nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒09‒20
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Estimating regime-switching Taylor rules with trend inflation By Castelnuovo , Efrem; Greco , Luciano; Raggi, Davide
  2. Central Bank Learning and Monetary Policy By Mewael F. Tesfaselassie
  3. Money as Friction: Conceptual dissonance in Woodford's Interest and Prices By Colin Rogers
  4. International monetary co-operation in a world of imperfect information By Tan, Kang Yong; Tanaka, Misa
  5. Has the Adoption of Inflation Targeting Represented a Regime Switch? Empirical evidence from Canada, Sweden and the UK By Jerome Creel; Paul Hubert
  6. The conduct of global monetary policy and domestic stability By Blake, Andrew P; Markovic, Bojan
  7. Short-term interest rate futures as monetary policy forecasts By Giuseppe Ferrero; Andrea Nobili
  8. Do Frictionless Models of Money and the Price level Make sense? By Colin Rogers
  9. Panel Cointegration and the Monetary Exchange Rate Model By Basher, Syed A.; Westerlund, Joakim
  10. Monetary Policy Effects: New Evidence from the Italian Flow of Funds By Riccardo Bonci; Francesco Columba
  11. Durable Goods, Inter-Sectoral Linkages and Monetary Policy By Hafedh Bouakez; Emanuela Cardia; Francisco J. Ruge-Murcia
  12. The principle of effective demand and the state of post Keynesian monetary economics By Colin Rogers
  13. Modelling and forecasting the yield curve under model uncertainty By Paola Donati; Francesco Donati
  14. Fluctuation in the International Currency Reserves of Less Developed Countries: HIPC vs Non-HIPC By Augustine A. Boakye; Hassan Molana
  15. Capital Flow Bonanzas: An Encompassing View of the Past and Present By Carmen M. Reinhart; Vincent R. Reinhart
  16. How informative are macroeconomic risk forecasts? An examination of the Bank of England’s inflation forecasts By Knüppel, Malte; Schultefrankenfeld, Guido
  17. Dealing with country diversity: challenges for the IMF credit union model By Irwin, Gregor; Penalver, Adrian; Salmon, Chris; Taylor, Ashley
  18. Non-linear adjustment of import prices in the European Union By Campa, Jose Manuel; Gonzalez Minguez, Jose M; Sebastia Barriel, Maria
  19. Exploring agent-based methods for the analysis of payment systems: a crisis model for StarLogo TNG By Luca Arciero; Claudia Biancotti; Leandro DÂ’Aurizio; Claudio Impenna
  20. The Impact of Capital Inflows on Emerging East Asian Economies: Is Too Much Money Chasing Too Little Good? By Kim, Soyoung; Yang, Doo Yong
  21. The Strategic Euro Laggards By Martin Gregor

  1. By: Castelnuovo , Efrem (University of Padua and Bank of Finland Research); Greco , Luciano (University of Padua); Raggi, Davide (University of Bologna)
    Abstract: This paper estimates regime-switching monetary policy rules featuring trend inflation using post-WWII US data. We find evidence in favour of regime shifts and time-variation of the inflation target. We also find a drop in the inflation gap persistence when entering the Great Moderation sample. Estimated Taylor rule parameters and regimes are robust across different monetary policy models. We propose an ‘internal consistency’ test to discriminate among our estimated rules. Such a test relies upon a feedback mechanism running from the monetary policy stance to the inflation gap. Our results support the stochastic autoregressive process as the most consistent model for trend inflation, above all when conditioning to the post-1985 subsample.
    Keywords: active and passive Taylor rules; trend inflation; inflation gap persistence; Markov-switching models
    JEL: E52 E61 E62
    Date: 2008–09–10
  2. By: Mewael F. Tesfaselassie
    Abstract: We analyze optimal monetary policy when a central bank has to learn about an unknown coefficient that determines the effect of surprise inflation on aggregate demand. We derive the optimal policy under active learning and compare it to two limiting cases---certainty equivalence policy and cautionary policy, in which learning takes place passively. Our novel result is that the two passive learning policies represent an upper and lower bound for the active learning policy, irrespective of the state of the economy
    Keywords: parameter uncertainty; learning; monetary policy
    JEL: C02 E52
    Date: 2008–08
  3. By: Colin Rogers (School of Economics, University of Adelaide)
    Abstract: In Interest and Prices Woodford employs a frictionless model to derive nominal interest rate rules that can be applied by central banks to achieve price level stability. But frictionless models are Walrasian general equilibrium models that preclude any role for money. Furthermore frictionless model have no role for nominal values or the price level and therefore no role for a central bank. Consequently, conceptual anomalies arise in Woodford's attempt to analyse questions of monetary theory and policy that are precluded by construction in frictionless models. In some states of the model money is converted into a ‘friction', contra economic theory.
