nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒11‒24
nineteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Inertia in Taylor Rules By Driffill, John; Rotondi, Zeno
  2. Resurrecting Keynes to Revamp the International Monetary System By Pietro Alessandrini; Michele Fratianni
  3. Communicating Policy Options at the Zero Bound By Burkhart, Lucas; Fischer, Andreas M
  4. The timeless perspective vs. discretion : theory and monetary policy implications for an open economy By Guender, Alfred V.
  5. Liability Dollarization and Fear of Floating By Quoc Hung Nguyen
  6. Unconditionally Optimal Monetary Policy By Tatiana Damjanovic; Vladislav Damjanovic; Charles Nolan
  7. The Euro, a blessing for Africa? Consequences of the peg of the African Franc CFA to the Euro By Kohnert, Dirk
  8. The growing role of the euro in emerging market finance By Masson, Paul R.
  9. The timing and magnitude of exchange rate overshooting By Hoffmann, Mathias; Sondergaard, Jens; Westelius, Niklas J.
  10. Multiple paper monies in Sweden, 1789-1903: Substitution or complementarity? By Engdahl, Torbjörn; Ögren, Anders
  11. Measurement Error in Monetary Aggregates: A Markov Switching Factor Approach By Barnett, William A.; Chauvet, Marcelle; Tierney, Heather L. R.
  12. Counterfeiting as private money in mechanism design By Ricardo Cavalcanti; Ed Nosal
  13. The Thai Currency Crisis: Fracture in a Fixed Exchange Rate Regime By Hartogh, Matthew
  14. Imperfect monitoring and the discounting of inside money By David C. Mills, Jr.
  15. When countries do not do what they say: Systematic discrepancies between exchange rate regime announcements and de facto policies By Bersch, Julia; Klüh, Ulrich H.
  17. Cointegration in the Foreign Exchange Market and Market Efficiency since the ntroduction of the Euro: Evidence based on bivariate Cointegration Analyses By Michael Kühl
  18. Inflation and Financial Development: Evidence from Brazil By Manoel Bittencourt
  19. Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Models By Robert J Shiller

  1. By: Driffill, John; Rotondi, Zeno
    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 modelled 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: expectations hypothesis; Interest Rate Rules; Interest Rate Smoothing; Monetary Policy; Monetary Policy Inertia; Predictability of interest rates; Taylor rule; term structure
    JEL: E52 E58
    Date: 2007–11
  2. By: Pietro Alessandrini (Department of Economics, Università Politecnica delle Marche, Ancona); Michele Fratianni (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)
    Abstract: There is a broad consensus that the current, large U.S. current-account deficits financed with foreign capital inflows at low interest rates cannot continue forever; there is much less consensus on when the system is likely to end and how badly it will end. The paper resurrects the basic principles of the plan Keynes wrote for the Bretton Woods Conference to propose an alternative to the current international monetary system. We argue for the creation of a supranational bank money that would coexist along side national currencies and for the establishment of a new international clearing union. The new international money would be created against domestic earning assets of the Fed and the ECB. In addition to recording credit and debit entries of the supranational bank money, the new agency would determine the size of quotas, the size and time length of overdrafts, and the coordination of monetary policies. The substitution of supranational bank money for dollars would harden the external constraint of the United States and resolve the n-1 redundancy problem.
    Keywords: Keynes Plan, external imbalances, exchange rates, international monetary system, key currency, supranational bank money
    JEL: E42 E52 F33 F36
    Date: 2007–11
  3. By: Burkhart, Lucas; Fischer, Andreas M
    Abstract: This paper examines a special episode in communication practices of the Swiss National Bank (SNB) when short-term interest rates reached the zero bound. A particular feature of SNB communication policy at the time was to talk openly about alternative policy instruments despite the fact that they were never implemented. Non-sterilized FX interventions were frequently mentioned as a potential instrument. We ask how did financial markets respond to the SNB's repeated references of non-sterilized interventions? The empirical results with high frequency data provide strong evidence that SNB intervention references depreciated the domestic currency for several hours. The case study supports the view that communication is an effective tool for monetary policy.
