nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒07‒05
thirteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Optimal Central Bank Transparency By Eijffinger, Sylvester C W; Hoogduin, Lex; van der Cruijsen, Carin A B
  2. What Do Reaction Functions Tell Us About Central Bank Preferences? By Steffen Elstner; Amer Tabakovic
  3. The Quantity Theory of Money in Historical Perspective By Michael Graff
  4. Estimation of weights for the Monetary Conditions Index in Poland By Andrzej Toroj
  5. Signal Extraction and Hyperinflations with a Responsive Monetary Policy By Judit Temesvary
  6. Governing the Governors: A Clinical Study of Central Banks By Frisell, Lars; Roszbach, Kasper F.; Spagnolo, Giancarlo
  7. Money and Nominal Bonds By Marchesiani, Alessandro; Senesi, Pietro
  8. On Choosing an Exchange Rate Regimes in Emerging Economies By Adamcik, Santiago
  9. The Long or Short of it: Determinants of Foreign Currency Exposure in External Balance Sheets By Lane, Philip R.; Shambaugh, Jay C
  10. Crisis and Responses: the Federal Reserve and the Financial Crisis of 2007-2008 By Stephen G. Cecchetti
  11. Capital Flows and Exchange Rates An empirical Analysis By Gregorios Siourounis
  12. The Continuing Puzzle of Short Horizon Exchange Rate Forecasting By Kenneth S. Rogoff; Vania Stavrakeva
  13. Menu Costs and Inflation Asymmetries Some Micro Data Evidence By Peter Karadi; Adam Reiff

  1. By: Eijffinger, Sylvester C W; Hoogduin, Lex; van der Cruijsen, Carin A B
    Abstract: Should central banks increase their degree of transparency any further? We show that there is likely to be an optimal intermediate degree of central bank transparency. Up to this optimum more transparency is desirable: it improves the quality of private sector inflation forecasts. But beyond the optimum people might: (1) start to attach too much weight to the conditionality of their forecasts, and/or (2) get confused by the large and increasing amount of information they receive. This deteriorates the (perceived) quality of private sector inflation forecasts. Inflation then is set in a more backward looking manner resulting in higher inflation persistence. By using a panel data set on the transparency of 100 central banks we find empirical support for an optimal intermediate degree of transparency at which inflation persistence is minimized. Our results indicate that while there are central banks that would benefit from further transparency increases, some might already have reached the limit.
    Keywords: central bank transparency; inflation persistence; monetary policy
    JEL: E31 E52 E58
    Date: 2008–06
  2. By: Steffen Elstner; Amer Tabakovic
    Abstract: Since Taylor’s 1993 paper researchers have devoted a lot effort to estimation of monetary policy rules. Taylor showed that a simple central bank reaction function, with the interest rate as monetary policy instrument and inflation and output gap as explanatory variables, mimics the Fed funds rate pretty well during the period from 1987 to 1992. Often, the Taylor rule coefficients are interpreted as if they reflect central bank’s preferences. However, this may be misleading. In this paper we show that Taylor rule coefficients are complicated terms consisting of preference parameters as well as parameters given by the structure of the economy. We illustrate our conclusion that Taylor rule coefficients cannot be interpreted as reflecting central bank preferences by estimating standard forward-looking Taylor rules for the Bundesbank, the Fed and UK and confront these with our results obtained by a multi-equation GMM approach in order to detect central bank preferences.
    Keywords: technology spillovers; trade; investment; panel cointegration
    Date: 2008–03
  3. By: Michael Graff (KOF Swiss Economic Institute, ETH Zurich)
    Abstract: The paper reconstructs the origins of the quantity theory of money and its applications. Against the background of the history of money, it is shown that the theory was flexible enough to adapt to institutional change and thus succeeded in maintaining its relevance. To this day, it is useful as an analytical framework. Although, due to Goodhart's Law, it now has only limited potential to guide monetary policy and was consequently abandoned by most central banks, an empirical analysis drawing on a panel data set covering more than hundred countries from 1991 to the present confirms that the theory still holds: a positive correlation between the excess growth rate of the stock of money and the rate of inflation cannot be rejected. Yet, while the correlation holds for the whole sample, proportionality is driven by a small number of influential observations with very high inflation
    Keywords: Quantity theory of money, demand for money, monetary targeting
    JEL: B10 E41 E58
    Date: 2008–04
  4. By: Andrzej Toroj (Warsaw School of Economics, National Bank of Poland)
    Abstract: In this paper, we follow the econometric approach to assess relative importance of real interest rate and real exchange rate for the monetary conditions in Poland, quantified as weights for Monetary Conditions Index (MCI). We consider both single- and multiple-equation specifications proposed in the literature with an application to Poland. Although MCI is nowadays broadly considered a rather obsolete indicator in monetary policy conduct, we argue that the econometric framework used for this purpose could be a good departure point when modelling monetary adjustments in a monetary union, provided correct dynamic specification of the models.
