nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒09‒13
fifteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Are Central Banks following a linear or nonlinear (augmented) Taylor rule? By Vítor Castro
  2. International Financial Aggregation and Index Number Theory: A Chronological Half-Century Empirical Overview. By William Barnett; Marcelle Chauvet
  3. Speed Limit Policies versus Inflation Targeting: A Free Lunch? By Hatcher, Michael C.
  4. The use of staff policy recommendations in central banks By Attila Csajbók
  5. The Relativity Theory Revisited: Is Publishing Interest Rate Forecasts Really so Valuable? By Brzoza-Brzezina, Michal; Kot, Adam
  7. Does the US international debt affect the euro/dollar exchange rate? By Costas Karfakis
  8. Fluctuations in the Foreign Exchange Market: How Important are Monetary Policy Shocks? By Hafedh Bouakez; Michel Normandin
  9. Indeterminate Equilibria in New Keynesian DSGE Model: An Application to the US Great Moderation By Erdemlioglu, Deniz M; Xiao, Wei
  10. Does Monetary Policy React to Asset Prices? Some International Evidence By Francesco FURLANETTO
  11. The Formation of Inflation Perceptions – Some Empirical Facts for European Countries By Sarah M. Lein; Thomas Maag
  12. Have Long-term Financial Trends Changed the Transmission of Monetary Policy? By Boris Cournède; Rudiger Ahrend; Robert Price
  13. Money Velocity and Asset Prices in the Euro Area By Christian Dreger; Jürgen Wolters
  14. On the Evolution of Monetary Policy By Gary Koop; Roberto Leon-Gonzalez; Rodney W. Strachan
  15. Smooth Regimes, Macroeconomic Variables, and Bagging for the Short-Term Interest Rate Process By Francesco Audrino; Marcelo C. Medeiros

  1. By: Vítor Castro (Universidade do Minho - NIPE)
    Abstract: The Taylor rule establishes a simple linear relation between the interest rate, inflation and output gap. However, this relation may not be so simple. To get a deeper understanding of central banks' behaviour, this paper asks whether central banks are indeed following a linear Taylor rule or, instead, a nonlinear rule. At the same time, it also analyses whether that rule can be augmented with a financial conditions index containing information from some asset prices and financial variables. A forward-looking monetary policy reaction function is employed in the estimation of the linear and nonlinear models. A smooth transition model is used to estimate the nonlinear rule. The results indicate that the European Central Bank and the Bank of England tend to follow a nonlinear Taylor rule, but not the Federal Reserve of the United States. In particularm those two central banks tend to react to inflation only when inflation is above or outside their targets. Moreover, our evidence suggests that the European Central Bank is targeting financial conditions, contrary to the other two central banks. This lack of attention to the financial conditions might have made the United States and the United Kingdom more vulnerable to the recent credit crunch than the Eurozone.
    Keywords: Taylor rule; ECB monetary policy; Financial Conditions Index; Nonlinearity; Smooth transition regression models.
    JEL: E43 E44 E52 E58
    Date: 2008
  2. By: William Barnett (Department of Economics, The University of Kansas); Marcelle Chauvet (University of California at Riverside)
    Abstract: This paper comprises a survey of a half century of research on international monetary aggregate data. We argue that since monetary assets began yielding interest, the simple sum monetary aggregates have had no foundations in economic theory and have sequentially produced one source of misunderstanding after another. The bad data produced by simple sum aggregation have contaminated research in monetary economics, have resulted in needless “paradoxes,” and have produced decades of misunderstandings in international monetary economics research and policy. While better data, based correctly on index number theory and aggregation theory, now exist, the official central bank data most commonly used have not improved in most parts of the world. While aggregation theoretic monetary aggregates exist for internal use at the European Central Bank, the Bank of Japan, and many other central banks throughout the world, the only central banks that currently make aggregation theoretic monetary aggregates available to the public are the Bank of England and the St. Louis Federal Reserve Bank. No other area of economics has been so seriously damaged by data unrelated to valid index number and aggregation theory. In this paper we chronologically review the past research in this area and connect the data errors with the resulting policy and inference errors. Future research on monetary aggregation and policy can most advantageously focus on extensions to exchange rate risk and its implications for multilateral aggregation over monetary asset portfolios containing assets denominated in more than one currency. The relevant theory for multilateral aggregation with exchange rate risk has been derived by Barnett (2007) and Barnett and Wu (2005).