    Keywords: Frictionless models; time-0 auction; ‘monetary frictions'
    JEL: B E40 E42 E50
    Date: 2008–09
  4. By: Tan, Kang Yong (University of Oxford); Tanaka, Misa (Bank of England)
    Abstract: This paper examines the welfare implications of international monetary co-operation using a stylised two-country New Keynesian general equilibrium model of imperfect information. We show that setting a self-oriented monetary policy rule generally leads to welfare gains relative to passive monetary policy even when central banks do not have perfect information about the foreign economy. However, information sharing between central banks in this set-up, by itself, has ambiguous welfare implications. Gains from monetary co-ordination are largest when productivity shocks are negatively correlated across countries.
    Keywords: Policy co-ordination; imperfect information; monetary policy; new open economy macroeconomics.
    JEL: F41 F42
    Date: 2008–03
  5. By: Jerome Creel (Observatoire Français des Conjonctures Économiques); Paul Hubert (Observatoire Français des Conjonctures Économiques)
    Abstract: Since 1990, a growing number of countries have adopted inflation targeting (IT) around the world. Empirical evidence on its advantages has been mixed so far, and most assessments have been based on a control group methodology. In this paper, using a MSVAR technique, we assess the adoption of IT in three industrialised countries over time; in addition, we compare their outcomes with a non-IT country, the US. Results are manifold. First, an inflation targeting regime exists, although it does not constitute a change in monetary policy reaction. Second, this conclusion is robust on a subsample excluding the periods of high inflation and early sharp disinflation. Third, the sacrifice ratio of higher output volatility generally attributed to inflation stabilisation policies is not sensitive to the adoption of inflation targeting. Fourth, this framework is shown to be conducive to higher monetary policy leeway.
    Keywords: Inflation targeting; MSVAR; Counterfactuals.
    JEL: E52 E58
    Date: 2008
  6. By: Blake, Andrew P (Bank of England); Markovic, Bojan (Bank of England)
    Abstract: The purpose of this paper is to examine how important an improvement in global monetary policy might be for the macroeconomic performance of a small open economy such as the United Kingdom. Our paper contributes to the literature by proposing a new methodology to treat indeterminate solutions (the most-robust solution), and by analysing a policy improvement within a three-country framework. Both contributions yield a rich set of theoretical and policy implications. We find that the performance of the domestic macroeconomy depends crucially on domestic monetary policy, but there remains significant potential for monetary policy abroad to improve the stability of inflation and output in a small open economy. Importantly, how much of this potential spillover from policy abroad crystallises is still endogenous to the conduct of domestic policy. We also show that an improvement in policy abroad may not reduce domestic volatility when domestic policy is the only poor policy globally. In such a case domestic volatility can even become worse. Our paper also yields interesting results related to the impact of a policy improvement abroad on inflation persistence in the domestic economy and her exposure to foreign shocks.
    Keywords: Indeterminacy; stochastic volatility; Taylor rule; international spillovers; Great Inflation.
    JEL: C62 D84 E30 E58 E61 F41 F42
    Date: 2008–08
  7. By: Giuseppe Ferrero (Bank of Italy, Economics and International Relations); Andrea Nobili (Bank of Italy, Economics and International Relations)
    Abstract: The prices of futures contracts on short-term interest rates are commonly used by central banks to gauge market expectations concerning monetary policy decisions. Excess returns - the difference between futures rates and the realized rates - are positive, on average, and statistically significant, both in the euro area and in the United States. We find that these biases are significantly related to the business cycle only in the United States. Moreover, the sign and the significance of the estimated relationships with business cycle indicators are unstable over time. Breaking the excess returns down into risk premium and forecast error components, we find that risk premia are counter-cyclical in both areas. On the contrary, ex-post prediction errors, which represent the greater part of excess returns at longer horizons in both areas, are correlated with the business cycle (negatively) only in the United States.
