nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒07‒14
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Inflation Target Shocks and Monetary Policy Inertia in the Euro Area By FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
  2. Money in the Inflation Equation: the Euro Area Evidence By Fourçans, André; Vranceanu, Radu
  3. The Rise and Fall of the Dollar, or When Did the Dollar Replace Sterling as the Leading International Currency? By Barry Eichengreen; Marc Flandreau
  4. "The Collapse of Monetarism and the Irrelevance of the New Monetary Consensus" By James K. Galbraith
  5. The Implementation of Monetary Policy in Canada By Walter Engert, Toni Gravelle, and Donna Howard
  6. Optimal monetary and fiscal policies in a search theoretic model of monetary exchange By Pere Gomis-Porqueras; Adrian Peralta-Alva
  7. Estimating open economy Phillips curves for the euro area with directly measured expectations By Paloviita, Maritta
  8. Term premiums and inflation uncertainty: empirical evidence from an international panel dataset By Jonathan H. Wright
  9. Managing Disinflation under Uncertainty By Mewael F. Tesfaselassie; Eric Schaling
  10. Are long-run inflation expectations anchored more firmly in the Euro area than in the United States? By Meredith J. Beechey; Benjamin K. Johannsen; Andrew T. Levin
  11. Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia By Kajuth, Florian; Watzka, Sebastian
  12. Monetary Persistence and the Labor Market: A New Perspective By Lechthaler, Wolfgang; Merkl, Christian; Snower, Dennis J.
  13. Real interest rate persistence: evidence and implications By Christopher J. Neely; David E. Rapach
  14. Regional development and monetary policy : a review of the role of monetary unions, capital mobility and locational effects By Ridhwan, M.M.; Nijkampa, P.; Rietveld, P.
  15. Reconsideration of the P-Bar Model of Gradual Price Adjustment By Bennett T. McCallum
  16. "Securitization" By Hyman P. Minsky; L. Randall Wray
  17. Asset Prices and Assymetries in the Fed's Interest Rate Rule : a Financial Approach By Romaniuk, Katarzyna; Vranceanu, Radu
  18. Determinacy, Learnability, and Plausibility in Monetary Policy Analysis: Additional Results By Bennett T. McCallum
  19. How Much Intraregional Exchange Rate Variability Could a Currency Union Remove? The Case of ASEAN+3 By Duo Qin; Tao Tan
  20. Pitfalls in Measuring Exchange Rate Misalignment: The Yuan and Other Currencies By Yin-Wong Cheung; Menzie D. Chinn; Eiji Fujii

  1. By: FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
    Date: 2008–06
  2. By: Fourçans, André (ESSEC Business School); Vranceanu, Radu (ESSEC Business School)
    Abstract: The ECB is the only major central bank that still emphasizes the role of money in monetary policy management. In this paper, we bring some support to this approach. Taking into account Euro area data from the period between 1999 and 2007, we demonstrate that a steady 10 per cent increase in M3 may result in an inflation rate of approximately 2½ percentage points. A negative output gap would have a short term offsetting effect, and vice versa.
    Keywords: ECB; Inflation; Monetary Policy; Money
    JEL: E31 E51 E58
    Date: 2008–05
  3. By: Barry Eichengreen; Marc Flandreau
    Abstract: We present new evidence on the currency composition of foreign exchange reserves in the 1920s and 1930s. Contrary to the presumption that the pound sterling continued to dominate the U.S. dollar in central bank reserves until after World War II, we show that the dollar first overtook sterling in the mid-1920s. This suggests that the network effects thought to lend inertia to international currency status and to create incumbency advantages for the dominant international currency do not apply in the reserve currency domain. Our new evidence is similarly incompatible with the notion that there is only room in the market for one dominant reserve currency at a point in time. Our findings have important implications for our understanding of interwar monetary history but also for the prospects of the dollar and the euro as reserve currencies.
    JEL: F0 F33 N1 N2
    Date: 2008–07
  4. By: James K. Galbraith
    Abstract: What in monetarism, and what in the "new monetary consensus," led to a correct or even remotely relevant anticipation of the extraordinary financial crisis that broke over the housing sector, the banking system, and the world economy in August 2007 and that has continued to preoccupy central bankers ever since? Absolutely nothing, says Senior Scholar James K. Galbraith. In this new Policy Note, Galbraith reevaluates monetary policy in light of the collateral damages inflicted by the subprime mortgage crisis. He provides a critique of monetarism--what Milton Friedman famously defined as the proposition that "inflation is everywhere and always a monetary phenomenon"--and of the "new monetary consensus" on which Federal Reserve Chairman Ben Bernanke's ostensible doctrine of inflation targeting rests. Given the current economic crisis, Galbraith says, the Fed would do well to embrace the intellectual victory of John Maynard Keynes, John Kenneth Galbraith, and Hyman P. Minsky--and act accordingly.
