nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒08‒21
fifteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Do Central Banks Respond to Exchange Rate Movements? Some New Evidence from Structural Estimation By Wei Dong
  2. Monetary Transmission in an Emerging Targeter: The Case of Brazil By A. R. Pagan; Luis Catão; Douglas Laxton
  3. Monetary Aggregates and Liquidity in a Neo-Wicksellian Framework By Matthew Canzoneri; Robert E. Cumby; Behzad Diba; David Lopez-Salido
  4. What horizon for targeting inflation? By Q. Farooq Akram.
  5. Daily Monetary Policy Shocks and the Delayed Response of New Home Sales By James D. Hamilton
  6. What Can Taylor Rules Say About Monetary Policy in Latin America? By Carvalho, Alexandre; Moura, Marcelo L.
  7. Unrestrained Credit In A Credit Economy, The Credit Cycle, And Fiat Money Defy Monetarism In The Attempt to Control Price Level Changes By Salvary, Stanley C. W.
  8. The Phillips Curve and the Italian Lira, 1861-1998 By Alessandra Del Boca; Michele Fratianni; Franco Spinelli; Carmine Trecroci
  9. Monetary stabilisation in a currency union of small open economies By Marcelo Sánchez
  10. Financial Stability, the Trilemma, and International Reserves By Maurice Obstfeld; Jay C. Shambaugh; Alan M. Taylor
  11. Monetary Policy by Committee:Consensus, Chairman Dominance or Simple Majority? By RIBONI, Alessandro; RUGE-MURCIA, Francisco J.
  12. Federal Reserve Information during the Great Moderation By Antonello D’Agostino; Karl Whelan
  14. The Macroeconomic Implications of a Key Currency By Matthew Canzoneri; Robert E. Cumby; Behzad Diba; David Lopez-Salido
  15. Understanding the Inflationary Process in the GCC Region: The Case of Saudi Arabia and Kuwait By Maher Hasan; Hesham Alogeel

  1. By: Wei Dong
    Abstract: This paper investigates the impact of exchange rate movements on the conduct of monetary policy in Australia, Canada, New Zealand and the United Kingdom. We develop and estimate a structural general equilibrium two-sector model with sticky prices and wages and limited exchange rate pass-through. Different specifications for the monetary policy rule and the real exchange rate process are examined. The results indicate that the Reserve Bank of Australia, the Bank of Canada and the Bank of England paid close attention to real exchange rate movements, whereas the Reserve Bank of New Zealand did not seem to incorporate exchange rate movements explicitly into their policy rule. With a higher degree of intrinsic inflation persistence, the central bank of New Zealand seems less concerned about future inflation pressure induced by current exchange rate movements. In addition, the structure of the shocks driving inflation and output variations in New Zealand is such that it may be sufficient for the Reserve Bank of New Zealand to only respond to exchange rate movements indirectly through stabilizing inflation and output.
    Keywords: Exchange rates; Monetary policy framework; International topics
    JEL: F3 F4
    Date: 2008
  2. By: A. R. Pagan; Luis Catão; Douglas Laxton
    Abstract: This paper lays out a structural model that incorporates key features of monetary transmission in typical emerging-market economies, including a bank-credit channel and the role of external debt accumulation on country risk premia and exchange rate dynamics. We use an SVAR representation of the model to study the monetary transmission in Brazil. We find that interest rate changes have swifter effects on output and inflation compared to advanced economies and that exchange rate dynamics plays a key role in this connection. Importantly, the response of inflation to monetary policy shocks has grown stronger and the output-inflation tradeoff improved since the introduction of inflation targeting.
    Keywords: Brazil , Monetary policy , Inflation targeting , Emerging markets , Bank credit , Interest rates , Developed countries , Economic models , Disinflation ,
    Date: 2008–08–05
  3. By: Matthew Canzoneri; Robert E. Cumby; Behzad Diba; David Lopez-Salido
    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 modeled. 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 behavior 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.
    JEL: E40 E50
    Date: 2008–08
  4. By: Q. Farooq Akram. (Norges Bank (Central Bank of Norway))
    Abstract: We investigate optimal horizons for targeting inflation in response to different shocks and their properties under alternative preferences of an inflation-targeting central bank. Our analysis is based on a well specified macroeconometric model of Norway, but we examine how alternative specifications of its key equations would affect our results. We find that the optimal horizon is highly shock-specific, precluding general conclusions for demand and supply shocks. An extension of the horizon with concern for output and/or interest rate fluctuations beyond some shock-specific level proves counterproductive. The size of a given shock does not affect the horizon unless the central bank cares about interest rate volatility, while its sign does not matter unless the model is non-linear. The optimal horizon in response to a combination of shocks cannot be derived from those for each of the shocks, as different shocks may amplify or modify the effects of each other. In this case, however, sources of shocks as well as their sizes and signs become relevant, leading to complex dynamics of inflation and output. Successful inflation targeting in such cases may require a complex interest rate response. The optimal horizon generally increases with the degree of persistence in a shock and decreases with the strength of stabilisation mechanisms in the model.
