nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒11‒17
29 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Inertia in Taylor Rules By John Driffill; Zeno Rotondi
  2. Measures of Monetary Policy Stance: The Case of Pakistan By Sajawal Khan; Abdul Qayyum
  3. Convergence and anchoring of yield curves in the euro area. By Michael Ehrmann; Marcel Fratzscher; Refet S. Gürkaynak; Eric T. Swanson
  4. Inflation Targeting - a Framework for Communication By Maria Demertzis; Nicola Viegi
  5. Evolving U.S. monetary policy and the decline of inflation predictability. By Luca Benati; Paolo Surico
  6. The Importance of Being Vigilant: Has ECB Communication Influenced Euro Area Inflation Expectations? By David-Jan Jansen; Jakob de Haan
  7. Euro Area Inflation: Aggregation Bias and Convergence By Joseph P. Byrne; Norbert Fiess
  8. Does high money growth put the inflation target at further risk? By Tim Congdon
  9. Is Time ripe for price level path stability? By Vitor Gaspar; Frank Smets; David Vestin
  10. Canada's Pioneering Experience with a Flexible Exchange Rate in the 1950s:(Hard) Lessons Learned for Monetary Policy in a Small Open Economy By Michael D. Bordo; Ali Dib; Lawrence Schembri
  11. Social value of public information - testing the limits to transparency. By Michael Ehrmann; Marcel Fratzscher
  12. The long road to EMU: The Economic and Political Reasoning behind Maastricht By Francisco Torres
  13. Spill-over effects of monetary policy: a progress report on interest rate convergence in Europe By Fladung, Michael
  14. Euro Area Inflation Differentials: Unit Roots, Structural Breaks and Non-Linear Adjustment By Alberto Montagnoli; Andros Gregoriou; Alexandros Kontonikas
  15. Do real interest rates converge? Evidence from the European Union By Michael G. Arghyrou; Andros Gregoriou; Alexandros Kontonikas
  16. The Implementation of Monetary Policy in New Zealand: What Factors Affect the 90-Day Bank Bill Rate? By Alfred V. Guender; Oyvinn Rimer
  17. The Costs to Consumers of a Depreciated Conversion Rate to the Euro By Marques, Luis B
  18. Great Moderation(s) and U.S. Interest Rates: Unconditional Evidence By James M. Nason; Gregor W. Smith
  19. Zimbabwe’s Black Market for Foreign Exchange By Albert Makochekanwa
  20. Zimbabwe’s Hyperinflation Money Demand Model By Albert Makochekanwa
  21. Central banking in the iberian peninsula: a comparison By Pablo Martin Aceña
  22. Testing Uncovered Interest Parity: A Continuous-Time Approach By Antonio Diez de los Rios; Enrique Sentana
  23. What can probability forecasts tell us about inflation risks? By Juan Angel Garcia; Andres Manzanares
  24. Global Yield Curve Dynamics and Interactions: A Dynamic Nelson-Siegel Approach By Francis X. Diebold; Canlin Li; Vivian Z. Yue
  25. The Effects of Federal Funds Target Rate Changes on S&P100 Stock Returns, Volatilities, and Correlations By Chulia-Soler, H; Martens, M.P.E.; Dijk, D.J.C. van
  26. Discount Window Borrowing after 2003: The Explicit Reduction in Implicit Costs By Selva Demiralp; Erhan Artuç
  28. A Dynamic Enquiry into the Causes of Hyperinflation in Zimbabwe By Albert Makochekanwa
  29. Incentive Conflict In Central-Bank Responses to Sectoral Turmoil in Financial Hub Countries By Edward J. Kane

  1. By: John Driffill (School of Economics, Mathematics & Statistics, Birkbeck); Zeno Rotondi
    Abstract: The inertia found in econometric estimates of interest rate rules is a continuing puzzle. Many reasons for it have been offered, though unsatisfactorily, and the issue remains open. In the empirical literature on interest rate rules, inertia in setting interest rates is typically modeled by specifying a Taylor rule with the lagged policy rate on the right hand side. We argue that inertia in the policy rule may simply reflect the inertia in the economy itself, since optimal rules typically inherit the inertia present in the model of the economy. Our hypothesis receives some support from US data. Hence we agree with Rudebusch (2002) that monetary inertia is, at least partly, an illusion, but for different reasons.
