nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒10‒21
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Lending interest rate pass-through in the euro area. A data-driven tale By Giuseppe Marotta
  2. Breaking Credibility in Monetary Policy: The Role of Politics in the Stability of the Central Banker By Miguel Rueda Author-X-Name_First: Miguel Author-X-Name_Last: Rueda
  3. Adopting Price-Level Targeting under Imperfect Credibility: An Update By Oleksiy Kryvtsov; Malik Shukayev; Alexander Ueberfeldt
  4. The Extensive Margin of Trade under Alternative Monetary Policy Regimes By Stéphane Auray; Aurélien Eyquem; Jean-Christophe Poutineau
  5. Optimal Monetary Policy in an Operational Medium-Sized DSGE Model By Adolfson, Malin; Laseén, Stefan; Lindé, Jesper; Svensson, Lars E.O.
  6. Asset Price Bubbles and Monetary Policy: Why Central Banks Have Been Wrong and What Should Be Done By Thomas I. Palley
  7. Macroeconomics without the LM: A Post-Keynesian Perspective By Thomas I. Palley
  8. Should the SARB Have Stayed Time Inconsistent? By Rangan Gupta; Josine Uwilingiye
  9. Policy Preferences for Output Stability before and after Inflation Targeting By Araújo, Eurilton; Pinheiro, Tatiana
  10. The Challenges of Monetary Policy in Turkey By Olcay Çulha; Ali Çulha; Rauf Gönenç
  11. Asymmetric expectation effects of regime shifts in monetary policy By Zheng Liu; Daniel F. Waggoner; Tao Zha
  12. Macroeconometric equivalence, microeconomic dissonance, and the design of monetary policy By Andrew T. Levin; J. David López-Salido; Edward Nelson; Tack Yun
  13. Price Level Targeting in a Small Open Economy with Financial Frictions: Welfare Analysis By Ali Dib; Caterina Mendicino; Yahong Zhang
  14. Inflation Range Targets with Hard Edges By Niklas J. Westelius
  15. Temporary price changes and the real effects of monetary policy By Patrick J. Kehoe; Virgiliu Midrigan
  16. Inflation Persistence: Is It Similar in the New EU Member States and the Euro Area Members? By Michal Franta; Branislav Saxa; Katerina Smidkova
  17. Lessons on Reshaping the International Monetary Order - Revisiting J. M. Keynes “Activities 1940-1944” on the Creation of the Bretton Woods Institutions By Piffaretti, Nadia F.
  18. Central bank communication and crowding out of private information in an experimental asset market By Menno Middeldorp; Stephanie Rosenkranz
  19. Evidence on the effects of inflation on price dispersion under indexation By Juliane Scharff; Sven Schreiber
  20. Determinacy and Learnability of Monetary Policy Rules in Small Open Economies By Luis Gonzalo Llosa Author-X-Name_First: Luis Gonzalo Author-X-Name_Last: Llosa; Vicente Tuesta Author-X-Name_First: Vicente Author-X-Name_Last: Tuesta

  1. By: Giuseppe Marotta
    Abstract: The harmonized MIR retail interest rates for the euro area, available as of January 2003, show remarkable differences both in levels and dynamics with the previous unharmonized NRIR rates. This evidence should suggest caution in extrapolating the findings of the NRIR-based literature on the incomplete long-run pass-through of market rates even into the short term business lending rates, the least sticky ones among bank rates. We show that long run pass-throughs for MIR rates of smaller and larger short-term business loans are almost always complete or nearly so in nine of the founding EMU countries and in Greece.
    Keywords: Interest rates; Monetary policy; European Monetary Union (EMU); Taylor principle
    JEL: E43 E52 E58 F36
    Date: 2008–10
  2. By: Miguel Rueda Author-X-Name_First: Miguel Author-X-Name_Last: Rueda
    Abstract: This paper studies the relationship between the hazard rate of the exit of a president of a central bank and a measure of credibility in monetary policy. The expected hazard rate of exit is estimated as a function of legal and political variables. The measure of credibility is the expected probability of a disinflation beginning when inflation is rising. For a sample of 22 Latin American and G7 countries, I find a negative relationship between the hazard rate of exit and the measure of credibility. This provides evidence of the expected relationship between independence and credibility not found in previous cross country studies. Using the executive’s party ideology as a measure of aversion to inflation, there was no evidence that this relationship is different for countries where the government is identified as more conservative. However, when a president of the central bank appointed by a conservative government is in office, a rise in the probability of a disinflation beginning when inflation was rising was found. The results show that legal independence after controlling for the hazard rate of the president’s exit is not associated with credibility gains.
