nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒05‒17
24 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary policy: why money matters and interest rates don't By Daniel L. Thornton
  2. Why money growth determines inflation in the long run: answering the Woodford critique By Edward Nelson
  3. Optimal Monetary Policy and Interest Income Taxation By Araújo, Eurilton
  4. Inflation, monetary policy and stock market conditions By Michael D. Bordo; Michael J. Dueker; David C. Wheelock
  5. Political constraints on monetary policy during the Great Inflation By Weise, Charles L
  6. Exchange Rate Pass-Through And Monetary Policy By Frederic S. Mishkin
  7. Uncertainty, Inflation, and Welfare By Jonathan Chiu; Miguel Molico
  8. Taylor-type rules versus optimal policy in a Markov-switching economy By Fernando Alexandre; Vasco J. Gabriel; Pedro Bação
  9. Robust Monetary Policy with the Consumption-Wealth Channel By Araújo, Eurilton
  10. Price Level versus Inflation Targeting under Model Uncertainty By Gino Cateau
  11. Monetary Policy Under Uncertainty in an Estimated Model with Labour Market Frictions By Sala, Luca; Söderström, Ulf; Trigari, Antonella
  12. Currency Substitution and Financial Repression By Rangan Gupta
  13. Money demand and financial liberalization in Mexico: A cointegration approach By L. Arnaut, Javier
  14. Euroization: What Factors drive its Persistence? Household Data Evidence for Croatia, Slovenia and Slovakia By Helmut Stix
  15. Creating Maryland's Paper Money Economy, 1720-1739: The Role of Power, Print, and Markets By Farley Grubb
  16. Sophisticated monetary policies By Andrew Atkeson; V. V. Chari; Patrick J. Kehoe
  17. Structural heterogeneity or asymmetric shocks? Poland and the euro area through the lens of a two-country DSGE model By Kolasa, Marcin
  18. Temporary price changes and the real effects of monetary policy By Patrick J. Kehoe; Virgiliu Midrigan
  19. Does Stabilizing Inflation Contribute To Stabilizing Economic Activity? By Frederic S. Mishkin
  20. Constrained Smoothing Splines for the Term Structure of Interest Rates By Laurini, Márcio P.; Moura, Marcelo
  21. Will Subprime be a Twin Crisis for the United States? By Michael P. Dooley; David Folkerts-Landau; Peter M. Garber
  22. Monetary Non-Neutrality in a Multi-Sector Menu Cost Model By Emi Nakamura; Jon Steinsson
  23. The Determinants of Exchange Rate Regimes in Emerging Market Economies By Mehmet Guclu
  24. Inflation-Finance Nexus: A Case Study of Pakistan An Econometric ARDL Co-integration Approach By Sabihuddin, Muhammad; Nasir, Najeeb; Shahbaz, Muhammad

  1. By: Daniel L. Thornton
    Abstract: Monetary policy is now conducted by targeting a very short-term interest rate. The Fed and other central banks attempt to control the price level by manipulating aggregate demand by adjusting their interest rate target. At best, money's role is tertiary. Indeed, a few prominent and influential macroeconomists have suggested that money is not essential, or perhaps is irrelevant, for the determination of the price level. Against this backdrop, this paper argues that the essential feature of money is that it guarantees "final payment" and is essential for price determination. It also suggests that the ability of the central banks to control interest rates may be greatly exaggerated.
    Keywords: Monetary policy
    Date: 2008
  2. By: Edward Nelson
    Abstract: Woodford (2007) argues that it is not appropriate to regard inflation in the steady state of New Keynesian models as determined by steady-state money growth. Woodford instead argues that the intercept term in the monetary authority's interest-rate policy rule determines steady-state inflation. In this paper, I offer an alternative interpretation of steady-state behavior, according to which it is appropriate to regard steady-state inflation as determined by steady-state money growth. The argument relies on traditional interpretations of the central bank's power in the long run and appeals to model properties that are common to textbook and New Keynesian analysis. According to this argument, the only way the central bank can control interest rates in the long run is via affecting inflation, and its only means available for determining inflation is by determining the money growth rate.
    Keywords: Monetary policy ; Macroeconomics
    Date: 2008
  3. By: Araújo, Eurilton
    Date: 2008–10
  4. By: Michael D. Bordo; Michael J. Dueker; David C. Wheelock
    Abstract: This paper examines the association between inflation, monetary policy and U.S. stock market conditions during the second half of the 20th century. We estimate a latent variable VAR to examine how macroeconomic and policy shocks affect the condition of the stock market. Further, we examine the contribution of various shocks to market conditions during particular episodes and find evidence that inflation and interest rate shocks had particularly strong impacts on market conditions in the postwar era. Disinflation shocks promoted market booms and inflation shocks contributed to busts. We conclude that central banks can contribute to financial market stability by minimizing unanticipated changes in inflation.
