nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒08‒14
seventeen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Inflation without a quantity of money: a simple Wicksellian model outlined By William Coleman
  2. Is Old Money Better than New? Duration and Monetary Regimes By Mihov, Ilian; Rose, Andrew K.
  3. The Rise and Fall of U.S. Inflation Persistence By Beechey, Meredith; Österholm, Pär
  4. The Exchange Rate Targeting of Central Banks Revised: The Role of Long-term Interest Rates By Lahtinen, Markus; Mäki-Fränt, Petri
  5. Optimal Monetary Policy in an Interdependent World By Michael Evers
  6. Asset-Price Misalignments and Monetary Policy: How Flexible Should Inflation-Targeting Regimes Be? By Jack Selody; Carolyn Wilkins
  7. Japan's monetary policy transition, 1955-2004 By Rhodes, James; Yoshino, Naoyuki
  8. Inflation risk premia in the term structure of interest rates By Peter Hoerdahl; Oreste Tristani
  9. Liquidity, Redistribution, and the Welfare Cost of Inflation By Jonathan Chiu; Miguel Molico
  10. Pairwise-core Monetary Trade in the Lagos-Wright Model By Tai-wei Hu; John Kennan; Neil Wallace
  11. Ambiguity Aversion and the Term Structure of Interest Rates By Patrick Gagliardini; Paolo Porchia; Fabio Trojani
  12. Optimum Policy Domains in an Interdependent World By Michael P. Evers
  13. Market Integration in the Golden periphery The Lisbon/London Exchange, 1854-1891 By Rui Pedro Esteves; Jaime Reis; Fabiano Ferramosca
  14. Multilateral Adjustment and Exchange Rate Dynamics: The Case of Three Commodity Currencies By Jeannine Bailliu; Ali Dib; Takashi Kano; Lawrence Schembri
  15. Real Interest Parity in the EU and the Consequences for Euro Area Membership: Panel Data Evidence, 1979-2005 By Martin O'Brien
  16. Are All Measures of International Reserves Created Equal? An Empirical Comparison of International Reserve Ratios By Cheung, Yin-Wong; Yuk-Pang Wong, Clement
  17. Measuring Long-Run Exchange Rate Pass-Through By de Bandt, Olivier; Banerjee, Anindya; Kozluk, Tomasz

  1. By: William Coleman
    Abstract: The paper advances a simple and tractable Wicksellian model of inflation, in which the price level is determined by the interaction of the nominal rate of return on capital with a rule that governs the interest rate at which the Central Bank supplies money, and in which the equality of the supply of money with its demand has no explanatory role to play.
    Keywords: Wicksell, inflation, monetary policy, central banks
    JEL: E31 E52 E58
    Date: 2007–07
  2. By: Mihov, Ilian; Rose, Andrew K.
    Abstract: We compare the duration and performance of different monetary regimes, especially the contrast between countries those that fix exchange rates and those that target inflation. Inflation targeting is a more durable policy; no country has yet been forced to abandon an inflation target, while many have abandoned fixed exchange rates. Indeed, even though inflation targeting began only in 1990, the duration of inflation targeting regimes is at least as long as, or longer than all alternative monetary regimes for comparable countries. Regime duration also matters in monetary policy; older regimes are typically more successful than younger ones in achieving low inflation.
    Keywords: empirical, panel, exchange, rate, inflation, policy, data, success, target, filter, time
    JEL: E52 E58
    Date: 2007
  3. By: Beechey, Meredith (Monetary Affairs Division); Österholm, Pär (Department of Economics)
    Abstract: This paper estimates the path of inflation persistence in the United States over the last 50 years and draws implications about the evolution of the Federal Reserve's monetary-policy preferences. Standard models of central bank optimization predict that the central bank's preference for output stability is a determinant of inflation persistence. Hence, time variation of that preference should be reflected in changes in inflation persistence. We estimate an ARMA(1,q) model with a time-varying autore- gressive parameter for monthly U.S. inflation data from 1955 to 2006.The coefficients provide an estimate of the inflation target and the path of inflation persistence. The estimated inflation target over the sample is approximately 2.8 percent and we find that inflation persistence declined substantially during Volcker and Greenspan's tenures to a level significantly less than one and significantly below that of the 1970s and early 1980s.
