nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒05‒31
27 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. A New Keynesian Model for Analysing Monetary Policy in Mainland China By Li-gang Liu; Wenlang Zhang
  2. The Maastricht Convergence Criteria and Optimal Monetary Policy for the EMU Accession Countries. By Anna Lipinska
  3. Inflation, Monetary Policy and Stock Market Conditions By Michael D. Bordo; Michael J. Dueker; David C. Wheelock
  4. Time-Varying Yield Curve Dynamics and Monetary Policy By Mumtaz, Haroon; Surico, Paolo
  5. Supply-side effects of monetary policy and the central bank’s objective function By Araújo, Eurilton
  6. Monetary Aggregates and Liquidity in a Neo-Wicksellian Framework By Canzoneri, Matthew B; Cumby, Robert; Diba, Behzad; López-Salido, J David
  7. Optimal Monetary Policy under Staggered Loan Contracts By Yuki Teranishi
  8. Central Bank communication and monetary policy - a survey of theory and evidence. By Alan S. Blinder; Michael Ehrmann; Marcel Fratzscher; Jakob De Haan; David-Jan Jansen
  9. Credit and the natural rate of interest. By Fiorella De Fiore; Oreste Tristani
  10. Can the Facts of UK Inflation Persistence be Explained by Nominal Rigidity? By Meenagh, David; Minford, Patrick; Nowell, Eric; Sofat, Prakriti; Srinivasan, Naveen
  11. M3 Money Demand and Excess Liquidity in the Euro Area By Christian Dreger; Jürgen Wolters
  12. The behaviour of the MPC: Gradualism, inaction and individual voting patterns By Groth, Charlotta; Wheeler, Tracy
  13. Insiders versus Outsiders in Monetary Policy-Making By Besley, Timothy; Meads, Neil; Surico, Paolo
  14. Can Central Banks Go Broke? By Buiter, Willem H
  15. House prices and the stance of monetary policy. By Marek Jaroci?ski; Frank Smets
  16. Robust monetary rules under unstructured and structured model uncertainty. By Paul Levine; Joseph Pearlman
  17. Money and the Natural Rate of Interest: Structural Estimates for the United States and the Euro Area By Andrés, Javier; López-Salido, J David; Nelson, Edward
  18. The US Dollar and the Euro: Deus Ex-Machina By Lorca-Susino, Maria
  19. Expected Inflation, Expected Stock Returns, and Money Illusion: What can we learn from Survey Expectations? By Maik Schmeling; Andreas Schrimpf
  20. Globalisation, domestic inflation and global output gaps - evidence from the euro area. By Alessandro Calza
  21. Monetary and Fiscal Policy Coordination when Bonds Provide Transactions Services By Canzoneri, Matthew B; Cumby, Robert; Diba, Behzad; López-Salido, J David
  22. How Do Macroeconomic Developments in Mainland China Affect Hong Kong's Short-term Interest Rates? By Dong He; Frank Leung; Philip Ng
  23. Assessing the Credibility of The Convertibility Zone of The Hong Kong Dollar By Laurence Fung; Ip-wing Yu
  24. The Sources of Volatility Transmission in the Euro Area Money Market: From Longer Maturities to the Overnight? By Zagaglia, Paolo
  25. Monetary Policy and Data Uncertainty: A Case Study of Distribution, Hotels and Catering Growth By Mahadeva, Lavan
  26. Estimation of De Facto Exchange Rate Regimes: Synthesis of the Techniques for Inferring Flexibility and Basket Weights By Jeffrey A. Frankel; Shang-Jin Wei
  27. Exchange Rate Pass-Through to Domestic Inflation in Hong Kong By Li-gang Liu; Andrew Tsang

  1. By: Li-gang Liu (Research Department, Hong Kong Monetary Authority); Wenlang Zhang (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper adopts a three-equation New Keynesian model to evaluate the appropriateness of China's monetary policy framework. Our simulation results show that a hybrid rule that relies on both interest rate and quantity of money to conduct monetary policy appears to be more suitable than its alternatives at the current stage of economic and financial market development. Our simulation results also show that a sharp appreciation of the renminbi exchange rate would be disruptive to the inflation and output processes of the economy, despite its effectiveness in curbing inflation.
