nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒11‒25
fourteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. On Financial Markets Incompleteness, Price Stickiness, and Welfare in a Monetary Union ? By Stéphane Auray; Aurélien Eyquem
  2. Inflation persistence in the Franc Zone: evidence from disaggregated prices By Simeon Coleman
  3. Assessing Spill-Over Effects of U.S. Monetary Policy and Macroeconomic Announcements on Financial Markets in Argentina By Bernd Hayo; Matthias Neuenkirch
  4. The Changing Relation Between the Canadian and U.S. Yield Curves By Kathlyn Lucia; Stephanie Price; Edwin Wong; Richard Startz
  5. Monetary Union Among Arab Gulf Cooperation Council (AGCC) Countries: Does the symmetry of shocks extend to the non-oil sector? By Louis, Rosmy; Balli, Faruk; Osman, Mohammad
  6. Monetary Policy Design under Imperfect Knowledge: An Open Economy Analysis By Yu-chin Chen; Pisut Kulthanavit
  7. Prices and output co-movements : an empirical investigation for the CEECs. By Iuliana Matei
  8. Is the Great Moderation Ending? UK and US Evidence. By Giorgio Canarella; WenShwo Fang; Stephen M. Miller; Stephen K. Pollard
  9. Monetary Policy Trade-Offs in an Estimated Open-Economy DSGE Model By Malin Adolfson; Stefan Laséen; Jesper Lindé; Lars E.O. Svensson
  10. On The Road to Monetary Union – Do Arab Gulf Cooperation Council Economies React in the same way to United States' Monetary Policy Shocks? By Louis, Rosmy; Osman, Mohammad; Balli, FAruk
  11. The End of the Great Moderation: “We told you so.” By Barnett, William A.; Chauvet, Marcelle
  12. Demand for International Reserves: A Quantile Regression Approach By Sula, Ozan
  13. Monetary Policy and European Unemployment By Ronald Schettkat; Rongrong Sun
  14. Measurement Error in Monetary Aggregates: A Markov Switching Factor Approach By Barnett, William A.; Chauvet, Marcelle; Tierney, Heather L. R.

  1. 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)
    Abstract: The paper builds a two-country model of a monetary union with home bias and price stickiness. Incompleteness of financial asset markets is allowed. In this environment, we derive the solution for optimal behavior by the monetary policymaker and show that welfare can be higher under incomplete markets than under complete markets. The argument is a second- best one. In a monetary union with equal nominal rigidity across countries, optimal monetary policy stabilizes aggregate, union-wide inflation, but cannot fully stabilize the country-level inflation rates. Market incompleteness results in less volatility of the terms of trade (because part of the adjustment goes through the current account), and hence less volatile national inflation rates. Through this channel, welfare ends up being higher under incomplete markets. These results are also robust when nominal rigidity differs across countries and when the form of the monetary policy is modified.
    Keywords: monetary union, asymmetric shocks, financial market incompleteness, price stickiness, welfare
    JEL: E51 E58 F36 F41
    Date: 2008
  2. By: Simeon Coleman
    Abstract: In sub-Saharan Africa, where inflation persistence is likely to have deleterious welfare consequences, little attempt has been made to study this phenomenon. Using data over 1989:11-2002:09, this paper investigates persistence in disaggre- gated (food and non-food) inflation for thirteen Communaute Financiere Africaine (CFA) member states using fractional integration (FI) methods. The results show that both inflation series are characterized by mean-reversion and finite variance, however it also exposes some asymmetry in inflation persistence across member states in both sectors. In Chad and Niger, the phenomenon is found to exist in both sectors. With uniform monetary policy across member states, implications for Monetary Policy, Nominal Convergence and Optimal Currency Area are then discussed.
