marika Karanassou; Hector Sala; Dennis J. Snower
  18. Money and Bonds: An Equivalence Theorem By Narayana Kocherlakota
  19. Volatile public spending in a model of money and sustainable growth By Dimitrios Varvarigos
  20. Net Worth, Exchange Rates, and Monetary Policy: The Effects of a Devaluation in a Financially Fragile Environment By Domenico Delli Gatti; Mauro Gallegati; Bruce C. Greenwald; Joseph E. Stiglitz
  21. Which Interest Rate Seems Most Related to Business Investment? A Few Preliminary Findings from an Ongoing Study By John J. Heim
  22. Comparative analysis of the exchange market pressure in Central European countries with the Eurozone membership perspective By Stavarek, Daniel
  23. Money Laundering and its Regulation By Alberto Chong; Florencio López-de-Silanes
  24. The Welfare Costs of Inflation in a Micro-Founded Macroeconometric Model By Pablo A. Guerron
  25. Unemployment, Imperfect Risk Sharing, and the Monetary Business Cycle. By Gregory E. Givens

  1. By: Barbara Annicchiarico (University of Rome “Tor Vergata”); Giancarlo Marini (University of Rome “Tor Vergata”); Alessandro Piergallini (CeFiMS, University of London)
    Abstract: This paper analyzes the dynamic properties of the Taylor rule with the zero lower bound on the nominal interest rate in an optimizing monetary model with overlapping generations. The main result is that the presence of wealth effects is not sufficient to rule out the possibility of infinite equilibrium paths with decelerating inflation. In particular, the operation of wealth effects does not avoid the occurrence of liquidity traps when the central bank implements a Taylor-type interest-rate feedback rule.
    Keywords: Wealth Effects, Taylor Rules, Liquidity Traps.
    JEL: E31 E52
    Date: 2007–05–21
  2. By: Michael F. Gallmeyer; Burton Hollifield; Francisco Palomino; Stanley E. Zin
    Abstract: We examine the relationship between monetary-policy-induced changes in short interest rates and yields on long-maturity default-free bonds. The volatility of the long end of the term structure and its relationship with monetary policy are puzzling from the perspective of simple structural macroeconomic models. We explore whether richer models of risk premiums, specifically stochastic volatility models combined with Epstein-Zin recursive utility, can account for such patterns. We study the properties of the yield curve when inflation is an exogenous process and compare this to the yield curve when inflation is endogenous and determined through an interest-rate/Taylor rule. When inflation is exogenous, it is difficult to match the shape of the historical average yield curve. Capturing its upward slope is especially difficult as the nominal pricing kernel with exogenous inflation does not exhibit any negative autocorrelation - a necessary condition for an upward sloping yield curve as shown in Backus and Zin (1994). Endogenizing inflation provides a substantially better fit of the historical yield curve as the Taylor rule provides additional flexibility in introducing negative autocorrelation into the nominal pricing kernel. Additionally, endogenous inflation provides for a flatter term structure of yield volatilities which better fits historical bond data.
    JEL: E4 G0 G1
    Date: 2007–07
  3. By: Joao Miguel Sousa (Banco de Portugal); Andrea Zaghini (Banca d'Italia)
    Abstract: The paper constructs a global monetary aggregate, namely the sum of the key monetary aggregates of the G5 economies (US, Euro area, Japan, UK, and Canada), and analyses its indicator properties for global output and inflation. Using a structural VAR approach we find that after a monetary policy shock output declines temporarily, with the downward effect reaching a peak within the second year, and the global monetary aggregate drops significantly. In addition, the price level rises permanently in response to a positive shock to the global liquidity aggregate. The similarity of our results with those found in country studies might supports the use of a global monetary aggregate as a summary measure of worldwide monetary trends.
    Keywords: Monetary policy, Structural VAR, Global economy.
    JEL: E52 F01
    Date: 2007–02–20
  4. By: Benjamin D. Keen; Michael R. Pakko
    Abstract: In the immediate aftermath of Hurricane Katrina, speculation arose that the Federal Reserve might respond by easing monetary policy. This paper uses a dynamic stochastic general equilibrium (DSGE) model to investigate the appropriate monetary policy response to a natural disaster. We show that the standard Taylor (1993) rule response in models with and without nominal rigidities is to increase the nominal interest rate. That finding is unchanged when we consider the optimal policy response to a disaster. A nominal interest rate increase following a disaster mitigates both temporary inflation effects and output distortions that are attributable to nominal rigidities.
