nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒07‒27
eighteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Money Demand Function By Yiu, Kai Wing
  2. Flattened Inflation-Output Tradeoff and Enhanced Anti-Inflation Policy: Outcome of Globalization? By Assaf Razin; Alon Binyamini
  3. Are the facts of UK inflation persistence to be explained by nominal rigidity or changes in monetary regime? By Meenagh, David; Minford, Patrick; Nowell, Eric; Sofat, Prakriti; Srinivasan, Naveen
  4. An estimated New Keynesian policy model for Australia By Buncic, Daniel; Melecky, Martin
  5. Optimal Monetary Policy in a 'Sudden Stop' By Fabio Braggion; Lawrence J. Christiano; Jorge Roldos
  6. Economic Liberalization and the Causal Relations among Money, Income, and Prices: The Case of Pakistan By Husain, Fazal; Rashid, Abdul
  7. Inflation-output gap trade-off with a dominant oil supplier By Anton Nakov; Andrea Pescatori
  8. Understanding the Forward Premium Puzzle: A Microstructure Approach By Burnside, A Craig; Eichenbaum, Martin; Rebelo, Sérgio
  9. Currency Preferences in a Tri-Polar Model of Foreign Exchange By Melecky, M
  10. Understanding the Forward Premium Puzzle: A Microstructure Approach By Craig Burnside; Martin S. Eichenbaum; Sergio Rebelo
  11. Money and Taxes: The Relationship Between Financial Sector Development and Taxation By Tatom, John; Ott, Mack
  12. An Evaluation of Foreign Exchange Intervention and Monetary Aggregates in Nigeria (1986- 2003) By Adebiyi, Michael Adebayo
  13. Is the Bank of Canada any more or less independent than the Fed? By J. Stephen Ferris
  14. Asian Currency Crises: Do Fundamentals still Matter? A Markov-Switching Approach to Causes and Timing By J L Ford; Bagus Santoso; N J Horsewood
  15. Large Hoarding of International Reserves and the Emerging Global Economic Architecture By Joshua Aizenman
  16. Monitoring In Teams: A Model and Experiment on the Central Monitor Hypothesis By Stefan Grosse; Louis Putterman; Bettina Rockenbach
  17. The Economics of Uncovered Interest Parity Condition for Emerging Markets: A Survey By Alper, C. Emre; Ardic, Oya Pinar; Fendoglu, Salih
  18. "Why Have Interest Rates Been So Low?" By Tatom, John

  1. By: Yiu, Kai Wing
    Abstract: Most, if not all, of available forms of money demand function take nominal interest rate of nonmonetary assets, which equals real interest rate of nonmonetary assets plus expected inflation, as one of its variables without taking expected inflation as a separate variable. This item shows that in fact we do need to introduce expected inflation as a separate variable in general.
    Keywords: money; demand; function
    JEL: E41 E4
    Date: 2007–07–17
  2. By: Assaf Razin; Alon Binyamini
    Abstract: The paper provides a unified analysis of globalization effects on the Phillips curve and monetary policy, in a New-Keynesian framework. The main proposition of the paper is twofold. Labor, goods, and capital mobility flatten the tradeoff between inflation and activity. If policy makers are guided by the welfare criterion of the representative household, globalization forces also lead monetary policy to be more aggressive with regard to inflation fluctuations but, at the same time, more benign with respect to the output-gap fluctuations.
    JEL: E31 F3 F4
    Date: 2007–07
  3. By: Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Nowell, Eric; Sofat, Prakriti; Srinivasan, Naveen
    Abstract: It has been widely argued that inflation persistence since WWII has been widespread and durable and that it can only be accounted for by models with a high degree of nominal rigidity. We examine UK post-war data and find that the varying persistence it reveals is largely due to changing monetary regimes and that models with moderate or even no nominal rigidity are best equipped to explain it.
