nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒09‒16
38 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Inflation Targeting in Georgia: Are We There Yet? By Andreas Billmeier; Giorgi Bakradze
  2. Monetary Policy In Islamic Economic Framework: Case of Islamic Republic of Iran By Kiaee, Hasan
  3. A Small Macroeconomic Model to Support Inflation Targeting in Israel By Argov, Eyal; Binyamini, Alon; Elkayam, David; Rozenshtrom, Irit
  4. Where Have the Monetary Surprises Gone? The Effects of FOMC Statements By Andrew Swiston
  5. On the Optimal Choice of a Monetary Policy Instrument By Andrew Atkeson; V. V. Chari; Patrick J. Kehoe
  6. The international transmission of monetary shocks in a dollarized economy: The case of USA and Lebanon By Charbel Cordahi; Jean-François Goux
  7. Toward a Bias Corrected Currency Equivalent Index By Kelly, Logan; Barnett, William; Keating, John
  8. A Simple DGE Model for Inflation Targeting By Jaromir Benes; David Vávra; Marta de Castello Branco
  9. Essential Interest-Bearing Money By Andolfatto, David
  10. The optimal inflation target in an economy with limited enforcement By Gaetano Antinolfi; Costas Azariadis; James B. Bullard
  11. Monetary Policy Rules for Managing Aid Surges in Africa By Edward F. Buffie; Christopher Adam; Catherine A. Pattillo; Stephen A. O'Connell
  12. Determinants of Inflation in Poland: A Structural Cointegration Approach By Kim , Byung-Yeon
  13. Globalisation and Inflation in OECD Countries By Gernot Pehnelt
  14. One for Some or One for All? Taylor Rules and Interregional Heterogeneity By Olivier Coibion; Daniel Goldstein
  15. The Impact of Monetary Policy Shocks on Stock Prices: Evidence from Canada and the United States By Yun Daisy Li; Talan B. Iscan; Kuan Xu
  16. Testing Globalization-Disinflation Hypothesis By Calani, Mauricio
  17. Financial contagion, interest rates and the role of the exchange rate as shock absorber in Central and Eastern Europe By Habib , Maurizio Michael
  18. Measuring Central Bank Independence in Selected Transition Countries and the Disinflation Process By Dvorsky , Sandra
  19. Leadership in Groups: A Monetary Policy Experiment By Alan S. Blinder; John Morgan
  20. Three great American disinflations By Michael Bordo; Christopher Erceg; Andrew Levin; Ryan Michaels
  21. What Explains Persistent Inflation Differentials Across Transition Economies? By Mark J Flanagan; Felix Hammermann
  22. Substituting a Substitute Currency – The Case of Estonia By Heimonen , Kari
  23. Quasi-fiscal operations of central banks in transition economies By Markiewicz , Malgorzata
  24. Money Shocks in a Small Open Economy with Dollarization, Factor Price Rigidities, and Nontradeables By Sarajevs, Vadims
  25. Growth and Inflation Dispersions in EMU: Reasons, the Role of Adjustment Channels, and Policy Implications By Emil Stavrev
  26. Fiscal Explanations for Inflation: Any Evidence from Transition Economies? By Komulainen, Tuomas; Pirttilä , Jukka
  27. Econometric Analysis of Currency Substitution: A Case of Latvia By Sarajevs, Vadims
  28. The Breakup of the Euro Area By Barry Eichengreen
  29. Similarity of supply and demand shocks between the Euro area and the CEECs By Fidrmuc, Jarko; Korhonen, Iikka
  30. Some empirical tests on the integration of economic activity between the Euro area and the accession countries By Korhonen , Iikka
  31. Money, Barter and Inflation in Russia By Kim, Byung-Yeon; Pirttilä, Jukka; Rautava , Jouko
  32. Notes on the inflation dynamics of the New Keynesian Phillips Curve By Andreas Hornstein
  33. Discrete Devaluations and Multiple Equilibria in a First Generation Model of Currency Crises By Fernando Broner
  34. Win or Lose, It’s the Policy We Choose: Comparative economic performance of the inflation targeters By Beja, Jr., Edsel
  35. Dollarization in Lithuania: An Econometric Approach By Vetlov , Igor
  36. Investigating the Balassa-Samuelson hypothesis in transition: Do we understand what we see? By Égert , Balázs
  37. Some benefits of reducing inflation in transition economies By Blaszkiewicz, Monika; Konieczny, Jerzy; Myslinska, Anna; Radziwiland, Artur; Wozniak , Przemyslaw
  38. What can the data tell us about carry trades in Japanese yen? By Joseph E. Gagnon; Alain P. Chaboud

  1. By: Andreas Billmeier; Giorgi Bakradze
    Abstract: This paper evaluates whether Georgia is ready to adopt inflation targeting (IT), a monetary policy framework that several emerging markets have adopted recently. After reviewing selected prerequisites for successfully implementing IT, the paper focuses on whether one specific precondition is in place-an empirically stable monetary transmission mechanism. Building on a baseline VAR model, it presents several extensions to explore the various channels using causality tests, impulse responses, and variance decompositions. The paper finds that once the central bank overcomes some institutional and operational weaknesses and establishes a more reliable transmission mechanism, it could adopt IT over the medium term.