    Keywords: Central Bank Communication; Exchange Rate; zero bound
    JEL: E58 F31
    Date: 2007–11
  4. By: Guender, Alfred V.
    Abstract: This paper proposes an open-economy Phillips Curve that features a real exchange rate channel. The resulting target rule under optimal policy from a timeless perspective (TP) involves additional history dependence in the form of lagged inflation. The target rule also depends on the discount factor as well as IS and Phillips Curve parameters. This is in sharp contrast to a closed economy where the target rule depends only on the change in the output gap, the current rate of inflation and the structural parameter in the Phillips Curve. Because of the additional history dependence in an open economy, price level targeting is no longer consistent with optimal policy. If a real exchange rate channel does not exist in the Phillips Curve, monetary policy eases in the wake of a positive cost-push disturbance under policy from a TP and is thus diametrically opposed to same under discretion. Maximum gains accrue from commitment relative to discretion in an open economy where the real exchange rate is absent from the Phillips Curve and the policymaker places strong emphasis on maintaining price stability.
    Keywords: Timeless Perspective, Discretion, Price Level Targeting, Exchange Rate Channel
    JEL: E52 F41
    Date: 2007
  5. By: Quoc Hung Nguyen (University of British Columbia)
    Abstract: This paper addresses the question of whether "fear of floating" in developing countries can be justified as optimal discretionary monetary policy in a dollarized economy with Bernanke-type credit constraints in the import sector and nominal rigidities. Balance sheet effects magnify the macroeconomic consequences of the economy that experiences external and techolonogy shocks. It can be shown that the fixed exchange rate regime dominates the inflation targeting regime in both the role of cushioning shocks and in welfare terms.
    Keywords: Liability Dollarizaion, Fear of Floating, Imported Goods
    JEL: F0 F4
    Date: 2007–10
  6. By: Tatiana Damjanovic; Vladislav Damjanovic; Charles Nolan
    Abstract: We develop a simple and intuitive approach for analytically deriving unconditionally optimal (UO) policies, a topic of enduring interest in optimal monetary policy analysis. The approach can be employed to both general linear-quadratic problems and to the underlying non-linear environments. We provide a detailed example using a canonical New Keynesian framework.
    Keywords: Unconditional expectations, optimal monetary policy.
    JEL: E20 E32 F32 F41
    Date: 2007–10
  7. By: Kohnert, Dirk
    Abstract: About five decades the Franc CFA-Zone in Western and Central Africa was praised as incarnation of economic and political stability in Africa, backed by France. But free convertibility and fixed parity, guaranteed by the French Treasury, mainly served the interest of a small elite of the Messieurs Afrique, both in France and in Africa. Generations of French entrepreneurs and of their African counterparts maintained a profitable self-service shop on expense of the African poor and the French taxpayer. In the aftermath of the devaluation of the Franc CFA in 1994, and of the peg of the currency to the Euro in 1998, the socio-economic divide between rich and poor, urban and rural regions, the formal and the informal sector even widened. However, the perpetuation of the established monetary structure of the CFA-Zone became increasingly anachronistic. As far as the political stability, previously guaranteed by the neo-colonial French Africa policy, becomes obsolete, the base for economic stability of the traditional arrangement of the currency union is threatened as well. The more so, as the CFA-Zone never fulfilled the most crucial preconditions of an optimal currency area. The peg to the EMU, orientated at the interests of highly industrialized European countries, led to an overvaluation of the real exchange rate of the CFA, and will increasingly constitute an obstacle to sustainable indigenous development in francophone Africa.
    Keywords: Monetary Union; regional integration; Optimum Currency Areas; Franc CFA-Zone; Francophone Africa; Euro; EMU
    JEL: F15 F35 E42 E52 F33 F31 F54 F36
    Date: 1998
  8. By: Masson, Paul R.
    Abstract: More than eight years after the introduction of the euro, impacts on developing countries have been relatively modest. Overall, the euro has become much more important in debt issuance than in official foreign exchange reserve holdings. The former has benefited from the creation of a large set of investors for which the euro is the home currency, while demand for euro reserves has been held back by the dominance of the dollar as a vehicle and intervention currency, and the greater liquidity of the market for US treasury securities. Fears of further dollar decline may fuel some shifts out of dollars into euros, however, with the potential for a period of financial instability.