    Keywords: Fractional integration, inflation persistence, Franc Zone
    JEL: C22 E31 E32
    Date: 2008–11
  3. By: Bernd Hayo (Faculty of Business Administration and Economics, Philipps Universitaet Marburg); Matthias Neuenkirch (Faculty of Business Administration and Economics, Philipps Universitaet Marburg)
    Abstract: We study the effects of U.S. monetary policy and macroeconomic announcements on Argentine money, stock and foreign exchange markets’ returns and volatility over the period 1998 to 2006 using a GARCH model. Firstly, we show that both types of news have a significant impact on all markets. Secondly, we conclude that the Argentine markets have become less dependent on U.S. news after the abandonment of the currency board. Thirdly, we find that U.S. dollar-denominated assets react less to news which suggests that the currency board was not completely credible. Fourthly, we discover that financial markets react stronger during the financial crisis. Fifthly, in the case of peso-denominated assets, U.S. central bank communication helps to reduce money market volatility during the financial crisis in Argentina.
    Keywords: Argentina, Financial Markets, U.S. Monetary Policy, Federal Reserve Bank, Central Bank Communication, Macroeconomic Announcements
    JEL: E52 F33 G14 G15
    Date: 2008
  4. By: Kathlyn Lucia; Stephanie Price; Edwin Wong; Richard Startz
    Abstract: The term structures of Canada and of the United States, two countries with historically close economic ties, have been closely linked. We investigate the link between Canadian and U.S. yield curves and show previously strong correlations between yield curve components dissipate after Canadian monetary policy reforms in the early 1990s. First, the effect is particularly evident in the diminished cross-country correlations of the short term bond yields. Secondly, cross-country yields are cointegrated before the reforms, but not afterwards. Lastly, the results on the term structure are shown using a vector autoregression with an endogenously determined break date for Canadian and U.S. estimates of the three-factor Nelson-Siegel (1987) yield curve model.
    Date: 2008–05
  5. By: Louis, Rosmy; Balli, Faruk; Osman, Mohammad
    Abstract: AGCC countries' output is heavily dichotomized into oil and non-oil. The oil shocks have similar effects on all member countries but little is known about their responses to non-oil shocks. This paper sets out to determine whether (1) aggregate demand (AD) and non-oil supply shocks (AS) are symmetrical across these countries to justify their suitability for monetary union; and (2) whether there is any commonality of shocks with the United States and the three major European countries, namely France, Germany, and Italy, which can warrant the choice of either the US dollar or the Euro as the anchor for the expected common currency of the bloc. We use bivariate structural vector autoregression models identified with long-run restrictions a la Blanchard and Quah (1989) to extract the shocks. Our results show that (a) AD shocks are unequivocally symmetrical but non-oil AS shocks are weakly symmetrical across AGCC countries thereby giving a green light for monetary union; (b) neither AD nor AS shocks are symmetrical between AGCC countries and the selected European countries; (c) AGCC's AD shocks are symmetrical with the US but non-oil AS shock are not. We therefore surmise that the US dollar is a far better candidate for the new currency than the Euro since US monetary policy can at least help smooth demand shocks in AGCC countries. Our results hold even when we consider the AGCC countries as a bloc. This paper makes a valuable contribution to AGCC decision makers who have been wrestling with the dilemma of whether to revalue or to depeg their actual currencies.
    Keywords: AGCC; monetary union; shocks symmetry; currency anchor
    JEL: E32 F33 F36
    Date: 2008–07–04
  6. By: Yu-chin Chen (University of Washington); Pisut Kulthanavit (University of Washington)
    Abstract: This paper incorporates adaptive learning into a standard New-Keynesian open economy dynamic stochastic general equilibrium (DSGE) model and analyze under what conditions policymakers should target domestic producer price inflation (DI) versus consumer price inflation (CI). Our goal is to examine how monetary policy rules should adjust when agents’ information sets deviate from those assumed under the rational expectation paradigm. When agents form expectations using an adaptive learning mechanism, even though the central bank has no informational advantage, monetary policy can nonetheless facilitate the learning process and thus mitigate distortions associated with imperfect knowledge. We assume the policy-maker follows a forwardlooking Taylor rule and focus on analyzing the interplay between the source of the dominant shock and the extent of knowledge imperfection. We find that when agents have very limited knowledge and have to learn the dynamics governing both the relevant economic indicators and the underlying structural shocks, a DI targeting rule introduces fewer forecast errors and is better at stabilizing the economy. However, when agents can observe contemporaneous shocks and need only learn how key economic variables evolve (a situation akin to a post-structural-shift economy), targeting away from the dominant shocks helps anchor expectations and improve welfare. A CI target can then become the preferred policy rule when the economy is subject to large domestic shocks.