    Keywords: Measurement error, monetary aggregation, Divisia index, aggregation, monetary policy, index number theory, exchange rate risk, multilateral aggregation, open economy monetary economics.
    JEL: E40 E52 E58 C43
    Date: 2008–09
  3. By: Hatcher, Michael C. (Cardiff Business School)
    Abstract: Inflation targeting is currently popular with central banks. Is this popularity justified? I investigate this question by comparing a speed limit policy and inflation targeting with a Lucas-type Phillips curve capturing output gap persistence. If the output gap is at least moderately persistent, a speed limit policy can: (1) partly eliminate the state-contingent inflation bias, and (2) reduce inflation variability at no output gap variability cost.
    Keywords: inflation targeting; speed limit policy; inflation bias; discretion; stabilisation
    JEL: E50 E52 E58
    Date: 2008–09
  4. By: Attila Csajbók (Magyar Nemzeti Bank)
    Abstract: The focus of this paper is on the use of staff policy recommendations in central banks. Based on the responses to a recent survey conducted by the Bank of International Settlements, the paper tries to answer two questions. (1) How (to what extent) do central bank decision-makers make use of staff views regarding the appropriate policy? (2) What institutional features determine the extent to which staff policy views are utilised by decision-makers? The ‘weight’ with which staff policy views are taken into account is proxied by how explicitly they are presented to the policy board. Based on the survey responses about how staff policy views are presented, a Staff Recommendation Explicitness Index (SREI) is constructed for each central bank surveyed. SREI is then regressed on a number of candidate explanatory variables. The results suggest that the use of staff policy views, proxied by SREI, is negatively related to the size of the policy committee. Furthermore, the use of staff policy views seems more pronounced if the committee is consensus-seeker and if the monetary regime is inflation targeting. Tentative explanations are offered for each of these findings.
    Keywords: monetary policy, central bank staff, committee, decision-making.
    JEL: D71 E58
    Date: 2008
  5. By: Brzoza-Brzezina, Michal; Kot, Adam
    Abstract: In a New Keynesian model with asymmetric information we show that publication of macroeconomic projections and of the future interest rate path by the central bank can improve macroeconomic outcomes. However, the gains from publishing interest rate paths are small relative to those from publishing macroeconomic projections. Given that most inflation targeting central banks are already publishing macroeconomic projections this means that most gains from increasing transparency in this area may already have been reaped. This, together with the potential costs, may explain the relative reluctance of central banks to publish interest rate paths.
    Keywords: interest rate path; monetary policy; adaptive learning
    JEL: E43 E58 E52
    Date: 2008–07–20
  6. By: Iris Claus; Brandon Sloan
    Abstract: To help maintain price stability in New Zealand a countercyclical use of the goods and services tax (GST) has been proposed. This paper argues that a variable GST rate is unlikely to be a useful stabilisation tool for monetary policy. It first discusses some of the problems that would arise with the implementation of a variable GST rate. It then develops a stylised model of the New Zealand economy to assess the effects of using a variable GST rate as a monetary policy tool relative to the conventional instrument, an interest rate. The results show that a variable GST rate would be less effective in dampening business cycles than an interest rate. It would lead to larger adjustments in the policy instrument and fluctuations in the real economy and inflation. Moreover, a variable GST rate would produce greater welfare losses from monetary policy than an interest rate tool.
    JEL: E32 E52
    Date: 2008–09
  7. By: Costas Karfakis (Department of Economics, University of Macedonia)
    Abstract: The impact of the US international debt on the euro/dollar exchange rate is examined in the context of an Error Correction monetary model with rational expectations. Overall, the relative real income is the most economically significant determinant, whereas the debt is the most statistically significant determinant..
    Keywords: Monetary model, US international debt, co-integration analysis, error correction model
    JEL: F31
    Date: 2008–09
  8. By: Hafedh Bouakez; Michel Normandin
    Abstract: We study the effects of U.S. monetary policy shocks on the bilateral exchange rate between the U.S. and each of the G7 countries. We also estimate deviations from uncovered interest rate parity and exchange rate pass-through conditional on these shocks. The analysis is based on a structural vector autoregression in which monetary policy shocks are identified through the conditional heteroscedasticity of the structural disturbances. Unlike earlier work in this area, our empirical methodology avoids making arbitrary assumptions about the relevant policy indicator or transmission mechanism in order to achieve identification. At the same time, it allows us to assess the implications of imposing invalid identifying restrictions. Our results indicate that the nominal exchange rate exhibits delayed overshooting in response to a monetary expansion, depreciating for roughly ten months before starting to appreciate. The shock also leads to large and persistent departures from uncovered interest rate parity, and to a prolonged period of incomplete pass-through. Variance-decomposition results indicate that monetary policy shocks account for a non-trivial proportion of exchange rate fluctuations.