    Date: 2008–05
  5. By: Walter Engert, Toni Gravelle, and Donna Howard
    Abstract: The authors present a detailed discussion of the Bank of Canada's framework for the implementation of monetary policy. As background, they provide a brief overview of the financial system in Canada, including a discussion of the financial services industry and the money market. Key features of the large-value payments system, which is integral to the implementation of monetary policy, are also explained. The authors then discuss in some detail the operating framework for the implementation of monetary policy. An assessment of the effectiveness of the Bank of Canada's framework is also provided, including an analysis of monetary policy implementation in the period of financial market stress beginning in August 2007.
    Keywords: Financial institutions; Financial markets; Monetary policy implementation; Payment, clearing, and settlement systems
    JEL: E52 E58 G21
    Date: 2008
  6. By: Pere Gomis-Porqueras; Adrian Peralta-Alva
    Abstract: In this paper we study optimal monetary and fiscal policies, and the welfare costs of inflation, within the Lagos and Wright (2005) framework. Monetary equilibria may be inefficient without fiscal policy tools due to bargaining frictions. We show that subsidies in decentralized markets can be implemented to alleviate underproduction, while money is still essential. Deviations from the Friedman rule may be large, and having fiscal and monetary policies in place results in considerable welfare gains. When fiscal policies are held constant, the welfare costs of increasing inflation may be as high as 8% of lifetime consumption. When lump sum monetary transfers are not available, a positive production subsidy may be inflationary and welfare reducing. However, sales taxes in the decentralized market and production taxes in the centralized market may increase welfare. The optimality of the Friedman rule in this case depends crucially on the bargaining power of the buyer, and equilibria are not first best.
    Keywords: Monetary policy ; Fiscal policy
    Date: 2008
  7. By: Paloviita, Maritta (Bank of Finland Research)
    Abstract: This paper examines euro area inflation dynamics by estimating open economy New Keynesian Phillips curves based on the assumption that all imports are intermediate goods. Instead of imposing rational expectations a priori, Consensus Economics survey data and OECD inflation forecasts are used to proxy inflation expectations. The results suggest that, compared with a closed economy New Keynesian Phillips curve, euro area inflation dynamics are better captured by the open economy specification. Moreover, in the open economy context, and even if we allow for persistence in expectations, the hybrid specification of the New Keynesian Phillips curve is needed in order to capture the euro area inflation process properly. We also provide some evidence that in recent years of low and stable inflation, euro area inflation dynamics have become more forward-looking and the link between inflation and domestic demand has weakened (ie the euro area Phillips curve has flattened). On the other hand, in low-inflation euro area countries the inflation process seems to have been more forward-looking already since the early 1980s.
    Keywords: New Keynesian Phillips curve; open economy; expectations; euro area
    JEL: C52 E31 F41
    Date: 2008–06–25
  8. By: Jonathan H. Wright
    Abstract: This paper provides cross-country empirical evidence on term premia, inflation uncertainty, and their relationship. It has three components. First, I construct a panel of zero-coupon nominal government bond yields spanning ten countries and eighteen years. From these, I construct forward rates and decompose these into expected future short-term interest rates and term premiums, using both statistical methods (an affine term structure model) and using surveys. Second, I construct alternative measures of time-varying inflation uncertainty for these countries, using actual inflation data and survey expectations. I discuss some possible determinants of inflation uncertainty. Finally, I use panel data methods to investigate the relationship between term premium estimates and inflation uncertainty measures, and find a strong positive relationship. The economic determinants of term premia remain mysterious; but this evidence points to uncertainty about intermediate- to long-run inflation rates being a substantial part of the explanation for why yield curves slope up.
    Date: 2008
  9. By: Mewael F. Tesfaselassie; Eric Schaling
    Abstract: In this paper we analyze disinflation policy when a central bank has imperfect information about private sector inflation expectations but learns about them from economic outcomes, which are in part the result of the disinflation policy. The form of uncertainty is manifested as uncertainty about the effect of past disinflation policy on current output gap. Thus current as well as past policy actions matter for output gap determination. We derive the optimal policy under learning (DOP) and compare it two limiting cases---certainty equivalence policy (CEP) and cautionary policy (CP). It turns out that under the DOP inflation stay between the levels implied by the CEP and the CP. A novel result is that this holds irrespective of the initial level of inflation. Moreover, while at high levels of inherited inflation the DOP moves closer to the CEP, at low levels of inherited inflation the DOP resembles the CP
    Keywords: Learning, Inflation Expectations, Disinflation Policy, Separation Principle, Kalman Filter, Optimal Control
    JEL: C53 E42 E52 F33
    Date: 2008–06
  10. By: Meredith J. Beechey; Benjamin K. Johannsen; Andrew T. Levin
    Abstract: This paper compares the recent evolution of long-run inflation expectations in the euro area and the United States, using evidence from financial markets and surveys of professional forecasters. Survey data indicate that long-run inflation expectations are reasonably well-anchored in both economies, but also reveal substantially greater dispersion across forecasters' long-horizon projections of U.S. inflation. Daily data on inflation swaps and nominal-indexed bond spreads--which gauge compensation for expected inflation and inflation risk--also suggest that long-run inflation expectations are more firmly anchored in the euro area than in the United States. In particular, surprises in macroeconomic data releases have significant effects on U.S. forward inflation compensation, even at long horizons, whereas macroeconomic news only influences euro area inflation compensation at short horizons.