    Keywords: Monetary Policy, Interest Rate Rules, Taylor rule, Interest Rate Smoothing, Monetary Policy Inertia, Predictability of Interest Rates, Term Structure, Expectations Hypothesis
    JEL: E52 E58
    Date: 2007–11
  2. By: Sajawal Khan (Pakistan Institute of Development Economics, Islamabad.); Abdul Qayyum (Pakistan Institute of Development Economics, Islamabad.)
    Abstract: In this paper we construct two measures of the monetary policy stance. The stance of monetary policy, regarded as a quantitative measure of whether the policy is too tight, neutral, or too loose relative to objectives of stable prices and output growth, is useful and important for at least two reasons. First, it helps the authority (central bank) to determine the course of monetary policy needed to keep the objective (goals) within the target range. Secondly, a quantitative measure of the stance is important for an empirical study of the transmission of monetary policy actions through the economy. Measuring the stance of the monetary policy free from any criticism, however, is not an easy task. As pointed out by Gecchetti (1994), “there seems to be no way to measure monetary actions that does not raise serious objections”. Our results show that an individual coefficient Monetary Condition Index (MCI) performs better than both the summarised MCI coefficient and the Overall measure proposed by Bernanke and Mihov (1998). The results show that in the 21-year period from 1984 to 2004, the demand shocks have dominated for about eight years. The MCI (IS-Individual coefficient) can explain six of them. However, it indicates the negative demand shock in two years as neutral. The other two measures, however, fail to capture demand shocks most of the time. This analysis suggests that the MCI (IS-Individual coefficient) plays an important role in determining output and inflation when the economy is not dominated by supply shocks. The results also show that supply shocks are dominant in the case of Pakistan. Furthermore, the exchange rate channel is more important than the interest rate channel.
    Keywords: Monetary Policy Measures, Monetary Condition Index, Composite Measures
    JEL: E42 E52 E58
    Date: 2007
  3. By: Michael Ehrmann (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Refet S. Gürkaynak (CEPR and Bilkent University, 06800 Bilkent, Ankara, Turkey.); Eric T. Swanson (Federal Reserve Bank of San Francisco, 101 Market Street, San Francisco, CA 94105, USA.)
    Abstract: We study the convergence of European bond markets and the anchoring of inflation expectations in euro area countries using high-frequency bond yield data for France, Germany, Italy and Spain. We find that Economic and Monetary Union (EMU) has led to substantial convergence in euro area sovereign bond markets in terms of interest rate levels, unconditional daily fluctuations, and conditional responses to major macroeconomic data announcements. Our findings also suggest a substantial increase in the anchoring of long-term inflation expectations since EMU, particularly for Italy and Spain, which since monetary union have seen their long-term interest rates become much lower, much less volatile, and much better anchored in response to news. Finally, the reaction of far-ahead forward interest rates to macroeconomic announcements has converged substantially across euro area countries and even been eliminated over time, thus underlining not only market integration but also the credibility that financial markets attach to monetary policy in the euro area. JEL Classification: E52, E58.
    Keywords: Bond markets, euro area, EMU, convergence, anchoring, credibility, monetary policy.