    Date: 2008–09
  3. By: Oleksiy Kryvtsov; Malik Shukayev; Alexander Ueberfeldt
    Abstract: This paper measures the welfare gains of switching from inflation-targeting to price-level targeting under imperfect credibility. Vestin (2006) shows that when the monetary authority cannot commit to future policy, price-level targeting yields higher welfare than inflation targeting. We revisit this issue by introducing imperfect credibility, which is modeled as gradual adjustment of the private sector's beliefs about the policy change. We find that gains from switching to price-level targeting are small. A welfare loss occurs, if imperfect credibility is highly persistent.
    Keywords: Credibility; Monetary policy framework
    JEL: E31 E52
    Date: 2008
  4. By: Stéphane Auray (Université Lille 3 (GREMARS), Université de Sherbrooke (GREDI) and CIRPÉE); Aurélien Eyquem (GATE, UMR 5824, Université de Lyon and Ecole Normale Supérieure Lettres et Sciences Humaines, France); Jean-Christophe Poutineau (CREM, UMR 6211, Université de Rennes 1 and Ecole Normale Supérieure de Cachan, France)
    Abstract: This paper investigates the impact of alternative monetary policy regimes on the creation of new varieties in open economies. Using a dynamic two-country model incorporating nominal rigidities, international trade and firm entries we compare an independent monetary policy regime to a monetary union regime. We find that a common monetary policy defined by a nominal interest rate rule reactive to inflation increases extensive margin of trade volatility. Simulations based on business cycle frequencies indicate that on average this increase reaches 3%. Although monetary policy interdependence is found to be a key ingredient in generating this effect, we stress that those parameters affecting international trade structures are crucial in determining its magnitude.
    Keywords: Extensive Margin, Variety Effect, Monetary Union, Monetary Policy
    JEL: E51 E58 F36 F41
    Date: 2008
  5. By: Adolfson, Malin (Monetary Policy Department, Central Bank of Sweden); Laseén, Stefan (Monetary Policy Department, Central Bank of Sweden); Lindé, Jesper (Monetary Policy Department, Central Bank of Sweden, Sveriges Riksbank, SE-103 37 Stockholm, Sweden and CEPR); Svensson, Lars E.O. (Central Bank of Sweden, Sveriges Riksbank, SE-103 37 Stockholm, Sweden, Princeton University, CEPR and NBER)
    Abstract: We show how to construct optimal policy projections in Ramses, the Riksbank’s openeconomy medium-sized DSGE model for forecasting and policy analysis. Bayesian estimation of the parameters of the model indicates that they are relatively invariant to alternative policy assumptions and supports that the model may be regarded as structural in a stable low inflation environment. Past policy of the Riksbank until 2007:3 (the end of the sample used) is better explained as following a simple instrument rule than as optimal policy under commitment. We show and discuss the differences between policy projections for the estimated instrument rule and for optimal policy under commitment, under alternative definitions of the output gap, different initial values of the Lagrange multipliers representing policy in a timeless perspective, and different weights in the central-bank loss function.
    Keywords: Optimal monetary policy; instrument rules; optimal policy projections; openeconomy DSGE models
    JEL: E52 E58
    Date: 2008–08–01
  6. By: Thomas I. Palley (Economics for Democratic & Open Societies, Washington DC, and Visiting Scholar at the Macroeconomic Policy Institute (IMK), Germany)
    Abstract: Over the last several years debate over monetary policy has focused on two issues, inflation targeting and asset price bubbles. This paper explores the case for explicitly targeting asset price bubbles, a policy that the Federal Reserve Bank has opposed on the grounds that it is both infeasible and undesirable. The paper argues that the Fed is wrong on both counts. Asset price bubbles are identifiable. Bubbles also do significant economic harm through the debt footprint effects they leave behind and through interest rate blunderbuss effects resulting from attempts to mitigate the aggregate demand impact of bubbles. Managing bubbles calls for additional policy instruments. These can be provided a system of asset based reserve requirements (ABRR).
