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on Monetary Economics |
| By: | Patrick J. Kehoe; Virgiliu Midrigan |
| Abstract: | In the data, prices change both temporarily and permanently. Standard Calvo models focus on permanent price changes and take one of two shortcuts when confronted with the data: drop temporary changes from the data or leave them in and treat them as permanent. We provide a menu cost model that includes motives for both types of price changes. Since this model accounts for the main regularities of price changes, its predictions for the real effects of monetary policy shocks are useful benchmarks against which to judge existing shortcuts. We find that neither shortcut comes close to these benchmarks. For monetary policy analysis, researchers should use a menu cost model like ours or at least a third, theory-based shortcut: set the Calvo model's parameters so that it generates the same real effects from monetary shocks as does the benchmark menu cost model. Following either suggestion will improve monetary policy analysis. |
| JEL: | E12 E5 E58 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14392&r=mon |
| By: | Philip Arestis; Luiz Fernando de Paula; Fernando Ferrari-Filho |
| Abstract: | The purpose of this paper is to examine inflation targeting (IT) in emerging countries by concentrating essentially on the case of Brazil. The IT monetary policy regime has been adopted by a significant number of countries. While the focus of this paper is on Brazil, which began inflation targeting in 1999, we also examine the experience of other countries, both for comparative purposes and for evidence of the extent of this "new" economic policy's success. In addition, we compare the experience of Brazil with that of non-IT countries, and ask the question of whether adopting IT makes a difference in the fight against inflation. |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_544&r=mon |
| By: | Menon, Jayant (Asian Development Bank) |
| Abstract: | Cambodia's economic and social achievements over the past ten years have been the most impressive in its history. Nevertheless, Cambodia today is still as dollarized, if not more so, than it was ten years ago. What is this so, and what, if anything, should the Government do? This paper attempts to answer both these questions, by examining the reasons behind the apparent paradox between a decade of economic and political improvements and continued dollarization, and drawing policy implications from it. We advise against pursuing enforced dedollarization, and advocate a policy option that focuses instead on accelerating accommodative reforms, especially in the financial sector and on legal and institutional reforms. We also identify a host of institutional barriers that need to be overcome to prepare the groundwork for a natural process of de-dollarization. |
| Keywords: | Cambodia; dollarization; exchange rates; currency board; hysteresis |
| JEL: | E42 E58 F31 F33 |
| Date: | 2008–09–01 |
| URL: | http://d.repec.org/n?u=RePEc:ris:adbrei:0019&r=mon |
| By: | Barnett, William A.; Chauvet, Marcelle; Tierney, Heather L. R. |
| Abstract: | This paper compares the different dynamics of the simple sum monetary aggregates and the Divisia monetary aggregate indexes over time, over the business cycle, and across high and low inflation and interest rate phases. Although traditional comparisons of the series sometimes suggest that simple sum and Divisia monetary aggregates share similar dynamics, there are important differences during certain periods, such as around turning points. These differences cannot be evaluated by their average behavior. We use a factor model with regime switching. The model separates out the common movements underlying the monetary aggregate indexes, summarized in the dynamic factor, from individual variations in each individual series, captured by the idiosyncratic terms. The idiosyncratic terms and the measurement errors reveal where the monetary indexes differ. We find several new results. In general, the idiosyncratic terms for both the simple sum aggregates and the Divisia indexes display a business cycle pattern, especially since 1980. They generally rise around the end of high interest rate phases – a couple of quarters before the beginning of recessions – and fall during recessions to subsequently converge to their average in the beginning of expansions. We find that the major differences between the simple sum aggregates and Divisia indexes occur around the beginnings and ends of economic recessions, and during some high interest rate phases. We note the inferences’ policy relevance, which is particularly dramatic at the broadest (M3) level of aggregation. Indeed, as Belongia (1996) has observed in this regard, “measurement matters.” |
| Keywords: | Measurement Error, Divisia Index, Aggregation, State Space, Markov Switching, Monetary Policy |
| JEL: | E51 C30 E4 |
| Date: | 2008–08–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:10177&r=mon |
| By: | Stefano Eusepi; Bruce Preston |
| Abstract: | This paper analyzes the constraints imposed on monetary and fiscal policy design by expectations formation. Households and firms learn about the policy regime using historical data. Regime uncertainty substantially narrows, relative to a rational expectations analysis of the model, the menu of policies consistent with expectations stabilization. There is greater need for policy coordination: the specific choice of monetary policy limits the set of fiscal policies consistent with macroeconomic stability --- and simple Taylor-type rules frequently lead to expectations-driven instability. In contrast, non-Ricardian fiscal policies combined with an interest rate peg promote stability. Resolving uncertainty about the prevailing monetary policy regime improves stabilization policy, enlarging the menu of policy options consistent with stability. However, there are limits to the benefits of communicating the monetary policy regime: the more heavily indebted the economy, the greater is the likelihood of expectations-driven instability. More generally, regardless of agents' knowledge of the policy regime, even when expectations are anchored in the long term, short-term dynamics display greater volatility than under rational expectations. |
| JEL: | E52 E62 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14391&r=mon |
| By: | Alon Binyamini; Assaf Razin |