    Date: 2007–10
  4. By: Maria Demertzis; Nicola Viegi
    Abstract: More than a monetary policy strategy, we interpret inflation targeting as a framework for communication. We model monetary policy as an information game between the Bank and private agents. Our analysis shows how the provision of an explicit numerical inflation objective overcomes potential information imperfections by providing a focal point for agents who form expectations. Furthermore, the combination of the target and the tolerance bands around it communicated, provide a very clear framework with which to evaluate monetary policy outcomes. A successful Central Bank then builds up credibility and a credible Central Bank is in a better position to be successful in subsequent periods. We show how (and when) inflation targeting exploits this self-reinforcing loop to help the Central Bank endure large and long-lasting shocks. Last, we show that a trade-off emerges when choosing the band-width: too narrow bands provide a focal point but reduce the likelihood of inflation being ‘successful'. Too wide bands on the other hand, lead easier to success but at the risk of failing to provide a clear focal point. We thus derive the optimal band-width for different scenarios.
    Keywords: Monetary Policy; Communication; Focal Points; Credibility; Optimal Band-Width.
    JEL: C71 C78 E52
    Date: 2007–10
  5. By: Luca Benati (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Paolo Surico (External Monetary Policy Committee Unit, Bank of England, Threadneedle Street, London, EC2R 8AH, United Kingdom.)
    Abstract: Using a structural VAR with time-varying parameters and stochastic volatility on post-WWII U.S. data, we document a striking negative correlation between the evolution of the long-run coefficient on inflation in the monetary rule and the evolution of the persistence and predictability of inflation relative to a trend component. Using a standard sticky-price model, we show that a more aggressive policy stance towards inflation causes a decline in inflation predictability, providing a possible interpretation for the findings of the structural VAR. JEL Classification: E37, E52, E58.
    Keywords: Bayesian time-varying VARs, sign restrictions, frequency domain, Great Inflation, predictability.
    Date: 2007–10
  6. By: David-Jan Jansen; Jakob de Haan
    Abstract: Using daily data on inflation-indexed bonds, we find evidence of a negative relationship between ECB communication regarding risks to price stability - measured on the basis of the frequency and strength of the keyword ‘vigilance' - and changes in euro area break-even inflation. However, this result is only found for the second half of 2005. At that time, the start of a tightening of ECB monetary policy was increasingly likely. This suggests that communication should be closely in line with policy actions before it can be effective. Still, we also find that the economic significance of this type of communication has been small.
    Keywords: central bank communication; ECB; inflation expectations 
    JEL: C71 C78 E52
    Date: 2007–10
  7. By: Joseph P. Byrne; Norbert Fiess
    Abstract: EMU monetary policy targets aggregate Euro Area inflation. Concerns are growing that a focus on aggregate inflation may cause national inflation rates to diverge. While different explanations for diverging aggregate Euro Area inflation have been brought forward, the very impact of aggregation on divergence has however not been studied. We find a striking difference in convergence depending on the level of aggregation. While aggregate national inflation rates are diverging, disaggregate inflation rates are converging. We find that aggregation appears to bias evidence towards non-convergence. Our results are consistent with prominent theoretical and empirical evidence on aggregation bias
    Keywords: Euro Area Inflation; Aggregation Bias; Convergence
    JEL: C12 C22 E31
    Date: 2007–10
  8. By: Tim Congdon
    Date: 2007–10
  9. By: Vitor Gaspar (Banco de Portugal, R. Francisco Ribeiro, 2, 1150-165 Lisboa, Portugal.); Frank Smets (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); David Vestin (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: In the paper, we provide a critical and selective survey of arguments relevant for the assessment of the case for price level path stability (PLPS). Using a standard hybrid new Keynesian model we argue that price level stability provides a natural framework for monetary policy under commitment. There are two main arguments in favour of a PLPS regime. First, it helps overall macroeconomic stability by making expectations operate like automatic stabilizers. Second, under a price level path stability regime, changes in the price level operate like an intertemporal adjustment mechanism, reducing the magnitude of required changes in nominal interest rates. Such a property is particularly relevant as a means to alleviate the importance of the zero bound on nominal interest rates. We also review and discuss the arguments against price level path stability. Finally, we also found, using the Smets and Wouters (2003) model which includes a wide variety of frictions and is estimated for the euro area, that the price level is stationary under optimal policy under commitment. The results obtain when the quasi-difference of inflation is used in the loss function, as in the hybrid new Keynesian model. Overall, the arguments in favour of or against price level path stability depend on the degree of dependence of private sector expectations on the characteristics of the monetary policy regime. JEL Classification: E52, D83.
