nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒01‒19
sixteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The monetary policy transmission mechanism under financial dollarization: the case of Peru 1996-2006 By Renzo Rossini; Marco Vega
  2. Re-examining the Importance of Trade Openness for Aggregate Instability By Stephen McKnight; Alexander Mihailov
  3. Flexible Rules cum Constrained Discretion: A New Consensus in Monetary Policy By Philip Arestis; Alexander Mihailov
  4. Real Indeterminacy and the Timing of Money in Open Economies By Stephen McKnight
  5. The international transmission of monetary policy in a dollar pricing model By Tervala, Juha
  6. International Money and Finance By Paul Hallwood; Ronald MacDonald
  7. The Money Demand with Random Output and Limited Access to Debt By Mierzejewski, Fernando
  8. Investment and Interest Rate Policy in the Open Economy By Stephen McKnight
  9. Determinants of the size of a monetary policy committee: Theory and cross country evidence By Szilárd Erhart; Jose Luis Vasquez-Paz
  10. Monetary policy uncertainty and macroeconomic performance: An extended non-bayesian framework By Daniel Laskar
  11. Political and institutional factors in regime change in the ERM: An application of duration analysis By Simón Sosvilla-Rivero; Francisco Pérez-Bermejo
  12. EU-15 sovereign governments' cost of borrowing after seven years of Monetary Union By Marta Gómez-Puig
  13. Simple Monetary-Fiscal Targeting Rules By Michal Horvath
  14. Integration of Financial Markets in SAARC Countries: Evidence Based on Uncovered Interest rate Parity Hypothesis By Khan, Muhammad Arshad; Sajid, Muhammad Zubair
  15. The payment system intraday liquidity in a dollarized economy: The Peruvian experience By Marylin Choy; Roy Ayllón
  16. Money on the Road to Empire —Japan's Choice for Gold Monometallism By Schiltz, Michael

  1. By: Renzo Rossini (Central Reserve Bank of Peru); Marco Vega (Central Reserve Bank of Peru)
    Abstract: This paper analyzes the changes in the monetary policy transmission mechanism in Peru. A strong conclusion that emerges from this research is that both, the direct interest rate channel and the expectations channel have become more important in the recent years, especially after the Inflation Targeting adoption. The research further explores the implications of financial dollarization for the practice of monetary policy by performing two exercises. First, it compares different degrees of exchange rate flexibility and finds out that the more flexible the exchange rate is, the quicker but weaker the exchange rate pass-through becomes. Second, since financial dollarization may trigger contractionary depreciations, the document studies implications for monetary policy. The conclusion is that the effectiveness of monetary policy can be further improved if the economy becomes less dollarized.
    Keywords: Transmission Channels, Financial dollarization, Monetary Policy, Emerging Markets.
    JEL: E52
    Date: 2007–11
  2. By: Stephen McKnight (Department of Economics, University of Reading); Alexander Mihailov (Department of Economics, University of Reading)
    Abstract: This paper re-considers the importance of trade openness for equilibrium determinacy when monetary policy is characterized by interest-rate rules. We develop a two-country, sticky-price model where money enters the utility function in a non-separable manner. Forward- and current-looking policy rules that react to domestic or consumer price inflation are analyzed. It is shown that the introduction of real balance effects substantially limits the validity of the Taylor principle and challenges recent conclusions concerning the relative desirability of the inflation indicator targeted.
    Keywords: Real indeterminacy; Open-economy macroeconomics; Interest-rate rules; Monetary policy
    JEL: E32 E43 E53 E58 F41
    Date: 2007–10
  3. By: Philip Arestis (Department of Land Economy, University of Cambridge); Alexander Mihailov (Department of Economics, University of Reading)
    Abstract: This paper demonstrates that recent influential contributions to monetary policy imply an emerging consensus whereby neither rigid rules nor complete discretion are found optimal. Instead, middle-ground monetary regimes based on rules (operative under ‘normal’ circumstances) to anchor inflation expectations over the long run, but designed with enough flexibility to mitigate the short-run effect of shocks (with communicated discretion in ‘exceptional’ circumstances temporarily overriding these rules), are gaining support in theoretical models and policy formulation and implementation. The opposition of ‘rules versus discretion’ has, thus, reappeared as the synthesis of ‘rules cum discretion’, in essence as inflation-forecast targeting.
