nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒12‒01
35 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The Long and the Short End of the Term Structure of Policy Rules By Josephine M. Smith; John B. Taylor
  2. Optimal monetary policy under heterogeneity in currency trade By Bask, Mikael
  3. Instrument rules in monetary policy under heterogeneity in currency trade By Bask, Mikael
  4. Toward a Bias Corrected Currency Equivalent Index By Barnett, William A.; Keating, John W.; Kelly, Logan
  5. Political Monetary Cycles and a New de facto Ranking of Central Bank Independence By Alpanda, Sami; Honig, Adam
  7. Fiscal Policy in a Monetary Union: Can Fiscal Cooperation be Counterproductive? By Luisa Lambertini; Paul Levine; Joseph Pearlman
  8. Monetary and Fiscal Policy Interaction with Various Degrees and Types of Commitment By Hughes Hallett, Andrew; Libich, Jan; Stehlík, Petr
  9. Is openess inflationary? Imperfect competition and monetary market power By Richard W. Evans
  10. Inflation Targeting, Credibility and Confidence Crises By Rafael Santos; Aloisio Araujo
  11. Coping with People's Inflation Perceptions during a Currency Changeover By Thomas A. Eife; W. Timothy Coombs
  12. Relative Goods' Prices and Pure Inflation By Ricardo Reis; Mark W. Watson
  13. Inflation targeting drawbacks in the absence of a 'natural' anchor By Angel Asensio
  14. The Maastricht Inflation Criterion: What is the Effect of Expansion of the European Union? By John Lewis; Karsten Staehr
  15. Oil and the Great Moderation By Anton Nakov; Andrea Pescatori
  16. New Open Economy Macroeconomics By Corsetti, Giancarlo
  17. Professor Becker on Free Banking: A Comment By van den Hauwe, Ludwig
  18. Costs and Benefits of Euro Membership: a Counterfactual Analysis By Emmanuel Dubois; Jerome Hericourt; Valerie Mignon
  19. Inflation Dynamics and the Cross-Sectional Distribution of Prices in the E.U. Periphery By Constantina Kottaridi; Diego Mendez-Carbajo; Dimitrios Thomakos
  20. Long swings and chaos in the exchange rate in a DSGE model with a Taylor rule By Bask, Mikael
  21. Further evidence on the impact of economic news on interest. By Dominique Guégan; Florian Ielpo
  22. Happiness, Contentment and Other Emotions for Central Banks By Rafael Di Tella; Robert MacCulloch
  25. Costly Inflation Misperceptions By Thomas A. Eife; Stephan Meier
  26. The Credibility Problem Revisited: Thirty Years on from Kydland and Prescott By Paul Levine; Joseph Pearlman; Bo Yang
  27. Flexible time series models for subjective distribution estimation with monetary policy in view. By Dominique Guégan; Florian Ielpo
  28. Inflation and Financial Development: Evidence from Brazil By Bittencourt, Manoel
  29. A monetary model of the exchange rate with informational frictions By Enrique Martinez-Garcia
  30. The Curse of Irving Fisher (Professional Forecasters' Version) By Gregor W. Smith; James Yetman
  31. Interest Rate Modeling: A Matlab Implementation By Daniele Marazzina
  32. China currency dispute: is a rise in the yuan inevitable, necessary or desirable? By Tatom, John
  33. Price Rigidity in Brazil: Evidence from CPI Micro Data By Solange Gouvea
  34. Non-Robust Dynamic Inferences from Macroeconometric Models: Bifurcation Stratification of Confidence Regions By Barnett, William A.; Duzhak, Evgeniya A.
  35. Inefficient Credit Booms By Guido Lorenzoni

  1. By: Josephine M. Smith; John B. Taylor
    Abstract: We first document a large secular shift in the estimated response of the entire term structure of interest rates to inflation and output in the United States. The shift occurred in the early 1980s. We then derive an equation that links these responses to the coefficients of the central bank's monetary policy rule for the short-term interest rate. The equation reveals two countervailing forces that help explain and understand the nature of the link and how its sign is determined. Using this equation, we show that a shift in the policy rule in the early 1980s provides an explanation for the observed shift in the term structure. We also explore a shift in the policy rule in the 2002-2005 period and its possible effect on long-term rates.