    Keywords: futures rates, monetary policy, risk-premium
    JEL: E43 E44 E52
    Date: 2008–06
  8. By: Colin Rogers (School of Economics, University of Adelaide)
    Abstract: No. As well-specified Walrasian general equilibrium systems, frictionless models are isomorphic with the Arrow-Debreu (A-D) world. It is well known that the A-D world has no role for money, credit or banks. Grafting a role for money onto a frictionless model by appending a quantity equation or cash-in-advance constraint makes the error of converting money into a friction. Furthermore, as frictionless models have no use for money or nominal values it makes no sense to use them to adjudicate between theories of the price level or to claim that they provide the theoretical foundations for monetary policy.
    Keywords: Frictionless models; `monetary frictions'; nominal and numeraire prices; theories of the price level.
    JEL: B40 E40 E42 E50
    Date: 2008–09
  9. By: Basher, Syed A.; Westerlund, Joakim
    Abstract: This paper re-examines the validity of the monetary exchange rate model during the post-Bretton Woods era for 18 OECD countries. Our analysis simultaneously considers the presence of both cross-sectional dependence and multiple structural breaks, which have not received much attention in previous studies of the monetary model. The empirical results indicate that the monetary model emerges only when the presence of structural breaks and cross-country dependence has been taken into account. Evidence is also provided suggesting that the breaks in the monetary model can be derived from the underlying purchasing power parity relation.
    JEL: C32 F41 F31 C33
    Date: 2008–09–12
  10. By: Riccardo Bonci (Bank of Italy, Economic and Financial Statistics Department); Francesco Columba (Bank of Italy, Economic Outlook and Monetary Policy Department)
    Abstract: We obtain new evidence on the transmission of monetary policy to the economy by analyzing the effects of restrictive monetary policy shocks on Italian flows of funds over the period 1980-2002. Firms reduce their issuance of debt and their acquisitions of financial assets, so there is no evidence of strong financial frictions. Households increase short-term liabilities and diminish purchases of liquid assets and shares in the first quarter following a shock. The public sector increases net borrowing during the first two years. Financial corporations decrease their borrowing for three quarters, while the foreign sector increases borrowed funds. The results shed new light on the role played by the financial decisions of the various economic sectors in the transmission of monetary policy.
    Keywords: flow of funds, monetary policy, VAR
    JEL: E32 E52
    Date: 2008–06
  11. By: Hafedh Bouakez; Emanuela Cardia; Francisco J. Ruge-Murcia
    Abstract: Barsky, House and Kimball (2007) show that introducing durable goods into a sticky-price model leads to negative sectoral comovement of production following a monetary policy shock and, under certain conditions, to aggregate neutrality. These results appear to undermine sticky-price models. In this paper, we show that these results are not robust to two prominent and realistic features of the data, namely input-output interactions and limited mobility of productive inputs. When extended to allow for both features, the sticky-price model with durable goods delivers implications in line with VAR evidence on the effects of monetary policy shocks.
    Keywords: Durability, input-output interactions, roundabout production, sectoral comovement, monetary policy
    JEL: E21 E23 E31 E52
    Date: 2008
  12. By: Colin Rogers (School of Economics, University of Adelaide)
    Date: 2008–09
  13. By: Paola Donati (DG-Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Francesco Donati (Politecnico of Torino, Department of Control and Computer Engineering, Corso Duca degli Abruzzi 24, I-10129 Torino, Italy.)
    Abstract: This paper proposes a procedure to investigate the nature and persistence of the forces governing the yield curve and to use the extracted information for forecasting purposes. The latent factors of a model of the Nelson-Siegel type are directly linked to the maturity of the yields through the explicit description of the cross-sectional dynamics of the interest rates. The intertemporal dynamics of the factors is then modeled as driven by long-run forces giving rise to enduring effects, and by medium- and short-run forces producing transitory effects. These forces are reconstructed in real time with a dynamic filter whose embedded feedback control recursively corrects for model uncertainty, including additive and parameter uncertainty and possible equation misspecifications and approximations. This correction sensibly enhances the robustness of the estimates and the accuracy of the out-of-sample forecasts, both at short and long forecast horizons. JEL Classification: G1, E4, C5.