    Keywords: Conditions heteroscedasticity, delayed overshooting, exchange rate pass-through, identification, structural vector autoregression, uncovered interest rate parity
    JEL: C32 E52 F31 F41
    Date: 2008
  9. By: Erdemlioglu, Deniz M; Xiao, Wei
    Abstract: This paper tests “Bad Policy” Hypothesis which refers to the Great Moderation in the US. We examine this hypothesis by simulating model based impulse response functions for the both pre-Volcker period and post 1982 period. Deriving and simulating standard New Keynesian DSGE Model explicitly, we find that while post 1982 policy i.e. active policy, is consistent with the unique stable equilibrium characteristics; pre-Volcker or passive monetary policy generates equilibrium indeterminacy. Moreover, our simulated-impulse response functions show that the response of inflation and the output gap in post 82 period is weaker than the macroeconomic responses of the pre-Volcker period.
    Keywords: The Great Moderation; Indeterminacy; Determinate Equilibrium; New Keynesian DSGE Model; Monetary Policy; Sunspot shocks.
    JEL: E0 E32 E52
    Date: 2008–05–15
  10. By: Francesco FURLANETTO
    Abstract: This paper attempts to measure the reaction of monetary policy to the stock market. We apply the procedure of Rigobon and Sack (2003) to identify and estimate a VAR in the presence of heteroskedasticity. This procedure fully takes into account the endogeneity of interest rates and stock returns that is ignored in the traditional VAR literature. We find a positive and significant reaction in the US and the UK. However, since the end of the 1990s, in a period of large stock market fluctuations, this reaction declines in the US and disappears in the UK. In Japan and the EU, we do not find any reaction. We provide evidence that the lower response to stock prices in the last part of the sample in the US is compensated by a higher response to real estate prices.
    Keywords: monetary policy; stock market; identifcation; VAR; heteroskedasticity
    JEL: E44 E52 E58
    Date: 2008–02
  11. By: Sarah M. Lein (KOF Swiss Economic Institute, ETH Zurich, Switzerland); Thomas Maag (KOF Swiss Economic Institute, ETH Zurich, Switzerland)
    Abstract: This paper presents some empirical facts on the dynamics of perceived inflation rates for EU countries. First, we find that perceptions are inefficient and highly heteroge- neous, yet contemporaneously related to the actual rate of inflation. Second, similar to studies on inflation expectations, we estimate how often European consumers up- date their inflation perceptions employing Carroll's (2003) epidemiological model. The advantage of employing perceived instead of expected inflation is that the value of the newest information can exactly be measured: the actual rate of inflation. Our findings indicate that the stickiness of perceptions is generally higher than the stick- iness of expectations. Unlike studies using expectations, however, we cannot confirm that a constant fraction of the population updates information every month. Also observed heterogeneity of perceptions is much higher than implied by the epidemio- logical model.
    Keywords: perceived inflation, sticky information, inattention, expectation formation
    JEL: E31 E50 D83
    Date: 2008–09
  12. By: Boris Cournède; Rudiger Ahrend; Robert Price
    Abstract: This paper addresses the question of whether and how long-term financial trends may have modified the transmission mechanism from monetary policy decisions to economic activity. The focus is on longterm changes, abstracting from the disruptions created by the 2007-08 financial turmoil which are temporarily affecting the transmission mechanism. The first series of findings is that a number of factors have worked to strengthen the transmission of monetary policy, including more competitive financial markets, higher household indebtedness, greater diversity in the supply of financial products, greater financial integration and more responsive asset pricing mechanisms. However, other factors appear to have simultaneously gone in the direction of weakening transmission of domestic policy, including greater external financial influences, lower exchange-rate pass-through and a broad-based shift towards fixed-rate assets and liabilities. On balance, monetary policy appears to remain a powerful tool for guiding aggregate demand, but a number of changes that have worked to support the strength of transmission have also increased risks to financial stability. <P>Les tendances de fond des marchés financiers ont-elles modifié la transmission <BR>Cette étude aborde la question de savoir dans quelle mesure les tendances de fond des marchés financiers ont pu modifier la transmission de la politique monétaire. L’accent est porté sur les changements de long-terme en faisant abstraction des modifications temporaires du mécanisme de transmission qui résultent des troubles financiers observés en 2007-08. Une première série de résultats indique que plusieurs facteurs ont joué dans le sens de renforcer la transmission de la politique monétaire. Ces facteurs incluent l’intensification de la concurrence sur les marchés financiers, l’accroissement de l’endettement des ménages, la diversification de l’offre de produits financiers et la plus grande réactivité des prix des actifs. Cependant, d’autres facteurs ont agi de manière concomitante dans le sens de réduire la puissance du mécanisme de transmission de la politique monétaire intérieure. Ces facteurs incluent l’accroissement des influences financières extérieures, la plus faible transmission des mouvements de change et le plus grand recours aux emprunts et titres à taux fixe. Au final, il apparaît que la politique monétaire demeure un outil puissant d’orientation de la demande agrégée, mais une partie des changements qui ont préservé la force du mécanisme de transmission se sont effectués au prix de risques accrus pour la stabilité financière.