    JEL: E43 E44 E52 E58 E65 G12
    Date: 2007–11
  2. By: Bask, Mikael (Bank of Finland Research)
    Abstract: We embed an expectations-based optimal policy rule into a DSGE model for a small open economy that is augmented with trend extrapolation or chartism, which is a form of technical trading, in currency trade to examine the prerequisites for monetary policy. We find that a unique REE that is least-squares learnable is often the outcome when there is a limited amount of trend extrapolation, but that a less flexible inflation rate targeting may cause a multiplicity of REE. We also compute impulse-response functions for key macroeconomic variables to study how the economy returns to steady state after being hit by a shock.
    Keywords: determinacy; DSGE model; least-squares learning; targeting rule; technical trading; monetary policy
    JEL: C62 E52 F31 F41
    Date: 2007–11–14
  3. By: Bask, Mikael (Bank of Finland Research)
    Abstract: We embed different instrument rules into a New Keynesian model for a small open economy that is augmented with technical trading in currency trade to examine the prerequisites for monetary policy. Specifically, this paper focuses on conditions for a determinate, least-squares learnable rational expectations equilibrium (REE). Under an interest rate rule with only contemporaneous macroeconomic data, the intensity of technical trading or trend-seeking in currency trade does not affect these conditions, except in the case of an extensive use of trend-seeking. On the other hand, if the central bank uses only forward-looking information in its interest rate rule, a determinate and learnable REE is a less likely outcome when trend-seeking in currency trade becomes more popular. The interest rate rule followed by the central bank in the model incorporates interest rate smoothing.
    Keywords: determinacy; DSGE model; interest rate rule; least-squares learning; technical trading
    JEL: C62 E52 F31 F41
    Date: 2007–11–20
  4. By: Barnett, William A.; Keating, John W.; Kelly, Logan
    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: E41
    Date: 2007–11–28
  5. By: Alpanda, Sami; Honig, Adam
    Abstract: This paper examines the extent to which monetary policy is manipulated for political purposes by testing for the presence of political monetary cycles between 1972 and 2001. This is the first study of its kind to include not only advanced countries but also a large sample of developing nations where these cycles are more likely to exist. We estimate panel regressions of a monetary policy indicator on an election dummy and control variables. We do not find evidence of political monetary cycles in advanced countries but find strong evidence in developing nations. Based on our results, we construct a new de facto ranking of central bank independence derived from the extent to which monetary policy varies with the election cycle. Our ranking of CBI is therefore based on the behavior of central banks during election cycles when their independence is likely to be challenged or their lack of independence is likely to be revealed. The ranking also avoids well-known problems with existing measures of central bank independence.
    Keywords: Political monetary cycles; central bank independence
    JEL: E58 E52
    Date: 2007–10
  6. By: Juan Manuel Julio
    Abstract: In order to asses the credibility of their targets and policies, in- °ation targeting central banks always keep an eye on market expectations of the future in°ation rates and short maturity interest rates. In economies with developed ¯nancial markets the prices of ¯nancial assets are a prime source of expectations. The spot curve, in particular, is thought to contain a great deal of information on market expectations. In this paper we study the pos- sibility to obtain market expectations on short maturity interest rates, that is, on the future monetary policy. A natural starting point in the program of deriving expectations from the spot curve is the Expectations Hypothesis of the Term Structure of the Interest Rates. According to this hypothesis the slope of the spot curve, the forward curve, represents the market expectations on interest rates aside from a negligible or at least time invariant forward term premium. For this note we developed a unique database of spot curves span- ning the period from Nov-1999 to Sep-2006 in order to test the validity of the Expectations Hypothesis for short maturities in Colombia. Our results indi- cate that the spot curve contains information on the future behavior of short maturity interest rates only for very short horizons. Moreover, we found that the forward term premium tend to be time varying. These result comprise in the rejection of the Expectations Hypothesis. Although these results imply that market expectations on future short maturity interest rates can not be obtained as easily as just applying the prescription of the Expectations Hy- pothesis, they do not rule out the possibility to obtain market expectations of the future monetary policy from the time series of spot curves.
    Date: 2007–11–01
  7. By: Luisa Lambertini (University of Surrey); Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University)
    Abstract: We analyze the interaction of monetary and fiscal policies in a monetary union where the common central bank is more conservative than the fiscal authorities. When monetary and fiscal policies are discretionary, we find that the Nash equilibrium is sub-optimal with higher output and lower inflation than the cooperative Ramsey op- timum. In a further example of counterproductive cooperative, we find that fiscal cooperation makes matters worse. We also examine cooperative and non-cooperative fiscal policy in the case where the central bank can commit and has the same prefer- ences as the fiscal authorities.