    Keywords: Yield curve, Model uncertainty, Frequency decomposition, Monetary policy.
    Date: 2008–08
  14. By: Augustine A. Boakye; Hassan Molana
    Abstract: This paper uses the principles of the monetary approach model of balance of payments and exchange market pressure to analyze the fluctuations in the international reserves of LDCs. The motivation for this analysis derives from the recent emphasis of the debt reduction policies that target the HIPCs. These policies stress the importance of non-monetary, and to some extent non-economic factors such as institutional improvements, good governance, infrastructural development and poverty reduction strategies. The argument is that once such reforms are implemented effectively, the economic forces will work in the right direction enabling the HIPCs to sustain a healthy balance of payments. We use panel data analysis to examine whether there is a significant difference between international reserves fluctuations in the HIPCs and in the rest of the LDCs. Evidence from data over the period 1983–2003 for 47 LDCs - of which 20 qualify as HIPCs by the IMF-World Bank criteria - suggests that there are significant differences in the way the reserve flows respond to their main determinants in the two sets of countries. This begs the question of whether the above mentioned policies can alleviate the causes of such differences.
    Keywords: monetary approach, exchange market pressure, international reserves, Heavily Indebted Poor Country (HIPC)
    JEL: F31 F33 F34 F35 H63 O11
    Date: 2007–09
  15. By: Carmen M. Reinhart; Vincent R. Reinhart
    Abstract: A considerable literature has examined the causes, consequences, and policy responses to surges in international capital flows. A related strand of papers has attempted to catalog current account reversals and capital account "sudden stops." This paper offers an encompassing approach with an algorithm cataloging capital inflow bonanzas in both advanced and emerging economies during 1980-2007 for 181 countries and 1960-2007 for a subset of 66 economies from all regions. In line with earlier studies, global factors, such as commodity prices, international interest rates, and growth in the world's largest economies, have a systematic effect on the global capital flow cycle. Bonanzas are no blessing for advanced or emerging market economies. In the case of the latter, capital inflow bonanzas are associated with a higher likelihood of economic crises (debt defaults, banking, inflation and currency crashes). Bonanzas in developing countries are associated with procyclical fiscal policies and attempts to curb or avoid an exchange rate appreciation -- very likely contributing to economic vulnerability. For the advanced economies, the results are not as stark, but bonanzas are associated with more volatile macroeconomic outcomes for GDP growth, inflation, and the external accounts. Slower economic growth and sustained declines in equity and housing prices follow at the end of the inflow episode.
    JEL: F30 F32 F34
    Date: 2008–09
  16. By: Knüppel, Malte; Schultefrankenfeld, Guido
    Abstract: Macroeconomic risk assessments play an important role in the forecasts of many institutions. However, to the best of our knowledge their performance has not been investigated yet. In this work, we study the Bank of England’s risk forecasts for inflation. We find that these forecasts do not contain the intended information. Rather, they either have no information content, or even an adverse information content. Our results imply that under mean squared error loss, it is better to use the Bank of England’s mode forecasts than the Bank of England’s mean forecasts.
    Keywords: Forecast evaluation, risk forecasts, Bank of England inflation forecasts
    JEL: C12 C53 E37
    Date: 2008
  17. By: Irwin, Gregor (Bank of England); Penalver, Adrian (Bank of England); Salmon, Chris (Bank of England); Taylor, Ashley (London School of Economics)
    Abstract: We develop a model in which countries can protect themselves against shocks by subscribing to a credit union that shares the key features of the International Monetary Fund, or by self-insuring through accumulating reserves. We assess the impact of the increasing heterogeneity of the Fund's membership on the political equilibrium Fund size and hence its effectiveness as a credit union. We find the Fund's existing lending framework is well suited to a world in which its members have homogeneous interests, but as the membership has become more heterogeneous the Fund is increasingly unlikely to provide financing on a sufficient scale to meet the demands of higher-risk members, leading them to rely more heavily on self-insurance. We conclude that the framework governing the Fund's lending operations may no longer be appropriate.