    Keywords: Monetary policy, Inflation targeting, Horizon
    JEL: C53 E31 E52
    Date: 2008–01–24
  5. By: James D. Hamilton
    Abstract: This paper offers an explication of the hump-shaped response of real economic activity to changes in monetary policy, focusing on the particular channel operating through new home sales. I suggest that the conventional notion of a monetary policy shock as a surprise change in the fed funds rate is misspecified. The primary news for market participants is not what the Fed just did, but is instead new information about what the Fed is going to do in the near future. Revisions in these anticipations show up instantaneously in long-term mortgage rates. Although mortgage rates respond well before the Fed actually changes its target rate, home sales do not respond until much later. The paper attributes this delay to cross-sectional heterogeneity in search times. This framework offers a description of the lags in the effects of monetary policy that is both more detailed, allowing us in principle to measure the consequences at the daily frequency, and more believable than traditional measures.
    JEL: E44 E52
    Date: 2008–08
  6. By: Carvalho, Alexandre; Moura, Marcelo L.
    Date: 2008–10
  7. By: Salvary, Stanley C. W.
    Abstract: Monetarists maintain that changes in the price level are attributable to the level of the money supply. Hence, price stability has been the rationale for the money supply rule derived from the Quantity Theory of Money. Consequently, to curb inflation, the general price level index is the lever for periodic adjustments of the short-term interest rate. Nevertheless, monetary control is ineffective due the fact that: (1) with the collapse of the gold standard during the 1930s and the removal of the final link to a commodity - gold (an exogenous variable with a variable nominal value), fiat money (an endogenous variable with an invariable nominal value) emerged unchallenged; (2) the realignment of relative prices - the perennial cause of changes in the general level of prices - cannot be abated since it is the effective mechanism for the efficient functioning of the economic system; and (3) unrestrained consumer credit - driven by unbridled aggressive business policies and producing documented credit cycles with periods of credit expansion and credit saturation - has severely amplified the impact of price level changes. This paper examines the issue of price level changes within the context of money (types and functions), economic systems (barter, monetary, and credit), aggressive business practices, unrestrained consumer credit, and credit cycles.
    Keywords: fiscal policy; inflation; credit cycles; credit economy; monetarism; aggressive business practices; commodity money; exchange ratios; crisis of doubt; fiat money; interest rate policy; unrestrained consumer credit; purchasing power; realignment of relative prices.
    JEL: E31 E00 E3
    Date: 2008–08–12
  8. By: Alessandra Del Boca (University of Brescia); Michele Fratianni (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); Franco Spinelli (University of Brescia); Carmine Trecroci (University of Brescia)
    Abstract: We examine Italian inflation rates and the Phillips curve with a very long-run perspective, one that covers the entire existence of the Italian lira from political unification (1861) to the entry of Italy in the European Monetary Union (end of 1998). We first study the volatility, persistence and stationarity of the Italian inflation rate over the long run and across various exchange-rate regimes that have shaped Italian monetary history. Next, we estimate alternative Phillips equations and investigate the extent to which nonlinearities, asymmetries and structural changes characterize the inflation-output trade-off in the long run. We capture the effects of structural changes and asymmetries on the estimated parameters of the inflation-output trade-off relying partly on sub-sample estimates and partly on time-varying parameters estimated with the Kalman filter. Finally, we investigate causal relationships between inflation rates and output and extend the analysis to include the US and the UK for comparison purposes. The inference is that Italy has experienced a conventional inflation-output trade-off only during times of low inflation and stable aggregate supply.
    Keywords: inflation, Phillips curve, Italian lira
    JEL: E31 E32 E5 N10
    Date: 2008–07
  9. By: Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany)
    Abstract: This paper studies stabilisation policies in a multi-country currency union of small open economies. It abstracts from key factors favouring currency union formation, such as reduced transaction costs and enhanced credibility, which are exogenous to the factors studied here. Demand-side shocks hamper monetary union stabilisation unless members face identical output-inflation tradeoffs and their business cycles are perfectly synchronised. Under supply shocks, welfare implications from joining a currency union are less clear cut. In particular, when these shocks are common across participating countries a tradeoff arises whereby the latter bene?t if they are relatively open but are at a disadvantage in case they are of small size. Monetary-?scal interaction leads to a free rider problem, with area-wide supply shocks eliciting higher interest rate variability. Compared with the case of real wage rigidity, increased real wage ?exibility mitigates the free rider problem. Higher trade union decentralisation overall favours a currency union. The present multi-country currency union setup should not be seen as an attempt at settling the sharp differences that exist in the literature. Our model could be modi?ed in order to derive results that are valid in more realistic environments. These include the analysis of public debt considerations in the case of ?scal policies, and both institutional and (further) macroeconomic aspects in the area of wage determination. JEL Classification: E52, E58, F33, F42, E63.
    Keywords: Monetary union, stabilisation, welfare, small open economies, fi?scal policy, wage setting.