    Keywords: fiscal-monetary policy interactions, fiscal cooperation and non-cooperation.
    JEL: F33 F42
    Date: 2007–11
  8. By: Hughes Hallett, Andrew; Libich, Jan; Stehlík, Petr
    Abstract: Monetary and Fiscal policies interact in many ways. Recently the stance of fiscal policy in a number of countries has raised concerns about the risks for the outcomes of monetary policy. This paper first shows that these concerns are justified since, under ambitious fiscal policy makers, inflation bias and lack of monetary policy credibility may obtain in equilibrium even if the central banker is fully independent, patient and responsible. To reach a solution, the paper proposes an asynchronous game framework that generalises the standard commitment analysis. It allows concurrent and partial commitment; both policies may be committed at the same time for varying degrees or different periods. It is demonstrated that these undesirable outcomes can be prevented if monetary commitment is sufficiently strong relative to fiscal commitment. Interestingly, that monetary commitment cannot only resist fiscal pressure, but also discipline and ambitious fiscal policy maker to achieve socially desirable outcomes for both policies. We extend the setting to the European monetary union case with a common central bank and many fiscal policy makers, to show that these results carry over. The implication therefore is: by explicitly committing to a long run inflation target, the central bank can not only ensure its credibility, but also indirectly induce more disciplined fiscal policies. The paper shows that these predictions are broadly supported empirically.
    Keywords: asynchronous moves; Battle of sexes; commitment; Game of chicken; inflation targeting; monetary-fiscal interactions
    JEL: C73 E61 E63
    Date: 2007–11
  9. By: Richard W. Evans
    Abstract: Much empirical work has documented a negative correlation between different measures of globalization or openness and inflation levels across countries and across time. However, there is much less work exploring this relationship through structural international models based on explicit microeconomic foundations. This paper asks the question of how the degree of openness of an economy affects the equilibrium inflation level in a simple two-country OLG model with imperfect competition in which the monetary authority in each country chooses the money growth rate to maximize the welfare of its citizens. I find that a higher degree of openness in a country is associated with a higher equilibrium inflation rate. This result is driven by the fact that the monetary authority enjoys a degree of monopoly power in international markets as Foreign consumers have some degree of inelasticity in their demand for goods produced in the Home country. The decision of the monetary authority is then to balance the benefitsof increased money growth that come from the open economy setting with the well-known consumption tax costs of inflation. In addition, I find that the level of imperfect competition among producers within a country is a perfect substitute for the international market power of the monetary authority in extracting the monopoly rents available in this international structure.
    Keywords: Globalization ; Equilibrium (Economics)
    Date: 2007
  10. By: Rafael Santos; Aloisio Araujo
    Abstract: We study the interplay between the central bank transparency, its credibility, and the inflation target level. Based on a model developed in the spirit of the global games literature, we argue that whenever a weak central bank adopts a high degree of transparency and a low target level, a bad and self confirmed type of equilibrium may arise. In this case, an over-the-target inflation becomes more likely. The central bank is considered weak when favorable state of nature is required for the target to be achieved. On the other hand, if a weak central bank opts for less ambitious goals, namely lower degree of transparency and higher target level, it may avoid confidence crises and ensure a unique equilibrium for the expected inflation. Moreover, even after ruling out the possibility of confidence crises, less ambitious goals may be desirable in order to attain higher credibility and hence a better coordination of expectations. Conversely, a low target level and a high central bank transparency are desirable whenever the economy has strong fundamentals and the target can be fulfilled in many states of nature.
