nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒02‒07
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Does Monetary Policy Play Effective Role in Controlling Inflation in Pakistan By Qayyum, Abdul
  2. Monetary policy regime shifts and inflation persistence By Troy Davig; Taeyoung Doh
  3. Optimal Monetary Policy with a Convex Phillips Curve By Tambakis, D.N.
  4. The role of labor markets for Euro area monetary policy By Kai Christoffel; Keith Kuester; Tobias Linzert
  5. Central bank independence and ageing By Farvaque, Etienne; Héricourt, Jérôme; Lagadec, Gaël
  6. What drives euro area break-even inflation rates? By Matteo Ciccarelli; Juan Angel García
  7. Sources of the Great Moderation: shocks, friction, or monetary policy? By Zheng Liu; Daniel F. Waggoner; Tao Zha
  8. Monetary Ease – A Factor behind Financial Crises? Some Evidence from OECD Countries By Ahrend, Rudiger
  9. Hazardous times for monetary policy: What do twenty-three million bank loans say about the effects of monetary policy on credit risk-taking? By Gabriel Jiménez; Steven Ongena; José Luis Peydró; Jesús Saurina
  10. The Taylor rule and forecast intervals for exchange rates By Jian Wang; Jason J. Wu
  11. The Bank, the Bank-Run, and the Central Bank: The Impact of Early Deposit Withdrawals in a New Keynesian Framework By Totzek, Alexander
  12. New Estimation of China’s Exchange Rate Regime By Jeffrey A. Frankel
  13. Should Eastern European Countries Join the Euro? A Review and Update of Trade Estimates and Consideration of Endogenous OCA Criteria By Frankel, Jeffrey
  14. A Local Examination for Persistence in Exclusions-from-Core Measures of Inflation Using Real-Time Data By Tierney, Heather L.R.
  15. Uncertainty over models and data: the rise and fall of American inflation By Seth Pruitt
  16. Does forecast combination improve Norges Bank inflation forecasts? By Hilde C. Bjørnland; Karsten Gerdrup; Anne Sofie Jore; Christie Smith; Leif Anders Thorsrud
  17. Estimating Term Structure Equations Using Macroeconomic Variables By Fair, Ray C.
  18. Matching International Financial Shocks in Emerging Markets By Almira Buzaushina; Michael Brei
  19. Experimetnal Evidence on Inflation Expectation Formation By Pfajfar, D.; Zakelj, B.
  20. How Much Did Speculation Contribute to Recent Food Price Inflation? By Amanor-Boadu, Vincent; Zereyesus, Yacob
  21. Resolving the unbiasedness puzzle in the foreign exchange market By Daniel L. Thornton

  1. By: Qayyum, Abdul
    Abstract: This paper presented the salient features of current Monetary Policy and its effectiveness to control inflation in Pakistan. The monetary authority was successful in controlling inflation when it successfully controlled the money supply target. The calculation of money supply target needs to be improved to get appropriate target level of M2. It is also concluded that in the recent years SBP failed to control money supply and hence rate of inflation within the set target level. There seems to be a lack of coordination between Fiscal and Monetary Authorities. The understanding of issues regarding monetary policy transmission mechanism, effectiveness of different channels, lag structure of monetary policy changes, magnitude of pass-through of policy changes to inflation and output and nature of relationship amongst, instruments and goals of monetary policy (inflation and output) seems to be lacking and need fresh investigation.
    Keywords: Monetary Policy; Pakistan; Money Supply; Inflation
    JEL: E31 E58 E52
    Date: 2008
  2. By: Troy Davig; Taeyoung Doh
    Abstract: This paper reports the results of estimating a Markov-Switching New Keynesian (MSNK) model using Bayesian methods. The broadest and best fitting MSNK model is a four-regime model allowing independent changes in the regimes governing monetary policy and the volatility of the shocks. We use the estimates to investigate the mechanisms that lead to a decline in the persistence of inflation. We show that the population moment describing the serial correlation of inflation is a weighted average of the autocorrelation parameters of the exogenous shocks. Changes in the monetary or shock volatility regimes shift weight over these serial correlation parameters and affect the serial correlation properties of inflation. Estimation results indicate that a shift to a monetary regime that reacts more aggressively to inflation reduces the weight on the more persistent shocks, so lowers inflation persistence. Similarly, a shift to the low-volatility regime reduces the weight on the more persistent shocks and also contributes to reducing inflation persistence. Estimates of model-implied inflation persistence indicate that it began rising in the late 1960s and peaked around the Volcker disinflation. The subsequent decline in persistence is due to both a more aggressive monetary policy regime and less volatile shocks.