    Keywords: Inflation Persistence; New Keynesian; New Classical; Nominal Rigidity; Monetary Regime Shifts
    JEL: E31 E37
    Date: 2007–07
  4. By: Buncic, Daniel; Melecky, Martin
    Abstract: An open economy New Keynesian policy model for Australia is estimated in this study. We investigate how important external shocks are as a source of macroeconomic fluctuations when compared to domestic ones. The results of our analysis suggest that the Australian business cycle and domestic inflation are most affected by domestic demand and supply shocks, respectively. However, domestic output also appears to be strongly affected by foreign demand shocks, and domestic inflation by exchange rate shocks. Domestic variables do not seem to be significantly affected by foreign supply and monetary policy shocks.
    Keywords: New Keynesian Policy Modelling; Small Open Economy Model; Australia; US; Bayesian Estimation.
    JEL: E40 E37 F41
    Date: 2007–07–18
  5. By: Fabio Braggion; Lawrence J. Christiano; Jorge Roldos
    Abstract: In the wake of the 1997-98 financial crises, interest rates in Asia were raised immediately, and then reduced sharply. We describe an environment in which this is the optimal monetary policy. The optimality of the immediate rise in the interest rate is an example of the theory of the second best: although high interest rates introduce an inefficiency wedge into the labor market, they are nevertheless welfare improving because they mitigate distortions due to binding collateral constraints. Over time, as various real frictions wear off and the collateral constraint is less binding, the familiar Friedman forces dominate, and interest rates are optimally set as low as possible.
    JEL: E4 E44 E5
    Date: 2007–07
  6. By: Husain, Fazal; Rashid, Abdul
    Abstract: This study re-examines the causal relations between money and the two variables, i.e., income and prices. Using annual data from 1959/60 to 2003/04, examining the stochastic properties of the variables used in the analysis, and taking care of the shifts in the series due to the start of the economic liberalization program in the early 1990s, we investigate the causal relations between real money and real income, between nominal money and nominal income, and between nominal money and prices. The analysis indicates, in general, the long run relationship among money, income, and prices. The analysis further suggests a one way causation from income to money in the long run implying that probably real factors rather than money supply has played a major role in increasing Pakistan’s national income. The study fails to find the active role of money in changing income even after taking care of possible shifts in these variables due to the economic reforms. As Regards the causal relationship between money and prices, the analysis suggests a unidirectional causality from money to prices implying monetary expansion increases inflation in Pakistan.
    Keywords: Money; Income; Prices; Economic Liberalization; Causal Relations; Pakistan
    JEL: E40
    Date: 2006
  7. By: Anton Nakov (Banco de España; Universitat Pompeu Fabra); Andrea Pescatori (Universitat Pompeu Fabra)
    Abstract: An exogenous oil price shock raises inflation and contracts output, similar to a negative productivity shock. In the standard New Keynesian model, however, this does not generate a tradeoff between inflation and output gap volatility: under a strict inflation targeting policy, the output decline is exactly equal to the efficient output contraction in response to the shock. We propose an extension of the standard model in wich the presence of a dominant oil supplier (OPEC) leads to inefficient fluctuations in the oil price markup, reflecting a dynamic distortion of the economy´s production process. As a result, in the face of oil sector shocks, stabilizing inflation does not automatically stabilize the distance of output from first-best, and monetary policymarkers face a tradeoff between the two goals.
    Keywords: oil shocks, inflation-output gap tradeoff, dominant firm
    JEL: E31 E32 E52 Q43
    Date: 2007–07
  8. By: Burnside, A Craig; Eichenbaum, Martin; Rebelo, Sérgio
    Abstract: High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this `forward premium puzzle.' The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.