    Keywords: Inflation targeting , Georgia , Monetary policy , Monetary transmission mechanism , Working Paper ,
    Date: 2007–08–02
  2. By: Kiaee, Hasan
    Abstract: Abstract When we accept money and its functions in the Islamic economic framework, the same as all other economic systems, we should consider monetary policy as an important available tool for governments to pursuit macroeconomic objectives. But the problem is that, in the conventional economic system, the interest rate plays a critical role for executing monetary policy while in the Islamic economic framework, interest rate is forbidden according to Shariah rules and we are not allowed to use interest based instruments for monetary policy. The dominant view between Islamic scholars is that, since interest based instruments like open market operation is forbidden in Islamic economics, hear, we should only use monetary aggregate instruments like credit ceiling for executing monetary policy. But in reality, many Islamic countries do not restrict theirselves to only monetary aggregate instruments; instead, they use widely profit rate instruments like Musharakah certificates as a substitute for interest based instruments. What we discuss in this paper is the explanation for this gap between theory and practice in the monetary policy of Islamic economic system. Comparing interest based instruments and monetary aggregate instruments from economic point of view shows that, when we use interest based instruments, there is more macroeconomic stability in goods and money markets after executing monetary policy. This advantage of interest based instruments over monetary aggregate instruments has made monetary officials of Islamic countries like Islamic republic of Iran, use extensively profit rate instruments like Musharakah certificates for executing monetary policy.
    Keywords: Islamic Economics; Islamic Monetary Policy; Iranian Monetary System
    JEL: E52 E43
    Date: 2007–04–13
  3. By: Argov, Eyal; Binyamini, Alon; Elkayam, David; Rozenshtrom, Irit
    Abstract: This study presents a small New Keynesian model of Israel’s economy describing the relationships among the main variables relevant to the transmission mechanism of monetary policy. The model encompasses three structural equations––for inflation, the output gap, and the exchange rate––and an interest rate rule, that describes how the interest rate should be adjusted in order to eventually achieve the inflation target. The theory underlying the model is broadly in line with the current monetary theory prevailing in academia and central banks. The model is small, yet it includes the main channels through which the central bank’s interest rate affects inflation in a small open economy. An important advantage of a small model is its ability to describe, clearly and simply, the interrelation between the main variables that are related to the transmission mechanism of the monetary policy, while maintaining theoretical coherence. The model presented is intended to serve as an operational tool that can aid policy makers to assess the interest rate path required to achieve the inflation target, but it can also serve others interested in monitoring monetary developments or in forecasting the evolution of the relevant variables. The model can also help to focus the monetary-policy discussion and enhance the communication between the various entities, both within and outside the central bank, involved in monetary policy and its outcomes. To improve the forecasting ability of the model, in formulating the equations we tried to strike a balance between the need to maintain economic logic and the need to obtain an adequate empirical description of the relation between the relevant variables. The parameters of the model were estimated using quarterly data of Israel’s economy in the years 1992 to 2005.
    Keywords: MacroeconomicModel; Inflation Targeting; New Keynesian Model
    JEL: E5 E4
    Date: 2007–07
  4. By: Andrew Swiston
    Abstract: This paper examines the impact of central bank communication on market expectations of monetary policy and long-term interest rates by comparing Federal Open Market Committee (FOMC) action dates when a policy statement was made to dates before statements were issued. Increased communication has been associated with a reduction in the magnitude of short-term monetary surprises; a greater flow of information about the long-term path of policy that is distinct from the short-term surprise; and a larger role for these long-term surprises in the determination of long-term interest rates.
    Keywords: Working Paper , United States ,
    Date: 2007–07–26
  5. By: Andrew Atkeson; V. V. Chari; Patrick J. Kehoe
    Abstract: The optimal choice of a monetary policy instrument depends on how tight and transparent the available instruments are and on whether policymakers can commit to future policies. Tightness is always desirable; transparency is only if policymakers cannot commit. Interest rates, which can be made endogenously tight, have a natural advantage over money growth and exchange rates, which cannot. As prices, interest and exchange rates are more transparent than money growth. All else equal, the best instrument is interest rates and the next-best, exchange rates. These findings are consistent with the observed instrument choices of developed and less-developed economies.
