nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒12‒15
twenty-six papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Optimal monetary policy in a hybrid New Keynesian model with a cost channel By Bask, Mikael
  2. The Maastricht Convergence Criteria and Optimal Monetary Policy for the EMU Accession Countries By Anna Lipinska
  3. Optimal monetary policy with a regime-switching exchange rate in a forward-looking model By Fernando Alexandre; Pedro Bação; John Driffill
  4. Optimal Monetary Policy in the Euro Area in the Presence of Heterogeneity By Sophocles N. Brissimis; Ifigeneia Skotida
  5. Simple interest rate rules with a role for money By Scharnagl, Michael; Gerberding, Christina; Seitz, Franz
  6. Robustly Optimal Monetary Policy By Kevin D. Sheedy
  7. Towards Measurement of Political Pressure on Central Banks in the Emerging Market Economies: The Case of the Central Bank of Egypt By Ibrahim L. Awad
  8. A Portofolio Balance Approach to Euro-Area Money Demand in a Time-Varying Environment By Stephen G.Hall; George Hondroyiannis; P.A.V.B. Swamy; George S. Tavlas
  9. The Single Global Currency - Common Cents for Business By Bonpasse, Morrison M.
  10. Yield curve reaction to macroeconomic news in Europe : disentangling the US influence By Marie Brière; Florian Ielpo
  11. Quantile Inferences for Inflation and Its Variability: Does a Threshold Inflation Rate Exist? By WenShwo Fang; Stephen M. Miller; Chih-Chuan Yeh
  12. Money and Overseas Investments in the Relative Fall of British Empire By Rota, Mauro; Schettino, Francesco
  13. Indian currency regime and its consequences. By Patnaik, Ila
  16. CHARACTERIZING THE BRAZILIAN TERM STRUCTURE OF INTEREST RATES By Osmani Teixeira de Carvalho Guillén; Benjamin M. Tabak?
  17. Interest rate rules and global determinacy: An alternative to the Taylor principle By Jean-Pascal Bénassy
  18. Reserves Accumulation in African Countries: Sources, Motivations, and Effects By Léonce Ndikumana; Adam Elhiraika
  20. Intrinsic Inflation Persistence By Kevin D. Sheedy
  21. Inflation Persistence When Price Stickiness Differs Between Industries By Kevin D. Sheedy
  22. Does the Nominal Exchange Rate Regime Affect the Long Run Properties of Real Exchange Rates? By Christian Dreger; Eric Girardin
  23. Scylla and Charybdis. The European Economy and Polands Adherence to Gold, 1928-1936 By Nikolaus Wolf
  24. Capital Controls and Foreign Investor Subsidies Implicit in South Africa's Dual Exchange Rate System By Windt, P.C. van der; Schaling, E.; Huizinga, H.P.
  25. Will the Renminbi become a world currency? By Wndy Dobson; Paul R. Masson

  1. By: Bask, Mikael (Bank of Finland Research)
    Abstract: This study shows that an expectations-based optimal policy rule has desirable properties in a standard macroeconomic model incorporating a cost channel for monetary disturbances and inflation rate expectations that are partly backward-looking. Specifically, optimal monetary policy under commitment is associated with a determinate REE that is stable under learning, whereas, under discretion, the central bank has to be sufficiently inflation averse for the equilibrium to have these properties.
    Keywords: commitment; determinacy; discretion; expectations-based rule; least squares learning
    JEL: E52 E61
    Date: 2007–12–05
  2. By: Anna Lipinska
    Abstract: The EMU accession countries are obliged to fulfill the Maastricht convergence criteria prior toentering the EMU. What should be the optimal monetary policy satisfying these criteria? To answer this question, the paper proposes a DSGE model of a two-sector small open economy.First, I derive the micro founded loss function that represents the objective function of theoptimal monetary policy not constrained to satisfy the criteria. I find that the optimal monetary policy should not only target inflation rates in the domestic sectors and aggregate output fluctuations but alsodomestic and international terms of trade. Second, I show how the loss function changes when themonetary policy is constrained to satisfy the Maastricht criteria. The loss function of such aconstrained policy is characterized by additional elements penalizing fluctuations of the CPI inflation rate, the nominal interest rate and the nominal exchange rate around the new targets which are different from the steady state of the unconstrained optimal monetary policy. Under the chosen parameterization, the optimal monetary policy violates two criteria:concerning the CPI inflation rate and the nominal interest rate. The constrained optimal policy ischaracterized by a deflationary bias. This results in targeting the CPI inflation rate and the nominal interest rate that are 0.7% lower (in annual terms) than the CPI inflation rate and the nominal interest rate in the countries taken as a reference. Such a policy leads to additional welfare costs amounting to 30% of the optimal monetary policy loss.