    Keywords: Price Level Stability, Expectations, Adaptive Learning.
    Date: 2007–10
  10. By: Michael D. Bordo; Ali Dib; Lawrence Schembri
    Abstract: This paper revisits Canada's pioneering experience with floating exchange rate over the period 1950-1962. It examines whether the floating rate was the best option for Canada in the 1950s by developing and estimating a New Keynesian small open economy model of the Canadian economy. The model is then used to conduct a counterfactual analysis of the impact of different monetary policies and exchange rate regimes. The main finding indicates that the flexible exchange rate helped reduce the volatility of key macro-economic variables. The Canadian monetary authorities, however, clearly did not understand all of the implications of conducting monetary policy under a flexible exchange rate and a high degree of capital mobility. The paper confirms that monetary policy was more volatile in the post-1957 period and Canada's macroeconomic performance suffered as a result.
    JEL: E32 E37 F31 F32 N01
    Date: 2007–11
  11. By: Michael Ehrmann (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: Transparency has become an almost universal virtue among central banks. The paper tests empirically, for the case of the Federal Reserve, two hypotheses about central bank transparency derived from the debate of Morris and Shin (2002) and Svensson (2006). First, the paper finds that the precision of communication is a key determinant of the predictability of both FOMC decisions as well as the future policy path. Second, the effectiveness of communication is found to depend on the market environment. Specifically, a given statement may enhance predictability in an environment of high market uncertainty, but may reduce it when uncertainty is low. The findings underline the limits to transparency and stress the need for communication to be flexible and adjust to market conditions in order for central banks to achieve their ultimate objectives. JEL Classification: E52, E58, D82.
    Keywords: Communication, transparency, monetary policy, predictability, effectiveness, Federal Reserve.
    Date: 2007–10
  12. By: Francisco Torres (IEE - Universidade Católica Portuguesa and INA)
    Abstract: This paper aims to examine whether the economic and political reasoning behind Maastricht is consistent with earlier approaches to monetary integration. In doing so, it revisits the intellectual debate on monetary integration in Europe at different stages. It concludes that Economic and Monetary Union (EMU) as agreed at Maastricht reflected a compromise between two different but converging preferences, in the context of the experience of the European Monetary System (EMS) and other developments in national and European politics as well as in economic thought, on the role of monetary policy and institutions; the fall of the Berlin Wall may have added a new political dimension that might have made it easier to agree on the blueprint and on the calendar for the realisation of EMU. The various (political and economic) motivations for the convergence of initially different views on the role of monetary policy and successive interpretations of the objectives of EMU are discussed within the wider context of the process of European integration.
    Keywords: Economic and Monetary Union; Bretton Woods; European integration; Werner plan; European Monetary System; inflation; convergence of preferences; epistemic communities; currency crisis; monetary sovereignty; Maastricht treaty; convergence requirements.
    JEL: N14 E52 E58 E61 E65
    Date: 2007–11
  13. By: Fladung, Michael
    Abstract: This study examines differences in the interest rate response to an ECB policy impulse in the euro area, the new EU-member states, and in the other non-eurozone EU countries in order to gauge the degree of interest rate alignment in Europe. To this end, PANIC, a Panel Analysis of Non-stationarity in I diosyncratic and Common components, is employed in a structural factor set-up. Under the assumption that the ECB sets the short end of the yield curve, the analysis shows that : (i) The response of Europe’s money and government bond markets to new information can be summarized by two common stochastic trends and one stationary common factor, which together explain more than 68% of the overall variation of the two market segments; (ii) one of the factor innovations can be associated with the ECB’s policy stance, which strongly affects the short end of the euro area’s yield curve; (iii) compared to the euro area, the short-term market segments in the new EU-member states react, on average, 12% more weakly to the monetary policy signal, whereas these countries’ long-term government bond yields respond up to 25% more strongly to such a common innovation.