    Keywords: Monetary Policy Rule, New Keynesian Model, China
    JEL: E42 E52
    Date: 2007–11
  2. By: Anna Lipinska (Bank of England, Monetary Analysis, International Economic Analysis Division, Threadneedle Street, London EC2R 8AH, UK.)
    Abstract: The EMU accession countries are obliged to fulfill the Maastricht convergence criteria prior to entering the EMU. This paper uses a DSGE model of a two-sector small open economy, to address the following question: How do the Maastricht convergence criteria modify optimal monetary policy in an economy facing domestic and external shocks? First, we derive the micro founded loss function that represents the objective function of the optimal monetary policy not constrained to satisfy the criteria. We find that the optimal monetary policy should not only target inflation rates in the domestic sectors and aggregate output fluctuations but also domestic and international terms of trade. Second, we show how the loss function changes when the monetary policy is constrained to satisfy the Maastricht criteria. The loss function of such a constrained 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 potentially different from the steady state of the unconstrained optimal monetary policy. Under the chosen parameterization, the unconstrained optimal monetary policy violates two criteria: concerning the CPI in.ation rate and the nominal interest rate. The constrained optimal policy 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. The welfare costs associated with these constraints need to be offset against credibility gains and other benefits related to the compliance with the Maastricht criteria that are not modelled. JEL Classification: F41, E52, E58, E61.
    Keywords: Optimal monetary policy, Maastricht convergence criteria, EMU accession countries.
    Date: 2008–05
  3. 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.
    JEL: E31 E52 G12 N12 N22
    Date: 2008–05
  4. By: Mumtaz, Haroon (Monetary Assessment and Strategy, Bank of England); Surico, Paolo (Monetary Policy Committee Unit, Bank of England)
    Abstract: The dynamics of the US economy are modelled using a time-varying structural vector autoregression that incorporates information from the yield curve. We find important changes in the dynamics of macroeconomic variables such as inflation and the federal funds rate. In addition our results suggest a change in the relationship between the yield curve and macroeconomic variables. The monetary policy shocks of the early 1980s explain a large portion of the persistence of inflation and the level of the yield curve. Shocks to the level of the yield curve account for the persistence of the federal funds rate. We use our time-varying model provides to revisit the evidence on the expectations hypothesis.
    Keywords: Nelson-Siegel; time variation; inflation expectations; credibility building; evidence on expectations hypothesis
    JEL: C15 E44 E52
    Date: 2008–03
  5. By: Araújo, Eurilton
    Date: 2008–10
  6. By: Canzoneri, Matthew B; Cumby, Robert; Diba, Behzad; López-Salido, J David
    Abstract: Woodford (2003) describes a popular class of neo-Wicksellian models in which monetary policy is characterized by an interest-rate rule, and the money market and financial institutions are typically not even modelled. Critics contend that these models are incomplete and unsuitable for monetary-policy evaluation. Our Banks and Bonds model starts with a standard neo-Wicksellian model and then adds banks and a role for bonds in the liquidity management of households and banks. The Banks and Bonds model gives a more complete description of the economy, but the neo-Wicksellian model has the virtue of simplicity. Our purpose here is to see if the neo-Wicksellian model gives a reasonably accurate account of macroeconomic behaviour in the more complete Banks and Bonds model. We do this by comparing the models’ second moments, variance decompositions and impulse response functions. We also study the role of monetary aggregates and velocity in predicting inflation in the two models.