    Date: 2008
  11. By: Kajuth, Florian; Watzka, Sebastian
    Abstract: We provide a critical assessment of the method used by the Cleveland Fed to correct expected inflation derived from index-linked bonds for liquidity and inflation risk premia and show how their method can be adapted to account for time-varying inflation risk premia. Furthermore, we show how sensitive the Cleveland Fed approach is to different measures of the liquidity premium. In addition we propose an alternative approach to decompose the bias in inflation expectations derived from index-linked bonds using a state-space estimation. Our results show that once one accounts for time-varying liquidity and inflation risk premia current 10-year U.S. inflation expectations are lower than estimated by the Cleveland Fed.
    Keywords: Inflation expectations; liquidity risk premium; inflation risk premium; treasury inflation-protected securities (TIPS); state-space model
    JEL: E31 E52 G12
    Date: 2008–07–10
  12. By: Lechthaler, Wolfgang (Kiel Institute for the World Economy); Merkl, Christian (Kiel Institute for the World Economy); Snower, Dennis J. (Kiel Institute for the World Economy)
    Abstract: It is common knowledge that the standard New Keynesian model is not able to generate a persistent response in output to temporary monetary shocks. We show that this shortcoming can be remedied in a simple and intuitively appealing way through the introduction of labor turnover costs (such as hiring and firing costs). Assuming that it is costly to hire and fire workers implies that the employment rate is slow to converge to its steady state value after a monetary shock. The after-effects of a shock continue to exert an effect on the labor market even long after the shock is over. The sluggishness of the labor market translates to the product market and thus the output effects of the monetary shock become more persistent. Under reasonable calibrations our model generates hump-shaped output responses. In addition, it is able to replicate the Beveridge curve relationship and a negative correlation between job creation and job destruction.
    Keywords: monetary persistence, labor market, hiring and firing costs
    JEL: E24 E32 E52 J23
    Date: 2008–05
  13. By: Christopher J. Neely; David E. Rapach
    Abstract: The real interest rate plays a central role in many important financial and macroeconomic models, including the consumption-based asset pricing model, neoclassical growth model, and models of the monetary transmission mechanism. We selectively survey the empirical literature that examines the time-series properties of real interest rates. A key stylized fact is that postwar real interest rates exhibit substantial persistence, shown by extended periods of time where the real interest rate is substantially above or below the sample mean. The finding of persistence in real interest rates is pervasive, appearing in a variety of guises in the literature. We discuss the implications of persistence for theoretical models, illustrate existing findings with updated data, and highlight areas for future research.
    Keywords: Interest rates
    Date: 2008
  14. By: Ridhwan, M.M. (Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics); Nijkampa, P.; Rietveld, P.
    Abstract: Standard economic theory assumes money to be neutral, at least in the long run, driven by interregional arbitrage and perfect capital mobility. This may easily be used as a justification for regional economists to ignore monetary factors. However, in a world with market imperfections, such arguments are no longer valid. This paper provides a critical review of theoretical arguments and empirical evidence on the issue. Special attention is devoted to asymmetric information problems caused by geographical factors. We conclude that monetary policy and financial markets can have a potentially important role to play in promoting regional development especially in less-developed countries.
    Keywords: Regional Finance; Monetary Union; Capital Mobility; Asymmetric Regional Finance; Monetary Union; Capital Mobility; Asymmetric;Information; Economic Geography
    JEL: R51 R58 G14 E44 F15
    Date: 2008
  15. By: Bennett T. McCallum
    Abstract: This paper compares the P-bar model of price adjustment with the currently dominant Calvo specification. Theoretically, the P-bar model is more attractive as it depends upon adjustment costs for physical quantities rather than nominal prices, while incorporating a one-period information lag. Furthermore, the resulting adjustment relation is more completely free of "money illusion," in terms of dynamic relationships, and therefore satisfies the natural rate hypothesis of Lucas (1972), which is not satisfied by the Calvo model in any of its variants. Along the way, it shows that both the P-bar and Calvo models can be formulated in distinct versions in which current real wages are, or are not, allocative. Quantitatively, for a given calibration of the demand parameters, the implied time series properties of the inflation rate, output gap, and nominal interest rate are determined for various policy parameters, and are compared with quarterly data for the U.S. economy. Neither model dominates but, overall, the comparison seems somewhat more favorable to the P-bar model and certainly does not provide support for the dominant position held by the Calvo model in current monetary policy analysis.