    Date: 2007
  5. By: Karlygash Kuralbayeva (Lincoln College, University of Oxford)
    Abstract: We analyze implications of in.ation persistence for business cycle dynamics following terms of trade and risk-premium shocks in a small open economy, under fixed and flexible exchange rate regimes. We show that the country's adjustment paths are slow and cyclical if there is a signi.cant backward-looking element in the in.ation dynamics and the exchange rate is fixed. We also show that such cyclical adjustment paths are moderated if there is a high proportion of forward-looking price setters. In contrast, with an independent monetary policy, flexible exchange rate allows to escape severe cycles, supporting the conventional wisdom about the insulation role of flexible exchange rates.
    Keywords: inflation inertia, monetary policy, exchange rates, persistence, Phillips curve, small open economy
    JEL: E32 F40 F41
    Date: 2007–02–20
  6. By: Rajeev Dhawan; Karsten Jeske
    Abstract: Should a central bank accommodate energy price shocks? Should the central bank use core inflation or headline inflation with the volatile energy component in its Taylor rule? To answer these questions, we build a dynamic stochastic general equilibrium model with energy use, durable goods, and nominal rigidities to study the effects of an energy price shock and its impact on the macroeconomy when the central bank follows a Taylor rule. We then study how the economy performs under alternative parameterizations of the rule with different weights on headline and core inflation after an increase in the energy price. Our simulation results indicate that a central bank using core inflation in its Taylor rule does better than one using headline inflation because the output drop is less severe. In general, we show that the lower the weight on energy price inflation in the Taylor rule, the impact of an energy price increase on gross domestic product and inflation is also lower.
    Date: 2007
  7. By: Charles Goodhart
    Date: 2007–02
  8. By: Enzo Weber
    Abstract: This paper demonstrates effects of economic convergence processes on the foreign exchange behaviour in a monetary modelling approach. Since the exchange rate represents the relative price of two currencies, commonness of stochastic trends between the fundamental determinants of supply and demand of the underlying monies restricts exchange rate movements to transitory fluctuations. In the spirit of optimal currency areas, this has the potential to serve as a criterion for an all-round integration of two economies. Empirically, such a constellation is found between Australia and New Zealand, whereas diverging trends in money and interest rates characterise the relation of Australia towards the US.
    Keywords: Monetary Exchange Rate Model, Convergence, Stationarity, Australia.
    JEL: F31 F41 C32
    Date: 2007–06
  9. By: Dong Fu
    Abstract: This paper extracts information on inflation expectations, the real interest rate, and various risk premiums by exploring the underlying common factors among the actual inflation, University of Michigan consumer survey inflation forecast, yields on U.S. nominal Treasury bonds, and particularly, yields on Treasury Inflation Protected Securities (TIPS). Our findings suggest that a significant liquidity risk premium on TIPS exists, which leads to inflation expectations that are generally higher than the inflation compensation measure at the 10-year horizon. On the other hand, the estimated expected inflation is mostly lower than the consumer survey inflation forecast at the 12-month horizon. Survey participants slowly adjust their inflation forecasts in response to inflation changes. The nominal interest rate adjustment lags inflation movements, too. Our model also edges out a parsimonious seasonal AR(2) time series model in the one-step-ahead forecast of inflation.
    Keywords: Inflation (Finance)
    Date: 2007
  10. By: Jérôme Blanc (LEFI - Laboratoire d'économie de la firme et des institutions - [Université Lumière - Lyon II]); Ludovic Desmedt (LEG - Laboratoire d'Economie et de Gestion - [CNRS : UMR5118] - [Université de Bourgogne])
    Abstract: False money appeared as the general common issue in monetary debates that occured in European countries in the 16th and 17th centuries. It first refered to sovereignty, in a time of state-building, as well as to a serious economic problem. Beyond sovereignty and economy, justice and, then, the public faith, were endangered by those who devoted themselves to produce false coins. The thesis of this communication is that one cannot understand clearly the general topic of false money by reading texts of the time with today's general definition of false money. We propose, then, to identify the multiple dimensions of false money : counterfeiting (by individuals), degradations of coins (by individuals and officers of the Mint) and debasement and enhancement (by princes). These dimensions appeared in monetary discourses like Bodin's, Mariana's and Locke's ones, with sometimes a lack of clarity. Then, a general claim to counteract counterfeiting may conceal a claim to suppress any possibility of debasing currency. Making clearer monetary discourses on that topic and establishing a hierarchy between the three dimensions of false money helps to understand why the false money issue was firstly a matter of monetary justice by the prince himself. In order to do so, we pay special attention to Bodin, Mariana and Locke.