    Date: 2007–08
  11. By: Thomas A. Eife (University of Heidelberg, Department of Economics); W. Timothy Coombs (University of Illinois)
    Abstract: The discrepancy between popular impressions of how the 2002 changeover to the euro affected prices and its actual impact is perhaps the most surprising consequence of the single currency’s introduction. Following the changeover, perceived inflation rose significantly and returned to its prechangeover level only several months later. This paper argues that people’s inflation misperceptions could have been avoided. Using principles of crisis communication, we identify the mistakes made and present policy recommendations for future changeovers
    Keywords: euro changeover, perceived inflation, communication, perceptual crisis
    JEL: E50 E60 Y80
    Date: 2007–11
  12. By: Ricardo Reis; Mark W. Watson
    Abstract: This paper uses a dynamic factor model for the quarterly changes in consumption goods' prices to separate them into three components: idiosyncratic relative-price changes, aggregate relative-price changes, and changes in the unit of account. The model identifies a measure of "pure" inflation: the common component in goods' inflation rates that has an equiproportional effect on all prices and is uncorrelated with relative price changes at all dates. The estimates of pure inflation and of the aggregate relative-price components allow us to re-examine three classic macro-correlations. First, we find that pure inflation accounts for 15-20% of the variability in overall inflation, so that most changes in inflation are associated with changes in goods' relative prices. Second, we find that the Phillips correlation between inflation and measures of real activity essentially disappears once we control for goods' relative-price changes. Third, we find that, at business-cycle frequencies, the correlation between inflation and money is close to zero, while the correlation with nominal interest rates is around 0.5, confirming previous findings on the link between monetary policy and inflation.
    JEL: C32 C43 E31
    Date: 2007–11
  13. By: Angel Asensio (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII)
    Abstract: The economic performances of the Eurozone look weaker than those of the United States over<br />the period 1999-2006, in spite of the fact that the former applies more thoroughly the 'new<br />macroeconomics' governance rules concerning public deficits and inflation control. The<br />literature emphasizes Alan Greenspan's pragmatism when discussing the relative success of<br />the Fed, but the reasons why pragmatism ought to do better than a thorough application of the<br />'new macroeconomics' theoretical recommendations remain unexplored. The paper focuses on<br />the advantage of monetary policy pragmatism in the face of Keynesian uncertainty. More<br />specifically, it points out the trials of the 'new macroeconomics' principles of monetary policy<br />when they are implemented in a Keynesian context, that is, within a system which does not<br />have any 'natural' anchor.
    Keywords: Monetary policy; Post Keynesian; Uncertainty
    Date: 2007–11–20
  14. By: John Lewis; Karsten Staehr
    Abstract: Following the Maastricht criteria, a country seeking to join the European Monetary Union cannot have an inflation rate in excess of 1.5 percent plus the average inflation rates in the three 'best performing' EU countries. This inflation reference value is a non-increasing function of the number of EU members. Looking backwards, the effect of increasing the number of EU countries from 15 to 27would have been sizeable in 2003 and 2004, but relatively modest since 2005. Monte Carlo simulations show that the expansion of the EU from 15 to 27 members reduces the expected inflation reference value by 0.15-0.2 percentage points, but with a considerable probability of a larger reduction. The treatment of countries with negative inflation rates in the calculation of the reference value has a major impact on the results.
    Keywords: Maastricht Treaty; European Monetary Union; inflation; convergence.
    Date: 2007–11
  15. By: Anton Nakov; Andrea Pescatori
    Abstract: We assess the extent to which the period of great U.S. macroeconomic stability since the mid-1980s can be accounted for by changes in oil shocks and the oil share in GDP. To do this we estimate a DSGE model with an oil-producing sector before and after 1984 and perform counterfactual simulations. We nest two popular explanations for the Great Moderation: (1) smaller (non-oil) real shocks;and (2) better monetary policy. We find that the reduced oil share accounted for as much as one-third of the inflation moderation and 13% of the growth moderation, while smaller oil shocks accounted for 11% of the inflation moderation and 7% of the growth moderation. This notwithstanding, better monetary policy explains the bulk of the inflation moderation, while most of the growth moderation is explained by smaller TFP shocks.
    Keywords: Monetary policy ; Petroleum products - Prices ; Business cycles
    Date: 2007
  16. By: Corsetti, Giancarlo
    Abstract: 'New open economy macroeconomics' (NOEM) refers to a body of literature embracing a new theoretical framework for policy analysis in open economy, aiming to overcome the limitations of the Mundell-Fleming model while preserving the empirical wisdom and policy friendliness of traditional analysis. NOEM contributions have developed general equilibrium models with imperfect competition and nominal rigidities, to reconsider conventional views on the transmission of monetary and exchange rate shocks; they have contributed to the design of optimal stabilization policies, identifying international dimensions of optimal monetary policy; and they have raised issues about the desirability of international policy coordination.
