nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒02‒02
25 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Investigating inflation persistence across monetary regimes By Luca Benati
  2. Resurrecting Keynes to Revamp the International Monetary System By Pietro ALESSANDRINI; Michele FRATIANNI
  3. Re-examining the Importance of Trade Openness for Aggregate Instability By Stephen McKnight; Alexander Mihailov
  4. Flexible Rules cum Constrained Discretion: A New Consensus in Monetary Policy By Philip Arestis; Alexander Mihailov
  5. The lending channel under optimal choice of monetary policy By Kilponen , Juha; Milne, Alistair
  6. Real Indeterminacy and the Timing of Money in Open Economies By Stephen McKnight
  7. Explaining Movements in the NZ Dollar - Central Bank Communication and the Surprise Element in Monetary Policy? By Özer Karagedikli; Pierre L. Siklos
  8. Some benefits of monetary policy transparency in New Zealand By Aaron Drew; Özer Karagedikli
  9. The working of the eurosystem - monetary policy preparations and decision-making – selected issues By Philippe Moutot; Alexander Jung; Francesco Paolo Mongelli
  10. Interdependencies between Monetary policy and Foreign-Exchange Intervention under Inflation Targeting: The case of Brazil and the Czech Republic By Luiz de Mello; Diego Moccero; Jean-Yves Gnabo
  11. What determines commercial banks’ demand for reserves in the interbank market By Kempa, Michal
  12. Investment and Interest Rate Policy in the Open Economy By Stephen McKnight
  13. Robust learning stability with operational monetary policy rules By Evans , George W; Honkapohja, Seppo
  14. Expectations, learning and monetary policy: an overview of recent research By Evans , George W; Honkapohja, Seppo
  15. What Explains the Spread Between the Euro Overnight Rate and the ECB’s Policy Rate? By Linzert, Tobias; Schmidt, Sandra
  16. Uncertainty and the price of risk in a nominal convergence process By Ricardo Gimeno; José Manuel Marqués
  17. Banking Market Integration in the SADC Countries: Evidence from Interest Rate Analyses By Aziakpono Meshach; Kleimeier Stefanie; Sander Harald
  18. The welfare effects of inflation: a cost-benefit perspective By Tödter, Karl-Heinz; Manzke, Bernhard
  19. East Asian Crisis and Currency Pressure: The Case of India By Pami Dua; Arunima Sinha
  20. Inflation persistence, structural breaks and omitted variables: a critical view By Andrea Vaona
  21. The Phillips Curve and NAIRU Revisited: New Estimates for Germany By Fitzenberger, Bernd; Franz, Wolfgang; Bode, Oliver
  22. Irving Fisher and the UIP Puzzle: Meeting the Expectations a Century Later By Campbell, R.A.J.; Koedijk, C.G.; Lothian, J.R.; Mahieu, R.J.
  23. What can (macro-)prudential policy do to support monetary policy? By Claudio Borio; Ilhyock Shim
  24. Solution of RE Models with Anticipated Shocks and Optimal Policy By Wohltmann, Hans-Werner; Winkler, Roland
  25. Fiscal Policy and Monetary Integration in Europe: An Update By Candelon Bertrand; Muysken Joan; Vermeulen Robert

  1. By: Luca Benati (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Under inflation targeting inflation exhibits negative serial correlation in the United Kingdom, and little or no persistence in Canada, Sweden and New Zealand, and estimates of the indexation parameter in hybrid New Keynesian Phillips curves are either equal to zero, or very low, in all countries. Analogous results hold for the Euro area–and for France, Germany, and Italy–under European Monetary Union; for Switzerland under the new monetary regime; and for the United States, the United Kingdom and Sweden under the Gold Standard: under stable monetary regimes with clearly defined nominal anchors, inflation appears to be (nearly) purely forward-looking, so that no mechanism introducing backward-looking components is necessary to fit the data. These results question the notion that the intrinsic inflation persistence found in post-WWII U.S. data–captured, in hybrid New Keynesian Phillips curves, by a significant extent of backward-looking indexation–is structural in the sense of Lucas (1976), and suggest that building inflation persistence into macroeconomic models as a structural feature is potentially misleading. JEL Classification: E31, E42, E47, E52, E58.