    Keywords: Optimal monetary policy, Maastricht convergence criteria, EMU accession countries
    JEL: F41 E52 E58 E61
    Date: 2007–07
  3. By: Fernando Alexandre (NIPE and niversidade do Minho); Pedro Bação (GEMF and Faculdade de Economia, Universidade de Coimbra); John Driffill (Birkbeck College, University of London)
    Abstract: We evaluate the macroeconomic performance of different monetary policy rules when there is exchange rate uncertainty. We do this in the context of a non-linear rational expectations model. The exchange rate is allowed to deviate from its fundamental value and the persistence of the deviation is modeled as a Markov switching process. Our results suggest that taking into account the switching nature of the economy is important only in extreme cases.
    Keywords: Exchange Rates, Monetary Policy, Markov Switching
    JEL: E52 E58 F41
    Date: 2007
  4. By: Sophocles N. Brissimis (Bank of Greece and University of Piraeus); Ifigeneia Skotida (Bank of Greece and Athens University of Economics and Business)
    Abstract: This paper examines the optimal design of monetary policy in the European monetary union in the presence of structural asymmetries across union member countries. It derives analytically an optimal interest rate rule under commitment and studies the dependence of its coefficients on the parameters of the structural model of each economy, the central bank's preferences for inflation and output stabilization as shown in its loss function, and the relative size of each country. Based on a twocountry, forward-looking, general equilibrium model, which is estimated for two euro area countries (Germany and France), we show that there are gains to be achieved by the ECB taking into account the heterogeneity of economic structures. This finding appears to be robust under alternative weights given by the central bank to the stabilization of the target variables. Although the implementation of the proposed rule involves difficulties relating to data and estimation constraints as well as risks of accommodating structural divergences, it is important that the ECB takes into consideration national characteristics in formulating its monetary policy, especially in view of more countries joining the European monetary union in the future. However, as monetary and financial integration advances, the welfare benefits of monetary policy responding to individual countries' variables may become less significant.
    Keywords: Monetary policy rules; Heterogeneous monetary union
    JEL: E52 E58
    Date: 2007–11
  5. By: Scharnagl, Michael; Gerberding, Christina; Seitz, Franz
    Abstract: The paper analyses the performance of simple interest rate rules which feature a response to noisy observations of inflation, output and money growth. The analysis is based on a small empirical model of the hybrid New Keynesian type which has been estimated on euro area data by Stracca (2007). To assess the magnitude of the measurement problems regarding the feedback variables, we draw upon the real-time data set for Germany compiled by Gerberding et al. (2004). We find that interest rate rules which include a response to money growth outperform both Taylor-type rules and speed limit policies once real-time output gap uncertainty is accounted for. One reason is that targeting money growth introduces history dependence into the policy rule which is desirable when private agents are forward-looking. The second reason is that money growth contains information on the “true” growth rate of output which can only be measured imperfectly.
    Keywords: Monetary policy rules, euro area, data uncertainty
    JEL: E43 E52 E58
    Date: 2007
  6. By: Kevin D. Sheedy
    Abstract: This paper analyses optimal monetary policy in response to shocks using a model that avoidsmaking specific assumptions about the stickiness of prices, and thus the nature of the Phillipscurve. Nonetheless, certain robust features of the optimal monetary policy commitment arefound. The optimal policy rule is a flexible inflation target which is adhered to in the shortrun without any accommodation of structural inflation persistence, that is, inflation which itis costly to eliminate. The target is also made more stringent when it has been missed in thepast. With discretion on the other hand, the target is loosened to accommodate fully anystructural inflation persistence, and any past deviations from the inflation target are ignored.These results apply to a wide range of price stickiness models because the market failurewhich the policymaker should aim to mitigate arises from imperfect competition, not fromprice stickiness itself.