    Keywords: Banks; Monetary Aggregates
    JEL: E51 E52
    Date: 2008–05
  7. By: Yuki Teranishi (Institute for Monetary and Economic Studies, Bank of Japan (E-mail: yuuki.teranishi
    Abstract: The first aim of the paper is to investigate a new source of economic stickiness, staggered nominal loan interest rate contracts between a private bank and a firm under the monopolistic competition. We introduce this staggered loan contract mechanism with micro-foundation based on agent's optimized behaviors into a standard New Keynesian model in a tractable way. Simulation results show that staggered loan contracts play an important role in determining both the amplitude and the persistence of economic fluctuations. The second aim of the paper is to analyze optimal monetary policy in this environment with staggered loan contracts. To this end, we derive an approximated microfounded-welfare function in the model. Unlike the loss functions derived in other New Keynesian models, this model's welfare function includes a term that measures the first order difference in loan interest rates, which requires reduction of the magnitude of policy interest rate changes in the welfare itself. We derive the optimal monetary policy rule when the central bank can commit to its policy in the timeless perspective. One implication of the optimal policy rule is that the central bank has the incentive to smooth the policy interest rate. This empirically realistic conclusion can be seen in our simulation results.
    Keywords: Staggered Loan Interest Rate Contract, Optimal Monetary Policy, Economic Fluctuation
    JEL: E32 E44 E52 G21
    Date: 2008–05
  8. By: Alan S. Blinder (Princeton University - Department of Economics, Princeton, NJ 08544-1021, USA.); Michael Ehrmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Jakob De Haan (University of Groningen - Department of Economics, Postbus 72, 9700 AB Groningen, NL.); David-Jan Jansen (De Nederlandsche Bank - Economics and Research Division, P.O. Box 98, 1000 AB Amsterdam, NL.)
    Abstract: Over the last two decades, communication has become an increasingly important aspect of monetary policy. These real-world developments have spawned a huge new scholarly literature on central bank communication — mostly empirical, and almost all of it written in this decade. We survey this evergrowing literature. The evidence suggests that communication can be an important and powerful part of the central bank’s toolkit since it has the ability to move financial markets, to enhance the predictability of monetary policy decisions, and potentially to help achieve central banks’ macroeconomic objectives. However, the large variation in communication strategies across central banks suggests that a consensus has yet to emerge on what constitutes an optimal communication strategy. JEL Classification: E52, E58.
    Keywords: communication, central bank, monetary policy.
    Date: 2008–05
  9. By: Fiorella De Fiore (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Oreste Tristani (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We analyze the of the natural rate of interest in an economy where nominal debt contracts generate a spread between loan rates and the policy interest rate. In our model, monetary policy has real effects in the flexible-price equilibrium, because it affects the credit spread. Relying on a definition suitable for this environment, we demonstrate that: (i) the natural rate is independent of monetary policy and (ii) it delivers price stability, if used as the intercept of a monetary policy rule. The second result hold exactly if real balances are remunerated at a constand spread below policy interest rates, approximately otherwise. We also highlight, however, that the natural rate is not robust to model uncertainty. The natural rate reacts differently to aggregate shocks - not only quantitatively but also qualitatively - depending on the underlying model assumptions (e.g. whether or not financial markets are frictionless). JEL Classification: E40, E50, G10.
    Keywords: Monetary policy, natural rate of interest, credit frictions.
    Date: 2008–04
  10. By: Meenagh, David; Minford, Patrick; Nowell, Eric; Sofat, Prakriti; Srinivasan, Naveen
    Abstract: It has been widely argued that inflation persistence since WWII has been widespread and durable and that it can only be accounted for by models with a high degree of nominal rigidity. We examine UK post-war data where after confirming previous studies’ findings of varying persistence due to changing monetary regimes, we find that models with little nominal rigidity are best equipped to explain it.
    Keywords: Inflation Persistence; Monetary Regime Shifts; New Classical; New Keynesian; Nominal Rigidity
    JEL: E31 E37
    Date: 2008–05
  11. By: Christian Dreger; Jürgen Wolters
    Abstract: Money growth in the euro area has exceeded its target since 2001. Likewise, recent empirical studies did not find evidence in favour of a stable long run money demand function. The equation appears to be increasingly unstable if more recent data are used. If the link between money balances and the macroeconomy is fragile, the rationale of monetary aggregates in the ECB strategy has to be doubted. In contrast to the bulk of the literature, we are able to identify a stable long run money demand relationship for M3 with reasonable long run behaviour. This finding is robust for different (ML and S2S) estimation methods. To obtain the result, the short run homogeneity restriction between money and prices is relaxed. In addition, a rise in the income elasticity after 2001 is taken into account. The break might be linked to the introduction of euro coins and banknotes. The monetary overhang and the real money gap do not indicate significant inflation pressures. The corresponding error correction model survives a battery of specification tests.