    Keywords: Inflation, European Monetary Union, inflation targeting, Gold Standard, Lucas critique, median-unbiased estimation, Markov Chain Monte Carlo.
    Date: 2008–01
  2. By: Pietro ALESSANDRINI (Universita' Politecnica delle Marche, Dipartimento di Economia); Michele FRATIANNI (Indiana University, Graduate School of Business Bloomington)
    Abstract: There is a broad consensus that the current, large US current-account deficits financed with foreign capital inflows at low interest rates cannot continue forever; there is much less consensus on when the system is likely to end and how badly it will end. The paper resurrects the basic principles of the plan Keynes wrote for the Bretton Woods Conference to propose an alternative to the current international monetary system. We argue for the creation of a supranational bank money that would coexist along side national currencies and for the establishment of a new international clearing union. The new international money would be created against domestic earning assets of the Fed and the ECB. In addition to recording credit and debit entries of the supranational bank money, the new agency would determine the size of quotas, the size and time length of overdrafts, and the coordination of monetary policies. The substitution of supranational bank money for dollars would harden the external constraint of the United States and resolve the n-1 redundancy problem.
    Keywords: Keynes Plan, exchange rates, external imbalances, international monetary system, key currency, supranational bank money
    JEL: E42 E52 F33 F36
    Date: 2008–01
  3. 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
  4. 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
  5. By: Kilponen , Juha (Bank of Finland Research); Milne, Alistair (Cass Business School, City University, London and Bank of Finland Research)
    Abstract: Building on Cecchetti and Li (2005), we show that the bank lending channel affects monetary policy trade-offs only when interest rates affect marginal costs of production (ie when there is a cost channel of monetary policy) in the New Keynesian monetary policy model. In our calibrated model the resulting impact of the bank lending channel on output-inflation trade-offs is quantitatively small and of ambiguous sign. When bank capital varies counter cyclically and bank loan rates have a relatively large impact on marginal costs, variation of bank loan margins improves monetary policy trade-offs. The new Basel accord, by increasing capital requirements during economic downturns, offsets this beneficial impact.
    Keywords: bank capital; bank lending; capital buffers; pro-cyclicality; capital regulation; cost channel; credit channel; loan margins; monetary trade-offs
    JEL: E51 E52 G21
    Date: 2007–12–15
  6. 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
  7. By: Özer Karagedikli; Pierre L. Siklos (Reserve Bank of New Zealand)
    Abstract: We conduct a high frequency event analysis to estimate the effects of monetary policy surprises, data surprises, and central bank verbal statements on the New Zealand-US dollar and the New Zealand-Australian dollar exchange rates. We find data surprises and monetary policy surprises have significant and large effects on exchange rate movements. More importantly, RBNZ interest rate decisions have a largely permanent impact on the exchange rate. Significantly, the impact of the published interest rate track seems to explain some 10 per cent additional variation in the exchange rate.
    JEL: E43 E44 E52
    Date: 2008–02
  8. By: Aaron Drew; Özer Karagedikli (Reserve Bank of New Zealand)
    Abstract: The Reserve Bank of New Zealand (RBNZ) is regarded as one of the most transparent central banks in the world. Recent research suggests that one benefit of such transparency is that financial markets better anticipate a central bank's reaction to incoming data, and in relation, do not over-react to macroeconomic data surprises. In this paper, we provide some institutional details of how the RBNZ communicates its monetary policy decisions to financial markets and conduct an events analysis to test whether there are any transparency benefits in the pricing of New Zealand's yield curve. In line with the recent empirical literature, our results suggest that short-term interest rates tend to react appropriately to the data flow, while longer term interest rates are not unduly influenced. We also show that market reactions tend to be in line with the RBNZ's inflation target objective.