    Keywords: History of monetary thought; monetary history; modern times; counterfeiting; debasement
    Date: 2007–07–09
  11. By: Roger E.A. Farmer; Daniel F. Waggoner; Tao Zha
    Abstract: This paper studies a New Keynesian model in which monetary policy may switch between regimes. We derive sufficient conditions for indeterminacy that are easy to implement and we show that the necessary and sufficient condition for determinacy, provided by Davig and Leeper, is necessary but not sufficient. More importantly, we use a two-regime model to show that indeterminacy in a passive regime may spill over to an active regime no matter how active the latter regime is. As a result, a passive monetary policy is more damaging than has been previously thought. Our results imply that the propagation of shocks in an active regime, such as that of the Federal Reserve in the post-1982 period, may be substantially affected by the possibility of a return to a passive regime of the kind that was followed in the 1960s and 1970s.
    Date: 2007
  12. By: Luisa Corrado (Faculty of Economics, University of Cambridge and University of Rome, Tor Vergata.); Marcus Miller (Department of Economics, University of Warwick and CEPR); Lei Zhang (Department of Economics, University of Warwick.)
    Abstract: In this paper we show how trading rules can generate excess volatility in the exchange rate through repeated entry and exit of currency "bears" and "bulls". This is something of a caricature: but it allows us to show that official action can have self-ful.lling e¤ects as market composition shifts in ways that support official stabilization. Intervention if and when the rate moves outside what Williamson has labelled "monitoring bands" can reduce market volatility as the effect of the policy is to select endogenously traders from the market whose expectations match official intervention.
    Keywords: Monitoring Rules, Monitoring Band, Bear and Bull Traders, Excess Volatility, Central Bank Volatility
    JEL: D52 F31 G12
    Date: 2007–02–20
  13. By: Nadine Leiner-Killinger (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Víctor López Pérez; Roger Stiegert (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Giovanni Vitale (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The need for structural reforms in the euro area has often been advocated. These reforms would improve the welfare of euro area citizens and also, as a welcome side-effect, facilitate the conduct of monetary policy. Against this background, a particularly relevant question that can be posed is whether monetary policy should help implement structural reforms. The objective of this paper is to provide a review of the existing literature on structural reforms in Economic and Monetary Union (EMU) and to discuss the possible ways in which monetary policy could support the structural reform process. In the context of EMU, the main conclusions that emerge are that the monetary policy for the euro area is not the appropriate tool for mitigating the potential and uncertain short-term costs of reforms or for providing incentives for structural reforms at the national level. However, credible monetary policy aimed at price stability can improve the functioning of the supply side of the economy and contribute to an environment which is conducive to welfare-enhancing structural changes. In addition, the ECB’s contribution to the implementation of structural reforms takes the form of analysis, assessment and communication.
    Date: 2007–07
  14. By: Giulio PALOMBA ([n.a.]); Alberto ZAZZARO (Universita' Politecnica delle Marche, Dipartimento di Economia); Emma SARNO ([n.a.])
    Abstract: In this paper we introduce new definitions of pairwise and multivariate similarity between short-run dynamics of inflation rates in terms of equality of forecast functions and show that in the context of invertible ARIMA processes the Autoregressive distance introduced by Piccolo (1990) is a useful measure to evaluate such similarity. Then, we study the similarity of shortrun inflation dynamics across EU-15 area countries during the Euro period. Consistent with studies on inflation differentials and inflation persistence, our findings suggest that after seven years from the launch of the Euro the degree of similarity of short-run inflation dynamics across EU countries is still weak.
    Keywords: Euro, autoregressive metric, inflation dynamics
    JEL: C23 E31
    Date: 2007–06
  15. By: Simona Delle Chiaie (University of Rome, Tor Vergata)
    Abstract: This paper contributes to the recent literature that studies the quantitative implications of the imperfect information about potential output for the conduct of monetary policy. By means of Bayesian techniques, a small New Keynesian model is estimated taking explicitly account of the imperfect information problem. The estimation of the structural parameters and of the monetary authorities.objectives is key in assessing the quantitative relevance of the imperfect information problem and in evaluating the robustness of previous exercises based on calibration. Finally, the model allows us to analyse the usefulness of unit labor costs as monetary policy indicator.