    Keywords: exchange rates; international policy coordination; Mundell-Fleming model; open economy models; stabilization policy
    JEL: F33 F40 F41 F42
    Date: 2007–11
  17. By: van den Hauwe, Ludwig
    Abstract: Professor Becker´s 1956 paper about free banking was originally intended as a reaction to the 100-percent reserve proposals that were then popular at the University of Chicago. Today the original paper clearly illustrates how considerably our views and theories about free banking have evolved in the past 50 years. This development is to a considerable extent the result of the work and the writings of economists of the Austrian School. Pascal Salin is one of the most prominent members of the Austrian free banking school. In a new introduction to the 1956 paper written especially for the Festschrift in honor of Pascal Salin, Professor Gary Becker partially repudiates and mitigates some of his previous conclusions. This event offers a fitting opportunity to review some developments in the theory of free banking and related issues and to add a few clarifications concerning the present “state of the art” as regards an acceptable and adequate notion of free banking.
    Keywords: Free Banking; Monetary Regimes; Monetary Standards; Business Cycles
    JEL: E42 E32 E58
    Date: 2007–10–04
  18. By: Emmanuel Dubois; Jerome Hericourt; Valerie Mignon
    Abstract: The aim of this paper is to gauge quantitatively the macroeconomic costs or gains of EMU membership. Building on the Global VAR framework designed by Pesaran et al. (2004), we want to shed light on the following important questions: What if the euro had never been launched? How would have evolved national outputs and inflation rates? What would have been the consequences for Italy of not participating to Stage 3? We show that we cannot draw any general conclusion for the three largest euro area members, namely Germany, France and Italy. It is however certain that these countries had, and probably still have, conflicting interests regarding the most suitable monetary policy for each of them. Conversely, small euro area members like Finland, the Netherlands and Spain, seem to have benetted from the pre-euro convergence and from the single currency regime. Besides, the single currency regime probably did not have any significant impact on price developments. Finally, the non-participation of Italy to the single currency is quite neutral on the macroeconomic performances of the euro area.
    Keywords: Euro; counterfactual analysis; global VAR
    JEL: C32 E17 F42
    Date: 2007–11
  19. By: Constantina Kottaridi; Diego Mendez-Carbajo; Dimitrios Thomakos
    Abstract: We explore the connection between inflation and its higherorder moments for three economies in the periphery of the European Union (E.U.), Greece, Portugal and Spain. Motivated by a micro-founded model of inflation determination, along the lines of the hybrid New Keynesian Phillips curve, we examine whether and how much does the cross-sectional skewness in producer prices affect the path of inflation. We develop our analysis with the perspective of economic integration/inflation harmonization (in the E.U.) and discuss the peculiarities of these three economies. We find evidence of a strong positive relation between aggregate inflation and the distribution of relative-price changes for all three countries. A potentially important implication of our results is that, if the cross-sectional skewness of prices is directly related to aggregate inflation, not only the direction but also the magnitude of a nominal shock would influence output and inflation dynamics. Moreover, the effect of such a shock could be received asymmetrically, even when countries share a common currency.
    Keywords: Cross-sectional distribution of prices; Greece, Portugal, Spain, European Union, Harmonization.
    Date: 2007
  20. By: Bask, Mikael (Bank of Finland Research)
    Abstract: A DSGE model with a Taylor rule is augmented with an evolutionary switching between technical and fundamental analyses in currency trade, where the fractions of these trading tools are determined within the model. Then, a shock hits the economy. As a result, chaotic dynamics and long swings may occur in the exchange rate, which are appealing features of the model given existing empirical evidence on chaos and long swings in exchange rate fluctuations.