    Date: 2008
  7. By: Thomas I. Palley (Economics for Democratic & Open Societies, Washington DC, and Visiting Scholar at the Macroeconomic Policy Institute (IMK), Germany)
    Abstract: Romer (2000) provides an alternative model to the AS/AD and IS/LM models that abandons the LM schedule by having the short-term interest rate set by the central bank. His framework acknowledges the critical role of the central bank in determining short-term interest rates, which moves mainstream macroeconomics closer to Post Keynesian monetary theory. The current paper presents a Post Keynesian construction of macroeconomics without an LM schedule. Rather than describing the financial sector in terms of an exogenously determined interest rate set by the central bank, the model unpacks financial markets by fully specifying a banking sector. The key analytic feature of the Post Keynesian approach is to replace the money market with the loan market. That makes transparent the macroeconomic significance of the loan market and bank behavior, and generates an endogenous money supply driven by bank lending. If banks become more optimistic over the
    Keywords: bank lending, credit, endogenous money, loan market.
    JEL: E12 E40
    Date: 2008
  8. By: Rangan Gupta (Department of Economics, University of Pretoria); Josine Uwilingiye (Department of Economics, University of Pretoria)
    Abstract: This paper derives the econometric restrictions imposed by the Barro and Gordon (1983) model of dynamic time inconsistency on a bivariate time-series model of Consumer Price Index (CPI) inflation and real Gross Domestic Product (GDP), and tests these restrictions based on quarterly data for South Africa covering the period of 1960:01 through 1999:04, i.e., for the pre-inflation targeting period. The results show that the data are consistent with the short- and long-run implications of the theory of time-consistent monetary policy. Moreover, when the model is used to forecast one-step-ahead inflation over the period of 2001:01 to 2008:02, i.e., the period covering the starting point of the inflation targeting regime till date we, on average, obtain lower rates of inflation. The result tends to suggest that the South African Reserve Bank (SARB), perhaps needs to manage the inflation targeting framework better than it has done so far.
    Keywords: Dynamic Time Inconsistency; Inflation Targeting; One-Step-Ahead Forecasts
    JEL: E31 E52 E61
    Date: 2008–10
  9. By: Araújo, Eurilton; Pinheiro, Tatiana
    Date: 2008–10
  10. By: Olcay Çulha; Ali Çulha; Rauf Gönenç
    Abstract: Monetary policy has been one of the main pillars of the post-2001 stabilisation programme. Encouraged by its success, the central bank shifted from implicit to explicit inflation targeting in 2006 and set a medium-term inflation target of 4%, applicable from end 2007. However this objective faced with two important challenges. On the one hand, inflation inertia settled in and non-tradable inflation stagnated at more than 10%, further fuelled by persistent surge in global commodity and energy prices. On the other hand, real interest rates remained high, continuing to fuel strong capital inflows and currency appreciation, and undermining the competitiveness of labour-intensive segments of the economy. Turkey is, therefore, faced with the classic dilemma of successful catching-up economies: Inflation inertia requires a tight policy while competitiveness losses appear to go beyond the absorption and adaptation capacity of large segments of the economy. This chapter argues that resolving this issue requires monetary policy to be supported by broader policies, including proactive competition policy to reduce costs and prices in services, enforcement of a credible multi-yearly spending framework to consolidate confidence in fiscal stability, and employers' and employees' commitment to anchor prices and wages more on the inflation target. Success with such policies would help shift the burden away from the central bank's interest rate as the only available instrument to increase the credibility of the inflation target. <P>Les défis de politique monétaire en Turquie <BR>La politique monétaire est l'un des principaux piliers du programme de stabilisation engagé après 2001. Encouragée par ce succès, la banque centrale est passée en 2006 d'un ciblage implicite de l'inflation à un ciblage explicite, et a fixé un objectif d'inflation à moyen terme de 4%, applicable à compter de la fin de 2007. Toutefois, cet objectif s'est rapidement heurté à deux principaux écueils. D'une part, l'inertie de l'inflation a perduré et l'inflation dans les « non-tradables» a stagné à plus de 10 %. D'autre part, les taux d'intérêt réels sont restés élevés, ce qui a alimenté des entrées massives de capitaux et fait s'apprécier la monnaie, ce qui a pénalisé la compétitivité des segments de l'économie à forte intensité de main-d'œuvre. La Turquie est par conséquent confrontée au dilemme classique que connaissent les économies performantes en phase de rattrapage. L'inertie de l'inflation exige une politique monétaire restrictive, mais les pertes de compétitivité dépassent apparemment les capacités d'absorption et d'adaptation de pans entiers de l'économie. Ce document fait valoir que la politique monétaire doit être étayée par des initiatives menées dans d'autres domaines : incluant la politique de la concurrence proactive visant à réduire les coûts et les prix des services, la mise en œuvre d'un cadre de dépenses pluriannuel crédible afin de raffermir la confiance dans la stabilité budgétaire, et l’adoption par les employeurs et les salariés de l'objectif d'inflation comme point d'ancrage de leurs stratégies en matière de tarification et de salaires. La réussite de ces politiques atténuerait le poids qui s'exerce sur le taux d'intérêt directeur de la banque centrale en tant qu'instrument unique pour asseoir la crédibilité de l'objectif d'inflation.