    Keywords: Inflation persistence, optimal monetary policy, rules versus discretion,stabilization bias, inflation targeting
    JEL: E5
    Date: 2007–11
  7. By: Ibrahim L. Awad (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: This paper assesses whether the legal independence granted to the Central Bank of Egypt (CBE) under the latest legislation is factual. I followed Fry’s methodology, which assumes that the level of independence of the central bank is determined by fiscal attributes. In an attempt to develop Fry’s method, I used a simple criterion to assess the central bank’s independence, namely, that the central bank is actually independent if it can fulfill its money supply target. Applying this criterion to the CBE and some other CBs in the developed countries and emerging market economies, we find that: (i) the legal independence granted to the CBE under the latest legislation is not factual; although the final objective of monetary policy is to achieve price stability, the CBE failed to fulfill its money supply target and achieve price stability, because it was responsive to political pressure and did not react to fulfill its money supply target; (ii) such political pressure on the CBE is due to fiscal attributes, as measured by domestic credit to the government; (iii) CBs whose independence is factual, according to our criterion, showed a negative relationship between the legal indices, as measured by the GMT index, and the fiscal attributes measured by DCGY. However, the relationship was anomalous when measured by the rate of inflation.
    Keywords: monetary policy, central bank independence, fiscal dominance political pressure
    JEL: E51 E59 H75 C23
    Date: 2007–12
  8. By: Stephen G.Hall (Leicester University and NIESR); George Hondroyiannis (Bank of Greece); P.A.V.B. Swamy (U.S. Bureau of Labor Statistics); George S. Tavlas (Bank of Greece a)
    Abstract: As part of its monetary policy strategy, the European Central Bank has formulated a reference value for M3 growth. A pre-requisite for the use of a reference value for M3 growth is the existence of a stable demand function for that aggregate. However, a large empirical literature has emerged showing that, beginning in 2001, essentially all euro area M3 demand functions have exhibited instability. This paper considers euroarea money demand in the context of the portfolio-balance framework. Our basic premise is that there is a stable demand-for-money function but that the models that have been used until now to estimate euro area money-demand are not well-specified because they do not include a measure of wealth. Using two empirical methodologies - - a co-integrated vector equilibrium correction (VEC) approach and a time-varying coefficient (TVC) approach - - we find that a demand-for-money function that includes wealth is stable. The upshot of our findings is that M3 behaviour continues to provide useful information about medium-term developments on inflation.
    Keywords: Money demand; VEC, time varying coefficient estimation; Euro area
    JEL: C20 E41
    Date: 2007–10
  9. By: Bonpasse, Morrison M.
    Abstract: As globalization continues, businesses are increasingly importing and exporting from countries with different currencies. To conduct that business, they (whether one or both parties) must pay fees for exchanging one currency for another and they must determine the exchange rate for a particular time. If the transaction is to be conducted over time, they may purchase currency instruments to hedge against currency fluctuation. All of these tasks add up to an average of about 5% of revenue for international businesses. As an increasing number of international businesses understand that these expensive tasks are unnecessary for trade conducted within a monetary union, these businesses are likely candidates to lead the effort to implement a Single Global Currency, to be managed by a Global Central Bank within a Global Monetary Union. In short, a "3-G" world. It's common cents.
    Keywords: Single Global Currency; monetary union; dollar; euro; European Monetary Union; Global Central Bank; Global Monetary Union; international monetary system; Bretton Woods; foreign exchange; currency; currency crisis; transaction costs
    JEL: F4 F5 E5 E6
    Date: 2007–07–04
  10. By: Marie Brière (Centre Emile Bernheim, Solvay Business School, Université Libre de Bruxelles, Brussel and Credit Agricole Asset Management SGR, Paris.); Florian Ielpo (Centre d’Economie de la Sorbonne, Paris, France.)