    JEL: E43 E44 E52
    Date: 2008–01
  9. By: Philippe Moutot (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alexander Jung (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Francesco Paolo Mongelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The ECB’s monetary policy has received considerable attention in recent years. This is less the case, however, for its regular monetary policy preparation and decision-making process. This paper reviews how the factors usually considered as critical for the success of a central banking system and the federal nature of the Eurosystem are intertwined with its overall design and the functioning of its committee architecture. In particular, it examines the procedures for preparing monetary policy decisions and the role of the decision-making bodies and the committees therein. We suggest that technical committees, involving all national central banks (NCBs), usefully contribute to the regular processing of a vast amount of economic, financial and monetary data, as well as to the consensus building at the level of the Governing Council. A federal organisational structure, including a two-tier committee structure with the Executive Board taking the lead in preparing the monetary policy decisions and the Governing Council in charge of the decisions with collective responsibility for them, as well as committee work at the various hierarchical levels, contributes to the efficiency of the ECB’s monetary policy decision-making, and thereby facilitates the maintenance of price stability in the euro area. A fully-fledged committee structure has also contributed to the smooth integration of non-euro area Member States into the Eurosystem’s monetary policy decision-making process. JEL Classification: E42, E58, F33, F42.
    Keywords: European economic and monetary integration, monetary arrangements, central banks and their policies.
    Date: 2008–01
  10. By: Luiz de Mello; Diego Moccero; Jean-Yves Gnabo
    Abstract: The bulk of recent literature on foreign-exchange interventions has overlooked the potential interdependencies that may exist between these operations and the conduct of monetary policy. This is the case even under inflation targeting and especially in emerging-market economies, because central banks often explicitly reserve the right to intervene to calm disorderly markets and to accumulate foreign reserves, and when the exchange rate is perceived as out of step with fundamentals. This paper uses a friction model to estimate intervention reaction functions and the associated marginal effects for Brazil and the Czech Republic since adoption of inflation targeting in these countries in 1999 and 1998, respectively. The main findings are that: i) in both countries interventions occur predominantly to reduce exchange-rate volatility, while in Brazil the central bank also reacts to exchange-rate deviations from medium-term trends; ii) there are strong, asymmetric threshold effects in the reaction functions, and interventions are more likely and of higher magnitudes when they are carried out to depreciate than to appreciate the domestic currency; and iii) interventions seem to take place independently of contemporaneous monetary policy in Brazil, but not in the Czech Republic, where both policies appear to be interrelated. <P>Interdépendance entre politique monétaire et interventions sur le marché du change dans des régimes de ciblage d’inflation : le cas du Brésil et de la République tchèque <BR>La littérature récente sur les interventions de banques centrales sur le marché des changes a négligé l’interdépendance potentielle qui peut exister entre ces opérations et la politique monétaire. Pourtant, la question de l’interdépendance se pose même lorsque les économies adoptent un ciblage inflation, en particulier pour les pays émergeants, car les banques centrales se réservent, en général, ouvertement le droit d’intervenir pour calmer les désordres de marché, accumuler des réserves, ou réajuster le niveau du taux de change lorsque celui-ci ne semble pas en phase avec les fondamentaux. Cet article utilise un modèle de friction afin d’estimer une fonction de réaction sur le marché du change et les effets marginaux qui y sont associés pour le Brésil et la République Tchèque, à partir du moment où ces deux pays ont adopté un ciblage d’inflation (i.e., respectivement 1999 et 1998). Les principaux résultats sont que : i) les interventions visent principalement à réduire la volatilité du taux de change dans les deux pays, toutefois, la Banque centrale brésilienne réagit également aux déviations du taux de change par rapport à la tendance de moyen terme ; ii) il y a une forte asymétrie dans le comportement des banques centrales : les interventions sont plus importantes et plus probables lorsque la banque centrale doit déprécier plutôt qu’apprécier sa monnaie ; enfin iii) la politique d’interventions semble être indépendante de la politique monétaire pour le Brésil, alors qu’elles sont liées dans le cas de la République tchèque.