    Keywords: chaotic dynamics; foreign exchange; fundamental analysis; monetary policy; technical analysis
    JEL: C65 E32 E44 E52 F31
    Date: 2007–11–12
  21. By: Dominique Guégan (Centre d'Economie de la Sorbonne); Florian Ielpo (Centre d'Economie de la Sorbonne)
    Abstract: US interest rates'overnight reaction to macroeconomic announcements is of tremendous importance trading fixed income securities. Most of the empirical studies achieved so far either assumed that the interest rates' reaction to announcements is linear or independent to the state of the economy. We investigate the shape of the tern structure reaction of the swap rates to announcements using several linear and non-linear time series models. The empirical results yield several not-so-well-known stylized facts about the bond market. First, and although we used a daily dataset, we find that the introduction of non linear models leads to the finding of a significant number of macroeconomic figures that actually produce an effect over the yield curve. Most of the studies using daily datasets did not corroborate so far this conclusion. Second, we find that the term structure response to announcements can be much more complicated that what is generally found : we noticed at least four types of patterns in the term structure reaction of interest rates across maturities, including the hump-shaped one that is generally considered. Third, by comparing the shapes of the rates' term structure reaction to announcements with the first four factors obtained when performing a principal component analysis of the daily changes in the swap rates, we propose a first interpretation and classification of these different shapes. Fourth, we find that the existence of some outliers in the one-day changes in interest rates usually leads to a strong underestimation of the reaction of interest rates to announcements, explaining the different results obtained between high-frequency and daily datasets : the first type of study seems to lead to the finding of fewer market mover announcements.
    Keywords: Macroeconomic announcements, interest rates dynamic, outliers, reaction function, principale component analysis.
    JEL: G14 E43 E44
    Date: 2007–10
  22. By: Rafael Di Tella; Robert MacCulloch
    Abstract: We show that data on satisfaction with life from over 600,000 Europeans are negatively correlated with the unemployment rate and the inflation rate. Our preferred interpretation is that this shows that emotions are affected by macroeconomic fluctuations. Contentment is, at a minimum, one of the important emotions that central banks should focus on. More ambitiously, contentment might be considered one of the components of utility. The results may help central banks understand the tradeoffs that the public is willing to accept in terms of unemployment for inflation, at least in terms of keeping the average level of one particular emotion (contentment) constant. An alternative use of these data is to study the particular channels through which macroeconomics affects emotions. Finally, work in economics on the design of monetary policy makes several assumptions (e.g., a representative agent, a summary measure of emotions akin to utility exists and that individuals only care about income and leisure) that can be used to interpret our results as weights in a social loss function.
    JEL: E0 E58 H0
    Date: 2007–11
  23. By: Philip Liu
    Abstract: This paper examines the sources of Australia’s business cycle fluctuations focusing on the role of international shocks and short run stabilization policy. A VAR model identified using robust sign restrictions derived from an estimated structural model is used to aid the investigation. The results indicate that, in contrast to previous VAR studies, foreign factors contribute over half of domestic output forecast errors whereas innovation from output itself has little effect. Furthermore, monetary policy was largely successful in mitigating the business cycle fluctuations in a counter-cyclical fashion while the floating exchange rate also help offset foreign disturbances. For Australia’s stable economic success, good policy helped but so did good luck.
    JEL: E32 E52 E63 F41
    Date: 2007–11
  24. By: Kai, Guo; Conlon, John R.
    Abstract: This paper examines the effect of bubble-bursting policy in the case where the central bank sometimes tries to deflate an asset which is not, in fact, overpriced. We consider the case of a “semi-bubble,” where some traders know that an asset is overpriced, but others do not. Unlike most previous papers on bubble policy, our framework assumes rational traders. We also assume a finite time horizon, to rule out infinite horizon type bubbles. The market’s “fulfilled expectations” equilibria are derived, and standard tools of welfare economics are applied to evaluate the effect of anti-bubble policy. Under the assumption that the announcements of the financial authority can help less informed traders to learn more about a risky asset, market equilibria are presented and compared. We show that, if sellers care relatively more about the states where the central bank makes a negative bubble-bursting announcement, an announcement policy interferes with the asset’s ability to share risks. Conversely, if sellers care relatively less about the announcement states, an announcement policy improves risk sharing. “Information leakage” plays an important role in our analysis. Because of this leakage, central bank announcements can initiate further information revelation between traders. That is, the leakage effect can reveal information that the central bank, itself, does not have. However, this information leakage may not be welfare improving. Also, this leakage effect makes it difficult to predict the effects of bubble-bursting policy. This may complicate both private investment strategies and public policy analysis.
    Keywords: greater-fool; asset bubble; asymmetric information; information leakage; Hirshleifer effect.