    Keywords: financial markets, marchés financiers, financial development, développement financier, réglementation, house prices, regulation, monetary policy, politique monétaire, asset prices, prix des actifs, interest rate, taux d'intérêt, financial innovation, innovation financière, transmission, transmission
    JEL: E40 E43 E44 E50 E52 E58
    Date: 2008–09–05
  13. By: Christian Dreger; Jürgen Wolters
    Abstract: Monetary growth in the euro area has exceeded its target since several years. At the same time, the money demand function seems 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 fact, a rise in the income elasticity after 2001 can be observed, and may reflect the exclusion of real and financial wealth in conventional specifications of money demand. This presumption is explored by means of a cointegration analysis. To separate income from wealth effects, the specification in terms of money velocity is preferred. Evidence for the presence of wealth in the long run relationship is provided. In particular, both stock and house prices have exerted a negative impact on velocity after 2001 and lead to almost identical equilibrium errors. The extended error correction model is stable over the entire sample period and survive a battery of specification tests.
    Keywords: Cointegration analysis, error correction, money demand, financial wealth, monetary policy
    JEL: C22 C52 E41
    Date: 2008
  14. By: Gary Koop (University of Strathclyde, UK and The RImini Centre for Economic Analisys, Italy); Roberto Leon-Gonzalez (National Graduate Institute for Policy Studies, Japan and The RImini Centre for Economic Analisys - Italy); Rodney W. Strachan (University of Queensland, Australia and The RImini Centre for Economic Analisys - Italy)
    Abstract: This paper investigates the evolution of monetary policy in the U.S. using a standard set of macroeconomic variables. Many recent papers have addressed the issue of whether the monetary transmission mechanism has changed (e.g. due to the Fed taking a more aggressive stance against ination) or whether apparent changes are simply due to changes in the volatility of exogenous shocks. A subsidiary question is whether any such changes have been gradual or abrupt. In this paper, we shed light on these issues using a mixture innovation model which extends the class of time varying Vector Autoregressive models with stochastic volatility which have been used in the past. The advantage of our extension is that it allows us to estimate whether, where, when and how parameter change is occurring (as opposed to assuming a particular form of parameter change). Our empirical results strongly indicate that the transmission mechanism, the volatility of exogenous shocks and the correlations between exogenous shocks are all changing (albeit at different times and to di¤erent extents) Furthermore, evolution of parameters is gradual.
    Keywords: structural VAR, monetary policy, Bayesian, mixture innovation model, time varying parameter model
    JEL: C11 C32 E52
    Date: 2008–01
  15. By: Francesco Audrino; Marcelo C. Medeiros
    Abstract: In this paper we propose a smooth transition tree model for both the conditional mean and the conditional variance of the short-term interest rate process. Our model incorporates the interpretability of regression trees and the flexibility of smooth transition models to describe regime switches in the short-term interest rate series. The estimation of such models is addressed and the asymptotic properties of the quasi-maximum likelihood estimator are derived. Model specification is also discussed. When the model is applied to the US short-term interest rate we find (1) leading indicators for inflation and real activity are the most relevant predictors in characterizing the multiple regimes' structure; (2) the optimal model has three limiting regimes, with significantly different local conditional mean and variance dynamics. Moreover, we provide empirical evidence of the strong power of the model in forecasting the first two conditional moments of the short rate process, in particular when it is used in connection with bootstrap aggregating (bagging).
    Keywords: Short-term interest rate, Regression tree, Smooth transition, Conditional variance, Bagging, Asymptotic theory
    JEL: C13 C22 C51 C53
    Date: 2008–08

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