    Abstract: This paper analyses the response of the Euro yield curve to macroeconomic and monetary policy announcements. We present a new methodology for estimating the reaction of the Euro swap curve to economic news, in a data-rich environment. Given the sharp degree of interdependence between Euro rates and US rates, we propose to use the factors of the US yield curve to disentangle the daily variation in Euro rates stemming from US influence and the variation resulting from European news. We highlight the importance of taking the US yield curve influence into account and investigate the shape of the Euro term structure reaction to a range of news types. We find that the impact of economic announcements on the yield curve shows different patterns according to the news and we provide a hierarchy of the economic figures that have the strongest impact on the different maturities.
    Keywords: announcements, news, swap rates, yield curve, interest rates, Euro area.
    JEL: E43 E52 F42
    Date: 2007–09
  11. By: WenShwo Fang (Feng Chia University); Stephen M. Miller (University of Nevada, Las Vegas, and University of Connecticut); Chih-Chuan Yeh (The Overseas Chines Institute of Technology, Taichung)
    Abstract: Using quantile regressions and cross-sectional data from 152 countries, we examine the relationship between inflation and its variability. We consider two measures of inflation - the mean and median - and three different measures of inflation variability - the standard deviation, coefficient of variation, and median deviation. Using the mean and standard deviation or the median and the median deviation, the results support both the hypothesis that higher inflation creates more inflation variability and that inflation variability raises inflation across quantiles. Moreover, higher quantiles in both cases lead to larger marginal effects of inflation (inflation variability) on inflation variability (inflation). Using the mean and the coefficient of variation, however, the findings largely support no correlation between inflation and its variability. Finally, we also consider whether thresholds for inflation rate or inflation variability exist before finding such positive correlations. We find evidence of thresholds for inflation rates below 3 percent, but mixed results for thresholds for inflation variability.
    Keywords: inflation, inflation variability, inflation targeting, threshold effects, quantile regression
    JEL: C21 E31
    Date: 2007–12
  12. By: Rota, Mauro; Schettino, Francesco
    Abstract: Investigating on the reasons of British overseas investments (1850-1913) we analyze two different approaches on data and we conclude that they are not different from a stochastic view. Inquiring on ‘push’ approach, we find that exists a negative correlation between GDP and overseas investments where the former cause the latter. The link between monetary events and colonialism highlights India’s role as a reserve of bullions. In this way, British capital was able to complete its natural cycle, draining money for future foreign investments. This improve the theory by introducing the monetary element in ‘push’ and ‘pull’ hypothesis as well.
    Keywords: overseas Investments; Bimetallism; Gold Standard
    JEL: N1
    Date: 2007–12
  13. By: Patnaik, Ila (National Institute of Public Finance and Policy)
    Keywords: Currency
    Date: 2007–07
  14. By: Gilberto Tadeu Lima; Mark Setterfield
    Date: 2007
  15. By: Jacob Poke; Graeme Wells
    Abstract: This paper analyses the effectiveness of the spread between short and long term interest rates for predicting GDP growth in Australia, and whether the predictive relation deteriorates, as theory suggests, with the adoption of a credible inflation-targeting regime. We test whether predic- tive power is sensitive to inclusion of other conditioning variables which may be useful in forecasting GDP growth, and whether forecasting sig- ni?ficance is due primarily to the expected change in short-term interest rates, the term premium, or a combination of the two. In a simple bivari- ate model, results strongly suggest that the shift to a credible inflation- targeting regime has reduced the predictive content of the term spread. However, extensions to this basic model tend to undermine this result. The predictive power of the term spread in Australia may have been over- sold.