    Keywords: Cointegration analysis, error correction, excess liquidity, money demand, monetary policy
    JEL: C22 C52 E41
    Date: 2008
  12. By: Groth, Charlotta (Monetary Policy Committee Unit, Bank of England); Wheeler, Tracy (Monetary Policy Committee Unit, Bank of England)
    Abstract: We evaluate the degree of gradualism and inaction in UK monetary policy over the Monetary Policy Committee (MPC) period (1997-2007) at the quarterly and the monthly frequency. After accounting for misspecification in standard Taylor rules, we find little evidence for gradualism. A measure of optimal policy is calculated. Comparing this with actual policy suggests that there is less inaction in monetary policy decisions than previous work suggested for the period prior to the formation of the MPC. In an analysis of the MPC's monthly voting decisions, we find that the activity rate, defined as the probability that the MPC vote to change interest rates in a given month, has fallen over time. This reflects the increased stability of inflation and output growth, rather than changes in the degree of gradualism and/or inaction. There is some evidence for inaction at the monthly frequency however, demonstrated by the fact that the MPC is more active in the forecast month than in the non-forecast month. The MPC also tends to wait longer before reversing the direction of interest rate changes than continuing them. This difference appears not to be driven by gradualism, and so provides further evidence for inaction at the monthly frequency. A panel data analysis suggests that the MPC as a whole is equally active as its individual members, so inaction appears not to be driven by the use of a committee to set monetary policy. There is no evidence that activity rates fall with the length of time that a member has served on the committee, suggesting that learning about the transmission mechanism has no impact on the tendency for gradualism and inaction.
    Keywords: Monetary Policy; Taylor Rules; Voting Patterns
    JEL: D78 E43 E52
    Date: 2008–01
  13. By: Besley, Timothy (Monetary Policy Committee Unit, Bank of England); Meads, Neil (Monetary Policy Committee Unit, Bank of England); Surico, Paolo (Monetary Policy Committee Unit, Bank of England)
    Abstract: This paper looks at the voting patterns of internal and external members of the MPC to investigate how far there are differences between insiders and outsiders. We make three contributions. First, we assess the extent to which the Bank of England internally generated forecasts explain the MPC members' voting decisions. This is important as generating forecasts on a quarterly basis is a key part of the process used by the Bank of England. The forecast for inflation is made public in the Inflation Report while the output gap forecast is not. Second, we use a random coefficient method of estimation in which the parameters of the interest rate rule are allowed, but not required, to be different across members. Third, we find evidence of some heterogeneity in the intercept, a measure of experience on the MPC and the interest rate smoothing parameter, but no significant differences in the members' reaction to the forecasts of inflation and the output gap.
    Keywords: Monetary Policy; Voting Patterns
    JEL: D78 E52
    Date: 2007–12
  14. By: Buiter, Willem H
    Abstract: Central banks can go broke and have done so, although mainly in developing countries. The conventional balance sheet of the central bank is uninformative about the financial resources it has at its disposal and about its ability to act as an effective lender of last resort and market marker of last resort. As long as central banks don’t have significant foreign exchange-denominated liabilities or index-linked liabilities, it will always be possible for the central bank to ensure its solvency though monetary issuance (seigniorage). However, the scale of the recourse to seigniorage required to safeguard central bank solvency may undermine price stability. In addition, there are limits to the amount of real resources the central bank can appropriate by increasing the issuance of nominal base money. For both these reasons, it may be desirable for the Treasury to recapitalise the central bank should the central bank suffer a major capital loss as a result of its lender of last resort and market maker of last resort activities. The fiscal authorities of the Euro Area should as a matter of urgency agree on a formula for dividing the fiscal burden of recapitalising the European Central Bank/Eurosystem, should the need arise.