    Keywords: optimal monetary policy, flexible rules, constrained discretion, central bank independence, inflation targeting
    JEL: E52 E58 E61
    Date: 2007–10
  4. By: Stephen McKnight (Department of Economics, University of Reading)
    Abstract: This paper investigates the conditions under which interest-rate rules induce real equilibrium indeterminacy in a two-country, sticky-price, monetary model. Using a discrete-time framework, we employ the two most commonly used timing assumptions on which money balances enter into the utility function. This paper shows that the tim- ing equivalence result derived for a closed-economy no longer holds for open economies. This arises because modifications in the trading environment impact on the behavior of the real exchange rate. Consequently this helps explain the seemingly contradictory findings in the literature on real indeterminacy in open economies. Furthermore it challenges the belief that domestic inflation targeting is superior to consumer price inflation targeting, in minimizing aggregate instability.
    Keywords: Real indeterminacy; Open economy macroeconomics; Interest rate rules; Monetary Policy
    JEL: E32 E43 E53 E58 F41
    Date: 2007
  5. By: Tervala, Juha (University of Helsinki and HECER)
    Abstract: This paper analyses the international transmission of monetary policy in a case where all export prices are set in US dollars. ‘Dollar pricing’ implies that the international effects of US monetary shocks are different to those of European shocks because of asymmetric exchange rate pass-through to import prices. A dollar pricing model can explain the observed asymmetry in the transmission of monetary policy: US monetary policy affects US output more than European monetary policy affects European output. I also show that the dollar pricing model reintroduces the current account as an important channel through which monetary policy affects welfare in the short run. The paper concludes that under dollar pricing monetary expansion is a beggar-thy-neighbour policy.
    Keywords: open economy macroeconomics; monetary policy; international policy transmission
    JEL: F30 F41 F42
    Date: 2007–12–16
  6. By: Paul Hallwood (University of Connecticut); Ronald MacDonald (University of Glasgow)
    Abstract: We discuss the effectiveness of pegged exchange rate regimes from an historical perspective, drawing conclusions for their effectiveness today. Starting with the classical gold standard period, we point out that a succession of pegged regimes have ended in failure; except for the first, which was ended by the outbreak of World War I, all of the others we discuss have been ended by adverse economic developments for which the regimes themselves were partly responsible. Prior to World War II the main problem was a shortage of monetary gold that we argue is implicated as a cause of the Great Depression. After World War II, more particularly from the late-1960s, the main problem has been a surfeit of the main international reserve asset, the US dollar. This has led to generalized inflation in the 1970s and into the 1980s. Today, excessive dollar international base money creation is again a problem that could have serious consequences for world economic stability.
    Keywords: Bretton Woods, exchange rate expectations gold standard, new Bretton Woods, realignment expectations, pegged exchange rates, target zone, world economic instability
    JEL: F31 F33 N20
    Date: 2008–01
  7. By: Mierzejewski, Fernando
    Abstract: The money-demand of the economy is characterised, when national output is random and investors cannot attract any level of debt at any moment without incurring in additional costs. The optimal cash balance is then expressed as the probability-quantile (or Value-at-Risk) of the series of capital returns on income, and in this way, it is explicitly determined by risk. As a consequence, the interest-rate-elasticity depends on the kind of risks and expectations, in such a way that the more unstable the economy, the greater the interest-rate-elasticity of the money-demand. Therefore, the effectiveness of monetary policy is increased by diminishing the variability of output. Moreover, since flows of capital can affect the riskiness of financial securities by modifying the amounts involved in transactions, part of the adjustment to reestablish the short-run monetary equilibrium can be performed through volatility shocks. Finally, for different parametrisations of risks, aggregated parameters are expressed as the weighted average of sectorial estimations, so that multiple equilibria of the economy are allowed.
    Keywords: Money demand; Monetary policy; Economic capital; Distorted risk principle; Value-at-Risk.