    Keywords: intervention, intervention, monetary policy, politique monétaire, Brazil, Brésil, Czech Republic, République tchèque
    JEL: C24 E52 F31
    Date: 2008–01–21
  11. By: Kempa, Michal (University of Helsinki)
    Abstract: In this paper I analyse the determinants of commercial banks’ demand for reserves in the interbank market. I first document the pattern in the Eurosystem, where banks deviate from the required reserves balance at the start of the maintenance period only to meet the requirements closer to the settlement day. Using my model I show that this behaviour can be explained by certain trade-related frictions and costs. Examples include potential extra expenses tied to large transactions or the asymmetry between the cost of borrowing and profits from lending. I also find that borrowing decisions can be largely unaffected by current liquidity, which has important implications for the implementation of central bank monetary policy: in order to influence the level of interest rates, the central bank must focus on controlling market expectations.
    Keywords: money markets; EONIA; liquidity effect
    JEL: E43 E52 E58
    Date: 2007–12–12
  12. 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
  13. By: Evans , George W (University of Oregon and University of St. Andrews); Honkapohja, Seppo (Bank of Finland and University of Cambridge)
    Abstract: We consider the robust stability of a rational expectations equilibrium, which we define as stability under discounted (constant gain) least-squares learning, for a range of gain parameters. We find that for operational forms of policy rules, ie rules that do not depend on contemporaneous values of endogenous aggregate variables, many interest-rate rules do not exhibit robust stability. We consider a variety of interest-rate rules, including instrument rules, optimal reaction functions under discretion or commitment, and rules that approximate optimal policy under commitment. For some reaction functions we allow for an interest-rate stabilization motive in the policy objective. The expectations-based rules proposed in Evans and Honkapohja (2003, 2006) deliver robust learning stability. In contrast, many proposed alternatives become unstable under learning even at small values of the gain parameter.
    Keywords: commitment; interest-rate setting; adaptive learning; stability; determinacy
    JEL: D84 E31 E52
    Date: 2007–12–13
  14. By: Evans , George W (University of Oregon and University of St. Andrews); Honkapohja, Seppo (Bank of Finland and University of Cambridge)
    Abstract: Expectations about the future are central for determination of current macroeconomic outcomes and the formulation of monetary policy. Recent literature has explored ways for supplementing the benchmark of rational expectations with explicit models of expectations formation that rely on econometric learning. Some apparently natural policy rules turn out to imply expectational instability of private agents’ learning. We use the standard New Keynesian model to illustrate this problem and survey the key results for interest-rate rules that deliver both uniqueness and stability of equilibrium under econometric learning. We then consider some practical concerns such as measurement errors in private expectations, observability of variables and learning of structural parameters required for policy. We also discuss some recent applications, including policy design under perpetual learning, estimated models with learning, recurrent hyperinflation, and macroeconomic policy to combat liquidity traps and deflation.
    Keywords: imperfect knowledge; learning; interest-rate setting; fluctuations; stability; determinacy
    JEL: D84 E31 E52
    Date: 2007–12–14
  15. By: Linzert, Tobias; Schmidt, Sandra
    Abstract: In this paper we employ a time series econometric framework to explore the structural determinants of the spread between the euro overnight rate and the ECB’s policy rate (EONIA spread) aiming to explain the widening of the EONIA spread in the period from mid-2004 to mid-2006. We mainly estimate a model of the EONIA spread from March 2004 until August 2006. The analysis identifies possible driving forces underlying the evolution of the spread over time and aims to quantify the impact of specific factors on the observed upward shift. We show that the increase in the EONIA spread can for the largest part be explained by the current liquidity deficit. Moreover, tight liquidity conditions as well as an increase in banks’ uncertainty about the liquidity conditions lead to a significant upward pressure on the spread. ECB’s liquidity policy only has a significant impact on the reduction of the spread if a loose policy is conducted during the last week of an MRO. Interestingly, interest rate expectations have not been found to have an important influence.