    Keywords: central bank insolvency; lender of last resort; market maker of last resort; recapitalising central banks
    JEL: E31 E41 E44 E52 E58 E63 F31 F41
    Date: 2008–05
  15. By: Marek Jaroci?ski (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Frank Smets (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper estimates a Bayesian VAR for the US economy which includes a housing sector and addresses the following questions. Can developments in the housing sector be explained on the basis of developments in real and nominal GDP and interest rates? What are the effects of housing demand shocks on the economy? How does monetary policy affect the housing market? What are the implications of house price developments for the stance of monetary policy? Regarding the latter question, we implement a version of a Monetary Conditions Index (MCI) due to Céspedes et al. (2006). JEL Classification: E3-E4.
    Keywords: House prices, monetary conditions index, Bayesian VAR, monetary policy shock, conditional forecast.
    Date: 2008–04
  16. By: Paul Levine (The University of Surrey, Guildford, Surrey GU2 7XH, UK.); Joseph Pearlman (London Metropolitan University - Department of Economics, Finance and InternationalBusiness (EFIB), London EC2M 6SQ, UK.)
    Abstract: This paper compares two contrasting approaches to robust monetary policy design. The first developed by Hansen and Sargent (2003, 2007) assumes unstructured model uncertainty and uses a minimax robustness criterion to design monetary rules. This contrasts with an older literature that structures uncertainty by seeking rules that are robust across competing views of the economy. This paper carries out and compares robust design exercises using both approaches using a standard ‘canonical New Keynesian model’. We pay particular attention to a number of issues: First, we distinguish three possible forms of the implied game between malign nature and the policymaker in the Hansen-Sargent procedure. Second, in both approaches, we examine the consequences for robust rules of the zero lower bound (ZLB) constraint on the nominal interest rate, the monetary instrument. Finally, again for both types of robustness exercise we explore the implications of policy design when the policymaker is obliged to use simple Taylor-type interest rate rules. JEL Classification: E52, E37, E58.
    Keywords: Robustness, structured and unstructured uncertainty, zero lower bound interest rate constraint.
    Date: 2008–05
  17. By: Andrés, Javier; López-Salido, J David; Nelson, Edward
    Abstract: We examine the role of money in three environments: the New Keynesian model with separable utility and static money demand; a nonseparable utility variant with habit formation; and a version with adjustment costs for holding real balances. The last two variants imply forward-looking behaviour of real money balances, with forecasts of future interest rates entering current portfolio decisions. We conduct a structural econometric analysis of the U.S. and euro area economies. FIML estimates confirm the forward-looking character of money demand. A consequence is that real money balances are valuable in anticipating future variations in the natural interest rate.
    Keywords: money; natural rate; New Keynesian models
    JEL: E51 E52
    Date: 2008–05
  18. By: Lorca-Susino, Maria
    Abstract: Until the 19th and mid-20th centuries, economic theory explained that the economic status of a country was represented by the strength of its currency. This strength is measured by the exchange rate of one currency vis-á-vis another currency, a “zero-sum” game in which one currency gains what the other loses. In fact, during the 19th century, the strength of the Pound Sterling facilitated Britain’s global hegemonic political and economic power known as the Pax Britanica. During the 20th century, the strength of the US dollar represented both the economic and political hegemony of the US around the world known as the Pax Americana. Nowadays, the weakness of the US dollar is making specialists wonder if we are witnessing the end of Pax Americana and the beginning of something else, possibly a Pax Europea, led by the strength of the euro. This is the argument surrounding the current behaviour of the US$-€ exchange rate and its effect on the economic performance of these two economic blocs. While the current exchange rate between the US dollar and the euro has been considered a blessing for the US, it has become a matter of concern for most Eurozone countries. In fact, we are witnessing an unprecedented scenario where the country with a weak currency is actually pleased and the group of countries with a strong currency is worried. The strength of the euro is becoming irritating for the Eurozone and, nevertheless, the weakness of the US dollar is also pushing it to the brink of losing its status as a global currency. This exchange rate debate is accompanied by another debate concerning how the latest monetary policy actions taken by the US and Eurozone monetary authorities , aimed at solving current economic imbalances, are affecting the US$-€ exchange rate. Scholars, economists, and politicians argue that these monetary policies seem unable to solve today’s economic problems in the EU as well as in the Eurozone, but are having a tremendous impact on the US$-€ exchange rate. This paper will explain in layman’s terms the relationship (or lack thereof) between two of today’s most important economic issues: the US dollar and euro exchange rate, and the monetary policy behind it.