    Date: 2008–05
  7. By: Iuliana Matei (Centre d'Economie de la Sorbonne)
    Abstract: This article studies the features of co-movements of prices and production between six CEECs recently joined the EU and the euro zone. More precisely, based partially on the methodology suggested by Alesina, Barro and Tenreyro [2002], we evaluate the size and the persistence of prices and outputs shocks between each CEECs and euro zone. Results will contribute to the debate around the participation of the new members to the EMU.
    Keywords: European monetary integration, co-movements, AR models, CEECs.
    JEL: C22 E30 F33 F42 F47
    Date: 2008–10
  8. By: Giorgio Canarella (Department of Economics, University of Nevada, Las Vegas); WenShwo Fang (Feng Chia University); Stephen M. Miller (Department of Economics, University of Nevada, Las Vegas); Stephen K. Pollard (Department of Economics, California State University, Los Angeles)
    Abstract: The Great Moderation, the significant decline in the variability of economic activity, provides a most remarkable feature of the macroeconomic landscape in the last twenty years. A number of papers document the beginning of the Great Moderation in the US and the UK. In this paper, we use the Markov regime-switching models of Hamilton (1989) and Hamilton and Susmel (1994) to document the end of the Great Moderation. The Great Moderation in the US and the UK begin at different point in time. The explanations for the Great Moderation fall into generally three different categories: good monetary policy, improved inventory management, or good luck. Summers (2005) argues that a combination of good monetary policy and better inventory management led to the Great Moderation. The end of the Great Moderation, however, occurs at approximately the same time in both the US and the UK. It seems unlikely that good monetary policy would turn into bad policy or that better inventory management would turn into worse management. Rather, the likely explanation comes from bad luck. Two likely culprits exist: energy-price and housing-price shocks.
    Keywords: Great Moderation, Regime switching, SWARCH
    JEL: C32 E32 O40
    Date: 2009–11
  9. By: Malin Adolfson; Stefan Laséen; Jesper Lindé; Lars E.O. Svensson
    Abstract: This paper studies the transmission of shocks and the trade-offs between stabilizing CPI inflation and alternative measures of the output gap in Ramses, the Riksbank's empirical dynamic stochastic general equilibrium (DSGE) model of a small open economy. The main results are, first, that the transmission of shocks depends substantially on the conduct of monetary policy, and second, that the trade-off between stabilizing CPI inflation and the output gap strongly depends on which concept of potential output in the output gap between output and potential output is used in the loss function. If potential output is defined as a smooth trend this trade-off is much more pronounced compared to the case when potential output is defined as the output level that would prevail if prices and wages were flexible.
    JEL: E52 E58 F33 F41
    Date: 2008–11
  10. By: Louis, Rosmy; Osman, Mohammad; Balli, FAruk
    Abstract: This paper empirically estimates the responses of inflation and non-oil output growth from Arab Gulf Cooperation Council (AGCC) Countries to monetary policy shocks from the United States (US) in order to determine whether there is evidence to support the US dollar as the anchor for the proposed unified currency. For this, a structural vector autoregression identified with short-run restrictions was employed for each country with fund rate as US monetary policy instrument, non-oil output growth, and inflation. The main results that are of interest to decision makers suggest that (i) with respect to inflation, AGCC countries show synchronized responses to monetary policy shocks from the US and these responses are similar to US own inflation; (ii) with respect to non-oil output growth, there is no clear indication that US monetary policy can do as good of a job for AGCC countries as it has done at home. Therefore, importing monetary policy from the United States via a dollar peg may guarantee stable inflation for AGCC countries but not necessarily stable non-oil output growth. To the extent that the non-oil output response is taken seriously and there are concerns over the dollar's ability to perform its role as a store of value, a basket peg with both the US dollar and the Euro may be a sound alternative as confirmed by the variance decomposition analysis of our augmented SVAR with a proxy for the European short-term interest rate.