    JEL: D53 E58 G18
    Date: 2007–10
  25. By: Thomas A. Eife (University of Heidelberg, Department of Economics); Stephan Meier (UniCredit Group)
    Abstract: One of the consequences of the euro changeover in 2002 was that for a period of several years people considerably overestimated actual inflation. The goal of this paper is to study whether misperceptions of this kind may have real effects, that is, whether they induce people to alter their behaviour. We also discuss the question how far the euro changeover and the ensuing discussion about price stability contributed to the recession that followed the changeover. Looking at the German restaurant sector, we find that people’s misperceptions can have significant negative effects. The contraction this sector experienced in the months after the changeover was too pronounced to be explained by normal business cycle movements. We provide a discussion about the causes of these misperceptions and how to avoid them in future changeovers.
    Keywords: euro changeover, perceived inflation
    JEL: D12 E21 C22
    Date: 2007–10
  26. By: Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University); Bo Yang (University of Surrey)
    Abstract: Macroeconomics research has changed profoundly since the Kydland-Prescott seminal paper. In order to address the Lucas Critique, modelling now is based on microfoundations treating agents as rational utility optimizers. Bayesian estimation has produced models which are more data consistent than those based simply on calibration. With micro-foundations and new linear-quadratic techniques, normative policy based on welfare analysis is now possible. In the open economy, policy involves a ‘game’ with policymakers and private institutions or private individuals as players. This paper attempts to reassess the Kydland-Prescott contribution in the light of these developments.
    Keywords: Monetary rules, commitment, discretion, open economy, coordination gains.
    JEL: E52 E37 E58
    Date: 2007–11
  27. By: Dominique Guégan (Centre d'Economie de la Sorbonne); Florian Ielpo (Centre d'Economie de la Sorbonne)
    Abstract: In this paper, we introduce a new approach to estimate the subjective distribution of the future short rate from the historical dynamics of futures, based on a model generated by a Normal Inverse Gaussian distribution, with dynamical parameters. The model displays time varying conditional volatility, skewness and kurtosis and provides a flexible framework to recover the conditional distribution of the future rates. For the estimation, we use maximum likelihood method. Then, we apply the model to Fed Fund futures and discuss its performance.
    Keywords: Subjective distribution, autoregressive conditional density, generalized hyperbolic distribution, Fed Funds futures contracts.
    JEL: C51 E44
    Date: 2007–10
  28. By: Bittencourt, Manoel
    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
  29. By: Enrique Martinez-Garcia
    Abstract: Data for the U.S. and the Euro area during the post-Bretton Woods period shows that nominal and real exchange rates are more volatile than consumption, very persistent, and highly correlated with each other. Standard models with nominal rigidities match reasonably well the volatility and persistence of the nominal exchange rate, but require an average contract duration above 4 quarters to approximate the real exchange rate counterparts. I propose a two-country model with financial intermediaries and argue that: First, sticky and asymmetric information introduces a lag in the consumption response to currently unobservable shocks, mostly foreign. Accordingly, the real exchange rate becomes more volatile to induce enough expenditure-switching across countries for all markets to clear. Second, differences in the degree of price stickiness across markets and firms weaken the correlation between the nominal exchange rate and the relative CPI price. This correlation is important to match the moments of the real exchange rate. The model suggests that asymmetric information and differences in price stickiness account better for the stylized facts without relying on an average contract duration for the U.S. larger than the current empirical estimates.
    Keywords: Foreign exchange rates
    Date: 2007
  30. By: Gregor W. Smith (Queen's University); James Yetman (University of Hong Kong)
    Abstract: Dynamic Euler equations restrict multivariate forecasts. Thus a range of links between macroeconomic variables can be studied by seeing whether they hold within the multivariate predictions of professional forecasters. We illustrate this novel way of testing theory by studying the links between forecasts of U.S. nominal interest rates, inflation, and real consumption growth since 1981. By using forecast data for both returns and macroeconomic fundamentals, we use the complete cross-section of forecasts, rather than the median. The Survey of Professional Forecasters yields a three-dimensional panel, across quarters, forecasters, and forecast horizons. This approach yields 14727 observations, much greater than the 107 time series observations. The resulting precision reveals a significant, negative relationship between consumption growth and interest rates.
    Keywords: forecast survey, asset pricing, Fisher effect
    JEL: E17 E21 E43
    Date: 2007–11
  31. By: Daniele Marazzina (SEMEQ Department - Faculty of Economics - University of Eastern Piedmont)
    Abstract: The aim of this work is to present a Matlab implementation of different methods for estimating the term structure of interest rate. More precisely, we implement the exponential functional form of Nelson-Siegel and polynomial spline methods (with or without penalty term), considering both coupon bonds, like Italian Btp, and Libor and Swap interest rates. Furthermore, we compare the models'performances, considering both computational costs and approximation results.