    Keywords: Monetary policy; Euro; US Dollar;
    JEL: C32 E2 A10 E3
    Date: 2008–04
  19. By: Maik Schmeling; Andreas Schrimpf
    Abstract: We show empirically that survey-based measures of expected inflation are significant and strong predictors of future aggregate stock returns in several industrialized countries both in-sample and out-of-sample. By empirically discriminating between competing sources of this return predictability by virtue of a comprehensive set of expectations data, we find that money illusion seems to be the driving force behind our results. Another popular hypothesis - inflation as a proxy for aggregate risk aversion - is not supported by the data.
    Keywords: Inflation expectations, Money Illusion, Proxy hypothesis, Stock returns
    JEL: G10 G12 E44
    Date: 2008–05
  20. By: Alessandro Calza (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper tests whether the proposition that globalisation has led to greater sensitivity of domestic inflation to the global output gap (the “global output gap hypothesis”) holds for the euro area. The empirical analysis uses quarterly data over the period 1979-2003. Measures of the global output gap using two different weighting schemes (based on PPPs and trade data) are considered. We find little evidence that global capacity constraints have either explanatory or predictive power for domestic consumer price inflation in the euro area. Based on these findings, the prescription that central banks should specifically react to developments in global output gaps does not seem to be justified for the euro area. JEL Classification: E3, F4.
    Keywords: Globalisation, inflation, global output gap.
    Date: 2008–04
  21. By: Canzoneri, Matthew B; Cumby, Robert; Diba, Behzad; López-Salido, J David
    Abstract: It is commonly asserted that monetary and fiscal policy may have to be coordinated if they are to provide a nominal anchor and avoid the pathological outcomes of sunspots or explosive price paths. In this paper, we study a model in which government bonds are an imperfect substitute for money in the transactions technology, providing a new channel for debt dynamics to feed into inflation dynamics. This modification of an otherwise standard NNS model substantially alters the conditions for local determinacy and the requirements for macroeconomic policy coordination: the Taylor Principle is no longer sacrosanct; a weak fiscal response to debt is no longer the panacea for a weak monetary policy; sunspot equilibria may be less relevant than previously thought; and the need for coordination may be less than previously thought. In addition, our model provides a new way of thinking about the structural break that is thought to have occurred around 1980 in monetary policy and in the dynamics of government spending and private consumption.
    Keywords: Bonds; Monetary and Fiscal Policies; Transaction Services
    JEL: E51 E52
    Date: 2008–05
  22. By: Dong He (Research Department, Hong Kong Monetary Authority); Frank Leung (Research Department, Hong Kong Monetary Authority); Philip Ng (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper studies the significance of Mainland-related shocks in determining Hong Kong money market interest rates after controlling for the influences of US variables. Analysis using a vector auto-regression model suggests that an unexpected rise in the Mainland policy interest rate, or a higher-than-expected growth in Mainland output or money supply, in general produces a positive and hump-shaped effect on the three-month HIBOR. Forecast error variance decomposition shows that US shocks still dominate, but Mainland shocks have become more important in accounting for the unexpected fluctuations in HIBOR in recent years. A historical decomposition shows that from autumn 2003 to spring 2005 the large negative spread between HIBOR and LIBOR was mainly due to Mainland factors. Thus, while the HIBOR-LIBOR spread is expected to be bounded inside a band that reflects the width of the Convertibility Zone of the Linked Exchange Rate system, Mainland-related shocks could exert a significant influence on the actual size of the spread.