    JEL: E3 E31 E4 E42 E51 E52 E58 E6 E61
    Date: 2007–09
  6. By: Charbel Cordahi (Université Saint Esprit de Kaslik (USEK), Kaslik); Jean-François Goux (GATE CNRS)
    Abstract: We show that an American monetary shock wields an influence, though limited, over the Lebanese output in accordance with the literature advances. However, as we are waiting for a stronger transmission of U.S. short-term rates to Lebanese short-term rates, we notice that this transmission is weak in the first year. The result can be explained by the presence of pricing-to-market. After the end of the first year, we find the traditional result where the increase in the American interest rate is transmitted integrally to the Lebanese interest rate. We recognize this phenomenon as the dollarization effect.
    Keywords: interest rate - International transmission - law of one price - monetary shock - purchasing power parity
    JEL: E3 E4 F3 F4
    Date: 2007–07
  7. By: Kelly, Logan; Barnett, William; Keating, John
    Abstract: Measuring the economic stock of money, defined to be the present value of current and future monetary service flows, is a difficult asset pricing problem, because most monetary assets yield interest. Thus, an interest yielding monetary asset is a joint product: a durable good providing a monetary service flow and a financial asset yielding a return. The currency equivalent index provides an elegant solution, but it does so by making strong assumptions about expectations of future monetary service flows. These assumptions cause the currency equivalent index to exhibit significant downward bias. In this paper, we propose an extension to the currency equivalent index that will correct for a significant amount of this bias.
    Keywords: Currency Equivalent Index; Monetary Aggregation; Money Stock
    JEL: E49 C43
    Date: 2007–09–09
  8. By: Jaromir Benes; David Vávra; Marta de Castello Branco
    Abstract: The paper presents a DGE model designed as a core projection tool to support monetary policy in inflation-targeting (IT) emerging market economies. The paper uses a particularly simple and flexible general equilibrium model structure that can be amended to account for various phenomena that often complicate policy analysis in emerging markets, such as persistent trends in relative prices. The model's calibration is intuitive and can draw on the vast experience many countries have with calibrating small 'gap' models of monetary policy transmission. Moreover, the definition of the model's steady state in terms of nominal expenditure ratios, rather than levels of real variables, allows for the easy use of the model in a regular forecast production cycle in an IT central bank. The paper tests the model's properties on recent Turkish data, demonstrating that the main stylized features relevant for monetary policy making are well captured by the model.
    Date: 2007–08–03
  9. By: Andolfatto, David
    Abstract: In this paper, I provide a rationale for why money should earn interest; or, what amounts to the same thing, why risk-free claims to non-interest-bearing money should trade at discount. I argue that interest-bearing money is essential when individual money balances are private information. The analysis also suggests one reason for why it is sufficient (as well as necessary) for interest to be paid only on large money balances; or equivalently, why bonds need only be issued in large denominations.
    Keywords: Money; Bonds; Monetary Policy; Friedman Rule
    JEL: E4
    Date: 2007–09–07
  10. By: Gaetano Antinolfi; Costas Azariadis; James B. Bullard
    Abstract: We formulate the central bank?s problem of selecting an optimal long-run inflation rate as the choice of a distorting tax by a planner who wishes to maximize discounted utility for a heterogeneous population of infinitely-lived households in an economy with constant aggregate income. Households are divided into cash agents, who store value in currency alone, and credit agents who have access to both currency and loans. The planner?s problem is equivalent to choosing inflation and nominal rates consistent with a resource constraint along with an incentive constraint that ensures credit agents prefer the superior consumption-smoothing power of loans to that of currency. We show that the optimum rate of inflation is positive, and the optimum nominal interest rate is higher than the inflation rate, if the social welfare function weighs credit agents no more than their population fraction.
    Keywords: Inflation (Finance) ; Deflation (Finance) ; Monetary policy - United States
    Date: 2007
  11. By: Edward F. Buffie; Christopher Adam; Catherine A. Pattillo; Stephen A. O'Connell
    Abstract: Since the turn of the century, aid flows to Africa have increased on average and become more volatile. As a result, policymakers, particularly in post-stabilization countries where inflation has only recently been brought under control, have been increasingly preoccupied with how best to deploy the available instruments of monetary policy without yielding on hard-won inflation gains. We use a stochastic simulation model, in which private sector currency substitution effects play a central role, to examine the properties of alternative monetary and fiscal policy strategies in the face of volatile aid flows. We show that simple monetary rules, specifically an (unsterilized) exchange rate crawl and a 'reserve buffer plus float'-under which the authorities set a time-varying reserve target corresponding to the unspent portion of aid financing and allow the exchange rate to float freely once this reserve target is satisfied-have attractive properties relative to a range of alternative strategies including those involving heavy reliance on bond sterilization or a commitment to a 'pure' exchange rate float.