    JEL: F33 F34
    Date: 2008–05
  18. By: Campa, Jose Manuel (IESE Business School); Gonzalez Minguez, Jose M (Banco de Espana); Sebastia Barriel, Maria (Bank of England)
    Abstract: This paper focuses on the non-linear adjustment of import prices in national currency to shocks in exchange rates and foreign prices measured in the exporters' currency of products originating outside the euro area and imported into European Union countries (EU-15). The paper looks at three different types of non-linearities: (a) non-proportional adjustment (the size of the adjustment grows more than proportionally with the size of the misalignments), (b) asymmetric adjustment to cost-increasing and cost-decreasing shocks, and (c) the existence of thresholds in the size of misalignments below which no adjustment takes place. There is evidence of more than proportional adjustment towards long-run equilibrium in manufacturing industries. In these industries, the adjustment is faster the further away current import prices are from their implied long-run equilibrium. In contrast, a proportional linear adjustment cannot be rejected for some other imports (especially within agricultural and commodity imports). There is also strong evidence of asymmetry in the adjustment to long-run equilibrium. Deviations from long-run equilibrium due to exchange rate appreciations of the home currency result in a faster adjustment than those caused by a home currency depreciation. Finally, we also find that adjustment takes place in the industries in our sample only when deviations are above certain thresholds, and that these thresholds tend to be somewhat smaller for manufacturing industries than for commodities.
    Keywords: Exchange rate adjustment; European Union; monetary union.
    JEL: F31 F36 F42
    Date: 2008–04
  19. By: Luca Arciero (Bank of Italy); Claudia Biancotti (Bank of Italy); Leandro DÂ’Aurizio (Bank of Italy); Claudio Impenna (Bank of Italy)
    Keywords: agent-based modeling, payment systems, RTGS, liquidity, crisis simulation Abstract: This paper presents an exploratory agent-based model of a real time gross settlement (RTGS) payment system. Banks are represented as agents who exchange payment requests, which are settled according to a set of simple rules. The model features the main elements of a real-life system, including a central bank acting as liquidity provider, and a simplified money market. A simulation exercise using synthetic data of BI-REL (the Italian RTGS) predicts the macroscopic impact of a disruptive event on the flow of interbank payments. The main advantage of agent - based modeling is that we can dynamically see what happens to the major variables involved. In our reduced-scale system, three hypothetical distinct phases emerge after the disruptive event: 1) a liquidity sink effect is generated and the participants’ liquidity expectations turn out to be excessive; 2) an illusory thickening of the money market follows, along with increased payment delays; and, finally 3) defaulted obligations dramatically rise. The banks cannot staunch the losses accruing on defaults, even after they become fully aware of the critical event, and a scenario emerges in which it might be necessary for the central bank to step in as liquidity provider. The methodology presented differs from traditional payment systems simulations featuring deterministic streams of payments dealt with in a centralized manner with static behavior on the part of banks. The paper is within a recent stream of empirical research that attempts to model RTGS with agent – based techniques.
    JEL: C63 E47 G21
    Date: 2008–08
  20. By: Kim, Soyoung (Korea University); Yang, Doo Yong (Korea Institute for International Economic Policy)
    Abstract: In recent years, emerging East Asian economies have experienced large capital inflows-especially a surge in portfolio inflows-and an appreciation of asset prices such as equities, land, and both nominal and real exchange rates. The paper reviews why a surge in capital inflows can increase asset prices, and then empirically investigates the effects by employing a panel vector autoregression (VAR) model. The empirical results suggest that capital inflows have indeed contributed to the asset price appreciation in this region, although capital inflow shocks explain a relatively small part of asset price fluctuations. How to manage these capital inflows is also discussed.
    Keywords: Capital inflows; portfolio inflows; asset prices
    JEL: F10 F31 F32 G15 G18
    Date: 2008–05–01
  21. By: Martin Gregor (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: A government applying for a club membership may strategically delay entry to cope with the hold-up problem introduced by anticipatory investments of the private sector. In equilibrium of a two-period incomplete information game, we find that a pro-entry government may strategically delay to imitate an anti-entry government and thereby affect expectations of the private sector. The delay is more likely if the government has a good electoral prospect, is internationally weak, and is not considered to be too keen on entry. The model is related to the case of the Czech Republic where the government recently softened commitment in the euro adoption strategy.
    Keywords: EMU, club enlargement, international unions, bargaining
    JEL: D74 E42 F31 F50
    Date: 2008–09

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