    Keywords: Debt Markets,Emerging Markets,Fiscal & Monetary Policy,Currencies and Exchange Rates,
    Date: 2007–11–01
  9. By: Hoffmann, Mathias; Sondergaard, Jens; Westelius, Niklas J.
    Abstract: Empirical evidence suggests that a monetary shock induces the exchange rate to overshoot its long-run level. The estimated magnitude and timing of the overshooting, however, varies across studies. This paper generates delayed overshooting in a new Keynesian model of a small open economy by incorporating incomplete information about the true nature of the monetary shock. The framework allows for a sensitivity analysis of the overshooting result to underlying structural parameters. It is shown that policy objectives and measures of the economy's sensitivity to exchange rate dynamic affect the timing and magnitude of the overshooting in a predictable manner, suggesting a possible rationale for the cross-study variation of the delayed overshooting Phenomenon.
    Keywords: Exchange rate overshooting, Partial information, Learning
    JEL: E31 F31 F41
    Date: 2007
  10. By: Engdahl, Torbjörn (Department of Economic History Stockholm University); Ögren, Anders (EHFF - Institute for Economic and Business History at the Stockholm School of Economics and HTE EconomiX (UMR 7166) CNRS Université de Paris X - Nanterre)
    Abstract: Complementarity of money mean that two or more kinds of monies together fulfil the demand of the users better than they would without the existence of the other(-s). In this paper we study complementarity between paper monies in Sweden. We address four questions: 1) What was used as money on a macro level (money supply) and on a micro level (monetary remittances)? 2) What was the relative value of different monies in parallel circulation? 3) Was there seasonal variations in use and/or value? 4) Was there geographical variations in use and value? What we find is that the complementarity helped to solve the problem of providing sufficient liquidity domestically over time and space and thus and to keep a stable value of the currency.
    Keywords: Complementarity; Liquidity; Money Supply; Money Remittances; Paper Money; Parallel Circulation of Money; Variations in Money Demand
    JEL: E50 G21 N13 N23
    Date: 2007–11–12
  11. By: Barnett, William A.; Chauvet, Marcelle; Tierney, Heather L. R.
    Abstract: This paper compares the different dynamics of simple sum monetary aggregates and the Divisia indexes over time, over the business cycle, and across high and low inflation and interest rate phases. Although the traditional comparison of the series may suggest that they share similar dynamics, there are important differences during certain times and around turning points that can not be evaluated by their average behavior. We use a factor model with regime switching that offers several ways in which these differences can be analyzed. The model separates out the common movements underlying the monetary aggregate indexes, summarized in the dynamic factor, from individual variations in each one series, captured by the idiosyncratic terms. The idiosyncratic terms and the measurement errors represent exactly where the monetary indexes differ. We find several new results. In general, the idiosyncratic terms for both the simple sum aggregates and the Divisia indexes display a business cycle pattern, especially since 1980. They generally rise around the end of high interest rate phases – a couple of quarters before the beginning of recessions – and fall during recessions to subsequently converge to their average in the beginning of expansions. We also find that the major differences between the simple sum aggregates and Divisia indexes occur around the beginning and end of economic recessions, and during some high interest rate phases.
    Keywords: Measurement Error; Divisia Index; Aggregation; State Space; Markov Switching; Monetary Policy
    JEL: E4
    Date: 2007–06
  12. By: Ricardo Cavalcanti; Ed Nosal
    Abstract: We describe counterfeiting activity as the issuance of private money, one which is difficult to monitor. Our approach, which amends the basic random-matching model of money in mechanism design, allows a tractable welfare analysis of currency competition. We show that it is not efficient to eliminate counterfeiting activity completely. We do not appeal to lottery devices, and we argue that this is consistent with imperfect monitoring.
    Keywords: Counterfeits and counterfeiting ; Money
    Date: 2007
  13. By: Hartogh, Matthew
    Abstract: Abstract If the financial press had been paying attention to some crucial barometers of currency instability in Thailand last year, the ensuing crisis in Asia would perhaps not have been so much of a surprise. On July 2,1997, the Thai government allowed the Baht to float against the Dollar for the first time in a decade. As we all now know, this effective devaluation set of a train of events which would shock all of the Asian economies which had hitherto enjoyed unqualified growth and prosperity for the last several years.