    Date: 2007–07–26
  12. By: Kim , Byung-Yeon (BOFIT)
    Abstract: Using cointegration and error-correction models, this paper analyses the relative impacts of the monetary, labour and foreign sectors on Polish inflation from 1990 to 1999. Following the development of a theoretical framework, we use a structural system approach in which cointegration relationships are used to derive deviations from steady-state levels. The deviations are interpreted as excess demand pressure on inflation in a given sector and subsequently incorporated in order to determine the short-run dynamics of Polish inflation. The results suggest that the labour and external sectors dominated the determination of Polish inflation during the above period, but their effects have been opposite since 1994. The appreciation of the domestic currency contributed to reducing inflation, while excessive wage increases prevented inflation from decreasing to a lower level. The monetary sector appears not to have exerted influence on inflation, suggesting monetary policy has been passive.
    Keywords: inflation; cointegration; error correction mechanism; Poland
    Date: 2007–09–13
  13. By: Gernot Pehnelt (Friedrich-Schiller University Jena, School of Business and Economics Author-Workplace-Postal: Carl-Zeiss-Str. 3, D-07743 Jena)
    Abstract: During the last two decades, the world has experienced a remarkable process of disinflation, with average inflation rates in industrialized countries falling by 10 percentage points and an even sharper decline of the mean rate of inflation in developing countries. Parallel to the decline in inflation rates, a tremendous increase in economic integration - often referred to as globalisation - has been taking place. In this article, we analyse the effects of globalisation on inflation in OECD countries. We theoretically outline different channels through which globalisation may have influenced inflation dynamics and give an overview on the existing empirical evidence on this issue. In the empirical analysis we show that globalisation has contributed to the disinflation process in OECD countries since the 1980s. Inflation rates became much less prone to domestic parameters, especially the domestic output gap. Global factors such as the output gap of the main trading partners became more important in determining national inflation rates. Furthermore, economic freedom and the degree of globalisation are positively related to the disinflation process. Central bank independence seems to have contributed to the decline in inflation rates among OECD countries process, but the effect is rather modest. Though the inertia of inflation can still be observed, the persistence of inflation has considerably declined since the early 1990s.
    Keywords: inflation, globalisation, openness, panel analysis
    JEL: E30 E31 E58 F41
    Date: 2007–09–10
  14. By: Olivier Coibion (Department of Economics, College of William and Mary); Daniel Goldstein (Department of Economics, Pennsylvania State University)
    Abstract: We document a novel empirical phenomenon: both the US Federal Reserve and the European Central Bank appear to set interest rates partly in response to regional disparities in unemployment rates. This result is remarkably robust – particularly for the US – even after controlling for a wide variety of factors, including the central bank’s information set and a battery of explanatory variables. Furthermore, including measures of interregional unemployment dispersion improves the precision of the estimates of the central banks’ responses to aggregate inflation and unemployment rates. Moreover, inclusion of the variance of unemployment across regions brings each bank’s policies with respect to macroeconomic aggregates into alignment with each other. We propose three models in which central bank policymaking is influenced by disparities across regions. Testing specific implications of these models suggests that each bank’s approach to policy may differ in fundamental ways.
    Keywords: Regional Heterogeneity, Monetary Policy, Taylor Rules
    JEL: E5 E6
    Date: 2007–09–11
  15. By: Yun Daisy Li; Talan B. Iscan; Kuan Xu (Department of Economics, University of Western Ontario; Department of Economics, Dalhousie University; Department of Economics, Dalhousie University)
    Keywords: monetary policy shocks; stock prices; open economy; structural vector autoregressive model
    Date: 2007–09–12
  16. By: Calani, Mauricio
    Abstract: This paper addresses the globalization - disinflation hypothesis from the perspective of a open economy neo keynesian framework. This hypothesis proposes that globalization has changed the long-run inflation process, resulting in a global disinflation. If true, it makes us wonder about the merit of central banks in this phenomenon. Even more, challenges our knowledge that long-run inflation is ultimately a monetary issue. This paper explicitly addresses this hyphotesis, analyzing how different degrees of globalization change the response of output and inflation to supply shocks. To accomplish this, the use of a general equilibrium approach in which we can identify shocks and openness is a must. Globalization is however, a complex process. In this paper I explicitly model globalization just as an openness process. Simulation results suggest that as long as there is one distortion - free market for assets, the discussion about the changed values of price stickiness measures which would affect the long-run inflation process is of reduced importance. It is also suggested that financial integration, and not trade or competition, is the key to understanding the link between globalization and inflation.