    Date: 2007–11
  16. By: Osmani Teixeira de Carvalho Guillén; Benjamin M. Tabak?
    Date: 2007
  17. By: Jean-Pascal Bénassy
    Abstract: A most wellknown determinacy condition on interest rate rules is the "Taylor principle", which says that nominal interest rates should respond more than hundred percent to inflation. Unfortunately, notably because interest rates must be positive, the Taylor principle cannot be satisfied for all inflation rates, and as a consequence global determinacy may not prevail even though there exists a locally determinate equilibrium. We propose here a simple alternative to the Taylor principle, which takes the form of a new condition on interest rate rules that ensures global determinacy. An important feature of the policy package is that it does not rely at all on any of the fiscal policies associated with the "fiscal theory of the price level", which was so far the main alternative for determinacy.
    Date: 2007
  18. By: Léonce Ndikumana (University of Massachusetts, Amherst, and UNECA, Addis Ababa); Adam Elhiraika (UNECA, P.O.B 3005, Addis Ababa, Ethiopia)
    Abstract: African countries have accumulated substantial foreign currency reserves in recent years, mostly from higher commodity exports as well as aid flows. In the context of macroeconomic stabilization, which remains at the forefront of national economic policymaking and aid conditionality, African countries are induced to hold reserves to allow monetary authorities to intervene in markets to control the exchange rate and inflation. Adequate reserves also allow the country to borrow from abroad and to hedge against instability and uncertainty of external capital flows. However, reserve accumulation can have high economic and social costs, including a high opportunity cost emanating from low returns on reserve assets, losses due to reserve currency depreciation, and forgone gains from investment and social expenditures that could be financed by these reserves. Therefore, African countries need to have a better understanding of the determinants and economic costs of reserve accumulation and to design optimal reserve management strategies to minimize these costs and maximize the gains from resource inflows. This study uses panel data from 21 African countries to examine the sources, motivation and economic implications of reserve accumulation with a focus on the impact on the exchange rate, inflation, and public and private investment. While the level of reserves remains adequate on average, some countries have accumulated excessive reserves especially in recent years. The empirical analysis in this paper shows that the recent reserve accumulation cannot be justified by portfolio choice motives (in terms of returns to assets) or stabilization objectives. At the same time it has resulted in exchange rate appreciation while it has yielded little benefits in terms of public and private investment. The evidence suggests that African countries, especially those endowed with natural resources, need to adopt a more pro-growth approach to reserve management. JEL Categories: E22; E51; F31; F41
    Keywords: external reserves; exchange rate appreciation; sub-Saharan Africa; private and public investment; macroeconomic stabilization.
    Date: 2007–12
  19. By: Luciano Dias Carvalho; José Luís Oreiro
    Date: 2007
  20. By: Kevin D. Sheedy
    Abstract: It is often argued that the New Keynesian Phillips curve is at odds with the data because itcannot explain inflation persistence — the difficulty of returning inflation immediately totarget after a shock without any loss of output. This paper explains how a model where newerprices are stickier than older prices is consistent with this phenomenon, even though itintroduces no deviation from optimizing, forwards-looking price setting. The probability ofadjusting new and old prices is estimated using a novel method that draws only onmacroeconomic data, and the findings strongly support the premise of the model.
    Keywords: inflation persistence, hazard function, time-dependent pricing, New Keynesian Phillips curve
    JEL: E3
    Date: 2007–11
  21. By: Kevin D. Sheedy
    Abstract: There is much evidence that price-adjustment frequencies vary widely across industries. This paper shows that inflation persistence is lower with heterogeneity in price stickiness than without it, taking as given the degree of persistence in variables affecting inflation. Differences in the frequency of price adjustment mean that the pool of firms which responds to any macroeconomic shock is unrepresentative, containing a disproportionately large number of firms from industries with more flexible prices. Consequently, this group of firms is more likely to reverse any initial price change after a shock has dissipated, making inflation persistence much harder to explain.