    Date: 2008
  3. By: Tambakis, D.N.
    Abstract: This paper shows that convexity of the short-run Phillips curve is a source of positive inflation bias even when policymakers target the natural unemployment rate, that is when they operate with prudent discretion, and their loss function is symmetric. Optimal monetary policy also induces positive co-movement between average inflation, average unemployment and inflation variability–suggesting a new motive for inflation stabilization policy–and positively skewed unemployment distributions. The reduced form model is applied to the post-disinflation period (1986-2006) in developed countries and its properties are illustrated numerically for the United States.
    Keywords: Monetary policy, inflation bias, inflation variability, prudent discretion.
    JEL: E24 E31 E52 E58
    Date: 2008–12
  4. By: Kai Christoffel; Keith Kuester; Tobias Linzert
    Abstract: In this paper, we explore the role of labor markets for monetary policy in the euro area in a New Keynesian model in which labor markets are characterized by search and matching frictions.> We first investigate to which extent a more flexible labor market would alter the business cycle behavior and the transmission of monetary policy. We find that while a lower degree of wage rigidity makes monetary policy more effective, i.e. a monetary policy shock transmits faster onto inflation, the importance of other labor market rigidities for the transmission of shocks is rather limited. Second, having estimated the model by Bayesian techniques we analyze to which extent labor market shocks, such as disturbances in the vacancy posting process, shocks to the separation rate and variations in bargaining power are important determinants of business cycle fluctuations. Our results point primarily towards disturbances in the bargaining process as a significant contributor to inflation and output fluctuations. In sum, the paper supports current central bank practice which appears to put considerable effort into monitoring euro area wage dynamics and which appears to treat some of the other labor market information as less important for monetary policy.
    Keywords: Labor market - Europe ; European Union countries ; Monetary policy - Europe
    Date: 2009
  5. By: Farvaque, Etienne; Héricourt, Jérôme; Lagadec, Gaël
    Abstract: We contrast the influence of demography and central bank independence on inflation. The recent demographic trends in developed countries are shown to weight more on inflation than central bank independence, while the contrary stands for the period from 1960 to 1979.
    Keywords: Demography ; Central Bank Independence ; Inflation
    JEL: E58
    Date: 2008
  6. By: Matteo Ciccarelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Juan Angel García (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The yield spread between nominal and inflation-linked bonds (or break-even inflation rates, BEIR) is a fundamental indicator of inflation expectations (and associated premia). This paper investigates which macroeconomic and financial variables explain BEIRs. We evaluate a large number of potential explanatory variables through Bayesian model selection techniques and document their explanatory power at different horizons. At short horizons, actual inflation dynamics is the main determinant of BEIRs. At long horizons, financial variables (i.e. term spread, bond market volatility) become increasingly relevant, but confidence and cyclical indicators remain important. JEL Classification: C11, C52, E31.
    Keywords: Break-even inflation rates, inflation risk premia, business cycle indicators, Bayesian model selection.
    Date: 2009–01
  7. By: Zheng Liu; Daniel F. Waggoner; Tao Zha
    Abstract: We study the sources of the Great Moderation by estimating a variety of medium-scale DSGE models that incorporate regime switches in shock variances and in the inflation target. The best-fit model, the one with two regimes in shock variances, gives quantitatively different dynamics in comparison with the benchmark constant-parameter model. Our estimates show that three kinds of shocks accounted for most of the Great Moderation and business-cycle fluctuations: capital depreciation shocks, neutral technology shocks, and wage markup shocks. In contrast to the existing literature, we find that changes in the inflation target or shocks in the investment-specific technology played little role in macroeconomic volatility. Moreover, our estimates indicate much less nominal rigidities than those suggested in the literature.