    Keywords: Disinflation; Globalization
    JEL: E31 E50
    Date: 2007–08–19
  17. By: Habib , Maurizio Michael (BOFIT)
    Abstract: This paper studies the impact of external factors on daily exchange rates and short-term interest rates in the Czech Republic, Hungary and Poland during the period August 1997 – May 2001. I find that neither exchange rates nor interest rates are influenced by short-term German interest rates. Nevertheless, I show that shocks to emerging-market risk premia had a significant impact on exchange rates in all three Central and Eastern European countries and on interest rates in the Czech Republic. In addition, studying the second moment of the variables, I demonstrate that Czech and Polish exchange rates were affected by ‘volatility contagion’ coming from emerging markets. I find also some partial support for the ‘volatility contagion’ hypothesis on Czech interest rates. These findings shed some doubts on the alleged theoretical ability of a floating exchange rate – such as in the Czech Republic – to absorb external shocks and insulate a country's domestic monetary policy completely. However, the spill-over effect on Czech interest rates might be explained by the ‘managed’ nature of the exchange rate regime, thereby re-establishing some credibility of the theory.
    Keywords: exchange rates; short-term interest rates; volatility; Czech Republic; Hungary; Poland
    Date: 2007–09–11
  18. By: Dvorsky , Sandra (BOFIT)
    Abstract: The paper measures the degree of legal and actual central bank independence (CBI) in five Central and Eastern European transition economies striving for EU accession, namely the Czech Republic, Hungary, Poland, Slovakia and Slovenia (CEEC-5). The degree of legal CBI is measured by applying the two most widely used indices, the Cukierman and the Grilli-Masciandaro-Tabellini (GMT) indices. Moreover, the turnover rate of central bank governors is used as a proxy to measure actual CBI. The paper gives an interpretation of computed results, comparing the findings with those of other authors and earlier calculations. Furthermore, the indices on legal and actual CBI themselves are critically reviewed, in particular against the background of the Maastricht Treaty requirements, which in practice constitute the driving force for any amendment of central bank laws in the CEEC-5. Moreover, the role of CBI in bringing down inflation in the CEEC-5 at different stages of transition is briefly discussed. The paper concludes that the overall degree of legal CBI is comparatively high in all countries examined, while the measured turnover rates of governors do not seem to fully reflect the degree of actual CBI in the CEEC-5. Looking at the role of CBI in the disinflation process at different stages of transition, the main causes for inflation seem to have been beyond the direct control of the central bank. A high degree of CBI, together with a reasonable mix of fiscal and monetary policies as well as structural reforms, will be necessary for the CEEC-5 to meet all requirements for joining the EU and, in a more distant future, for adopting the euro.
    Keywords: transition; central bank independence; disinflation
    Date: 2007–09–13
  19. By: Alan S. Blinder; John Morgan
    Abstract: In an earlier paper (Blinder and Morgan, 2005), we created an experimental apparatus in which Princeton University students acted as ersatz central bankers, making monetary policy decisions both as individuals and in groups. In this study, we manipulate the size and leadership structure of monetary policy decisionmaking. We find no evidence of superior performance by groups that have designated leaders. Groups without such leaders do as well as or better than groups with well-defined leaders. Furthermore, we find rather little difference between the performance of four-person and eight-person groups; the larger groups outperform the smaller groups by a very small margin. Finally, we successfully replicate our Princeton results, at least qualitatively: Groups perform better than individuals, and they do not require more "time" to do so.
    JEL: E52 E58
    Date: 2007–09
  20. By: Michael Bordo; Christopher Erceg; Andrew Levin; Ryan Michaels
    Abstract: This paper analyzes the role of transparency and credibility in accounting for the widely divergent macroeconomic effects of three episodes of deliberate monetary contraction: the post-Civil War deflation, the post-WWI deflation, and the Volcker disinflation. Using a dynamic general equilibrium model in which private agents use optimal filtering to infer the central bank's nominal anchor, we demonstrate that the salient features of these three historical episodes can be explained by differences in the design and transparency of monetary policy, even without any time variation in economic structure or model parameters. For a policy regime with relatively high credibility, our analysis highlights the benefits of a gradualist approach (as in the 1870s) rather than a sudden change in policy (as in 1920-21). In contrast, for a policy institution with relatively low credibility (such as the Federal Reserve in late 1980), an aggressive policy stance can play an important signalling role by making the policy shift more evident to private agents.
    Keywords: Monetary policy - United States ; Deflation (Finance)
    Date: 2007
  21. By: Mark J Flanagan; Felix Hammermann
    Abstract: Panel estimates based on 19 transition economies suggests that some central banks may aim at comparatively high inflation rates mainly to make up for, and to perhaps exploit, lagging internal and external liberalization in their economies. Out-of-sample forecasts, based on expected developments in the underlying structure of these economies, and assuming no changes in institutions, suggest that incentives may be diminishing, but not to the point where inflation levels below 5 percent could credibly be announced as targets. Greater economic liberalization would help reduce incentives for higher inflation, and enhancements to central bank independence could help shield these central banks from pressures.