    Keywords: Inflation (Finance) ; Monetary policy ; Stock market
    Date: 2008
  5. By: Weise, Charles L
    Abstract: The U.S. Great Inflation of the 1970s was characterized by repeated, failed attempts at disinflation by the Federal Reserve as well as periods of inaction despite rising inflation. Previous research has attributed these failures to policymakers’ “misperceptions” about monetary policy and the macroeconomy. This paper argues instead that the Fed’s behavior during this period can be explained as a response to political constraints. Members of the Fed understood that a serious attempt to tackle inflation would be unpopular with the public and would generate opposition from Congress and the Executive branch. The result was a commitment to the policy of gradualism, under which the Fed would attempt to reduce inflation with mild policies that would not trigger an outright recession, and premature abandonment of anti-inflation policies at the first sign of recession. The Fed managed to disinflate successfully under Chairman Volcker only when the political constraints on Fed policy were lifted after 1979, allowing the Fed to abandon the policy of gradualism and knowingly take actions that risked recession. Evidence for this explanation of Fed behavior is found in Minutes and Transcripts of FOMC meetings and speeches of Fed chairmen.
    Keywords: Great Inflation; monetary policy; Federal Reserve
    JEL: E58 E50
    Date: 2008–05
  6. By: Frederic S. Mishkin
    Abstract: This paper discusses what recent economic research tells us about exchange rate pass-through and what this suggests for the control of monetary policy. It first focuses on exchange rate pass-through from a macroeconomic perspective and then examines the microeconomic evidence. In light of this evidence, it then discusses the implications of exchange rate movements on the conduct of monetary policy.
    JEL: E52 F41
    Date: 2008–05
  7. By: Jonathan Chiu; Miguel Molico
    Abstract: This paper studies the welfare costs and the redistributive effects of inflation in the presence of idiosyncratic liquidity risk, in a micro-founded search-theoretical monetary model. We calibrate the model to match the empirical aggregate money demand and the distribution of money holdings across households, and study the effects of inflation under the implied degree of market incompleteness. We show that in the presence of imperfect insurance the estimated long-run welfare costs of inflation are on average 40% smaller compared to a complete markets, representative agent economy, and that inflation induces important redistributive effects across households. For example, the welfare gains of reducing inflation from 10% to 0% is 0.59% of income. Furthermore, we estimate that the long-run welfare gains of reducing the typical current inflation target of 2 to 1 percent to be 0.06% of income.
    Keywords: Inflation: costs and benefits; Monetary policy framework
    JEL: E40 E50
    Date: 2008
  8. By: Fernando Alexandre (Universidade do Minho - NIPE); Vasco J. Gabriel (University of Surrey and Universidade do Minho - NIPE); Pedro Bação (GEMF and Universidade de Coimbra)
    Abstract: We analyse the effect of uncertainty concerning the state and the nature of asset price movements on the optimal monetary policy response. Uncertainty is modelled by adding Markov-switching shocks to a DSGE model with capital accumulation. In our analysis we consider both Taylor-type rules and optimal policy. Taylor rules have been shown to provide a good description of US monetary policy. Deviations from its implied interest rates have been associated with risks of financial disruptions. Whereas interest rates in Taylor-type rules respond to a small subset of information, optimal policy considers all state variables and shocks. Our results suggest that, when a bubble bursts, the Taylor rule fails to achieve a soft landing, contrary to the optimal policy.
    Keywords: Asset Prices, Monetary Policy, Markov Switching.
    JEL: E52 E58
    Date: 2008
  9. By: Araújo, Eurilton
    Date: 2008–10
  10. By: Gino Cateau
    Abstract: The purpose of this paper is to make a quantitative contribution to the inflation versus price level targeting debate. It considers a policy-maker that can set policy either through an inflation targeting rule or a price level targeting rule to minimize a quadratic loss function using the actual projection model of the Bank of Canada (ToTEM). The paper finds that price level targeting dominates inflation targeting, although it can lead to much more volatile inflation depending on the weight assigned to output gap stabilization in the loss function. The price level targeting rule is also found to mimic the full-commitment solution quite well. There is, however, an important difference: the full-commitment solution does not require stationarity in the price-level. The paper then analyzes the extent to which the results are sensitive to Hansen and Sargent (2004) model uncertainty. The paper finds the price level targeting rule to be robust; its performance deteriorates slower than the inflation targeting rule and the absolute decline in performance is small in magnitude.