    Keywords: Inflation persistence, heterogeneity, price stickiness, New Keynesian PhillipsCurve
    JEL: E3
    Date: 2007–11
  22. By: Christian Dreger; Eric Girardin
    Abstract: This paper examines whether the behaviour of the real exchange rate is associated with a particular regime for the nominal exchange rate, like fixed and flexible exchange rate arrangements. The analysis is based on 16 annual real exchange rates and covers a long time span, 1870-2006. Four subperiods are distinguished and linked to exchange rate regimes: the Gold Standard, the interwar float, the Bretton Woods system and the managed float thereafter. Panel integration techniques are applied to increase the power of the tests. Cross section correlation is embedded via common factor structures. The evidence shows that real exchange rates properties are affected by the exchange rate regime, although the impact is not very strong. A unit root is rejected in both fixed and flexible exchange rate systems. Regarding fixed-rate systems, mean reversion of real exchange rates is more visible for the Gold Standard. The half lives of shocks have increased after WWII, probably due to a higher stickiness of prices and a lower weight of international trade in the determination of exchange rates. Both for the periods before and after WWII, half lives are lower in flexible regimes. This suggests that the nominal exchange rate plays some role in the adjustment process towards PPP.
    Keywords: Real exchange rate persistence, exchange rate regime, panel unit roots
    JEL: F31 F37 F41
    Date: 2007
  23. By: Nikolaus Wolf
    Abstract: This paper examines the timing of exit from the gold-exchange standard for European countriesbased on a panel of monthly observations 1928-1936 for two purposes: first it aims to understandthe enormous variation in monetary policy choices across Europe. I show that the pattern of exitfrom gold can be understood in terms of variation in factors commonly suggested in thetheoretical literature, which makes it possible to predict with reasonable accuracy the very monthwhen a country will exit gold in the 1930s. Second, I analyse the case of Poland more closelybecause it appears to be an intriguing outlier. Poland did not leave gold until April 1936 andsuffered through one of the worst examples of a depression, with massive deflation and acomplete collapse of industrial production. The estimated model fares worst for Poland, andpredicts an exit even later than April 1936. By closer inspection, the factors that drive thisprediction are the non-democratic character of the regime and a surprisingly high degree of tradeintegration with France. I argue that Poland's monetary policy was determined by attempts of thePilsudski regime to defend Poland against foreign (esp. German) aggression. I provide evidencethat strongly supports this view until about mid-1933. Ironically, just when Poland had joined thegold-bloc there were signs of a broad strategic reorientation, which paved the way for an exit in1936.
    Keywords: Gold-Exchange Standard, Interwar Period, Europe, Poland
    JEL: E42 E44 N14
    Date: 2007–11
  24. By: Windt, P.C. van der; Schaling, E.; Huizinga, H.P. (Tilburg University, Center for Economic Research)
    Abstract: Both in theory and practice, capital controls and dual exchange rate systems can be part of a country's optimal tax policy. We first show how a dual exchange rate system can be interpreted as a tax (or subsidy) on international capital income. We show that a dual exchange rate system, with separate commercial and financial exchange rates, drives a wedge between the domestic and foreign returns on comparable assets. As a borrower, the government itself is a direct beneficiary. Secondly, based on data from South Africa, we present empirical evidence of this revenue implicit in a dual exchange rate system; a revenue that amounted to as much as 0.1 percent of GDP for the South African government. However, this paper also shows that both the capital controls and the dual exchange rate system in South Africa gave rise to many perverse unanticipated e?ects. The latter may render capital controls and dual exchange rate systems unattractive in the end and, thereby, provides a rationale for the recent trend in exchange rate liberalization and unification.
    Keywords: Dual exchange rate systems;capital controls;emerging markets;financial repression;optimal tax policy
    JEL: H21
    Date: 2007
  25. By: Wndy Dobson; Paul R. Masson (Wendy Dobson, Rotman School of Management Paul R. Masson, Rotman School of Management.)
    Abstract: China has emerged as a major power in the world economy, so it seems natural to consider whether its currency will also have a major role. However, at present it is not used internationally. We look at the factors that contribute to the international use of currencies, and focus on the aspects of China’s financial system that would have to change before the renminbi emerged as an important regional or world currency. Even with important reforms, two important questions would remain: whether the authorities would want to encourage its international use, and whether an economy with substantial party control could gain international acceptance for its currency.
    Date: 2007
  26. By: Edmar L. Bacha; Márcio Holland; Fernando M. Gonçalves
    Date: 2007

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