    Date: 2008–08
  10. By: Maurice Obstfeld; Jay C. Shambaugh; Alan M. Taylor
    Abstract: The rapid growth of international reserves---a development concentrated in the emerging markets---remains a puzzle. In this paper we suggest that a model based on financial stability and financial openness goes far toward explaining reserve holdings in the modern era of globalized capital markets. The size of domestic financial liabilities that could potentially be converted into foreign currency (M2), financial openness, the ability to access foreign currency through debt markets, and exchange rate policy are all significant predictors of reserve stocks. Our empirical financial-stability model seems to outperform both traditional models and recent explanations based on external short-term debt.
    JEL: E44 E58 F21 F31 F36 F41 N10 O24
    Date: 2008–08
  11. By: RIBONI, Alessandro; RUGE-MURCIA, Francisco J.
    Abstract: This paper studies the theoretical and empirical implications of monetary policy making by committee under three different voting protocols. The protocols are a consensus model, where super-majority is required for a policy change; an agenda-setting model, where the chairman controls the agenda; and a simple majority model, where policy is determined by the median member. These protocols give preeminence to different aspects of the actual decision making process and capture the observed heterogeneity in formal procedures across central banks. The models are estimated by Maximum Likehood using interest rate decisions by the committees of five central banks, namely the Bank of Canada, the Bank of England, the European Central Bank, the Swedish Riksbank, and the U.S. Federal Reserve. For all central banks, results indicate that the consensus model is statically superior to the alternative models. This suggests that despite institutionnal differences, committees share unwritten rules and informal procedures that deliver observationally equivalent policy decisions.
    Keywords: Committees, voting models, status-quo bias, median voter
    JEL: D7 E5
    Date: 2008
  12. By: Antonello D’Agostino (Central Bank); Karl Whelan (University College Dublin)
    Abstract: Using data from the period 1970-1991, Romer and Romer (2000) showed that Federal Reserve forecasts of inflation and output were superior to those provided by commercial forecasters. In this paper, we show that this superior forecasting performance deterio- rated after 1991. Over the decade 1992-2001, the superior forecast accuracy of the Fed held only over a very short time horizon and was limited to its forecasts of inflation. In addition, the performance of both the Fed and the commercial forecasters in pre- dicting inflation and output, relative to that of “naive” benchmark models, dropped remarkably during this period.
    Date: 2007–12–22
  13. By: Enrique Sentana; Antonio Diez de los Rios (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: Nowadays researchers can choose the sampling frequency of exchange rates and interest rates. If the number of observations per contract period is large relative to the sample size, standard GMM asymptotic theory provides unreliable inferences in UIP regression tests. We specify a bivariate continuous-time model for exchange rate and forward premia robust to temporal aggregation, unlike the discrete time models in the literature. We obtain the UIP restrictions on the continuous-time model parameters, which we estimate efficiently, and propose a novel specification test that compares estimators at different frequencies. Our empirical results based on correctly specified models reject UIP.
    Keywords: Exchange rates, forward premium puzzle, Hausman test, interest rates, Orstein-uhlenbeck process, temporal aggregation.
    JEL: F31 G15
    Date: 2007–09
  14. By: Matthew Canzoneri; Robert E. Cumby; Behzad Diba; David Lopez-Salido
    Abstract: What are the macroeconomic consequences of the dominant role of the dollar in the international monetary system? Here, we present a calibrated two country model in which exports are invoiced in the key currency, and government bonds denominated in the key currency are held internationally to facilitate trade. Domestic government bonds and money are held in each country to facilitate domestic transactions. Our model generates deviations from uncovered interest parity that are as volatile as some empirical estimates, but much too small by others. Our model also speaks to some other empirical anomalies, such as the Backus - Smith puzzle. Shocks affecting asset supplies -- such as bond financed tax cuts, and open market operations -- have large effects in our model because they generate non-Ricardian changes in household wealth. Generally, shocks emanating from the key currency country do more to destabilize the world economy than equal sized shocks coming from the other country. Similarly, monetary and fiscal policy innovations in the key currency country are more potent than those in the other country. On the other hand, the key currency country is more vulnerable to financial market turbulence, such as a sell off of key currency bonds, which can lower consumption dramatically.
    JEL: F3 F4 F41
    Date: 2008–08
  15. By: Maher Hasan; Hesham Alogeel
    Abstract: This paper investigates the factors that affect inflation in the GCC region by examining the inflationary processes in Saudi Arabia and Kuwait. The paper utilizes a model that accounts for foreign factors affecting inflation, such as trading partners' inflation and exchange rate pass-through effect, as well as domestic influences. The analysis concludes that, in the long run, higher inflation in trading partners' countries is the main driving force for inflation in the two countries, with significant but lower contributions from the exchange rate pass-through effect and oil prices. Demand and money supply shocks affect inflation in the short run.
    Keywords: Inflation , Saudi Arabia , Kuwait , Money supply , Exchange rate stability , Bilateral trade , Cooperation Council for the Arab States of the Gulf ,
    Date: 2008–08–06

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