    JEL: G11 E52 E44 E41
    Date: 2007–06
  8. By: Stephen McKnight (Department of Economics, University of Reading)
    Abstract: This paper presents a two-country sticky-price model that allows for capital and investment spending. It analyzes the conditions for equilibrium determinacy under alternative interest-rate rules that react to either domestic or consumer price inflation. It is shown that in the presence of investment, real indeterminacy is considerably easier to obtain once trade openness is permitted. Consequently we argue that sufficiently open economies should adopt a backward-looking rule and sufficiently closed economies should employ a current-looking rule, in order to minimize policy induced aggregate instability.
    Keywords: Real indeterminacy; Open economy macroeconomics; Interest rate rules; Monetary Policy
    JEL: E32 E43 E53 E58 F41
    Date: 2007–10
  9. By: Szilárd Erhart (Central Bank of Hungary); Jose Luis Vasquez-Paz (Banco Central de Reserva del Perú)
    Abstract: Theoretical and empirical studies of different sciences suggest that an optimal committee consists of roughly 5-9 members, although it can swell mildly under specific circumstances. This paper develops a conceptual model in order to analyze the issue in case of monetary policy formulation. The number of monetary policy committee (MPC) size varies according to the size of the monetary zone and overall economic stability. Our conceptual model is backed up with econometric evidence using a 2006 survey of 85 countries. The survey is available for further research and published on the web. The MPC size of large monetary zones (EMU, USA, Japan) is close to the estimated optimal level, but there exist several smaller countries with too many or too few MPC members.
    Keywords: Monetary policy.
    JEL: E50 E58
    Date: 2008–01
  10. By: Daniel Laskar
    Abstract: The existing literature has shown that less political uncertainty, or more central bank transparency, may worsen macroeconomic performance by raising the nominal wage. We extend this analysis to a non-bayesian framework, where there is some aversion to ambiguity. We show that the result found in the literature under the bayesian approach does not hold when the distance from the bayesian case is large enough, or when a reduction in "Knigtian uncertainty" is considered. Then, less uncertainty, or more transparency of the central bank, does not raise the nominal wage and, as a consequence, macroeconomic performance is not worsened (and is in general strictly improved).
    Date: 2008
  11. By: Simón Sosvilla-Rivero (FEDEA and Universidad Complutense de Madrid); Francisco Pérez-Bermejo (KPMG-Spain)
    Abstract: This paper analyses the functioning of the European Exchange Rate Mechanism (ERM). To that end, we apply duration models to estimate an augmented target-zone model, explicitly incorporating political and institutional factors into the explanation of European exchange rate policies. The estimations are based on quarterly data of eight currencies participating in the ERM, covering the complete history of the European Monetary System. Our results suggest that both economic and political factors are important determinants of the ERM currency policies. Concerning economic factors, the money supply, the real exchange rate, the interest in Germany and the central parity deviation would have negatively affected the duration of a given central parity, while credibility and the price level in Germany would have positively influenced such duration. Regarding political variables, elections, central bank independence and left-wing administrations would have increased the probability of maintaining the current regime, while unstable governments would have been associated with more frequent regime changes. Moreover, we show how the political augmented model outperforms, both in terms of explanatory power and goodness of fit, the model which just incorporates pure economic determinants.
    Keywords: Duration analysis, political variables, exchange rates, European Monetary System
    JEL: C41 D72 F31 F33
    Date: 2007–10
  12. By: Marta Gómez-Puig (Universitat de Barcelona)
    Abstract: Yield spreads over 10-year German government securities of the EU-15 countries converged dramatically in the seven years after the beginning of Monetary Integration. In this paper, we investigate the relative influence of systemic and idiosyncratic risk factors on their behaviour. Our conclusions suggest that in EMU-countries the relative importance of domestic risk factors (both credit and liquidity risk factors) is higher than that of international factors, which appear to play a secondary but significant role in non-EMU countries.