    Keywords: Monetary Conditions Index, MCI-ratio, IS curve, Phillips curve, VAR.
    JEL: C22 C32 E52 E59
    Date: 2008–06–23
  5. By: Judit Temesvary (Department of Economics, Cornell University, Ithaca)
    Abstract: This paper develops a multi-period extension of the Lucas (1972) overlapping generations "island" model with endogenous monetary policy (based on the minimization of a loss function over inflation and output deviations) and stochastic realization of the "allocation" of the young people across the two islands. These allocation realizations are interpreted as output shocks (since only the young people produce). The paper examines two cases: the certainty case when the exact monetary policy is known to the young, and uncertainty case where the young receive only a mixed signal of the output shock and the monetary policy weights through the price (the signal extraction problem). In the certainty case, the neutrality result holds. In the uncertainty case, even monetary shocks have real effects as a result of the signal extraction problem. After characterizing the resulting price function by its constant elasticity to the signal, we derive values of this elasticity and the monetary policy weights such that hyperinflations will develop. We find that for certain weights, hyperinflations can develop even when the price function is concave in the signal. Finally, we formulate a particular convex case of the price function (making distributional assumptions) to analyze the price and monetary policy examples and statics as functions of the weights on the inflation and output deviation terms.
    Keywords: Rational expectations, Neutrality of Money, Signal Extraction Problem, Loss function, Hyperinflations, High inflations
    JEL: E3 E4 E5
    Date: 2007–10
  6. By: Frisell, Lars; Roszbach, Kasper F.; Spagnolo, Giancarlo
    Abstract: Recent research on central bank governance has focused mainly on their monetary policy task. As the sub-prime loan market turmoil reminded us - central banks play a crucial role in financial markets not only in setting monetary policy, but also in ensuring their soundness and stability. In this paper we study the specific corporate governance structures of a number of central banks in light of their complex role of inflation guardians, bankers’ banks, financial industry regulators/supervisors and, in some cases, competition authorities and deposit insurance agencies. We review their current institutional arrangements, e.g. formal objectives, ownership, board and governor appointment rules, term limits and compensation, using both existing surveys and newly collected information; and we contrast them with the structures suggested in the corporate and public governance literatures, where present. Our analysis highlights a striking variety in central bank governance structures and a number of specific issues that appear unsatisfactorily addressed by existing research, including the incentive structure for governor and board members, the balance between central banks’ multiple objectives, and the need for term limits or post-employment restrictions.
    Keywords: accountability; bank regulation; board structure; central bank independence; central banks; cooling-off periods; governance; governor remuneration; regulatory capture; term limits
    JEL: E58 G18 G34 G38
    Date: 2008–06
  7. By: Marchesiani, Alessandro; Senesi, Pietro
    Abstract: This paper studies an economy with trading frictions, ex post heterogeneity and nominal bonds in a model à la Lagos and Wright (2005). It is shown that a strictly positive interest rate is a sufficient condition for the allocation with nominal bonds to be welfare improving. This result comes from the protection against the inflation tax.
    Keywords: money; search; nominal bonds and taxation
    JEL: H20 E40 H63
    Date: 2007–11–22
  8. By: Adamcik, Santiago
    Abstract: This paper discusses that a lot of the debate on selecting an exchange rate regime misses the time. It begins explaining the standard theory of choice between exchange rate regimes, and then explores the fragilities in this theory, specifically when this is applied to emerging economies. Next presents a extent of institutional characteristics that might have influence upon a country to choose either fixed or floating rates , and then turns to the converse question of whether the selection of exchange rate regime may make for the development of some helpful institutional traits. The conclusion is that the election of exchange rate regime is likely to be of second order significance to the development of good fiscal, financial, and monetary institutions in causing macroeconomic achievement in emerging market. A greater dedication in strong institution's development instead of focalizing in the exchange rate regimes could make economies healthier and less propense to the crises, as was observed of late years.