    Keywords: Monetary policy; Central bank preferences; Inflation persistence; Time-varying parameters; Kalman filter
    JEL: E52 E58
    Date: 2007–07–12
  4. By: Lahtinen, Markus; Mäki-Fränt, Petri
    Abstract: Using a New Keynesian macro model, the paper reconsiders the question, whether the central banks should directly respond to exchange rate movements. It is assumed that the transmission of monetary policy to output is carried out by the long-term interest rate, which is determined as a sum of expectations of short-term interest rates and a non-negligible term premium. According to the results, the central banks could gain from stabilizing the exchange rate movements more than suggested in the previous literature. The welfare gains are more clearly seen in the reduced volatility of inflation than stabilization of output, however.
    Keywords: Open economy, Exchange rate determination, Monetary policy
    JEL: E32 E52 E58
    Date: 2007
  5. By: Michael Evers
    Abstract: In the literature on international monetary policy, the paradigm is that gains from coordination are fairly small. Monetary policy is conducted to stabilize macroeconomic fluctuations and gains from policy coordination arise from preventing national monetary authorities from strategically manipulating the terms of trade by means of these stabilization policy instruments. However, as it has been emphasized by \cite{lucas:2003a}, welfare gains from stabilizing fluctuations are generically small since they are of second order. In this paper, I develop a dynamic stochastic two-country model with sticky wages and a cash-in-advance restriction which is in the spirit of the New Open Economy Macroeconomics framework. In this environment, monetary authorities can manipulate the terms of trade by conducting a general short-run monetary policy using both the nominal interest rate and the money supply. The money supply affects the terms of trade by altering the nominal exchange rate ex post and it is used in the traditional way so as to stabilize macroeconomic fluctuations. The nominal interest rate affects the terms of trade by changing expected inflation ex ante. Self-oriented national policymakers use the nominal interest rates to raise the terms of trade ex ante. This leads to an inefficient inflation tax whose welfare effects are of first order. Consequently, gains from monetary policy coordination are of first order.
    Keywords: International Policy Coordination, General Short-Run Monetary Policy, New Open Economy Macroeconomics
    JEL: F41 F42
  6. By: Jack Selody; Carolyn Wilkins
    Abstract: The authors analyze the extent to which inflation-targeting frameworks should incorporate flexibility in order to respond to asset-price misalignments and other atypical events. They examine the costs and benefits of adding flexibility to the Bank's current inflation-targeting framework, and conclude that maintaining low and stable consumer price inflation is the best contribution that monetary policy can make to promoting economic and financial stability, although some flexibility in the target horizon may allow monetary policy to deal appropriately with asset-price bubbles and other atypical events. The authors suggest that monetary policy may, in principle, be better able to maintain low and stable consumer price inflation by leaning against an asset-price bubble (even though it may mean that inflation deviates longer than usual from its target), when such an event is well identified and likely to have significant real economic effects. This circumstance is likely to be rare in practice, however, because economists are far from being able to determine consistently and reliably when leaning against a particular bubble is likely to be successful. The authors also describe ongoing Bank research to better understand the transmission of asset prices to the real economy and the interaction between asset prices and optimal monetary policy.
    Keywords: Monetary policy framework; Inflation targets
    JEL: E5 E6
    Date: 2007
  7. By: Rhodes, James; Yoshino, Naoyuki
    Abstract: This paper surveys the postwar evolution of Bank of Japan (BOJ) monetary policy. Using both qualitative and quantitative data, we describe the changes in the money supply process in response to changing institutional constraints. We focus on the transition from quantitative to qualitative control mechanisms, illuminating, in particular, the important role of the BOJ’s lending guidance (window guidance) in the early periods and financial liberalization in subsequent periods. Monetary policy reaction functions are estimated and used to verify major changes in policy instruments, targets, and indicators.
    Keywords: Japanese Monetary Policy
    JEL: E52 E51
    Date: 2005
  8. By: Peter Hoerdahl; Oreste Tristani
    Abstract: This paper estimates the size and dynamics of inflation risk premia in the euro area, based on a joint model of macroeconomic and term structure dynamics. Information from both nominal and index-linked yields is used in the empirical analysis. Our results indicate that term premia in the euro area yield curve reflect predominantly real risks, i.e. risks which affect the returns on both nominal and index-linked bonds. On average, inflation risk premia were negligible during the EMU period but occasionally subject to statistically signifcant fluctuations in 2004-2006. Movements in the raw break-even rate appear to have mostly reflected such variations in inflation risk premia, while long-term inflation expectations have remained remarkably anchored from 1999 to date.