    Keywords: Factor Models, Common Stochastic Trends, Interest Rate Channel, New Member States, Mixed Data Sampling
    JEL: C33 E52 G15
    Date: 2007
  14. By: Alberto Montagnoli; Andros Gregoriou; Alexandros Kontonikas
    Abstract: This paper examines the time series properties of inflation differentials in twelve EMU countries. We compute three alternative measures of inflation differentials using deviations from the policy reference value implied by the Maastricht Treaty, the ECB target, and deviations from the EMU average inflation. The evidence from standard linear unit root tests indicate that inflation differentials are highly persistent. However, when we account for endogenously determined structural breaks, we obtain greater support for stationarity. In addition, when we allow for the possibility that inflation differentials can be charterised by a non-linear mean reverting process we find evidence of stationarity. Our empirical results suggest that once we allow for structural breaks or non-linearities, inflation differentials do not consistently intensify real divergence in the euro area
    Keywords: EMU, ESTAR models; Inflation; Structural break; Unit root tests
    JEL: C22 E31
    Date: 2007–06
  15. By: Michael G. Arghyrou; Andros Gregoriou; Alexandros Kontonikas
    Abstract: We test for real interest parity (RIP) in the EU25 area. Our contribution is two-fold: First, we account for the previously overlooked effects of structural breaks on real interest rate differentials. Second, we test for RIP against the EMU average. For the majority of our sample countries we obtain evidence of real interest rate convergence towards the latter. Convergence, however, is a gradual process subject to structural breaks, typically falling close to the launch of the euro. Our findings have important implications relating to the single monetary policy and the progress new EU members have achieved towards joining the euro.
    Keywords: real interest rate parity; convergence, structural breaks; EU; EMU
    JEL: F21 F32 C15 C22
    Date: 2007–06
  16. By: Alfred V. Guender (University of Canterbury); Oyvinn Rimer
    Abstract: This paper discusses the implementation of monetary policy in New Zealand and its flow-on effects on the 90-day bank bill rate over the 1999-2005 period. The effects of external factors are considered as well. Our findings indicate that the maturity spectrum ratio exerted a positive effect on the 90-day rate while the allotment ratio did not. This interest rate had a tendency to revert to the level set by its Australian counterpart. No such link exists between the NZ 90-day rate and the US 90-day rate. Neither the maturity spectrum nor the allotment ratio contributed to the volatility of the New Zealand 90-day rate.
    Keywords: 90-Day Bank Bill Rate; Open-Market Operations; Allotment Ratio; Maturity Spectrum Ratio; Foreign Interest Rate Linkage
    JEL: E5
    Date: 2007–10–29
  17. By: Marques, Luis B
    Abstract: This paper measures the welfare cost to consumers of the bloc of Central and Eastern European Countries (CEEC), plus Malta and Cyprus, of choosing a de- preciated conversion rate when joining the European Monetary Union. For this, I present and solve an appropriately calibrated small open economy model where a euro-denominated bond and the equity on a traded goods sector are traded internationally. I show that the cost of depreciating the domestic currency against the euro by 20%, at the time of joining the European Monetary Union, entails a cost of approximately 1.65% in terms of lost lifetime utility (measured in equivalent units of consumption).
    Keywords: trade effect; valuation effect; wealth effect; exchange rate.
    JEL: F41 F47 F31
    Date: 2007–08
  18. By: James M. Nason (Federal Reserve Bank of Atlanta); Gregor W. Smith (Queen's University)
    Abstract: The US economy experienced a Great Moderation sometime in the mid-1980s -- a fall in the volatility of output growth -- at the same time as a fall in both the volatility of inflation and the average rate of inflation. We put this moderation in historical perspective by comparing it to the post-WWII moderation. According to theory, the statistical moments -- both real and nominal -- that shift during these moderations in turn influence interest rates. We examine the predictions for shifts in the unconditional average of US interest rates. A central finding is that such shifts probably were due to changes in average inflation rather than to those in the variances of inflation and consumption growth.