    Keywords: Exchange rates; microstructure; Uncovered interest parity
    JEL: F31
    Date: 2007–07
  9. By: Melecky, M
    Abstract: This paper reopens the subject of currency preferences while modeling the exchange rates among three major currencies - the US dollar, the euro and the Japanese yen. The exchange rate model presented in this paper includes not only traditional determinants of bilateral exchange rates but incorporates third-currency effects in addition. The obtained estimation results are interpreted from the perspective of possible currency substitution and complementarity relationships. We find evidence of currency complementarity between the yen and the euro, and currency substitution of the dollar for both the euro and the yen. The estimated third-currency effects are consistent with our findings on currency substitution and complementarity among the three major currencies.
    Keywords: Exchange Rate Modeling; Currency Substitution; Currency Complementarity; Third-Currency Effects
    JEL: F36 F42 F31
    Date: 2007–04
  10. By: Craig Burnside; Martin S. Eichenbaum; Sergio Rebelo
    Abstract: High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this 'forward premium puzzle.' The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.
    JEL: E30 F31
    Date: 2007–07
  11. By: Tatom, John; Ott, Mack
    Abstract: Requiring taxes to be paid in domestic money provides a legal tender basis for money demand and hence to the development of a financial system. In emerging markets, the level of taxation is a positive factor boosting financial development. At higher tax rates, however, taxation provides an incentive to reduce money demand and reduces the size of the financial sector. There is also evidence of re-switching in high-tax developed countries, where financial deepening increases with the tax rate. Such financial deepening represents a form of capital market repression, not unlike the growth-depressing effects of financial repression in many poor countries.
    Keywords: Taxation; financial development; money demand; money multiplier; emerging markets
    JEL: H2 O16 E62
    Date: 2006–10–10
  12. By: Adebiyi, Michael Adebayo
    Abstract: The paper investigates the impact of foreign exchange intervention in the Nigerian foreign exchange market using an Autoregressive Distributed Lag (ARDL) modeling approach. Quarterly time series data spanning 1986:1 to 2003:4 are used and a number of statistical tools are employed to verify this hypothesis. The study examines stochastic characteristics of each time series by testing their stationarity using Phillip Perron (PP) test. This is followed by performing cointegration test using Johansen technique. The existence of co-integration motivates us to estimate the error correction model for broad money, M2. The overall finding from all the techniques employed is that foreign exchange intervention in Nigeria is sterilized because the cumulative aid, which constitute part of foreign exchange inflows, and net foreign assets variables, which are proxies for intervention, are not significant. Thus, paper concludes by recommending, among others, that the use of stock of external reserves to support the exchange rate through increased funding of the foreign exchange market should be encouraged.
    Keywords: Nigeria; Foreign Exchange Intervention; Co-integration and Auto-regressive Distributed Lag
    JEL: E52 E5
    Date: 2007–07–04
  13. By: J. Stephen Ferris (Department of Economics, Carleton University)
    Abstract: In this paper I apply the work of Abrams and Iossifov (2006) to monetary policy in canada to see if same political party affiliation is needed to produce evidence of political opportunism. After modifying their anaylsis to maintain consistency in the time series dimensions of their variables for Canada, I find both an error correction model and a Taylor rule of reformulation of their test generate evidence consistent with same party political opportunism, but only weakly so. On the other hand, I find also that more traditional indicators of political influence present even more convincing evidence of political dependence. In particular, the data suggest that the election of a Liberal party government, a decrease in the degree of political competition, and to a lesser extent, the election of a minority government all positively influence the expansiveness of Canadian monetary policy. In combination, these findings are consistent with the hypothesis that the Bank of Canada is less rather than more independent that is the Fed.
    JEL: E52 E58
    Date: 2007–04–29
  14. By: J L Ford; Bagus Santoso; N J Horsewood
    Abstract: This paper examines the extent to which the Asian currency crises can be accounted for by the macroeconomic fundamentals suggested by first and second generation models, exclusive of the ideas of the third generation models. In doing so we extend the literature on the earlier models by using GARCH and Path Independent Markov-Switching GARCH models to explain the market pressure on the exchange rate, and the probability of the timing of a crisis. In addition, we account for appreciations of the exchange rate. Our empirical estimates for Indonesia, South Korea, Malaysia and Thailand confirm that macroeconomic variables can explain the crises and the probability of occurrence at any time, dominating the conventionally used logit model.