| Abstract: | The paper provides an integrated analysis of globalization effects on the inflation-output tradeoff and monetary policy in the New-Keynesian framework. The prediction of the analysis is threefold. First, labor, goods, and capital mobility flatten the Phillips curve, the tradeoff between inflation and activity. Second, the same globalization forces lead the welfare-based monetary policy to be more aggressive with regard to inflation fluctuations, and at the same time, more benign with respect to the output-gap fluctuations. Third, the equilibrium response of inflation to supply and demand shocks is more moderate, and the response of the output gap to these shocks is more pronounced, when the economy opens up; under such welfare-based monetary policy. |
| JEL: | E3 E4 E5 F37 F4 F41 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14379&r=mon |
| By: | Henriksen, Espen; Kydland, Finn; Sustek, Roman |
| Abstract: | We document that, at business cycle frequencies, fluctuations in nominal variables, such as aggregate price levels and nominal interest rates, are substantially more synchronized across countries than fluctuations in real output. To the extent that domestic nominal variables are determined by domestic monetary policy, and central banks generally attempt to keep the domestic nominal environment stable, this might seem surprising. We ask if a parsimonious international business cycle model can account for this aspect of cross-country aggregate fluctuations. It can. Due to spillovers of technology shocks across countries, expected future responses of national central banks to fluctuations in domestic output and inflation generate movements in current prices and interest rates that are synchronized across countries even when output is not. Even modest spillovers produce cross-country correlations such as those in the data. |
| Keywords: | International business cycles; prices; interest rates. |
| JEL: | E43 F42 E32 E31 |
| Date: | 2008–09–12 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:10963&r=mon |
| By: | L. Randall Wray |
| Abstract: | As homeowner equity continues to disappear, there is a growing consensus that losses on all mortgages will exceed $1 trillion, with financial losses spreading far beyond real estate. Mortgage rates are spiking and, more generally, interest rate spreads remain wide, as financial players shun private debt in the rush to safe Treasury securities. Labor markets continue to weaken as firms shed jobs, and state tax revenues have plummeted. In March, the dollar fell to new record lows against the euro and other currencies. Commodities prices have boomed, fueling inflation and adding to consumer distress. What's a central bank to do? So far, the Federal Reserve has met or exceeded the market's anticipations for rate cuts. It has allowed banks to offer securitized mortgages as collateral against borrowed reserves, and opened its discount window to a broad range of financial institutions to guard against future liquidity problems (remember Bear Stearns?). It helped to formulate a rescue plan for Freddie Mac and Fannie Mae, and Chairman Ben Bernanke even supported the fiscal stimulus package that will increase the federal budget deficit—something that is normally anathema to central bankers. Most importantly, Fed officials have consistently argued that, while they are carefully monitoring inflation pressures, they will not reverse monetary easing until the fallout from the subprime crisis is past. Unfortunately, the policy isn't working--the economy continues to weaken, the financial crisis is spreading, and inflation is accelerating. The problem is that policymakers do not recognize the underlying forces driving the crisis, in part because they operate with an incorrect model of how our economy works. This Policy Note summarizes that model, offers an alternative view based on Hyman Minsky's approach, and outlines an alternative framework for policy formation. |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:lev:levypn:08-3&r=mon |
| By: | Inoue, Takeshi; Hamori, Shigeyuki |
| Abstract: | This paper empirically analyzes India’s money demand function during the period of 1980 to 2007 using monthly data and the period of 1976 to 2007 using annual data. Cointegration test results indicated that when money supply is represented by M1 and M2, a cointegrating vector is detected among real money balances, interest rates, and output. In contrast, it was found that when money supply is represented by M3, there is no long-run equilibrium relationship in the　money demand function. Moreover, when the money demand function was estimated using　dynamic OLS, the sign onditions of the coefficients of output and interest rates were found to be　consistent with theoretical rationale, and statistical significance was confirmed when money supply was represented by either M1 or M2. Consequently, though India’s central bank presently uses M3 as an indicator of future price movements, it is thought appropriate to focus on M1 or M2, rather than M3, in managing monetary policy. |
| Keywords: | Cointegration, DOLS, Money, Money demand, Monetary policy, India |
| JEL: | E41 E51 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:jet:dpaper:dpaper166&r=mon |
| By: | José Manuel Gutiérrez |
| Abstract: | The existence of short-term monetary equilibrium in a frictionless economy with suboptimal agents is proved for any (reasonable) given interest rate. Separability ideas (as defined in Decision Theory) are applied. Two financial markets are in operation: for bank contracts (deposits and credits) and for shares. |
| JEL: | C62 D53 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:vie:viennp:0811&r=mon |
| By: | Castro, Vítor (University of Warwick, University of Coimbra and 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 particular, 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 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:872&r=mon |
| By: | Christian Conrad (University of Heidelberg, Department of Economics); Menelaos Karanasos (Economics and Finance, Brunel University) |
| Abstract: | This paper employs the unrestricted extended constant conditional correlation GARCH specification proposed in Conrad and Karanasos (2008) to examine the intertemporal relationship between the uncertainties of inflation and output growth in the US. We find that inflation uncertainty effects output variability positively, while output variability has a negative effect on inflation uncertainty. |
| Keywords: | Bivariate GARCH process, negative volatility feedback, inflation uncertainty, output variability |
| JEL: | C32 C51 E31 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:awi:wpaper:0475&r=mon |