    Keywords: great moderation, asset pricing
    JEL: E32 E43 N12
    Date: 2007–11
  19. By: Albert Makochekanwa (Department of Economics, University of Pretoria)
    Abstract: This paper looks into the changes of the black market premium for foreign exchange in Zimbabwe. Generally, the black market for foreign exchange arises as a direct consequence of the adoption of exchange rate controls in many developing economies facing substantial macroeconomic imbalances. Despite its negative impact on Zimbabwe’s economy, this market has not, so far, attracted the attention of researchers. The research attempts to describe the functioning of the black market and find out the determinants of the parallel premium based on a stock-flow model as well as to investigate whether inflation Granger causes the parallel exchange rate. Estimated results reveal that the determinants of the black market premium are international foreign reserves, real exchange rate, lagged values of the black market premium, expected rate of devaluation, money supply and inflation. On the other hand, inflation and black market are found to Granger-cause each other during the period under consideration.
    Keywords: Black Market Exchange Rate, Black Market Premium, Foreign Exchange Controls, Cointegration, Granger Causality
    JEL: F31 C23
    Date: 2007–07
  20. By: Albert Makochekanwa (Department of Economics, University of Pretoria)
    Abstract: The research attempts to empirically study the demand for money, especially the magnitudes of the price expectation and real cash balance adjustment for Zimbabwe. Price expectation and real cash balance adjustment models are estimated. The results show that both the interest rate and the rate of change in prices are relevant variables for explaining the variations in the demand for real cash balances in Zimbabwe. Overall, the findings suggest that the Zimbabwean hyperinflation does not appear to have been a self- generating process independent of money supply.
    Keywords: Hyperinflation, Real Cash Balances, Price Expectation, Equilibrium, Error Correction Model
    JEL: E41 P24 E51
    Date: 2007–07
  21. By: Pablo Martin Aceña
    Abstract: The paper explores the similiraties and differences between the origin, behavior and evolution of the central banks of Portugal and Spain. Portugal and Spain are two countries that share the same peninsular space in the west corner of Europe. Though different in size and population, the political, social and economic history of both nations offer more similarities than differences. In the financial sphere, he resemblances are remarkable. Both nations exhibit very low levels of financial intermediation, as measured by the ratio between total bank deposits and GDP. Another common feature of both Iberian nations is the dominance exerted by a sole institution. However, we also find some divergences between the financial structures of the two countries that are worth noting. Three differences merit our particular attention in this paper. The first diversity refers to the distinct composition of the quantity of money. The monetary regime is the second difference between the two countries (Portugal joined the gold standard while Spain remained off the gold standard). Finally, the Bank of Portugal and the Bank of Spain exhibit also significant contrasts in their behavior as central banks.
    Date: 2007–10
  22. By: Antonio Diez de los Rios; Enrique Sentana
    Abstract: Nowadays researchers can choose the sampling frequency of exchange rates and interest rates. If the number of observations per contract period is large relative to the sample size, standard GMM asymptotic theory provides unreliable inferences in UIP regression tests. We specify a bivariate continuous-time model for exchange rates and forward premia robust to temporal aggregation, unlike the discrete time models in the literature. We obtain the UIP restrictions on the continuous-time model parameters, which we estimate efficiently, and propose a novel specification test that compares estimators at different frequencies. Our empirical results based on correctly specified models reject UIP.