    Keywords: Econometric models ; Business cycles
    Date: 2009
  8. By: Ahrend, Rudiger
    Abstract: This paper addresses the question of whether and how easy monetary policy may lead to excesses in financial and real asset markets and ultimately result in financial dislocation. It presents evidence suggesting that periods when short-term interest rates have been persistently and significantly below what Taylor rules would prescribe are correlated with increases in asset prices, especially as regards housing, though no systematic effects are identified on equity markets. Significant asset price increases, however, can also occur when interest rates are in line with Taylor rules, associated with periods of financial deregulation and/or innovation. The paper argues that accommodating monetary policy over the period 2002-2005, in combination with rapid financial market innovation, would seem in retrospect to have been among the factors behind the run-up in asset prices and financial imbalances -- the (partial) unwinding of which helped trigger the 2007/08 financial market turmoil.
    Keywords: Interest rates, monetary policy, housing, sub-prime crisis, financial markets, macro-prudential, regulation Taylor rule, house prices
    JEL: E44 E5 F3 G15
    Date: 2008
  9. By: Gabriel Jiménez (Banco de España); Steven Ongena (Center–Tilburg University); José Luis Peydró (European Central Bank); Jesús Saurina (Banco de España)
    Abstract: We identify the impact of short-term interest rates on credit risk-taking by analyzing a comprehensive credit register from Spain, a country where for the last twenty years monetary policy was mostly decided abroad. Discrete choice, within borrower comparison and duration analyses show that lower overnight rates prior to loan origination lead banks to lend more to borrowers with a worse credit history and to grant more loans with a higher per period probability of default. Lower overnight rates during the life of the loan reduce this probability. Bank, borrower and market characteristics determine the impact of overnight rates on credit risk-taking.
    Keywords: monetary policy, low interest rates, financial stability, lending standards, credit risk-taking, credit composition, business cycle, liquidity risk
    JEL: E44 E5 G21
    Date: 2009–01
  10. By: Jian Wang; Jason J. Wu
    Abstract: This paper attacks the Meese-Rogoff (exchange rate disconnect) puzzle from a different perspective: out-of-sample interval forecasting. Most studies in the literature focus on point forecasts. In this paper, we apply Robust Semi-parametric (RS) interval forecasting to a group of Taylor rule models. Forecast intervals for twelve OECD exchange rates are generated and modified tests of Giacomini and White (2006) are conducted to compare the performance of Taylor rule models and the random walk. Our contribution is twofold. First, we find that in general, Taylor rule models generate tighter forecast intervals than the random walk, given that their intervals cover out-of-sample exchange rate realizations equally well. This result is more pronounced at longer horizons. Our results suggest a connection between exchange rates and economic fundamentals: economic variables contain information useful in forecasting the distributions of exchange rates. The benchmark Taylor rule model is also found to perform better than the monetary and PPP models. Second, the inference framework proposed in this paper for forecast-interval evaluation, can be applied in a broader context, such as inflation forecasting, not just to the models and interval forecasting methods used in this paper.
    Date: 2009
  11. By: Totzek, Alexander
    Abstract: Currently, private trust in commercial banks declines as a consequence of today´s financial crisis. As past crises, e.g. the Asian crisis, show, the loss of confidence in the financial sector typically causes private agents to withdraw their capital from financial institutions. Thus, the purpose of this paper is to implement the feature of early deposit withdrawal in a New Keynesian framework with commercial banks in order to analyze the implications of a loss of confidence. In addition, we present the optimal monetary policy to ensure a stabilized system.