    Keywords: Term structure of interest rates, inflation risk premia, central bank credibility
    Date: 2007–05
  9. By: Jonathan Chiu; Miguel Molico
    Abstract: This paper studies the long run welfare costs of inflation in a micro-founded model with trading frictions and costly liquidity management. Agents face uninsurable idiosyncratic uncertainty regarding trading opportunities in a decentralized goods market and must pay a fixed cost to rebalance their liquidity holdings in a centralized liquidity market. By endogenizing the participation decision in the liquidity market, this model endogenizes the responses of velocity, output, the degree of market segmentation, as well as the distribution of money. We find that, compared to the traditional estimates based on a representative agent model, the welfare costs of inflation are significantly smaller due to distributional effects of inflation. The welfare cost of increasing inflation from 0% to 10% is 0.62% of income for the U.S. economy and 0.20% of income for the Canadian economy. Furthermore, the welfare cost is generally non-linear in the rate of inflation, depending on the endogenous responses of the liquidity market participation to inflation and liquidity management costs.
    Keywords: Inflation: costs and benefits
    JEL: E40 E50
    Date: 2007
  10. By: Tai-wei Hu; John Kennan; Neil Wallace
    Abstract: The Lagos-Wright model has been analyzed using particular trading protocols. Here, weakly and strongly implementable allocations are studied, where weak and strong are used in the sense of (weak) Nash (immune to individual defection) and strong Nash (immune to individual and cooperative pairwise defection). It is shown that the first-best allocation is strongly implementable without intervention for all sufficiently high discount factors. And, if people are free to skip the centralized meeting, then Friedman-rule intervention that uses lump-sum taxation in the centralized meeting to raise the return on money does not enlarge even the set of weakly implementable allocations.
    JEL: E40
    Date: 2007–08
  11. By: Patrick Gagliardini; Paolo Porchia; Fabio Trojani
    Abstract: This paper studies the term structure implications of a simple structural economy in which the representative agent displays ambiguity aversion, modeled by Multiple Priors Recursive Utility. Bond excess returns reflect a premium for ambiguity, which is observationally distinct from the risk premium of affine yield curve models. The ambiguity premium can be large even in the simplest logutility model and is non zero also for stochastic factors that have a zero risk premium. A calibrated low-dimensional two-factor economy with ambiguity is able to reproduce the deviations from the expectations hypothesis documented in the literature, without modifying in a substantial way the nonlinear mean reversion dynamics of the short interest rate. In this economy, we do not find any apparent tradeoffs between fitting the first and second moments of the yield curve and the large equity premium.
    Keywords: General Equilibrium, Term Structure of Interest Rates, Ambiguity Aversion, Expectations Hypothesis, Campbell-Shiller Regression
    JEL: C68 G12 G13
    Date: 2007–07
  12. By: Michael P. Evers
    Abstract: In this paper, I argue that international policy coordination requires to include both monetary as well as fiscal policy because both sides include policy instruments that allow the strategic manipulation of the country's terms of trade. Hence, the coordination of one part of national macroeconomic policies through an international agreement still leaves room for national authorities to still unilaterally manipulate the terms of trade by means of different policy instruments. In a simple and tractable dynamic stochastic two-country sticky-wage model in line with the recent New Open Economy Macroeconomics it is demonstrated that potential gains from international policy coordination are squandered if policymakers only cooperate on monetary policy. Moreover, by letting the fiscal policy instruments be chosen non-cooperatively, monetary policy coordination might even create welfare losses as compared to no macroeconomic policy coordination at all.
    Keywords: International Policy Coordination; Monetary and Fiscal Policy Interaction; Beggar-Thy-Neighbor; New Open Economy Macroeconomics
    JEL: F41 F42 E62 E63
  13. By: Rui Pedro Esteves; Jaime Reis; Fabiano Ferramosca
    Abstract: The existence of a self-regulating arbitrage mechanism under the gold standard has been traditionally considered as one of its main advantages, and attracted a corresponding research interest. This research is arguably relevant not only to test for the efficiency of the "gold points", but also to study the evolution of financial integration during the so-called first era of globalization. Our first aim with this paper is to contribute to the enlargement of the scope of the literature by considering the case of Portugal that adhered to the system, in 1854, at a much earlier phase than the majority of countries, thus allowing for a broader perspective on the evolution of the efficiency of the foreign exchange market. As a typical "peripheral" country, Portugal can be used as the starting point for a study of the degree of integration of the periphery within the system. Furthermore, the Portuguese exchange also illustrates the role in practice of large players in sustaining currency stability, over and beyond the atomistic forces of arbitrage and speculation assumed in conventional theoretical frameworks. We also address the question of the credibility of the authorities` commitment to the standard, through the perspective of the target zone literature.