    Keywords: Uncertainty and monetary policy
    JEL: E5 E58 D8 D81
    Date: 2008
  11. By: Sala, Luca; Söderström, Ulf; Trigari, Antonella
    Abstract: We study the design of monetary policy in an estimated model with sticky prices, search and matching frictions, and staggered nominal wage bargaining. We find that the estimated natural rate of unemployment is consistent with the NBER description of the U.S. business cycle, and that the inflation/unemployment trade-off facing monetary policymakers is quantitatively important. We also show that parameter uncertainty has a limited effect on the performance or design of monetary policy, while natural rate uncertainty has more sizeable effects. Nevertheless, policy rules that respond to the output or unemployment gaps are more efficient than rules responding to output or unemployment growth rates, also in the presence of uncertainty about the natural rates.
    Keywords: Labour market search; Monetary policy; Natural rate uncertainty; Parameter uncertainty; Unemployment
    JEL: E24 E32 E52 J64
    Date: 2008–05
  12. By: Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: In this paper, we use a general equilibrium overlapping generations monetary endogenous growth model of a small open economy, to analyze whether financial repression, measured via the "high" mandatory reserve-deposit requirements of financial intermediaries, is an optimal response of a consolidated government following an increase in the degree of currency substitution. We find that higher currency substitution can yield higher reserve requirements, but, the result depends crucially on how the consumer weighs money in the utility function relative to domestic and foreign consumptions, and also the size of the government.
    Keywords: Currency Substitution, Endogenous Growth Models, Financial Repression, Small Open Economy, Public Finance
    JEL: E31 E44 E63 F43
    Date: 2008–04
  13. By: L. Arnaut, Javier
    Abstract: This paper examines the long run dynamics of Mexico’s money demand using Johansen’s cointegration approach with different specifications. The empirical evidence indicates that real balances, real income and the interest rate are cointegrated in all subperiods. The findings suggest that recent changes in economic policy through financial liberalization affected money demand functions; this due to the fact that income elasticity fell down during the transition through the subperiods, but simultaneously this did not affect the functional stability. The cointegrated coefficient on currency-money ratio (M0/M1) suggests that when the ratio falls, the demand for money falls too. Nevertheless, this last evidence is statistically weak. In addition, it was determined that alternative equations are not better than the conventional ones.
    Keywords: Money demand; financial liberalization; cointegration; error correction mechanism; currency-money ratio; Mexico
    JEL: C32 E50 G28 E41
    Date: 2008
  14. By: Helmut Stix (Oesterreichische Nationalbank, Economic Studies Division)
    Abstract: The question asked in this paper is why people continue to use foreign currencies even after their economies have stabilized. Survey data for Croatia, Slovenia and Slovakia are employed to provide an answer. The results confirm the role of network effects and of remittances. Furthermore, the extent of currency substitution is found to be positively associated with the level of income and education. An important aspect of euroization seems to be age (the older are more likely to hold foreign currencies). In contrast, neither expectations about inflation rates, nor about exchange rates, do seem to affect the degree of euroization in a systematic and predictable way. Trust in the banking system is found to affect the choice between foreign currency cash and foreign currency deposits. Overall, the results support the view that the persistence in the use of foreign currencies is driven to a large extent by factors that are related to the past.
    Keywords: Dollarization, euroization, currency substitution, survey data.
    JEL: E41 E50 D14
    Date: 2008–04–16
  15. By: Farley Grubb
    Abstract: The British North American colonies were the first western economies to rely on legislature-issued fiat paper money as their principal internal medium of exchange. This system arose piecemeal across the colonies making the paper money creation story for each colony unique. It was true monetary experimentation on a grand scale. The creation story for Maryland, perhaps the most unique among the colonies, is analyzed to evaluate how market forces, media influences, and the power of various constituents combined to shape its particular paper money system.
    JEL: E42 E51 H20 N11 N21 N41
    Date: 2008–05
  16. By: Andrew Atkeson; V. V. Chari; Patrick J. Kehoe
    Abstract: Sophisticated monetary policies can depend on the history of private actions and can differ on and off the equilibrium path. We show that such policies can uniquely implement any desired competitive outcome, even those in which along the equilibrium path interest rate policies violate the Taylor principle. We also show that the conventional restricted policies studied in the literature cannot uniquely support the best outcomes while sophisticated policies can. Finally, we show that sophisticated policies are robust to imperfect monitoring.
    Date: 2008
  17. By: Kolasa, Marcin
    Abstract: This paper presents a two-country model linking Poland and the euro area and applies it for assessment of heterogeneity across these two regions. Overall, our results can be seen as rather inconclusive about the differences in parameters describing agents' decision-making in Poland and in the euro area. On the contrary, we find strong evidence for heterogeneity in terms of volatility and synchronization of shocks hitting both economies. Our results may be viewed as a step towards estimating the costs of Poland's entry to the European Monetary Union, associated with giving up the monetary autonomy and losing benefits from stabilizing movements of the exchange rate.