    Date: 2007–07–31
  22. By: Heimonen , Kari (BOFIT)
    Abstract: This study evaluates substitution of foreign currency balances in Estonia, a transition economy neighbouring countries participating in EMU. The focus is on substitution between dollar and euro balances in the three basic functions of money - unit of account, store of value and means of payment. While traditional models for currency substitution concentrate on substitution between a domestic currency and aggregate foreign currency balances, we look for substitution between the dollar and the euro or euro-related foreign currency balances. We find substitution between dollarization and euroization to be asymmetric in the short run, which suggests that inertia, irreversibility and ratchet effects favour the euro. No significant evidence of asymmetries in the long run was detected. In general, the traditional model for currency substitution explains the dynamics of the euro and dollar as substitute foreign currencies.
    Keywords: euro; dollar; currency substitution; currency demand
    Date: 2007–09–13
  23. By: Markiewicz , Malgorzata (BOFIT)
    Abstract: This paper reviews issues associated with quasi-fiscal operations (QFO) of central banks in a sample of countries in Central and Eastern Europe and the former Soviet Union. The concern is the problem of transparency in fiscal and monetary accounts when the central bank undertakes quasi-fiscal operations and the government falls short of providing full coverage of fiscal operations. QFO can also jeopardize monetary policy designed to maintain price stability. A simple framework is developed to estimate the extent of QFO. In some cases, the magnitude of QFO is significant in indicating underestimation of fiscal deficit figures. We claim that the lack of transparency in fiscal accounts of transition countries warrants serious concern.
    Keywords: quasi-fiscal operations; transition economy and transparency
    Date: 2007–09–12
  24. By: Sarajevs, Vadims (BOFIT)
    Abstract: The impact of an unanticipated monetary shock in a small open economy with dollarization, factor price rigidities, and nontradeables is re-examined in an optimizing intertemporal general equilibrium model. The framework of an earlier study is extended to incorporate foreign real money balances into the repre-sentative agent's utility function and to account for the phenomenon of dollarization so characteristic of transition economies. The major finding is that in the event of small monetary shocks, the presence of dollarization does not alter the outcome that relates the sign of response of consumption, current account balance, and other macroeconomic variables to the difference between intertemporal and intratemporal elasticities of substitutions of the total consumption index. The solution also shows that the elasticity of intertemporal substitution of money services and the share of traded goods in total consumption - a proxy for openness of the economy - are the crucial parameters in determining the response and the possibility of overshooting of the model variables, with economic openness playing a stabilizing role for the econ-omy in the event of monetary shocks.
    Keywords: new open-economy macroeconomics; monetary shocks; dollarization; factor price rigidities; nontradeables; current account
    JEL: F31 F32 F41 F47
    Date: 2007–09–13
  25. By: Emil Stavrev
    Abstract: This paper's analysis of growth and inflation dispersions in the euro area reveals several findings. First, these dispersions have declined appreciably since EMU; remaining dispersions are small but persistent, relating mainly to country-specific shocks, not differences in the transmission of common shocks. Second, the different behavior of interest rates just before and after the introduction of the euro has contributed significantly to growth dispersions. However, this has been a one-off shock whose effects, particularly on construction, should be declining over time. Third, financial sector integration could do much more to insure countries against shocks and increase consumption smoothing.
    Keywords: Working Paper , Euro Area ,
    Date: 2007–07–17
  26. By: Komulainen, Tuomas (BOFIT); Pirttilä , Jukka (BOFIT)
    Abstract: Recent arguments, motivated partly by the new fiscal theory of price level, suggest that fiscal deficits undermine price stability in transition economies. This paper addresses these claims by examining vector-autoregressive models of inflation for three crisis-hidden transition economies (Bulgaria, Romania and Russia). The results indicate that while fiscal deficits have increased inflation in Bulgaria to a certain extent, this has not been the case in Romania and Russia. Even in the Bulgarian case, the usual money aggregate has proven more influential to inflation than fiscal deficits. The analysis based on this method therefore suggests that monetary policy plays an influential role in inflation determination in these countries. In other words, inflationary financing of deficits, rather than deficits themselves, accounts for inflation.
    Keywords: fiscal policy; inflation; vector autoregressive models; transition economies
    Date: 2007–09–13
  27. By: Sarajevs, Vadims (BOFIT)
    Abstract: The paper provides a comprehensive econometric analysis of currency substitution for Latvia. Rather than drawing inferences on the degree of currency substitution from domestic money demand modelling, the most common approach to empirical analysis of the phenomenon, direct modelling of currency substitution ratio is ap-plied. Extensive model construction, estimation, evaluation and testing are per-formed. Methodological issues are also discussed. No simple policy recommenda-tions can be made at this stage of research, but a number of instruments are identi-fied, which can be used by the authorities to influence currency substitution behaviour.