    Keywords: AGCC Countries; US monetary policy shock; monetary union; currency peg; SVARs
    JEL: C32 F15 E52
    Date: 2007–12
  11. By: Barnett, William A.; Chauvet, Marcelle
    Abstract: The current financial crisis followed the “great moderation,” according to which the world’s central banks had gotten so good at countercyclical policy that the business cycle no longer existed. As more and more economists and media people became convinced that the risk of recessions had moderated or ended, lenders and investors became willing to increase their leverage and risk-taking activities. Mortgage lenders, insurance companies, investment banking firms, and home buyers increasingly engaged in activities that would have been considered unreasonably risky, prior to the great moderation that was viewed as having lowered systemic risk. It is the position of this paper that the great moderation did not reflect improved monetary policy, and the perceptions that systemic risk had decreased and that the business cycle had ended were false. Contributing to those misperception was low quality data provided by central banks. 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,” have produced decades of misunderstandings in economic research and policy, and contributed to the widely held views about decreased systemic risk. While better data, based correctly on index number theory and aggregation theory, now exist, the usual official central bank data are not based on that better approach. 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. Dual to the aggregation-theoretic monetary aggregates are the aggregation-theoretic user cost and interest rate aggregates, which similarly are not in official use by central banks. No other area of economics has been so seriously damaged by data unrelated to valid index-number and aggregation theory. Many commentators have been quick to blame insolvent financial firms for their “greed” and their presumed self-destructive, reckless risk taking. Perhaps some of those commentators should look more carefully at their own role in propagating the misperceptions of the great moderation that induced those firms to be willing to take such risks.
    Keywords: Measurement error; monetary aggregation; Divisia index; aggregation; monetary policy; index number theory; financial crisis; great moderation; Federal Reserve.
    JEL: C43 E32 E58 E52 E40
    Date: 2008–11–14
  12. By: Sula, Ozan
    Abstract: I estimate the determinants of the demand for international reserves using quantile regressions. Employing a dataset of 96 developing nations over the period of 1980-1996, I find considerable differences at different points of the conditional distribution of reserves. The ordinary least squares estimates of elasticities that were found to be insignificant in previous studies become statistically significant at various quantiles of the reserve holding distribution. In particular, I find that the coefficients of interest rate differential and volatility of export receipts are significant and have the signs predicted by the traditional reserve models, but only for those nations that hold the highest amount of reserves. In contrast, the flexibility of the exchange rate does not seem to be an important factor for the nations that are located at the tails of the distribution.
    Keywords: International reserves; Quantile regression; Demand for reserves; Reserve policy
    JEL: F30
    Date: 2008
  13. By: Ronald Schettkat (Department of Economics University of Wuppertal); Rongrong Sun (Department of Economics University of Wuppertal)
    Abstract: In the long history of rising and persistent unemployment in Europe almost all institutions - employment protection legislation, unions, wages, wage structure, unemployment insurance, etc. - have been alleged and found guilty to have caused this tragic development at some point in time. Later, welfare state institutions in interaction with external shocks were identified as more plausible causes for rising equilibrium unemployment in Europe. Monetary policy has managed to be regarded as innocent. Based on the assertion of the neutrality of money in the medium and long run, the search for causes of European unemployment has shied away from the policy of central banks. But actually the institutional setup regarding monetary policy is very different between the FED and the Bundesbank (ECB). We argue that the interaction of negative external shocks and tight monetary policies may have been the major - although probably not the only - cause of unemployment in Europe remaining at ever higher levels after each recession. We identify the monetary policy of the Bundesbank as asymmetrical in the sense that the Bank did not actively fight against recessions, but that it dampened recovery periods. Less constraint on growth would have kept German unemployment at lower levels.
    Keywords: Production, Employment, Unemployment, Monetary Policy, Central Banks and Their Policies
    JEL: E23 E24 E42 E43 E52 E58
    Date: 2008–10
  14. 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

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