    Keywords: Monetary integration, sovereign securities markets, systemic and idiosyncratic risk
    JEL: E44 F36 G15
    Date: 2007–06
  13. By: Michal Horvath
    Abstract: We analyze the characteristics of optimal dynamics in an economy in which neither prices nor wages adjust instantaneously and lump-sum taxes are unavailable as a source of government finance. We then propose that monetar and fiscal policy should be coordinated to satisfy a pair of simple specific targeting rules, a rule for (wage) inflation and a relationship that links the growth of real wages to past price and wage developments, and output gap dynamics. We show that such simple rule-based conduct of policy can do remarkably well in replicating the dynamics of the economy under optimal policy following a given shock.
    Keywords: Optimal Monetary and Fiscal Policy, Timeless Perspective, Nominal Rigidity, Simple Targeting Rules.
    JEL: E52 E61 E63
    Date: 2008–01
  14. By: Khan, Muhammad Arshad; Sajid, Muhammad Zubair
    Abstract: This paper examines interest rate linkages among four SAARC countries vis-a-vis United State using monthly data over the period 1990M1 to 2006M3. The emperical findings suggest the existance of single cointegrating vector between SAARC countries interest rates and US interest rate. The result further suggest that except India, the coefficient restriction for Pakistan, Sri Lanka and Bangladesh are met segnificantly. However, in the case of India, the coefficient associated with foreign interest rate is far from the predicted value of UIP.The adjustment coefficient indicate no two ways causility. We also impemented the cointegration test within the SAARC countries. The test results suggest the existance of the one cointegrating vector.the existance of one cointegrating vector indicates the low degree of money markets integration in the region. Moreover, in the long run except Indian interest rate, other interest rates exerted positive impact on Pak-interest rate. Short Run Error Correction model is also estimated. the results suggest that Pakistani, Indian and Sri Lankan interest rates act as equlibrating factors in the long run, while no dynamic interaction between Pak-interst rate and Bangladesh-interest rate have been seen so far.
    Keywords: Financial markets integration; Interest Parity
    JEL: F15 G15 F36
    Date: 2007
  15. By: Marylin Choy (Banco Central de Reserva del Perú); Roy Ayllón (Banco Central de Reserva del Perú)
    Abstract: The Peruvian financial system is highly dollarized with more than 50 per cent of deposits held in dollars. The structure and operation of the payment system reflect this financial dollarization. Not only does it settle payments in local and foreign currency, but the Intraday Financial Facility (IFF), through which the Central Bank provides liquidity to assure the uninterrupted operation of the payment system, reflects as well the financial system dollarization. Thus, due to the high dollar composition of deposits in the financial system, banks keep large amounts of dollar liquidity at the Central Bank, so as to meet the marginal reserve requirement of 30 per cent, while the lower soles share of deposits as well as the minimum requirement to maintain 1 per cent deposited at the Central Bank, makes the soles liquidity of banks insufficient to settle all the transactions undertaken by the payment system, which for the most part are carried out in local currency, in spite of the financial dollarization. This situation leads the banks to utilize the IFF by means mainly of foreign currency swaps, given the ample availability of dollar liquidity. Nevertheless, the gradual dedollarization and the increasing bankarization are reducing the need to utilize the IFF. It is worth noting that at present not only foreign currency liquidity but also the holdings of Central Bank and Government securities are ensuring that the financial system is able to make use of the IFF and have the excess liquidity in order to settle total payments, both in local and foreign currency, thus enabling the payment system to run smoothly and efficiently.
    Keywords: Sistema de pagos, liquidez intradiaria, dolarización e instrumentos de política monetaria.
    JEL: D53 E44 E58 G21 G28
    Date: 2007–12
  16. By: Schiltz, Michael
    Abstract: Matsukata Masayoshi's decision to bring Japan upon the gold standard has often been presented as the self-evident result of his insight in some imperfections endemic to the silver standard and bimetallism. Turning to Marc Flandreau's refutation of the view that the growth toward an international gold standard system was preordained, this article inquires its consequences for discussions of Japan's late nineteenth century monetary situation. I argue that Matsukata's policies should not be discussed in terms of the assumed superiority of one standard over another, but should be studied as a political choice with respect to Japan's place in the world, both strategically (as an imperialist power) and economically (namely as economic partner of the gold standard countries).
    Keywords: Matsukata Masayoshi; monetary standards; Latin Monetary Union; Sino-Japanese war; imperialism
    JEL: N25 P16
    Date: 2007

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