    Keywords: Currency crisis, macroeconomic fundamentals, Markov-switching, volatile sate, stable state, probability of a crisis, logit model
    JEL: F31 F40
    Date: 2007–07
  15. By: Joshua Aizenman
    Abstract: This paper analyzes competing interpretations for the large increases in the hoarding of international reserves by developing countries. While the first phase of the rapid hoarding of reserves in the aftermath of the East Asian crisis has been dominated by self insurance against exposure to foreign shocks, the self insurance motive falls short of explaining the hoarding in Asia in the 2000s. These developments may be a symptom of an emerging new global financial architecture, which is manifested in the proliferation of decentralized and less cooperative arrangements. The emerging financial configuration of developing countries in the aftermath of the 1990s crises has been growing managed exchange rate flexibility, greater monetary independence, and deeper financial integration. Hoarding international reserves is a key ingredient enhancing the stability of this emerging configuration. While not a panacea, international reserves help by providing self insurance against sudden stops; mitigating REER effects of TOT shocks; smoothing overtime the adjustment to shocks by allowing more persistent current account patterns; and possibly even export promotion, though this mercantilist use of reserves remains debatable due to possible coordination issues. Countries following an export oriented growth strategy may end up with competitive hoarding, akin to competitive devaluations. The sheer size of China, and its lower sterilization costs suggests that China may be the winner of a hoarding game. Hoarding international reserves may also be motivated by a desire to deal with vulnerability to internal and external instability, which is magnified by exposure of the banking system to non performing loans. Testing the self insurance and precautionary motives in the context of China may be challenged by a version of the "peso problem." Hoarding international reserves and sterilization have been complementing each other during the last ten years, as developing countries have increased the intensity of both margins.
    JEL: F02 F1 F15 F31 F32 F33 F36 F4
    Date: 2007–07
  16. By: Stefan Grosse; Louis Putterman; Bettina Rockenbach
    Date: 2007
  17. By: Alper, C. Emre; Ardic, Oya Pinar; Fendoglu, Salih
    Abstract: Financial account liberalizations since the second half of the 1980s paved way for the burgeoning literature that investigates foreign exchange market efficiency in emerging markets via testing for the uncovered interest parity (UIP) condition. This paper provides a broad and critical survey on this recent literature as well as a general understanding on the topic through reviewing the related literature on developed economies where recent methodological advances in time series econometrics have provided favorable results, questioning the previously documented UIP puzzle. The literature on emerging markets suggests that these countries deserve a special treatment by taking into account the existence of additional types of risk premia, high inflation episodes, financial contagion, peso problem, simultaneity problem, asymmetricity, and the determination of de facto structural breaks.
    Keywords: Uncovered Interest Parity; Forward Premium Bias; Emerging Markets.
    JEL: F31
    Date: 2007–05–30
  18. By: Tatom, John
    Abstract: This paper looks at interest rate developments in the US and argues that long-term real interest rates are at lows not seen in the past 50 years. It explores competing hypotheses that there is a global saving glut, there is conundrum or that global capital formation has slowed. The dominant view is a glut of saving, especially in China and Asia, that is depressing global real interest rates and boosting growth. While private sector capital formation remains at historic strong levels in the US, the same is not the case abroad. Unfortunately strong saving in China had not resulted in a boom in saving in Asia or globally. A decline in global capital formation is the proximate cause of depressed real interest rates. This is not a cyclical problem that is likely to go away with a rebound in economic activity in Asia or Europe. The implications for economic growth are dismal, despite notable exceptions in China and the US.
    Keywords: interest rates; capital formation; saving
    JEL: G15 F4 E21
    Date: 2007–04–18

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