    Keywords: Gold Standard, Credibility, Portugal, Pre-1913
    JEL: F31 F33 N23
    Date: 2007
  14. By: Jeannine Bailliu; Ali Dib; Takashi Kano; Lawrence Schembri
    Abstract: In this paper, we empirically investigate whether multilateral adjustment to large U.S. external imbalances can help explain movements in the bilateral exchange rates of three commodity currencies -- the Australian, Canadian and New Zealand (ACNZ) dollars. To examine the relationship between exchange rates and multilateral adjustment, we develop a new regimeswitching model that augments a standard Markov-switching framework with a threshold variable. This enables us to model the exchange rate dynamics of our commodity currencies in the context of two regimes: one in which multilateral adjustment to large U.S. external imbalances is an important factor driving the commodity currencies and the second in which there are no significant U.S. external imbalances and hence multilateral adjustment is not a factor. We compare the performance of this model, both in and out-of-sample, to several other alternative models. In addition to developing this new model, another distinguishing feature of our paper is that we estimate all of our models using a Bayesian approach. We opt for a Bayesian approach in this context because it provides a simpler and more intuitive means of evaluating and comparing our different non-nested models. Moreover, it is relatively straightforward using a Bayesian approach to evaluate the importance of nonlinearities in the relationship between exchange rates and multilateral adjustment. Our findings suggest that during periods of large U.S. imbalances, fiscal and external, an exchange rate model for the ACNZ dollars should allow for multilateral adjustment effects. Moreover, we also find evidence to suggest that the adjustment of exchange rates to multilateral adjustment factors is best modelled as a non-linear process.
    Keywords: Exchange rates; Econometric and statistical methods
    JEL: F31 F32 C11 C22
    Date: 2007
  15. By: Martin O'Brien (Economic and Social Research Institute (ESRI))
    Abstract: This paper examines whether macroeconomic convergence is an automatic outcome of forming a currency union by combining an analysis of real interest parity (RIP) in the EU with the argument for the endogeneity of the Optimum Currency Area (OCA) criteria. Using the DF-GLS and the CIPS* panel unit root test, RIP is tested for a sample of Euro area and non-Euro area EU member states with respect to Germany for key sub-periods covering 1979 M3 – 2005 M12. RIP is not found to hold for most of the sample between 1979 M3 and 1998 M12. There is evidence in favour of RIP for most of the Euro area sample during the 1999 M1 – 2005 M12 sub-period, exceptions being Ireland, Italy and Spain. RIP does not hold for any of the non-Euro area countries during the same period. This indicates some support for the endogeneity hypothesis, with the caveat that certain country-specific issues can seriously hinder the “automatic” integration process.
    Date: 2007–03
  16. By: Cheung, Yin-Wong; Yuk-Pang Wong, Clement
    Abstract: Using available annual data of 174 economies since 1957, we examine the similarities and differences of seven international reserve ratios. While individual international reserve ratios display substantial variations across economies, they are associated with an economy’s characteristics including geographic location, income level, stage of development, degree of indebtedness, and exchange rate regime. The association pattern varies across time and type of international reserve ratios. Interestingly, there is only limited evidence that Asian and non-Asian economies have significantly different international reserve hoarding behavior. Our results suggest that the inference about whether an economy is hoarding too many or too few international reserves depends on the choice of international reserve ratio. Further, different international reserve ratios exhibit different persistence profiles, but the evidence of dependence on structural characteristics is rather weak.
    Keywords: International Reserve Ratios, Structural Characteristics, Cross-Economy Analysis
    JEL: F30 F40
    Date: 2007
  17. By: de Bandt, Olivier; Banerjee, Anindya; Kozluk, Tomasz
    Abstract: The paper discusses the issue of estimating short- and long-run exchange rate pass-through to import prices in euro area countries and reviews some problems with the measures recently proposed in the literature. Theoretical considerations suggest a long-run Engle and Granger cointegrating relationship (between import unit values, the exchange rate and foreign prices), which is typically ignored in existing empirical studies. We use time series and up-to-date panel data techniques to test for cointegration with the possibility of structural breaks and show how the long-run may be restored in the estimation. The main finding is that allowing for possible breaks around the formation of EMU and the appreciation of the euro starting in 2001 helps restore a long run cointegration relationship, where over the sample period the fixed component of the pass-through decreased while the variable component tended to increase.
    Keywords: exchange rates, pass-through, import prices, panel cointegration, structural break
    JEL: C23 F14 F31 F36 F42
    Date: 2007

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