    Keywords: Exchange rates; Econometric and statistical methods
    JEL: F31 G15
    Date: 2007
  23. By: Juan Angel Garcia (European Central Bank,Capital Markets and Financial Structure Division, Kaiserstraße 29, 60311 Frankfurt, Germany.); Andres Manzanares (European Central Bank,Risk Management Division, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: We show that international consumption risk sharing is significantly improved by capital flows, especially portfolio investment. Concomitantly, we show that poor institutions hamper risk sharing, but to an extent that decreases with openness. In particular, risk sharing is prevalent even among economies with poor institutions, provided they are open to international markets. This is consistent with the view that the prospect of retaliation may deter expropriation of foreign capital, even in institutional environments where it is possible. This deterrent is anticipated by investors, who act to diversify risk. By contrast, capital flows headed for closed economies with poor institutions are designed and constrained so as to limit the cost incurred in case of expropriation, and thus achieve little risk sharing. Finally, we show this non-linearity continues to be present in the determinants of international capital flows themselves. Institutions are crucial in attracting capital for closed economies, but are barely relevant in open ones. JEL Classification: C16, C42, E31, E47.
    Keywords: Inflation risk, inflation expectations, Survey of Professional Forecasters (SPF), skew-normal distribution, power divergence estimators.
    Date: 2007–10
  24. By: Francis X. Diebold; Canlin Li; Vivian Z. Yue
    Abstract: The popular Nelson-Siegel (1987) yield curve is routinely fit to cross sections of intra-country bond yields, and Diebold and Li (2006) have recently proposed a dynamized version. In this paper we extend Diebold-Li to a global context, modeling a potentially large set of country yield curves in a framework that allows for both global and country-specific factors. In an empirical analysis of term structures of government bond yields for the Germany, Japan, the U.K. and the U.S., we find that global yield factors do indeed exist and are economically important, generally explaining significant fractions of country yield curve dynamics, with interesting differences across countries.
    JEL: C01 G12
    Date: 2007–11
  25. By: Chulia-Soler, H; Martens, M.P.E.; Dijk, D.J.C. van (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: We study the impact of FOMC announcements of Federal funds target rate decisions on individual stock prices at the intraday level. We find that the returns, volatilities and correlations of the S&P100 index constituents only respond to the surprise component in the announcement, as measured by the change in the Federal funds futures rate. For example, an unexpected 25 basis points increase of the target rate leads on average to a 113 basis points negative market return within five minutes after the announcement. It also increases market volatility during the 60-minute window around the announcement with 147 basis points. Positive surprises, meaning bad news for stocks, provoke a stronger reaction than negative surprises. Market participants also respond differently to good and bad news. In case of bad news for stocks the fact that there is a surprise matters most, whereas in case of good news the magnitude of the surprise is more important. Across sectors, Financials and IT show the strongest response to target rate surprises.
    Keywords: monetary policy announcements;interest rate surprises;high-frequency data;realized volatility;
    Date: 2007–10–25
  26. By: Selva Demiralp (Department of Economics, Koç University); Erhan Artuç (Department of Economics, Koç University)
    Abstract: In January 2003, the Federal Reserve introduced primary credit as its main discount window lending program. The primary credit program replaced the adjustment credit program, which, subject to a number of restrictions, had generated a stigma associated with borrowing from the Fed. Eliminating or lessening the stigma of borrowing was viewed as essential for reducing the reluctance to borrow and strengthening the traditional role of the discount window as a safety valve when reserve markets tighten unexpectedly. In this paper we estimate the borrowing function prior to and after the introduction of the new facility and develop a daily model of borrowing. Using this model, we estimate the implicit cost associated with borrowing for the first time in the literature via “indirect inference” a la Gourieroux, Monfort and Renault (1993). Our results suggest that the stigma associated with borrowing from the Fed is significantly reduced in the post 2003 period.