    Keywords: currency substitution; exogeneity; unit roots; causality; cointegration; parameter constancy
    Date: 2007–09–13
  28. By: Barry Eichengreen
    Abstract: The possibility that the euro area might break up was being raised even before the single currency existed. These scenarios were then lent new life five or six years on, when appreciation of the euro and problems of slow growth in various member states led politicians to blame the European Central Bank for disappointing economic performance. Highly-placed European officials reportedly discussed the possibility that one or more participants might withdraw from the monetary union. How seriously should we take these scenarios? And how significant would be the economic and political consequences? It is unlikely, I argue here, that one or more members of the euro area will leave in the next ten years; total disintegration of the euro area is even more unlikely. While other authors have minimized the technical difficulties of reintroducing a national currency, I suggest that those technical difficulties would be quite formidable. Nor is it certain that the economic problems of the participating member states would be significantly ameliorated by abandoning the euro. And even if there are immediate economic benefits, there would be longer-term political costs.
    JEL: F15 F33
    Date: 2007–09
  29. By: Fidrmuc, Jarko (BOFIT); Korhonen, Iikka (BOFIT)
    Abstract: We assess the correlation of supply and demand shocks between the countries of the euro area and the accession countries in the 1990s. Shocks are recovered from estimated structural VAR models of output growth and inflation. We find that some accession countries have a quite high correlation of the underlying shocks with the euro area. However, even for many advanced accession countries, the shocks remain significantly more idiosyncratic. Furthermore, many EU countries seem to have a much higher correlation with the core euro area countries than in the previous decades. Continuing integration within the EU seems to have aligned the business cycles of these countries as well.
    Keywords: optimum currency area; EMU; EU enlargement; structural VAR
    JEL: E32 F42
    Date: 2007–09–13
  30. By: Korhonen , Iikka (BOFIT)
    Abstract: This note looks at the correlation of short-term business cycles in the euro area and the EU accession countries. The issue is assessed with the help of vector autoregressive models. There are clear differences in the degree of correlation between accession countries. For Hungary and Slovenia, euro area shocks can explain a large share of variation in industrial production, while for some countries this influence is much smaller. For the latter countries, the results imply that joining the monetary union could entail reasonably large costs, unless their business cycles converge closer to the euro area cycle. Generally, for smaller countries the relative influence of the euro area business cycle is larger. Also, it is found that the most advanced accession countries are at least as integrated with the euro area business cycle as some small present member countries of the monetary union.
    Keywords: optimal currency area; monetary union; EU enlargement
    JEL: E32 F15 F42
    Date: 2007–09–13
  31. By: Kim, Byung-Yeon (BOFIT); Pirttilä, Jukka (BOFIT); Rautava , Jouko (BOFIT)
    Abstract: Using a macroeconometric framework, this paper analyses relationships among money, barter and inflation in Russia during the transition period. Following the development of a theoretical framework that introduces barter in a standard small open economy macro model, we estimate our model using structural cointegration and vector error correction methods. Our findings suggest that barter has resulted partly from output losses and partly from a reduction in real money balances, but to a lesser extent. There is some evidence that the effect of barter on prices is less than that of money. We also find that increases in barter are affected by banking failure. Our results imply that a macro model that excludes barter fails to capture all the relevant information for inference on money and inflation in Russia.
    Keywords: barter; money; inflation; cointegration; error-correction mechanism; Russia
    Date: 2007–09–13
  32. By: Andreas Hornstein
    Abstract: These notes contain the derivations for results stated without proof in Hornstein (2007). First, I derive the log-linear approximation of the inflation dynamics in the Calvo-model with elements of backward-looking pricing when the approximation takes place around a positive average inflation rate. I derive a version of the "hybrid" New Keynesian Phillips Curve (NKPC) that can be estimated using standard GMM techniques. Second, I characterize the inflation dynamics implied by the NKPC when marginal cost follows an AR(1) process. For this purpose I derive the autocorrelation and crosscorrelation structure of inflation.
    Date: 2007
  33. By: Fernando Broner
    Abstract: The first generation models of currency crises have often been criticized because they predict that, in the absence of very large triggering shocks, currency attacks should be predictable and lead to small devaluations. This paper shows that these features of first generation models are not robust to the inclusion of private information. In particular, this paper analyzes a generalization of the Krugman-Flood-Garber (KFG) model, which relaxes the assumption that all consumers are perfectly informed about the level of fundamentals. In this environment, the KFG equilibrium of zero devaluation is only one of many possible equilibria. In all the other equilibria, the lack of perfect information delays the attack on the currency past the point at which the shadow exchange rate equals the peg, giving rise to unpredictable and discrete devaluations.