    Date: 2007–02–20
  16. By: Anthony Landry
    Abstract: This paper extracts information on inflation expectations, the real interest rate, and various risk premiums by exploring the underlying common factors among the actual inflation, University of Michigan consumer survey inflation forecast, yields on U.S. nominal Treasury bonds, and particularly, yields on Treasury Inflation Protected Securities (TIPS). Our findings suggest that a significant liquidity risk premium on TIPS exists, which leads to inflation expectations that are generally higher than the inflation compensation measure at the 10-year horizon. On the other hand, the estimated expected inflation is mostly lower than the consumer survey inflation forecast at the 12-month horizon. Survey participants slowly adjust their inflation forecasts in response to inflation changes. The nominal interest rate adjustment lags inflation movements, too. Our model also edges out a parsimonious seasonal AR(2) time series model in the one-step-ahead forecast of inflation.
    Date: 2007
  17. By: Marika Karanassou (Queen Mary, University of London and IZA); Hector Sala (Universitat Autònoma de Barcelona and IZA); Dennis J. Snower (Kiel Institute for the World Economy, Christian-Albrechts-University of Kiel and CEPR)
    Abstract: This paper analyses the relation between US inflation and unemployment from the perspective of "frictional growth," a phenomenon arising from the interplay between growth and frictions. In particular, we examine the interaction between money growth (on the one hand) and various real and nominal frictions (on the other). In this context we show that monetary policy has not only persistent, but permanent real effects, giving rise to a long-run inflation-unemployment tradeoff. We evaluate this tradeoff empirically and assess the impact of productivity, money growth, budget deficit, and trade deficit on the US unemployment and inflation trajectories during the nineties.
    Keywords: Inflation dynamics, Unemployment dynamics, Phillips curve, Roaring nineties
    JEL: E24 E31 E51 E62
    Date: 2007–07
  18. By: Narayana Kocherlakota
    Date: 2007
  19. By: Dimitrios Varvarigos (Dept of Economics, Loughborough University)
    Abstract: In a model where seignorage provides the financing instrument for the government’s budget, public spending volatility has an adverse effect on long-run growth. This negative relationship arises because the incidence of volatility in this type of public policy is responsible for higher average money growth, thus induces individuals to devote less time/effort towards capital accumulation. Another implication of the model is that policy variability provides a possible argument behind the positive correlation between inflation and inflation variability.
    Keywords: Growth, Inflation, Seignorage, Volatility
    JEL: E13 E31 O42
    Date: 2007–07
  20. By: Domenico Delli Gatti; Mauro Gallegati; Bruce C. Greenwald; Joseph E. Stiglitz
    Abstract: In this paper we propose an Open Economy Financial Accelerator model along the lines of Greenwald-Stiglitz (1993) close in spirit but different in many respects from the one proposed by Greenwald (1998.) The first goal of the paper is to provide a taxonomy of the effects of a devaluation in this context. The direct (first round) effect on output, taking as given net worth and interest rate, is negative for domestic firms (due to the input cost effect) and positive for exporting firms (due to a positive foreign debt effect). The indirect (second round) wealth effect (on output through net worth, taking as given the interest rate) is uncertain, depending on the relative size of the domestic and exporting firms. There is also an indirect effect on output through the response of the domestic interest rate to a devaluation due to the risk premium effect. Due to the uncertainty on the sign of most of these effects, it is difficult to assess the overall impact of a devaluation. One cannot rule out, however, an economy-wide contractionary effect of a devaluation. If the devaluation affects negatively the net worth of domestic firms, the domestic interest rate may rise (due to the risk premium effect), exerting an additional contractionary impact on output. If, on top of that, the monetary authorities force a further increase of the interest rate in an effort to curb the exchange rate, the contractionary effect will be emphasized.