    Keywords: Overnight Market Rate (EONIA), Interest Rate Determination, Monetary Policy Implementation, Operational Framework
    JEL: C22 E43 E52
    Date: 2007
  16. By: Ricardo Gimeno (Banco de España); José Manuel Marqués (Banco de España)
    Abstract: In this paper we decompose nominal interest rates into real risk-free rates, inflation expectations and risk premia using an affine model that takes as factors the observed inflation rate and the parameters generated in the zero yield curve estimation. We apply this model to the Spanish economy during the 90s, which is an especially challenging exercise given the nominal convergence towards the European Monetary Union (EMU) then under way. The methodology seems to be suitable for other countries currently involved in convergence towards EMU. The evidence indicates that inflation expectations and risk premia account for most of the observed variation in nominal rates, while real risk-free interest rates show a reduction during this period lower than that suggested by other approaches.
    Keywords: Real interest rates, Risk Premium, Inflation expectations, Affine Model
    JEL: G12 E43 E44 C53
    Date: 2008–01
  17. By: Aziakpono Meshach; Kleimeier Stefanie; Sander Harald (METEOR)
    Abstract: This paper investigates the state, development and drivers of banking market integration in the member countries of the Southern African Development Community (SADC) by employing interest rate data. We first conduct a principal component analysis and find evidence for both increasing monetary integration and banking integration in loan and deposit markets. These integration processes are not developing uniformly and we can identify a convergence club. As banking market integration can be a genuine process or simply be driven by monetary integration, we also investigate the interest rate pass through from national and South African Central bank interest rates onto national retail rates. With respect to the convergence club we find both, genuine and monetary-integration driven processes though the latter dominate. We conclude that a selective expansion of the Common Monetary Area is possible but needs to be complement by efficient financial development policies.
    Keywords: Economics (Jel: A)
    Date: 2007
  18. By: Tödter, Karl-Heinz; Manzke, Bernhard
    Abstract: This paper reviews theory and evidence of the welfare effects of inflation from a costbenefit perspective. Basic models and selected empirical results are discussed. Historically, in assessing the welfare effects of inflation, the distortion of money demand played a prominent role. More recently, interactions of inflation and taxation came into focus. Growth effects of inflation as well as welfare effects of unanticipated inflation and of inflation uncertainty are also addressed. To assess the policy question whether inflation should be reduced or eliminated, the costs of disinflation play a role. Finally, the trade-off between the benefits of reducing inflation and the costs of disinflation is discussed and an overall assessment of the net welfare effects of achieving price stability is provided.
    Keywords: Inflation, price stability, welfare costs and benefits, distortions, money demand, consumption allocation, tax-inflation interaction
    JEL: D61 E21 E31 E41 H21
    Date: 2007
  19. By: Pami Dua (Department of Economics, Delhi School of Economics, Delhi, India and Economic Cycle Research Institute, New York); Arunima Sinha (Department of Economics, Columbia University, New York, NY)
    Abstract: This paper tests and explains the impact of the East Asian crisis on India’s exchange rate. To examine this, an index of currency pressure is estimated for four countries -- Thailand, South Korea, Malaysia and India covering the period just before, during and after the crisis. A contagion model with panel data for these four countries is also estimated during the crisis period. On the basis of the panel data estimates, the paper concludes that while India experienced some effects of the crisis, these were not substantive. This is partly attributed to the role of stabilisation policy in India that included intervention in the foreign exchange market by the central bank, phased tightening of monetary policy and restrictions on capital flows.
    Date: 2007–08
  20. By: Andrea Vaona (Istituto Ricerche Economiche, Faculty of Economic Sciences, University of Lugano, Switzerland.)
    Abstract: Recent empirical contributions assess time changes in inflation persistence by means of simple autoregressive models. Their reliability is discussed in the light of the econometric literature on model misspecification and it is showed that their results can be misleading due to the omission of relevant variables.
    Keywords: inflation persistence, structural breaks, omitted variables, model misspecification, serial correlation.