    Keywords: Exchange Rates Currency Baht
    JEL: E42
    Date: 2007–01–01
  14. By: David C. Mills, Jr.
    Abstract: One of the fundamental questions concerning inside money is whether its issuers should be regulated and how. This paper evaluates the efficiency of one prevalent regulatory recommendation -- a requirement that private issuers redeem inside money on demand at par -- in a random-matching model of money where the issuers of inside money are only imperfectly monitored. I find that for sufficiently imperfect monitoring, a par redemption requirement leads to lower social welfare than if private money were redeemed at a discount. A central message of the paper is that if inside money and outside money are not perfect substitutes for one another, as is the case if there is sufficiently imperfect monitoring, a par redemption requirement may not be socially optimal because such a requirement effectively binds them to circulate as if they are. Such an outcome is a version of Gresham's law that bad money drives out good money.
    Date: 2007
  15. By: Bersch, Julia; Klüh, Ulrich H.
    Abstract: We study the apparent disconnect between what countries announce to be their exchange rate regime and what they de facto implement. Even though discrepancies between announcements and de facto polices are frequent, there is a lack of understanding of actual patterns and underlying reasons. We contribute to the literature by identifying a number of robust stylized facts by means of an in-depth analysis of a large cross-country dataset. A key insight is that countries that operate under intermediate de facto regimes tend to announce fixed or flexible exchange rate regimes. The exact nature of deviations is related to country characteristics such as trade structure, financial development, and financial openness. Furthermore, regime discrepancies have followed secular trends, which are most likely related to financial globalization and changes in monetary policy design.
    Keywords: Exchange rate regimes; de facto versus de jure; exchange rate policy
    JEL: F31 F33 F41
    Date: 2007–11–19
  16. By: Tanasie, Anca; Fratostiteanu , Cosmin
    Abstract: For most Eastern European countries that experienced former communist regimes, the EU accession and the use of European symbols – such as the EURO currency – represents both the integration into a strong and efficient economic system, but also the guarantee of a system based on real democratic values. Romania has been the first of this category of states, that has expressed the real and strong attachment for the European Union, its symbols and values. This paper wishes to analyze the key elements concerning Romania’s accession to the EMU and finally the EURO adoption: Romania’s actual macroeconomic situation, the situation of the real and nominal convergence to the accession criteria – in a fuzzy clustering approach in order to determine optimum sequencing of the Euro adoption and the envisaged official calendar for the EURO adoption.
    Keywords: Romania; Euro; monetary convergence; fuzzy clustering
    JEL: F47 F33 F36
    Date: 2007–11–20
  17. By: Michael Kühl
    Abstract: The aim of this paper is to investigate the market efficiency on the foreign exchange market since the introduction of the Euro by applying the cointegration analysis to exchange rates. The introduction of the Euro has changed the structure of the global foreign exchange market to the extent that the second most important currency in the world with the highest credibility in the foreign exchange market, namely the Deutsche Mark, has been assimilated into the Euro. In order to evaluate if the introduction of a new currency has resulted in inefficient markets, a bivariate cointegration analysis should be applied to the seven most important exchange rates. The empirical analysis predominantly draws on the Johansen (1988, 1991) approach and the Gregory-Hansen (1996) approach whereas the latter takes endogenous structural breaks into account. We show that the foreign exchange market is broadly consistent with the market efficiency hypothesis. A very important result is that we can find a longrun relationship between the exchange rate pairs EUR/USD and GBP/USD whereas the no-arbitrage condition is satisfied. Since the EUR/USD exchange rate is weakly exogenous the GBP/USD exchange rate takes the burden of adjustment to the long-run equilibrium.
    Keywords: Foreign Exchange Market, Market Efficiency, Cointegration
    JEL: C32 F31 F33 G14 G15
    Date: 2007–10–31
  18. By: Manoel Bittencourt (School of Economics, University of Cape Town / South Africa)
    Abstract: We examine the impact of inflation on financial development in Brazil and the data available permit us to cover the period between 1985 and 2002. The results–based initially on time-series and then on panel time-series data and analysis, and robust for different estimators and financial development measures–suggest that inflation presented deleterious effects on financial development at the time. The main implication of the results is that poor macroeconomic performance, exemplified in Brazil by high rates of inflation, have detrimental effects to financial development, a variable that is important for affecting, e.g. economic growth and income inequality. Therefore, low and stable inflation, and all that it encompasses, is a necessary first step to achieve a deeper and more active financial sector with all its attached benefits.
    Keywords: Financial development, inflation, Brazil
    JEL: E31 E44 O11 O54
    Date: 2007–10–10
  19. By: Robert J Shiller
    Date: 2007–11–15

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.