    JEL: E4 E5 F4
    Date: 2007–07
  21. By: John J. Heim (Department of Economics, Rensselaer Polytechnic Institute, Troy, NY 12180-3590, USA)
    Abstract: This paper examines (econometrically) which interest rates seem most systematically related to investment and the GDP and how long the lag time is before changes in these interest rates affect the GDP. We conclude that the Prime interest rate has the most important and systematic influence on these variables and that it affects investment and the GDP after a two year lag due to the lengthy periods required to design, bid and build new factories, commercial facilities and some machinery. Other rates examined, but not found related to investment - triggered GDP growth, include the Aaa and Baa corporate bond rates, the Mortgage interest rate and the 10 year Treasury bond rate. Our results also suggest the magnitude of the effect of interest rate changes on the economy is relatively modest, and that therefore the Federal Reserve's ability to influence the economy by changing rates may also be somewhat constrained.
    JEL: E00 E12 E22 E44
    Date: 2007–07
  22. By: Stavarek, Daniel
    Abstract: This paper estimates the exchange market pressure (EMP) in four Central European countries (Czech Republic, Hungary, Poland, Slovakia) during the period 1993-2006. Therefore, it is one of very few studies focused on this region and the very first paper applying concurrently model-dependent as well as model-independent approach to the EMP estimation on these countries. The results obtained suggest that the approaches are not compatible and lead to absolutely inconsistent findings. They often differ in both identification of principal development trends and estimated magnitude and direction of the pressure. Therefore, any general conclusion on those issues is hard to draw. The paper provides evidence that a shift in the exchange rate regime towards the quasi-fixed ERM II should not lead to increasing EMP. However, it is highly probable that some episodes of the excessive EMP will make the fulfillment of the exchange rate stability criterion more difficult in all countries analyzed unless the criterion will have eased.
    Keywords: exchange market pressure; model-dependent approach; model-independent approach; EU New Member States; exchange rate stability criterion
    JEL: F36 E42 F31 C32
    Date: 2007–06–28
  23. By: Alberto Chong (Inter-American Development Bank); Florencio López-de-Silanes (University of Amsterdam and NBER)
    Abstract: The recent wave of terrorist attacks has increased the attention paid to money laundering activities. Using several methodologies, this paper investigates empirically the determinants of money laundering and its regulation in over 80 countries by assembling a cross-country dataset on proxies for money laundering and the prevalence of feeding activities. The paper additionally constructs specific money laundering regulation indices based on available information on laws and their mechanisms of enforcement and measures their impact on money laundering proxies. The paper finds that tougher money laundering regulations, particularly those that criminalize feeding activities and improve disclosure, are linked to lower levels of money laundering across countries; the results are robust to potential endogeneity of money laundering regulation. The relevance of historical factors in explaining the variation of money laundering regulation across countries sheds light on theories of institutions and provides room for further action, particularly in the areas of the law that improve the impact of criminalization, including liability of intermediaries, reductions of the burden of proof and better disclosure.
    Keywords: Money laundering; regulation; laws; crime; enforcement
    JEL: K40 G10
    Date: 2007–01
  24. By: Pablo A. Guerron (Department of Economics, North Carolina State University)
    Abstract: This paper computes the welfare costs of inflation in an estimated dynamic stochastic general equilibrium model of the U.S. economy. Both steady state and transitional welfare results are reported. I find that a 10 percent inflation entails a steady state welfare cost of 1.9 % of annual consumption. Taking into account trasitional effects, the cost drops to 1.2%. Under some circumstances, the transitional effects can erase most of the steady state welfare losses. The role of nominal frictions such as price/wage sluggishness as well as that of uncertainty are also addressed.
    Keywords: Bayesian Estimation, DSGE, Inflation, Welfare, Transtional Dynamics
    JEL: E31 E32 E37
    Date: 2007–07
  25. By: Gregory E. Givens
    Abstract: This paper examines the impact of unemployment insurance on the propagation of monetary disturbances in a staggered price model of the business cycle. To motivate a role for risk sharing behavior, I construct a quantitative equilibrium model that gives prominence to an efficiency-wage theory of unemployment based on imperfectly observable labor effort. Dynamic simulations reveal that under a full insurance arrangement, staggered price-setting is incapable of generating persistent real effects of a monetary shock. Introducing partial insurance, however, bolsters the amount of endogenous wage rigidity present in the model, enriching the propagation mechanism. Positive real persistence appears in versions of the model that exclude capital accumulation as well as in versions that do not.
    Keywords: Unemployment, Partial Insurance, Staggered Prices, Endogenous Persistence
    JEL: E24 E31 E32 E52
    Date: 2007–07

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