    JEL: E3 E31
    Date: 2008
  21. By: Fitzenberger, Bernd; Franz, Wolfgang; Bode, Oliver
    Abstract: This paper provides new estimates of a time–varying NAIRU for Germany taking account of the structural break caused by German unification based on the Kalman Filter and on a partially linear model as two alternatives. Estimating a standard Phillips curve, the sum of coefficients associated with expected inflation is far beyond unity, whatever measure of expected inflation rates is employed. Therefore, either the NAIRU concept is not applicable to Germany or, as it is our suggestion, one estimates the unemployment rate that is compatible with a tolerable inflation rate of say 2 percent following roughly the inflation target put forward by the European Central Bank. The estimates presented in this paper suggest that the NAIRU compatible with 2 percent inflation in Germany is currently around 7 percent if the definition of unemployment follows the concept of the ILO. In contrast to the consensus in the literature, our estimates suggest furthermore that the NAIRU in Germany has not increased since the early 1990’s.
    Keywords: NAIRU, unemployment, inflation, Phillips curve, Okun’s Law, German unification, Kalman Filter, partially linear model
    JEL: C22 E24 E31
    Date: 2007
  22. By: Campbell, R.A.J.; Koedijk, C.G.; Lothian, J.R.; Mahieu, R.J. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: We review Irving Fisher’s seminal work on UIP and on the closely related equation linking interest rates and inflation. Like Fisher, we find that the failures of UIP are connected to individual episodes in which errors surrounding exchange rate expectations are persistent, but eventually transitory. We find considerable commonality in deviations from UIP and PPP, suggesting that both of these deviations are driven by a common factor. Using a dynamic latent factor model, we find that deviations from UIP are almost entirely due to expectational errors in exchange rates, rather than attributable to the risk premium; a result consistent with those reported by Fisher a century ago.
    Keywords: Irving Fisher;UIP;PPP;inflation;interest rates;exchange rates
    Date: 2007–12–07
  23. By: Claudio Borio; Ilhyock Shim
    Abstract: In the economic environment that has been emerging over the last couple of decades, it is more likely that the occasional build-up of financial imbalances, typically in the form of unsustainable credit and asset price booms, will occur against the background of low and stable inflation, posing a potential threat to financial and macroeconomic stability. This means that the scope for monetary policy to lean against the build-up may be more constrained than in the past, when those imbalances would normally develop alongside rising inflation. This puts a premium on a strengthening of the macroprudential orientation of prudential frameworks, designed to restrain the build up of the imbalances and to make the financial system better able to withstand their unwinding. In this paper, we review the progress made in this direction in recent years. We conclude that there is now a much keener awareness of the importance of a macroprudential orientation but that progress in making it operational, while considerable, has been slower. The main obstacles are of an analytical and, above all, institutional/political economy nature. We suggest ways in which these obstacles could be addressed and underline the potential complementary role that adjustments in monetary policy frameworks could play.
    Keywords: financial stability, price stability, financial imbalances, macroprudential, financial regulation and supervision, monetary policy
    Date: 2007–12
  24. By: Wohltmann, Hans-Werner; Winkler, Roland
    Abstract: The purpose of this paper is to solve linear dynamic rational expectations models with anticipated shocks by using the generalized Schur decomposition method. We also determine the optimal unrestricted and restricted policy responses to temporary as well as permanent shocks which both are anticipated by the public. In particular, our method is useful for the analysis of optimal monetary policy in New Keynesian dynamic general equilibrium models.
    Keywords: Anticipated Shocks, Optimal Monetary Policy, Rational Expectations, Generalized Schur Decomposition
    JEL: C32 C61 E52
    Date: 2007
  25. By: Candelon Bertrand; Muysken Joan; Vermeulen Robert (METEOR)
    Abstract: By distinguishing between discretionary and non-discretionary fiscal policy, this paper analyses the stability of fiscal rules for EMU countries before and after the Maastricht Treaty. Using both Instrumental Variables and GMM techniques, it turns out that discretionary fiscal policy remains procyclical after 1992. This result contradicts the previous findings of Galí and Perotti (2003). It also appears that fiscal rules differ between large and small countries: especially large countries follow a procyclical discretionary policy. Furthermore, the paper shows that discretionary fiscal policy does exhibit different behaviour facing supply or demand constraints. The procyclical discretionary policy is followed mainly during upswings, when supply constraints are prevalent. Finally, there is no support for the presence of a ‘fatigue effect’ in fiscal discipline.
    Keywords: macroeconomics ;
    Date: 2007

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