    Keywords: Regimenes de Tipo de Cambio; Economias Emergentes; Inflacion;Currency Board; Soft Pegs; Hard Pegs
    JEL: F4 F3 E5 E4
    Date: 2008–01
  9. By: Lane, Philip R.; Shambaugh, Jay C
    Abstract: Recently, there have been numerous advances in modelling optimal international portfolio allocations in macroeconomic models. A major focus of this literature has been on the role of currency movements in determining portfolio returns that may hedge various macroeconomic shocks. However, there is little empirical evidence on the foreign currency exposures that are embedded in international balance sheets. Using a new database, we provide stylized facts concerning the cross-country and time-series variation in aggregate foreign currency exposure and its various subcomponents. In panel estimation, we find that richer, more open economies take longer foreign-currency positions. In addition, we find that an increase in the propensity for a currency to depreciate during bad times is associated with a longer position in foreign currencies, providing a hedge against domestic output fluctuations. We view these new stylized facts as informative in their own right and also potentially useful to the burgeoning theoretical literature on the macroeconomics of international portfolios.
    Keywords: exchange rates; Financial globalization; international portfolios
    JEL: F31 F32
    Date: 2008–06
  10. By: Stephen G. Cecchetti
    Abstract: Realizing that their traditional instruments were inadequate for responding to the crisis that began on 9 August 2007, Federal Reserve officials improvised. Beginning in mid-December 2007, they implemented a series of changes directed at ensuring that liquidity would be distributed to those institutions that needed it most. Conceptually, this meant America's central bankers shifted from focusing solely on the size of their balance sheet, which they use to keep the overnight interbank lending rate close to their chosen target, to manipulating the composition of their assets as well. In this paper, I examine the Federal Reserve's conventional and unconventional responses to the financial crisis of 2007-2008.
    JEL: E5
    Date: 2008–06
  11. By: Gregorios Siourounis
    Abstract: This paper investigates the empirical relationship between capital flows and nominal ex-change rates for five major countries. It is well known that no theory based on current account or interest rates has ever been shown to work empirically at short to medium horizons. Recent international finance theory, however, suggests that currencies are influenced by capital flows as much as by current account balances and log-term interest rates. Using unrestricted VAR's we document the following: a) Incorporating net cross-border equity flows into linear exchange rate models can improve their in-sample performance. Using net cross-border bond flows, however, has no such effect; b) Positive shocks to home equity returns (relative to foreign markets) are associated with short-run home currency appreciation and equity inflow. Positive shocks to home interest rates (relative to foreign countries) cause currency movements that are not consistent with uncovered interest rate parity (UIP); c) An equity-augmented linear model supports exchange rate predictability and outperforms a random walk in several cases. Such superior forecast performance, however, depends on the exchange rate and the forecast horizon.
    Keywords: Net equity flows, net bond flows, equity returns, interest rates, and nominal exchange rates.
    Date: 2008
  12. By: Kenneth S. Rogoff; Vania Stavrakeva
    Abstract: Are structural models getting closer to being able to forecast exchange rates at short horizons? Here we argue that over-reliance on asymptotic test statistics in out-of-sample comparisons, misinterpretation of some tests, and failure to sufficiently check robustness to alternative time windows has led many studies to overstate even the relatively thin positive results that have been found. We find that by allowing for common cross-country shocks in our panel forecasting specification, we are able to generate some improvement, but even that improvement is not entirely robust to the forecast window, and much of the gain appears to come from non-structural rather than structural factors.
    JEL: C52 C53 F31 F47
    Date: 2008–06
  13. By: Peter Karadi (New York University); Adam Reiff (Central Bank of Hungary)
    Abstract: The paper explains the observed asymmetric inflation response to value-added tax (VAT) changes in Hungary by calibrating a standard sectoral menu cost model on a new micro-level CPI data set. The model is able to reproduce important moments of the data, and finds that the asymmetry can be explained by the interaction of menu costs, (sectoral) trend inflation and forward-looking firms, thereby it provides direct evidence to the argument of Ball and Mankiw (1994).
    Keywords: Menu Cost, Inflation Asymmetry, Sectoral Heterogeneity, Value-Added Tax
    JEL: E30
    Date: 2007–10

This nep-mon issue is ©2008 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.