    Keywords: exchange rates, taux de change, monetary policy, politique monétaire, inflation target, Turkey, Turquie, inflation expectation, anticipation d'inflation
    JEL: E40 E42 E50 E52 E58
    Date: 2008–10–16
  11. By: Zheng Liu; Daniel F. Waggoner; Tao Zha
    Abstract: This paper addresses two substantive issues: (1) Does the magnitude of the expectation effect of regime switching in monetary policy depend on a particular policy regime? (2) Under which regime is the expectation effect quantitatively important? Using two canonical DSGE models, we show that there exists asymmetry in the expectation effect across regimes. The expectation effect under the dovish policy regime is quantitatively more important than that under the hawkish regime. These results suggest that the possibility of regime shifts in monetary policy can have important effects on rational agents' expectation formation and on equilibrium dynamics. They offer a theoretical explanation for the empirical possibility that a policy shift from the dovish regime to the hawkish regime may not be the main source of substantial reductions in the volatilities of inflation and output.
    Keywords: Monetary policy
    Date: 2008
  12. By: Andrew T. Levin; J. David López-Salido; Edward Nelson; Tack Yun
    Abstract: Many recent studies in macroeconomics have focused on the estimation of DSGE models using a system of loglinear approximations to the models' nonlinear equilibrium conditions. The term macroeconometric equivalence encapsulates the idea that estimates using aggregate data based on first-order approximations to the equilibrium conditions of a DSGE model will not be able to distinguish between alternative underlying preferences and technologies. The concept of microeconomic dissonance refers to the fact that the underlying microeconomic differences become important when optimal monetary policy is analyzed in a nonlinear setting. The relevance of these concepts is established by analysis of optimal steady-state inflation and optimal policy in the stochastic economy using a small-scale New Keynesian model. Microeconomic and financial datasets are promising tools with which to overcome the equivalence problem.
    Keywords: Monetary policy ; Macroeconomics ; Microeconomics
    Date: 2008
  13. By: Ali Dib; Caterina Mendicino; Yahong Zhang
    Abstract: How important are the benefits of low price-level uncertainty? This paper explores the desirability of price-level path targeting in an estimated DSGE model fit to Canadian data. The policy implications are based on social welfare evaluations. Compared to the historical inflation targeting rule, an optimal price level targeting regime substantially reduces the welfare cost of business cycle fluctuations in terms of steady state consumption. The optimal price-level targeting rule performs also better than the optimal inflation targeting rule in minimizing the distortion generated by the presence of nominal debt contracts. The occurrence of financial shocks, which are among the main sources of business cycle fluctuations in the model, significantly contributes to quantify the welfare gains of price level targeting.
    Keywords: Financial stability; Inflation and prices; Monetary policy framework
    JEL: E31 E32 E52
    Date: 2008
  14. By: Niklas J. Westelius (Hunter College)
    Abstract: A number of inflation targeting central banks operate under provisions that allow for increased flexibility when faced with large supply shocks. These so-called escape clauses, however, are usually hard to interpret and discretionary in nature. This paper argues that a practical and more viable option is to specify a hard edged target range. Within the range, the central bank enjoys complete independence. Should, however, a large supply shock force inflation outside the range, the government may overrule the bank unless it adjusts its policy to address the government's concerns. Such an arrangement has the advantage of being easily understood and non-discretionary. Furthermore, it is shown that the bandwidth of the target range is inversely related to the degree of flexibility of the inflation targeting regime and thus, provides an easy way for the central bank to communicate its preferences to the public. The paper also discusses various determinants of the optimal design of the target range.
    Keywords: Inflation Range Targeting, Discretion, Escape Clauses
    JEL: E52 E61
    Date: 2008
  15. 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 bench-mark menu cost model. Following either suggestion will improve monetary policy analysis.