    Keywords: banks, financial crises, deposit withdrawal, optimal monetary policy
    JEL: E44 E50
    Date: 2008
  12. By: Jeffrey A. Frankel
    Abstract: The paper updates the answer to the question: what precisely is the exchange rate regime that China has put into place since 2005, when it announced a move away from the dollar peg? Is it a basket anchor with the possibility of cumulatable daily appreciations, as was announced at the time? We apply to this question a new approach to estimating countries' de facto exchange rate regimes, a synthesis of two techniques. One is a technique that has been used in the past to estimate implicit de facto currency weights when the hypothesis is a basket peg with little flexibility. The second is a technique used to estimate the de facto degree of exchange rate flexibility when the hypothesis is an anchor to the dollar or some other single major currency. Since the RMB and many other currencies today purportedly follow variants of Band-Basket-Crawl, it is important to have available a technique that can cover both dimensions, inferring weights and inferring flexibility. The synthesis adds a variable representing "exchange market pressure" to the currency basket equation, whereby the degree of flexibility is estimated at the same time as the currency weights. This approach reveals that by mid-2007, the RMB basket had switched a substantial part of the dollar's weight onto the euro. The implication is that the appreciation of the RMB against the dollar during this period was due to the appreciation of the euro against the dollar, not to any upward trend in the RMB relative to its basket.
    JEL: F31
    Date: 2009–02
  13. By: Frankel, Jeffrey (Harvard U)
    Abstract: An advantage of monetary union is facilitating trade. After many critiques, Rose's basic finding is left standing: currency unions have greater trade effects than previously believed. Updated estimates also find an effect of the euro on trade among members that is significant (though mysteriously still only 15%). An argument for retaining monetary independence is asymmetric shocks, i.e., low cyclical correlation. Eastern European countries might want to wait before joining, because their trade patterns and cyclical correlations have been gradually shifting toward Western Europe anyway; thus the argument for the euro strengthens as time passes, while the argument against it weakens.
    JEL: F10 F33
    Date: 2008–10
  14. By: Tierney, Heather L.R.
    Abstract: Using parametric and nonparametric methods, inflation persistence is examined through the relationship between exclusions-from-core inflation and total inflation for two sample periods and in five in-sample forecast horizons ranging from one quarter to three years over fifty vintages of real-time data in two measures of inflation: personal consumption expenditure and the consumer price index. Unbiasedness is examined at the aggregate and local levels. A local nonparametric hypothesis test for unbiasedness is developed and proposed for testing the local conditional nonparametric regression estimates, which can be vastly different from the aggregated nonparametric model. This paper finds that the nonparametric model outperforms the parametric model for both data samples and for all five in-sample forecast horizons.
    Keywords: Real-Time Data; Local Estimation; Nonparametrics; Inflation Persistence; Monetary Policy
    JEL: C14 E52 E40
    Date: 2009–01–30
  15. By: Seth Pruitt
    Abstract: An economic agent who is uncertain of her model updates her beliefs in response to the data. The updating is sensitive to measurement error which, in many cases of macroeconomic interest, is apparent from the process of data revision. I make this point through simple illustrations and then analyze a recent model of the Federal Reserve's role in U.S. inflation. The existing model succeeds at fitting inflation to optimal policy, but fails to link inflation to the economic trade-off at the heart of the story. I modify the model to account for data uncertainty and find that doing so ameliorates the existing problems. This suggests that the Fed's model uncertainty is largely overestimated by ignoring data uncertainty. Consequently, now there is an explanation for the rise and fall in inflation: the concurrent rise and fall in the perceived Philips curve trade-off.
    Date: 2008
  16. By: Hilde C. Bjørnland (Norwegian School of Management (BI) and Norges Bank (Central Bank of Norway)); Karsten Gerdrup (Norges Bank (Central Bank of Norway)); Anne Sofie Jore (Norges Bank (Central Bank of Norway)); Christie Smith (Norges Bank (Central Bank of Norway)); Leif Anders Thorsrud (Norges Bank (Central Bank of Norway))
    Abstract: We develop a system that provides model-based forecasts for inflation in Norway. Forecasts are recursively evaluated from 1999 to 2008. The performance of the models over this period is then used to derive weights that are used to combine the forecasts. Our results indicate that model combination improves upon the point forecasts from individual models. Furthermore, when comparing the whole forecasting period; model combination outperforms Norges Banks own point forecast for inflation at the forecast horizon up to a year. By using a suite of models we allow for a greater range of modelling techniques and data to be used in the forecasting process.