    Keywords: Hong Kong, HIBOR, Linked Exchange Rate system
    JEL: E4 F36
    Date: 2007–11
  23. By: Laurence Fung (Research Department, Hong Kong Monetary Authority); Ip-wing Yu (Research Department, Hong Kong Monetary Authority)
    Abstract: The features under the two-sided Convertibility Zone of the Hong Kong dollar resemble in many ways the target zone exchange rate regime in the literature. Following Tronzano et al. (2000), this paper utilises a Bayesian extension of the Svensson (1991) test, which takes into account the exchange rate movement and the differential between domestic and foreign interest rates, to assess the credibility of the Convertibility Zone since it was introduced in May 2005. The empirical evidence suggests that the Hong Kong Monetary Authority has been successful in building a high degree of credibility in maintaining the Convertibility Zone.
    Keywords: Bayesian Analysis, Credibility, Convertibility Zone, Markov Chain Monte Carlo
    JEL: C11 C15 C22 F31
    Date: 2007–12
  24. By: Zagaglia, Paolo (Dept. of Economics, Stockholm University)
    Abstract: This note investigates the transmission of volatility from longer maturities to the overnight segment of the Euro area money market. I use non-parametric estimates of the daily variance of swap rates to test for block exogeneity with respect to the overnight. The results suggest that there exists transmission of volatility shocks from the 1-year swap rate to the overnight market. The reform of the operational framework of March 2004 has improved the segmentation of the market, as it has insulated the overnight segment from spillovers in volatility stemming from swap rates up to 6 months of maturity.
    Keywords: Money Market; High-Frequency Data; Granger Causality
    JEL: C22 E58
    Date: 2008–05–22
  25. By: Mahadeva, Lavan (Monetary Policy Committee Unit, Bank of England)
    Abstract: This paper is a case study of the real world monetary policy data uncertainty problem. The initial and the latest release for growth rates of the distribution, hotels and catering sector are combined with official data on household income and two surveys in a state-space model. Though important to the UK economy, the distribution, hotels and catering sector is apparently difficult to measure. One finding is that the initial release data is not important in predicting the latest release. It could be that the statistical office develop the initial release as a building block towards the final release rather than an estimate of it. Indeed, there is multicollinearity between the initial release and the retail sales survey, which would then contain the same early available information. A second finding is that the estimate of the later release is sensitive to the estimate of the average historical growth rate. This means that establishing priors for this parameter and testing for shift structural breaks should be very important.
    Keywords: Data Uncertainty; Distribution Sector; Kalman Filter; Monetary Policy
    JEL: E52 L81
    Date: 2007–12
  26. By: Jeffrey A. Frankel; Shang-Jin Wei
    Abstract: The paper offers a new approach to estimate de facto exchange rate regimes, a synthesis of two techniques. One is a technique that the authors have used in the past to estimate implicit de facto weights when the hypothesis is a basket peg with little flexibility. The second is a technique used by others to estimate the de facto degree of exchange rate flexibility when the hypothesis is an anchor to the dollar or some other single major currency, but with a possibly-substantial degree of flexibility around that anchor. Since many currencies today follow variants of Band-Basket-Crawl, it is important to have available a technique that can cover both dimensions, inferring weights and inferring flexibility. We try out the technique on twenty-some currencies, over the period 1980-2007. Most are currencies that have officially used baskets as anchors for at least part of this sample period. But a few are known floaters or known simple peggers. In general the synthesis technique seems to work as it should.
    JEL: F31 F41
    Date: 2008–05
  27. By: Li-gang Liu (Research Department, Hong Kong Monetary Authority); Andrew Tsang (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper estimates pass-through of exchange rate changes to domestic inflation in Hong Kong in a two-step approach. We first estimate exchange rate pass-through to import prices and then from import price to domestic inflation using a Phillips-Curve model. We find that Hong Kong¡¦s exchange rate pass-through to import prices is relatively high compared to the OECD average, although Hong Kong also witnessed a decline of pass-through after 1991. With respect to exchange rate pass-through to domestic prices, we find that a 10% depreciation of the US dollar against all currencies except for the Hong Kong dollar would lead domestic prices to increase by 0.82 and 1.61 percent in the short run and medium run, respectively. These results are also broadly consistent with those obtained from a calibration exercise that estimates exchange rate pass-through to domestic prices via channels of the tradable and non-tradable goods.
    Keywords: Exchange rate pass-through, Phillips Curve, Hong Kong
    JEL: F3 F4
    Date: 2008–03

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