    JEL: E30 E52
    Date: 2008–07
  16. By: Hyman P. Minsky; L. Randall Wray
    Abstract: "At the annual banking structure and competition conference of the Federal Reserve Bank of Chicago in May 1987, the buzzword heard in the corridors and used by many of the speakers was 'that which can be securitized, will be securitized.'" So notes Hyman Minsky in a prescient memo on the nature, and the implications, of securitization, written 20 years before an explosion in the securitization of home mortgages helped create the current financial crisis. This memo, which served as the basis for a lecture in Minsky's monetary theory class at Washington University, has not been widely circulated. It is published here in its entirety, with a preface and an afterword by Senior Scholar L. Randall Wray that places Minsky's work in context.
    Date: 2008–06
  17. By: Romaniuk, Katarzyna (University of Paris 1 Panthéon-Sorbonne, PRISM); Vranceanu, Radu (ESSEC Business School)
    Abstract: Financial Newspapers have for long suggested that the Fed tends to provide additional Liquidity when the Stock Market thumbs. We provide a theoretical Explanation for this Behaviour that builds on the Methodology developed by Romaniuk (2008) for a central Banker with two main Goals, Output and Price stability. In this Paper, the Policymaker behaves as a Portfolio Manager who aims at stabilizing Output, Goods Prices, as well as Asset Prices. An optimal, Time-varying Interest Rate Rule is obtained as the Merton's (1971) continuous Time Solution to the Portfolio Manager's Problem. In a second Step, we infer the optimal Interest Rate Rule of a central Bank that can react differently to positive and negative Variations in the Stock Market.
    Keywords: Optimal Interest Rate Rule; Portfolio Choice; Fed; Asset Prices; Options Theory
    JEL: C61 E58 G11
    Date: 2008–03
  18. By: Bennett T. McCallum
    Abstract: In a very broad class of dynamic linear models, if agents possess knowledge of current endogenous variables in a least-squares learning process, determinacy of a rational expectations (RE) equilibrium is sufficient but not necessary for learnability of that equilibrium. Thus, since learnability is an attractive necessary condition for plausibility of any equilibrium, there may exist a single plausible RE solution even in cases of indeterminacy. This paper proposes and outlines a distinct criterion that plausible models should possess, termed "well formulated" (WF), which rules out infinite discontinuities in the implied impulse response functions. The paper explores the relationship between this WF property and learnability, under the information assumption mentioned above, and finds that they often agree but neither strictly implies the other. Extending the P-matrix requirement, implied for specified matrices by the WF property, to one that demands positive dominant-diagonal matrices would guarantee both WF and learnability, but a suitable rationale has not been found. Finally, under a second information assumption, which gives the agents only lagged information on endogenous variables during the learning process, the situation is less favorable in the sense that learnability can be guaranteed only under special assumptions.
    JEL: C62 E30 E52
    Date: 2008–07
  19. By: Duo Qin (Queen Mary, University of London); Tao Tan (Tianjin University of Finance and Economics)
    Abstract: A multilateral currency union removes the intraregional exchange rates but not the union rate variability with the rest of the world. The intraregional exchange rate variability is thus latent. A two-step procedure is developed to measure the variability. The measured variables are used to model inflation and intraregional trade growth of individual union members. The resulting models form the base for counterfactual simulations of the union impact. Application to ASEAN+3 shows that the intraregional variability consists of mainly short-run shocks, which have significantly affected the inflation and trade growth of major ASEAN+3 members, and that a union would reduce inflation and promote intraregional trade on the whole but the benefits facing each member vary and may not be significant enough to warrant a vote for the union.
    Keywords: Currency union, Latent variables, Dynamic factor model, Simulation
    JEL: F02 F40 O19 O53
    Date: 2008–07
  20. By: Yin-Wong Cheung; Menzie D. Chinn; Eiji Fujii
    Abstract: We evaluate whether the Renminbi (RMB) is misaligned, relying upon conventional statistical methods of inference. A framework built around the relationship between relative price and relative output levels is used. We find that, once sampling uncertainty and serial correlation are accounted for, there is little statistical evidence that the RMB is undervalued, even though the point estimates usually indicate economically significant misalignment. The result is robust to various choices of country samples and sample periods, as well as to the inclusion of control variables. We then update the results using the latest vintage of the data to demonstrate how fragile the results are. We find that whatever misalignment we detected in our previous work disappears in this data set.
    JEL: F31 F41
    Date: 2008–07

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