    JEL: E32 D58 F41 C11
    Date: 2008–05
  18. By: Patrick J. Kehoe; Virgiliu Midrigan
    Abstract: the data, a large fraction of price changes are temporary. We provide a simple menu cost model which explicitly includes a motive for temporary price changes. We show that this simple model can account for the main regularities concerning temporary and permanent price changes. We use the model as a benchmark to evaluate existing shortcuts that do not explicitly model temporary price changes. One shortcut is to take the temporary changes out of the data and fit a simple Calvo model to it. If we do so prices change only every 50 weeks and the Calvo model overestimates the real effects of monetary shocks by almost 70%. A second shortcut is to leave the temporary changes in the data. If we do so prices change every 3 weeks and the Calvo model produces only 1/9 of the real effects of money as in our benchmark. We show that a simple Calvo model can generate the same real effects as our benchmark model if we set parameters so that prices change every 17 weeks.
    Date: 2008
  19. By: Frederic S. Mishkin
    Abstract: This paper discusses recent economic research that demonstrates that the objectives of price stability and stabilizing economic activity are often likely to be mutually reinforcing. Thus, the answer to the title of this paper--"Does stabilizing inflation contribute to stabilizing economic activity?"--is, for the most part, yes.
    JEL: E31 E32 E52
    Date: 2008–05
  20. By: Laurini, Márcio P.; Moura, Marcelo
    Date: 2007–10
  21. By: Michael P. Dooley; David Folkerts-Landau; Peter M. Garber
    Abstract: We identify incentives generated by the Bretton Woods II system that may have contributed to the sub-prime liquidity crisis now working its way through the international monetary system. We then evaluate the persistent conjecture that the liquidity crisis is or will become a balance of payments crisis for the United States. Given that it happens, the additional costs associated with a sudden stop of net capital flows to the United States could be quite substantial. But we observe that emerging market governments have continued to acquire US assets even as yields have fallen, and the incentives for continuing to do so remain strong. Moreover, the Bretton Woods II system, which has clearly been the most resilient of the forces driving current markets, continues to generate low real interest rates in industrial countries and growth in emerging markets that will help limit the damage from the liquidity crisis.
    JEL: F02 F32 F33
    Date: 2008–05
  22. By: Emi Nakamura; Jon Steinsson
    Abstract: Empirical evidence suggests that roughly 1/3 of the U.S. business cycle is due to nominal shocks. We calibrate a multi-sector menu cost model using new evidence on the cross-sectional distribution of the frequency and size of price changes in the U.S. economy. We augment the model to incorporate intermediate inputs. We show that the introduction of heterogeneity in the frequency of price change triples the degree of monetary non-neutrality generated by the model. We furthermore show that the introduction of intermediate inputs raises the degree of monetary non-neutrality by another factor of three, without adversely affecting the model's ability to match the large average size of price changes. Our multi-sector menu cost model with intermediate inputs generates variation in real output in response to calibrated aggregate nominal shocks that can account for roughly 26% of the U.S. business cycle.
    JEL: E30
    Date: 2008–05
  23. By: Mehmet Guclu (Department of Economics, Ege University)
    Abstract: The choice of exchange rate regime has become one of the most important issues one more time in many economies after the financial crises in recent years. In the wake of the financial crises, many countries, especially emerging market economies, opted for floating exchange rate regimes by forsaking the pegged regimes. Consequently, an old debate on the choice and determinants of exchange rate regimes has been triggered. Economists have started to debate what appropriate exchange rate regime for an economy is. When the tendency in recent years is taken into consideration, the choice of exchange rate regime of countries, especially emerging economies, needs to be analyzed. To do this, in this paper, we attempt to uncover how emerging market economies choose their exchange rate regimes. In other words, we try to find the economic and political factors underlying the choice of exchange rate regimes. The study includes 25 emerging market economies over the period 1970-2006. We use random effect ordered probit model in order to find the long run economic and political determinants of exchange rate regimes for emerging economies. The determinants of both the de jure and de facto exchange regimes are empirically analyzed in the paper.
    Keywords: Exchange Rate Regime, Emerging Market
    JEL: E42 F31 F33 F41
    Date: 2008–05
  24. By: Sabihuddin, Muhammad; Nasir, Najeeb; Shahbaz, Muhammad
    Abstract: Economic literature reveals that inflation is harmful for the health of financial sector through its detrimental affects. The present study also confirms the relationship between inflation and financial sector’s performance. We employed ARDL bounds testing approach to investigate log run relationships and Error Correction Method (ECM) for short run dynamics. Our findings argue that inflation lowers the efficiency of financial intermediaries not in short run but also in long run. Financial sector improves its performance through its previous policies and development in both the periods. Real GNP per capita also promotes the development of financial sector through their causal channels. Government spending enhances the efficiency of financial institutions in long run. Human capital formation declines the performance of financial sector due to low quality of education.
    Keywords: Finance; Inflation; ARDL Approach
    JEL: B22
    Date: 2007–03–25

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