    Keywords: Forecasting, forecast combination
    JEL: E52 E37 E47
    Date: 2009–01–27
  17. By: Fair, Ray C. (Yale U)
    Abstract: This paper begins with the expectations theory of the term structure of interest rates with constant term premia and then postulates how expectations of future short term interest rates are formed. Expectations depend in part on predictions from a set of VAR equations and in part on the current and two lagged values of the short term interest rate. The results suggest that there is relevant independent information in both the VAR equations' predictions and the current and two lagged values of the short rate. The model fits the long term interest rate data well, including the 2004-2006 period, which some have found a puzzle. The properties of the model are consistent with the response of the long term U.S. Treasury bond rate to surprise price and employment announcements. The overall results suggest that long term rates can be fairly well explained by modeling expectation formation of future short term rates.
    JEL: E43
    Date: 2008–01
  18. By: Almira Buzaushina; Michael Brei
    Abstract: In the present paper, we develop a two-sector general equilibrium model of a small open economy to explore the transmission mechanisms of external financial shocks. In particular, we use a cash-in- advance model with limited participation augmented with a financial friction in the form of a fundamentals-related risk premium on external funds. The friction amplifies the effects of external financial shocks, especially when the economy is highly indebted in foreign currency. For a set of Latin American economies, the theoretical model is calibrated to match the empirical impulse responses of output, investment, trade balance, and domestic credits in response to an adverse shock to the country risk premium. In addition, we analyze the role of monetary policy during the financial crisis.
    Keywords: Emerging Markets, Financial Crises, International Capital Markets
    JEL: F34 F36 G21
    Date: 2009–01
  19. By: Pfajfar, D.; Zakelj, B. (Tilburg University, Center for Economic Research)
    Abstract: Using laboratory experiments, we establish a number of stylized facts about the process of inflation expectation formation. Within a New Keynesian sticky price framework, we ask subjects to provide forecasts of inflation and their corresponding confidence bounds. We study individual responses and properties of the aggregate empirical distribution. Many subjects do not rely on a single model of expectation formation, but are rather switching between di¤erent models. About 40% of the subjects predominately use a rational rule when forecasting inflation and about 35% of agents simply extrapolate trend. Around 5% of subjects behave in an adaptive manner, while the remaining 20% behaves in accordance to adaptive learning and sticky information models. Furthermore, we find that subjects in only 60% of cases correctly perceive the underlying uncertainty in the economy when reporting confidence intervals. However, empirical analysis does not support a significant countercyclical behavior of individuals' confidence intervals.
    Keywords: Inflation Expectations;Experiments;New Keynesian Model;Adaptive Learning
    JEL: E37 C90 D80
    Date: 2009
  20. By: Amanor-Boadu, Vincent; Zereyesus, Yacob
    Abstract: Recent increases in commodity prices have led to calls for the regulation of speculators. These calls have come from many reputable quarters including leading agricultural and food policy institutions such as International Food Policy Research Institute as well as different members of the U.S. Congress. They are based on an assumption that speculative activities are a primary or major source of the volatility in the markets and that controlling these activities through regulations would bring more stability to the market. The paper tests this hypothesis and assesses the contribution of speculative activities in the commodity markets over the past decade to price inflation. The paper argues that government regulatory policies to control speculation in commodity markets is a second best solution that would probably yield neutral or negative benefits to the very people the policy aims to protect.
    Keywords: speculators, inflation, prices, ARIMA, Agricultural and Food Policy, Agricultural Finance,
    Date: 2009
  21. By: Daniel L. Thornton
    Abstract: An unresolved puzzle in the empirical foreign exchange literature is that tests of forward rate unbiasedness using the forward rate and forward premium equations yield markedly different conclusions about the unbiasedness of the forward exchange rate. This puzzle is resolved by showing that because of the persistence in exchange rates, estimates of the slope coefficient from the forward premium equation are extremely sensitive to small violations of the null hypothesis of the type and magnitude that are likely to exist in the real world. Moreover, contrary to suggestions in the literature and common practice, the forward premium equation does not necessarily provide a better test of unbiasedness than the forward rate equation.
    Keywords: Foreign exchange
    Date: 2009

This nep-mon issue is ©2009 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.