    Keywords: Keynesian economics ; Prices
    Date: 2008
  16. By: Michal Franta (Czech National Bank; CERGE-EI); Branislav Saxa (Czech National Bank; CERGE-EI); Katerina Smidkova (Czech National Bank; Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: Inflation persistence has been put forward as one of the potential reasons of divergence among euro area members. It has also been proposed that the new EU Member States (NMS) may struggle with even higher persistence due to convergence factors. We argue that persistence may not be as different between the two country groups as one might expect. However, this empirical result can only be obtained if the adequate estimation methods, reflecting the scope of the convergence process the NMS went through, are applied. We emphasize that a time-varying mean models suggest similar or lower inflation persistence for the NMS compared to euro area countries while more traditional parametric statistical measures assuming a constant mean deliver substantially higher persistence estimates for the NMS than for the euro area countries. This difference is due to frequent breaks in inflation time series in the NMS. Structural persistence measures show that backward-looking behavior may be a more important component in explaining inflation dynamics in the NMS than in the euro area countries.
    Keywords: inflation persistence, new hybrid Phillips curve, new member states, time-varying mean
    JEL: E31 C22 C11 C32
    Date: 2008–10
  17. By: Piffaretti, Nadia F.
    Abstract: As we witness profound changes in the global economy, and the raise of a multipolar intergrated global economy, as it appears clear that so-called “Revived Bretton Woods System” as described by in their influential paper by Dooley, Folkerts-Landau and Garber (2003) (in which many countries, particularly in Asia, limit exchange rate fluctuation against the dollar, accumulating as a consequence enormous reserves in dollars) maybe be nothing more than a temporary non sustainable financing of the US structural internal imbalance, it’s worth revisiting the origins of the Bretton Woods Institutions, and pointing out to the relevance for today’s framework of Keynes’ original 1942 plan. In this note we explore the main characteristics of Keynes’ original plans for an international Clearing Union, by revisiting his original writings between 1940-1944, and we briefly outline the relevance of his plan to today’s framework.
    Keywords: International Financial Architecture; Bretton Woods Institutions; Plan Keynes; Money
    JEL: E12 E58 E42 F02 N20 E00 E50 F33
    Date: 2008–10–11
  18. By: Menno Middeldorp; Stephanie Rosenkranz
    Abstract: Theoretical results from previous work, presented in Kool, Middeldorp and Rosenkranz (2007), suggest that central bank communication crowds out private information acquisition and that this effect can lead to a deterioration of the ability of financial markets to predict future policy interest rates. We examine this result in an experimental asset market that closely follows the theoretical model. Crowding out of information acquisition takes place and, where this crowding out is most rapid, there is deterioration of the market’s predictive ability. This supports the theoretical result that central bank communication can actually make it more difficult for financial markets to predict future policy rates.
    Keywords: Experimental Economics, Private Information Acquisition, Information and Financial Market Efficiency, Central bank transparency and communication
    JEL: C92 D82 E58 G14
    Date: 2008–06
  19. By: Juliane Scharff (Halle Institute for Economic Research (IWH)); Sven Schreiber (Goethe University Frankfurt, and Macroeconomic Policy Institute (IMK) at the Hans Boeckler Foundation,)
    Abstract: Distortionary effects of inflation on relative prices are the main argument for inflation stabilization in macro models with sticky prices. Under indexation of non-optimized prices those models imply a nonlinear and dynamic impact of inflation on the cross-sectional price dispersion (relative-price variability, RPV). Using US sectoral prices we estimate (a generalized form of) the theoretical relationship between inflation and RPV. We confirm the impact of inflation fluctuations but find hitherto neglected endogeneity biases, and our IV and GMM estimates indicate that average ("trend") inflation is significant for indexation. Lagged inflation is less important.
    Keywords: relative price variability, trend inflation, endogeneity bias
    JEL: E31 C22
    Date: 2008
  20. By: Luis Gonzalo Llosa Author-X-Name_First: Luis Gonzalo Author-X-Name_Last: Llosa; Vicente Tuesta Author-X-Name_First: Vicente Author-X-Name_Last: Tuesta
    Abstract: This paper evaluates under which conditions different Taylor-type rules lead to determinacy and expectational stability (E-stability) of rational expectations equilibrium in a simple New Keynesian small open economy model, developed by Gali and Monacelli (2005). In particular, we extend the Bullard and Mitra (2002) results of determinacy and E-stability in a closed economy to this small open economy framework. Our results highlight an important link between the Taylor principle and both determinacy and learnability of equilibrium in small open economies. More importantly, the degree of openness coupled with the nature of the policy rule adopted by the monetary authorities might change this link in important ways. A key finding is that, contrary to Bullard and Mitra, expectations-based rules that involve the CPI and/or the nominal exchange rate limit the region of E-stability and the Taylor Principle does not guarantee E-stability. We also show that some forms of managed exchange rate rules can help to alleviate problems of both indeterminacy and expectational instability, yet these rules might not be desirable since they promote greater volatility in the economy.
    Date: 2006–12

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