    Keywords: Interest Rate; Matlab; Spline; Term Structure; Italian Market
    JEL: G12
    Date: 2007–04
  32. By: Tatom, John
    Abstract: China-bashing has become a popular media and political sport. This is largely due to the U.S. trade imbalance and the belief, by some, that China is responsible for it because it manipulates its currency to hold down the dollar prices of its goods, unfairly creating a trade advantage that has contributed to the loss of U.S. businesses and jobs. This paper reviews the problem of the large trade imbalance that the United States has with China and its relationship to Chinese exchange rate policy. It examines the link between a Chinese renminbi appreciation and the trade balance and also whether a generalized dollar decline could solve the global or Chinese U.S. trade imbalance. The consensus view explained here is that a renminbi appreciation is not likely to fix either the trade imbalance with China or overall. Though these perceived benefits of a managed float are small or non-existent, perhaps they should be pursued anyway because of small costs or even benefits for China. Section IV looks at the costs of a managed float in terms of the benefits of the earlier peg. Opponents of a fixed dollar/yuan exchange rate ignore the costs of a managed float for China, especially with limits on currency convertibility. These costs are outlined here in order to provide an economic basis for the earlier fixed rate and China’s reluctance to appreciate. Finally it is suggested that the necessary convertibility on capital account, toward which China is moving, could easily result in yuan depreciation under a floating rate regime. This is hardly the end that China critics have in mind and it is not one that would improve U.S. or other trade imbalances with China.
    Keywords: exchange rate policy; China; currency manipulation; current account imbalance.
    JEL: F41 E58
    Date: 2007–07–18
  33. By: Solange Gouvea
    Abstract: In this paper, I investigate the patterns of price adjustments in Brazil. I derive the main stylized facts describing the behavior of price setters directly from a large data set of the CPI price quotes spanning approximately ten years until 2006. I find that on average prices remain unchanged for 2.7 to 3.8 months, exhibiting, however, a large degree of product and sector heterogeneity. Data on the frequency and sign of price changes show that there is a strong symmetry between price increase and decrease. Conversely, as expected under a positive inflation environment, the magnitude of positive price changes compensates this effect. I also provide some insights on the determinants of the patterns of price adjustment. The average duration of price spells decreased when the economy was hit by a confidence shock before 2002 presidential elections. The inflation rate of 5.9 % in 2000, jumped to 7.7% in 2001 and hiked to 12.6 % in 2002. Results suggest that substantial disturbances to average inflation imposed a high enough cost of not adjusting prices and triggered more frequent price reviews.
    Date: 2007–09
  34. By: Barnett, William A.; Duzhak, Evgeniya A.
    Abstract: Grandmont (1985) found that the parameter space of the most classical dynamic models are stratified into an infinite number of subsets supporting an infinite number of different kinds of dynamics, from monotonic stability at one extreme to chaos at the other extreme, and with many forms of multiperiodic dynamics between. The econometric implications of Grandmont’s findings are particularly important, if bifurcation boundaries cross the confidence regions surrounding parameter estimates in policy-relevant models. Stratification of a confidence region into bifurcated subsets seriously damages robustness of dynamical inferences. Recently, interest in policy in some circles has moved to New Keynesian models. As a result, in this paper we explore bifurcation within the class of New Keynesian models. We develop the econometric theory needed to locate bifurcation boundaries in log-linearized New-Keynesian models with Taylor policy rules or inflation-targeting policy rules. Central results needed in this research are our theorems on the existence and location of Hopf bifurcation boundaries in each of the cases that we consider.
    Keywords: Bifurcation; Hopf bifurcation; Euler equations; New Keynesian macroeconometrics; Bergstrom-Wymer model
    JEL: C3 C5 E3
    Date: 2007–11–27
  35. By: Guido Lorenzoni
    Abstract: This paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks. In particular, it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post. Even though, from a first-best perspective the equilibrium always displays under-borrowing, from a second-best point of view excessive borrowing can arise. The inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market. This generates a pecuniary externality that is not internalized in private contracts. The model provides a framework to evaluate preventive policies which can be used during a credit boom to reduce the expected costs of a financial crisis.
    JEL: E32 E44 E61 G10 G18
    Date: 2007–11

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