    Keywords: Discount Window, Primary Credit, Federal Funds Market
    JEL: E40 E58
    Date: 2007–10
  27. By: Juan A. Lafuente (Universitat Jaume I); Javier Ordoñez (Universitat Jaume I)
    Abstract: This paper deals with the time evolution of stock market integration around the introductionof the euro. In particular we test whether the degree of integration between the main eurozonecountries increased after European monetary union. The contribution of the paper to the extantliterature is twofold: a) first, we take into account the potential long-run equilibrium relationshipbetween stock indices allowing for structural changes in the cointegration space that might capturethe effect of the introduction of the euro, and b) we formally test the existence of greater financialintegration after European monetary union across the main member countries and between thesemembers and the UK. Empirical evidence reveal the existence of long-run equilibrium relationshipsbetween European stock markets even before the introduction of the euro. Our empirical findingssuggest that financial integration is not the direct consequence of the removal of exchange rate riskdue to currency unification. Rather, it arises as a result of macroeconomic convergence. This aspectis corroborated by the nature of the principal component structure of estimated conditionalcorrelations. Este trabajo analiza la evolución del grado de integración de los mercados bursátileseuropeos en torno a la introducción del euro. En particular se contrasta si el grado de integraciónentre los principales miembros de la Unión Europea y Monetaria se ha incrementado a partir de laintroducción del euro. La contribución del trabajo es doble: a) por un lado se tiene en cuenta laposible existencia de relaciones de cointegración entre los índices bursátiles, permitiendo laexistencia de cambios estructurales en el espacio de cointegración y b) se proporciona un contrasteformal para la hipótesis nula de mayor grado de integración después de la introducción de la monedacomún. La evidencia empírica revela la existencia de relaciones de equilibrio a largo plazo entre losmercados, incluso antes de la introducción del euro. Los resultados sugieren que la integraciónfinanciera no es el resultado de la adopción de la moneda común sino que es un proceso dinámicoque se ha visto fortalecido por la unificación de la moneda. Este aspecto es corroborado por lanaturaleza de la estructura de componentes principales que se obtiene a partir de la medida deintegración considerada.
    Keywords: cointegración, mercados financieros, Unión Europea y Monetaria, integración financiera dinámica cointegration, dynamic financial integration, stock markets, European Monetary Union.
    JEL: C32 E44 G15
    Date: 2007–10
  28. By: Albert Makochekanwa (Department of Economics, University of Pretoria)
    Abstract: The purpose of this study is to determine the causes of hyperinflation in Zimbabwe for the period February 1999 to December 2006 using appropriate econometric techniques. Results from long run and shot run econometric models shows money supply, black market for foreign exchange (US$) and lagged values of hyperinflation to be positively correlated with the country’s hyperinflation trend. This result accords well with the various theories of hyperinflation. Surprisingly, political rights index as a determinant is negatively associated with hyperinflation, suggesting that an increase in this variable reduces hyperinflation. This is against economic theory, which expects a positive sign for this, variable. Granger causality test is also conducted between money supply and hyperinflation to empirically test the direction of causality, while sensitivity tests are done to infer the effect of money supply shock on hyperinflation trend.
    Date: 2007–07
  29. By: Edward J. Kane
    Abstract: National safety nets are imbedded in country-specific regulatory cultures that encompass contradictory goals of nationalistic welfare maximization, merciful treatment of distressed institutions, and bureaucratic blame avoidance. Focusing on this goal conflict, this paper develops two hypotheses. First, in times of financial-sector stress, political pressure is bound to increase the incentive force of the second and third goals at the expense of the first. Second, gaps and distortions in cross-country connections between national safety nets require improvisational responses from de facto hegemonic regulators. Reinforced by reputational concerns, the hegemons' goal conflicts dispose them to react to cross-country evidence of incipient financial-institution insolvencies in short-sighted ways. During the commercial-paper and interbank turmoil of summer 2007, de facto hegemons used repurchase agreements to transfer taxpayer funds -- implicitly but in large measure -- to several of the particular institutions whose imprudence in originating, pricing, and securitizing poorly underwritten loans led to the turmoil in the first place. The precedent established by these transfers promises to exacerbate the depth, breadth, and duration of future instances of financial-institution insolvency by confirming that institutions that underinvest in due diligence can expect taxpayers to protect them from much of the adverse consequences.
    JEL: E58 F33 G21 G28
    Date: 2007–11

This nep-mon issue is ©2007 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.