    Keywords: Currency Crises, First Generation Models, Private Information, Discrete Devaluations, Multiple Equilibria
    JEL: D8 E58 F31 F32
    Date: 2007–01
  34. By: Beja, Jr., Edsel
    Abstract: The inflation-growth relationship for the inflation targeters is estimated for the period 2001-2006. The results show that inflation is negatively correlated with economic growth, while the indicators for aggregate demand and aggregate supply are positively correlated with economic growth. The findings suggest that a combination of economic policies is more fruitful than a singular focus on inflation targeting. This conclusion is applicable to the case of the Philippines, where inflation is often driven by aggregate supply-linked factors rather than demand-linked factors.
    Keywords: Inflation targeting; inflation-growth tradeoff
    JEL: E30
    Date: 2007–04–25
  35. By: Vetlov , Igor (BOFIT)
    Abstract: The paper analyses the factors driving dollarization in Lithuania during the period from December 1992 to August 2000. Starting with a brief overview of the major economic and political developments in Lithuania, the study attempts to model the process of dollarization by applying rigorous time series analysis. In particular, it investigates the long- and short-run properties of the relationship between the dollarization ratio and interest rates paid on domestic and foreign currency deposits. The study identifies a relatively stable cointegrating relationship between variables, whereby the dollarization ratio is negatively related to the interest rate spread. In the constructed vector error correction model, the deviations from the long-run relationship are found be significant for the dynamics of all three variables. Overall, the model explains the development of dollarization rather well. Simple specification of the model is possible when interest rates reflect the major economic and political events relevant to the process of dollarization.
    Keywords: dollarization; transition economy; currency board; unit roots; cointegration; vector error-correction
    JEL: C22 C51 C52
    Date: 2007–09–12
  36. By: Égert , Balázs (BOFIT)
    Abstract: This paper studies the Balassa-Samuelson effect in the Czech Republic, Hungary, Poland, Slovakia and Slovenia. Time series and panel cointegration techniques are used to show that the BS effect works reasonably well in these transition economies during the period 1991:Q1 to 2001:Q2. However, productivity growth does not fully translate into price in-creases due to the structure of CPI indexes. We thus argue that productivity growth will not hinder the ability of the five EU accession candidates to meet the Maastricht criterion on inflation in the medium term. Moreover, the observed appreciation of the CPI-deflated real exchange rate is found to be systematically higher compared to the real appreciation justi-fied by the Balassa-Samuelson effect, particularly in the cases of the Czech Republic and Slovakia. This may be partly explained by the trend appreciation of the tradable-goods-price-based real exchange rate, increases in non-tradable sector prices due to price liberali-sation and demand-side pressures, and the evolution of the nominal exchange rate due to the exchange rate regime and magnitude of capital inflows.
    Keywords: Balassa-Samuelson effect; productivity; real exchange rate; transition; panel cointegration
    JEL: E31 F31 O11 P17
    Date: 2007–09–11
  37. By: Blaszkiewicz, Monika (BOFIT); Konieczny, Jerzy (BOFIT); Myslinska, Anna (BOFIT); Radziwiland, Artur (BOFIT); Wozniak , Przemyslaw (BOFIT)
    Abstract: We analyse welfare effects of the interactions between the tax system and inflation in Poland and in Ukraine, using the framework developed by Feldstein (1997, 1999). This approach stresses the fact that inflation increases distortions created by the tax system, in particular distortions to intertemporal saving decisions. We find that the effects are much smaller in the two transition countries than in developed marketeconomies. The reason is that taxation of investment returns is much more limited. Our results suggest that taxes on investment returns should be avoided in any future redesign of the tax system.
    Date: 2007–09–12
  38. By: Joseph E. Gagnon; Alain P. Chaboud
    Abstract: This paper examines the available data that may shed light on the carry trade in Japanese yen. We define an individual or a sector to be engaged in the carry trade if it has a short position in yen and a long position in other currencies. The tendency of large yen movements to be skewed toward appreciations is consistent with the existence of substantial carry positions, and other evidence from market prices provides some modest support for an effect from the carry trade. Data on bank loans and bond holdings by currency reveal a large apparent yen carry position of the Japanese official sector and modest carry positions in the Japanese and foreign banking sectors. The Japanese private non-banking sector has a large long foreign-currency position, but does not have a short yen position, and is thus not engaged in the yen carry trade in the aggregate. However, it is possible that exporters and investors in Japan use the derivatives markets to hedge some of their long foreign-currency exposure, with the private non-banking sector outside of Japan (including most hedge funds) likely to be taking on most of the associated carry exposure.
    Keywords: Foreign exchange rates ; Yen, Japanese ; Interest rates
    Date: 2007

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